Most experts agree that the Sub-Prime mortgage crisis was the primary cause of the economic crash of 2008 that brought down Wall Street firms, major, regional and smaller banks, and has devastated individuals and families whether those individuals or families had received a Sub-Prime loan or not. This crisis also allowed the Government to spend trillions of dollars bailing out those who caused the crisis, the Wall Street firms, Banks, and those in charge of Freddie Mac, Fannie Mae, and other government and quasi-governmental agencies, but has left individuals and families homeless and in some cases has wiped out life savings and investments. Now, the President, some in Congress, some advocacy groups, and certainly Wall Street, Banks, and the government and quasi-government agencies who thrive when the Mortgage Industry churns out trillions in new mortgages, are trying once again to revive the Sub-Prime market. This is beyond insanity as the 2008 crash is still crushing our economy with no end in site. The next wave could permanently damage this economy beyond recovery.
So what is our Government considering to “Help” the housing market? The same failed practices that brought us the 2008 Crisis. Some of the ideas include:
- Having taxpayer-owned Fannie Mae and Freddie Mac relax their rules for loans to investors thus creating another round of loan bubbles. In short, dumping bad loans to investors so the banks can make more bad loans…
- Putting more pressure on banks to loan again to low and middle-income neighborhoods with Sub-Prime packages. HELLO!
Every time Washington gets involved and tries to help, they make things worse… Just go back to tried and true lending practices AND ENFORCE REGULATIONS, ESPECIALLY ON GOVERNMENT SPONSORED ENTITIES… If you want to subsidize low and middle-income home buying, do it out in the open with a program taxpayers can see rather than bury it inside of housing bubbles that blow up in our faces.
In order to understand how we got to where we are, lets take a simple look at recent history
What caused the 2008 Crash?:
Much has been written about this topic but most of what has been written is difficult to understand and for the most part this has been intentional. To make matters worse, those who we expect to control our economy, such as our Federal Reserve Chairmen and Secretaries of the Treasury, give speeches that are intentionally vague and muddied with economic terms that are meaningless. The bottom line is that the 2008 Crash was caused by Greed. Surprised? Probably not.
Old Mortgage Process: When a bank loans someone money to buy a home, that bank no longer has to hold onto that mortgage over the life of the loan in order to make a profit on that loan. In the past, a bank had to make the loan, then the loan fees and the interest collected was the source of their gross profit. Bank regulations required that for every dollar loaned out, the bank had to have cash reserves of a specified percentage in case one or more of those loans went bad. The bank still had the house as collateral that it could sell in foreclosure but the house would probably not fetch top dollar in those instances.
Modern Mortgage Process: During the depression of the 1930’s, the housing market was decimated and banks had little or no cash to loan for home purchases and foreclosures were almost as high as they are today. Roosevelt got the Congress to pass the National Housing Act of 1934 that created the Federal Housing Administration (HUD) and the Federal Savings and Loan Insurance Corporation, (FSLIC). This law was again amended to expand the government’s role in “stabilizing” the mortgage industry and to ensure good housing conditions for a much broader range of people. In 1938, a Government Sponsored Enterprise, basically a company that was a “private” company but “backed” by the full faith and credit of the US Government, called Fannie Mae (Federal National Mortgage Association) was formed to add a way for banks to off load their mortgages from their books and thus free up their money to make new mortgage loans. They use a fancy term “securitizing mortgages”, basically selling your loan, by creating (another fancy term) Mortgage-backed Securities (MBS). Freddie Mac was created in 1970 to add an additional outlet for mortgages and thus increase the amount of money available to banks to offload their new mortgages so they could make more mortgages.
What this means can be boiled down to this. Assume a bank makes 10 mortgage loans to 10 families in Fresno, California. Those mortgages equal all of the cash reserves the bank has to make loans so basically the bank could not make any more loans until these mortgages are paid off in 10, 20 or 30 years. Banks don’t like this idea. So, the bank, takes the 10 loans, puts them into an envelope (hypothetically) called a Mortgage Back Security and sells the MBS (first one sold in 1981) to someone in the “secondary” mortgage market (not the direct lender), such as Fannie Mae. Fannie Mae charges a fee for this service. Then, the bank is free to take their new cash and lend it to someone else. The secondary mortgage market companies, like Fannie Mae. But, those 10 mortgages do not stop there…
Fannie Mae, or some other secondary mortgage company, takes those 10 mortgages from the Fresno bank, and add other mortgages from all over the country and creates a really big envelope of mortgages and creates a larger form of a mortgage-backed security and sells the larger envelope of loans to investors. This is where Wall Street comes in. Wall Street has access to the widest range of investors so Freddie, Fannie, and other secondary mortgage companies formed relationships with Wall Street so Wall Street could sell their big envelopes of loans to “investors”. This cycle is repeated by Wall Street by repackaging many big envelopes into larger envelopes or loan pools that are sold off. It is absolutely a very large “Ponzi” scheme (Remember Bernie Madoff?) that can only work as long as not too many of the original 10 Fresno home buyers do not default on their loan, OOPS!
