Who caused the mortgage meltdown?


The best lies have a grain of truth, and if repeated enough, become accepted as common knowledge. As Grandma used to say, “A lie travels twice around the world before the truth can tie its shoes.” And as we all know a great lie can be simplified into a convenient sound bite while the truth is a little more complex and messy.

There is a great lie being fed to you now. For nearly two years you have been told by President Obama that the Republicans are to blame for “getting us into this mess,” the ones who “drove us into the ditch and now want the keys to the car again.” That’s clever imagery, but I hope you didn’t drink that Kool-Aid.

The truth is America has been heading toward an economic reckoning for a very long time. Spending money we don’t have is the irresponsible foundation of our problem, personally and as a nation. How convenient it must be for politicians not to have to come to agreement on allocating limited resources, all they have to do is push their favorite programs and borrow from our children to pay for it, even if there are already five duplicate programs in operation.

Politicians promise the moon to voters to buy their vote with our money, piling up a mountain of entitlement obligations we cannot meet. Those very same louts swiped the Social Security surplus and spent it, worsening the Social Security crisis we are now facing. Add to that Medicare, Medicaid, an aging population, overwhelming debt, spending deficits that seem a bottomless well of red ink and we are facing fiscal Armageddon.

We like things to be simple, so who is the boogyman? Democrats and Republicans like to blame each other but maybe the ultimate culprits are you and me, the ones who hold out the “gimme” hand to politicians. But let’s look a little deeper.

Good thing the guys in white jackets with restraining straps didn’t see me yelling at my TV during the Bush administration. I yelled at the TV telling him not to pull the trigger on Iraq but he didn’t listen. When he did pull the trigger, I was a supporter, but I also thought the rest of us back home at least ought to be paying for it instead of sending the bill to our children.

But I yelled at President Bush for other things. When he preached that Islam is a peaceful religion in the wake of 9/11, I knew we were in trouble.

When he turned airport security guards into federal employees so you and I can pay them the rest of their lives, my yelling escalated into a scream, and I pounded my head on a wall when he created another bureaucracy titled Homeland Security.

My yelling was preceded by disbelief when he teamed up with Senator Ted Kennedy to give birth to the monstrous new prescription entitlement now known as Medicare Part D. Unbelievable.

So the Bush Administration was not innocent on our economic health. But where did the mortgage meltdown come from, the trigger to the crisis that rippled through countless financial institutions?

In 1977 during the Carter Administration, the Community Reinvestment Act (CRA) was passed to counter “redlining,” a mortgage lending practice that declined to lend for mortgages in low-income neighborhoods. The banks said the risk was higher, the government said redlining was discriminatory, and I say they were both right. CRA encouraged lending in low-income areas, but without posing undue risk to the lender. That seems sensible but it was a long time ago.

Flash forward to the Clinton Administration, during which a major push on low-income mortgages led to changes in CRA and heavy-handed political pressure. The President and key Democrats, notably Senator Chris Dodd and Congressman Barney Frank, led the charge that created a boom in subprime lending.

Subprime means the borrower does not have the pristine credit and ability to pay that lenders normally require, and the compensation for the higher risk of a subprime loan is a higher interest rate.

Fannie Mae (FNMA) and Freddie Mac (FHLMC) are quasi-government agencies with the mission of encouraging mortgage lending by purchasing mortgages from lending institutions, creating securities by packaging the loans for resale, and selling to other financial institutions as income-producing securities.

Fannie and Freddie had underwriting (quality control) standards that kept the sub-prime portion of their portfolio quite low to maintain high quality in the securities they offered, but the increasing pressure of CRA and direction from highly influential Democrats led to lowering underwriting standards.

Fannie and Freddie analysts protested because of the elevated risk and lower quality of loans, but they were forced to accept loans that heretofore would have been summarily rejected.

Some loans accepted by Fannie and Freddie were no-doc loans, absent documentation of a borrower’s ability to pay, a circumstance that would never have been acceptable by traditional standards. But the Democrats, with some Republican support, were pushing hard to make home ownership available to lower income Americans. And push they did. Nevertheless, Fannie and Freddie customers bought the subprime securities since the higher income they paid was attractive.

During his administration President Bush worried about the financial viability of Fannie and Freddie. He proposed measures to bolster their financial strength and re-establish underwriting standards, efforts defeated with Barney Frank leading the charge.

Meanwhile, real estate was booming, and the subprime lending industry boomed with it. Since underwriting standards were compromised, a few “predatory” subprime lenders could get away with dirty tricks like talking borrowers into loans they had no hope of paying.

There were also “liar loans” wherein the borrower simply lied about income and ability to pay, getting away with it by a subprime lender who didn’t do even the cursory underwriting required.

We all like to have a boogeyman to blame, and a few of these cases provided the boogeyman, but the real problem was in mainstream subprime lending where borrowers in great numbers were being encouraged by government to buy homes they simply could not afford.

Subprime lenders found a way to make it happen. They put the subprime borrowers in variable rate loans, with an artificially low “teaser rate” up front to lower their monthly payment, a ticking time bomb with a higher rate and higher payment coming due that would lead the borrower to default.

But no problem, real estate values are constantly increasing, so when the teaser rate expires, Mr. and Mrs. Borrower, just refinance and we’ll give you another teaser rate.

Subprime loans with inherently high default risk piled up at Fannie and Freddie, and the securities they resold to financial institutions had increasing problems that eventually became widely known.

The bubble burst when real estate values took a dip, teaser rate mortgages began to reset to the higher rates in great volume, refinancing was not possible since the loan-to-value ratio was now upside down, subprime borrowers defaulted in large numbers, and the whole government-sponsored low income mortgage ball of twine began to unravel.

Financial institutions were stuck with huge amounts of mortgage securities whose value was evaporating and the domino effect of toxic assets began to be felt in widespread lack of confidence, restrained lending and weakened financial strength sometimes leading to insolvency. America’s economy held its breath.

Fannie and Freddie (taxpayer) losses are estimated at $300 billion, but that was just the surface bleeding while the crisis cascaded throughout financial markets. The bailouts began, but don’t get me started, no more room today.

You might be interested to know that Democrats Chris Dodd and Barney Frank, the prime culprits who did in fact get us into this mess, are still pushing the same low-income mortgage agenda even while new waves of subprime defaults are headed our way when teaser rates reset to market rates and borrowers are unable to refinance, unable to make the higher payments.

Meanwhile, President Obama’s mortgage assistance programs both old and new, the ones that use your money to help pay for someone else’s mortgage, are only postponing the inevitable.

Next time you hear President Obama talk about the Republicans “… who got us into this mess,” remember a quote from my mother who would say, “He’s full of balloon juice!” Mom is far more polite than I am.

[Terry Garlock of Peachtree City occasionally contributes a column to The Citizen. His email is terry@garlock1.com.]