Let’s Review: So, we now see that banks make mortgage loans; the banks sell those loans to a secondary lender like Fannie Mae for a fee; Fannie Mae sells those loans to Wall Street for a large fee; Wall Street bundles those loans with other secondary lender loans and sells those to investors for very large fees. This cycle repeats itself over and over.
Now, where does the OOPS come in? Remembering that this whole Ponzi scheme relies on the borrower making the payments on the mortgage and so the SOUNDNESS OF THE ORIGINAL LOAN IS KEY TO THE SUCCESS OF THIS SCHEME. In the old days, pre 1990, mortgages were subject to strict lending criteria such as your loan could not exceed 80% of the property value; your mortgage could only be up to a certain percentage of your total disposable income and so on. In short, if you got a mortgage, there were reasonable assurances that you could repay the loan or that the property, even if foreclosed on, could repay the original loan.
Enter the Sub-Prime Mortgage: Politicians have always postured “affordable housing” as the American Dream and have created all sorts of programs and gimmicks in the form of Laws to try to make this happen. The more constituents in homes, the happier the constituents are and the more votes I get. Couple this with bank, secondary lender, and Wall Street greed and you have a recipe for disaster! The only thing standing in the way of creating the “American Dream” are those loan regulations and the pesky loan criteria to qualify as a Prime Loan. No worries, we just reduce the amount of loan regulation, or in this case, politically kill them, and relax the loan criteria so more people can qualify. After all, home prices always go up so the property collateral is sufficient! WRONG…
What is a Sub-Prime Loan? The term has nothing to do with the prime interest rate. A Prime loan is like a top cut of beef. The loan meets strict loan to value ratios; the borrower’s income to loan payment ratio is high; the house is in a nice neighborhood; and the region’s economic forecast is solid (meaning long-term employment is a probability). Sub-Prime loans not Prime Loans, period. They can be anything from loans where there is no down payment and thus a 1:1 loan to value ratio (or even worse); the borrower has marginal income so the income to loan payment ratio is very low; the house is in a weak neighborhood; or the region’s economic outlook is bleak, or all of the above. The Sub-Prime loans made in the 1990s and 2000s would never had been made if the industry and the government had maintained good lending practices and criteria. In short, the government took a political gamble that the PRIME LOAN MARKET WOULD SUBSIDIZE AND STABILIZE THE SUB-PRIME MARKET to the extent that everything would be fine! But, when politicians sided with Freddie and Fannie and told the Federal Regulators such as Office of Federal Housing Enterprise Oversight (OFHEO), to back off, the die was cast that would end in the 2008 Crash.
Factors leading up to the 2008 Crash: There were a whole series of events that created the ultimate market failure. A full discussion of these failures would require a couple of hundred pages so lets just focus on a few key factors:
- 1977 Community Reinvestment Act: This law was intended to eliminate the “redlining” of low-income neighborhoods and “encourage” banks to help meet the needs of borrowers in all segments of their communities, including low and moderate income neighborhoods. This was the start of the creation of Sub-Prime Lending.
- 1992-President George H.W. Bush signed the Housing and Community Development Act of 1992. This bill put into place Congress’s housing goal: “to have an affirmative obligation to facilitate the financing of affordable housing for low-income and moderate-income families.” GSEs were required to meet “affordable housing goals” set annually by the Department of Housing and Urban Development (HUD) and approved by Congress. The initial goal for low-income and moderate-income mortgage purchases for each GSE was 30% of the total number of housing units financed by mortgage purchases. This increased to 55% by 2007. In short, in 15 years, . the mortgage market was dominated by Sub-prime loans.
- 1991-James Johnson took over as the CEO of Fannie Mae. Johnson was a ruthless, driven individual that deservedly is credited with creating the underpinnings that led to the Crash in 2008. He made Fannie Mae into a heavy-handed lobbying machine that colluded with banks and mortgage companies to drive Fannie’s profits and EXECUTIVE BONUSES to levels never before imagined. He bullied Wall Street and intimidated major banks the size of Wells Fargo. He worked with questionable organizations such as Countrywide, Fremont Investment and Loan, and NovaStar just to name a few. His lobbying practices were legendary and he was able to kill bill after bill, audit after audit, that would have curtailed his out of control churning of the secondary market and his fostering of the Sub-Prime loans. He ushered in accounting practices that were created only to insure executive bonuses and hide the true insolvent position of Fannie Mae and its assets.
- 1999-Fannie Mae came under pressure from President Clinton to expand mortgage loans to low and moderate income borrowers by increasing the ratios of their loan portfolios in distressed inner city areas designated in the Community Reinvestment Act of 1977
- 1999-Franklin Raines succeeded James Johnson at Fannie Mae and Raines continued the practices of his mentor Johnson.
- 2000s-Bush and Congress failed to reign in the Sub-Prime market and the GSEs.
- Federal Regulators of Fannie and Freddie were intimidated or ignored.
- Fannie Mae and Freddie Mac gave contributions to lawmakers sitting on committees that primarily regulate their industry.
- In short, the fix was in and there was no stopping Freddie, Fannie, corrupt bankers, compromised politicians, and of course, Wall Street Greed.
Good Intentions: What started out to be an altruistic goal of providing affordable housing to low and moderate income households, quickly ballooned into a giant Ponzi scheme with everyone involved enjoying the ride, except those on the receiving end of those mortgages. Many of the new mortgagee had little or no experience in dealing with property purchases or loan documents. In California it is not unusual for a loan package and real estate forms to consist of 50-100 pages or more. Even sophisticated borrowers can become overwhelmed with the sheer volume of the paperwork. Someone who had never dealt with this complexity, was at the mercy of the person on the phone making them the loan. In the 1990s and 2000s, many of the mortgage lenders employed less than scrupulous sales people and encouraged predatory lending policies. These institutions jacked up fees and interest rates not caring if the borrower defaulted or not as they would have sold the load to Freddie or Fannie before that happened.
Unfortunately, in 2008, the first wave of defaults hit those with the Sub-Prime loans. These communities were devastated and left in ruin and disrepair. Those that the politicians sought to help were left much worse off than before they got the American Dream. The American Dream became a bankruptcy nightmare and one which these individuals may never recover from.
Then, by 2009, the Sub-Prime crisis began hitting Prime borrowers as well. Property values were plummeting erasing the equity in loans with 20%, 30% and even 40% down payments. The downturn caused in the economy as a whole, many of the Prime Loan borrowers lost one or more of the jobs in the family or their small business was hit hard. Also, as the banks failed that originally made the mortgages such as Washington Mutual, IndyMac Bank, Colonial Bank and others, the borrowers were left in a state of limbo until the bank was acquired or the FDIC found other ways to transfer the banks loans which could take months or even years. During this time, the borrower could not refinance while the market was in a free fall. By the time these banks or their loans were re-assigned, many prime borrowers, especially those with non conforming loans, were devastated financially or at best left holding a mortgage they could no longer afford.
So, when politicians start talking about fixing a problem by creating more bubbles, we have to rise up and say “NO MORE”. We are still in what will be looked at historically as the Depression of 2008 with no real end in sight. The government took care of their campaign benefactors, the big Banks and Wall Street, with their “Too Big To Fail” bailouts with TARP and other rip-offs and continue to do so. While touting too big to fail, the government created “Too Bigger To Fail” by giving large banks TARP funds to buy Banks that the FDIC closed, thus making the Too Big Bank, Bigger! How smart is that?
The gifts from our government to these remaining banks and financial institutions are amazing. FDIC “sold” the failed banks to other banks for, in many cases, 5 cents on the dollar THEN GAVE THEM TARP DOLLARS TO PAY FOR IT! Many paid for the failed banks with their stock! Such a deal. Meanwhile, you are stuck with a loan that is underwater by 40-60% and paying 5-8% interest while the banks are paying 1% or less. Just as an example of how sweet these bank to bank buyouts were, here is just one example.
Bank A was taken over by the FDIC in 2008. At the time of the banks failure, the bank’s assets were valued at $310B. Bank B was allowed to buy Bank A as follows:
Bank A Total Assets: $310 Billion
Bank A Total Home Loans: $176 Billion
Bank A did NOT get TARP Loans.
Bank B did get TARP Loans: $25 Billion
Bank B Paid Bank A: $1.7 Billion or .5% of the total asset value (this is a half of one percent)
Bank B Wrote off On their Taxes: Approximately $30 Billion which shelters profits from Bank B’s operation (ie free money)
Bank B Gets 2,200 Branch Offices from Bank A.
Stockholders of Bank A: Wiped Out… (Many were employees who had much of their 401K invested in their own bank)
So, if you were the borrower of Bank A, and your loan was for $100,000, Bank B paid $548 for your loan. Think they will let you pay off your $100,000 with a $548 payment? Probably not…
So when you hear that the Government wants to HELP YOU, RUN!
Unless you are Too Big To Fail!