The last big crash in the American housing industry, running roughly from the end of 2007 well into Barack Obama’s first term as president, has been blamed on a number of different factors.
But nearly every assessment cites the government’s lowered standards for loaning money as a contributor.
In fact, Peter Wallison, a member of the Financial Inquiry Commission that reviewed the disaster, contends that without the government’s actions, there would have been no housing crisis.
In the Atlantic magazine in 2011, he cited pressure from Democratic U.S. Rep. Barney Frank and others to have government mortgage institutions, Fannie Mae and Freddie Mac, move aggressively into the market for “no-downpayment loans,” “subprime” loans and “low quality” loans.
“There is no doubt that the government created the demand for these weak loans; less than 30 percent (7.8 million) were held or distributed by the banks, which profited from the opportunity created by the government,” he wrote then. “When these mortgages failed in unprecedented numbers in 2008, driving down housing prices throughout the U.S., they weakened all financial institutions and caused the financial crisis.”
So can American now expect another such crisis in which millions lose their homes in foreclosure and major banking institutions teeter and crash?
The circumstances could be aligning, according to the Washington Post, which reported a renewed movement to force lenders to loan money to customers who may not be able to repay.
“The Obama administration is engaged in a broad push to make more home loans available to people with weaker credit, an effort that officials say will help power the economic recovery but that skeptics say could open the door to the risky lending that caused the housing crash in the first place,” the report said.
The report said Obama’s administration is working “to get banks to lend to a wider range of borrowers by taking advantage of taxpayer-backed programs – including those offered by the Federal Housing Administration – that insure home loans against default.”
But federal intervention and mandates on the housing market had a key contributory role in the earlier round of housing disasters, Wallison wrote.
“Of the 19.2 million subprime and low quality loans that were on the books of government agencies in 2008, 12 million (about 62 percdent) were held or guaranteed by Fannie and Freddie,” he explained. “No one who has grasped the significant of these numbers … could believe that Fannie and Freddie were ‘not a major factors.’
“It was the unprecedented number of delinquencies and defaults among these mortgages … that drove down housing prices all over the country and caused the financial crisis,” he continued. “If it hadn’t been for the government’s housing policy, there would not have been a financial crisis.”
Yet, the new report said the Obama administration is trying to convince the Justice Department to assure banks – “which have become increasingly cautious” – that there will no legal repercussions if they make loans to risky borrowers who then default.
“Obama pledged in his State of the Union address to do more to make sure more Americans can enjoy the benefits of the housing recovery, but critics say encouraging banks to lend as broadly as the administration hopes will sow the seeds of another housing disaster and endanger taxpayer dollars,” the Post said.
The report quoted Ed Pinto of the American Enterprise Institute: “If that were to come to pass, that would open the floodgates to highly excessive risk and would send us right back on the same path we were just trying to recover from.”
According to the Financial Inquiry Commission’s report of the first collapse, it was “avoidable” and the result of “human action.”
“There were warning signs … they were ignored or discounted,” the report said. “There was an explosion in risky subprime lending and securitization, and unsustainable rise in housing prices, widespread reports of egregious and predatory lending practices, dramatic increases in household mortgage debt, and exponential growth in financial firms’ trading activities, unregulated derivatives, and short-term ‘repo’ lending markets, among many other red flags.”
Yet, the report said, the industry was dominated at the time by “pervasive permissiveness.”
“The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not. The record of our examination is replete with evidence of other failures: financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective; firms depended on tens of billions of dollars of borrowing that had to be renewed each and every night, secured by subprime mortgage securities; and major firms and investors blindly relied on credit rating agencies as their arbiters of risk.”
The Post report explained the demands that banks loan to people with weak credit.
“From 2007 through 2012, new-home purchases fell 30 percent for people with credit scores above 780 (out of 800), according to Federal Reserve Governor Elizabeth Duke. But they declined 90 percent for people with scores between 680 and 620 – historically a respectable range for a credit score,” the report said.
“If the only people who can get a loan have near-perfect credit and are putting down 25 percent, you’re leaving out of the market an entire population of creditworthy folks, which constrains demand and slows the recovery,” Jim Parrott, recently a senior adviser on housing for the White House’s National Economic Council, said in the report.
There’s an additional factor coming into play now that wasn’t present in the 2007-2009 collapse. Since then, the “tiny house” industry has surged.
Often the “tiny houses” are subdivided apartments in city centers or cabins on wheels, with living spaces as tight as 200 to 400 square feet.
A post on the Freedom Outpost blog noted that, “you are sharply admonished when you try to live your life outside the strictures of the 9-5 world. Is it any surprise that the government I snow taking steps to limit our ability to drastically reduce our expenses?”
The Post notes a ruled proposed by the Housing and Urban Administration that would affect the manufacturing regulations.
Since the small units, including RVs and others, “are being produced with patio roofs, screened in porches, and other extensions that exceed the 400 square foot maximum exemption in the current reuglations,” a new rule would define a recreational vehicle as a factory buil[t] vehicular structure, not certified as a manufactured home, designed only for recreational use and not as a primary residence or for permanent occupancy.”
Other rules that have created headwinds for the “tiny house” movement have been code and zoning restrictions that sometimes don’t allow the placement of such units within their borders.
“That’s right,” the blog post said, “If this law is passed, living full time in a tiny house or an RV may become illegal in April of this year.”
The Post outlined the need being cited by the Obama administration: “Banks are largely rejecting the lower end of the scale, and the average credit score on FHA loans has stood at about 700.”
And penalties can apply to banks if they lend the money and the borrower defaults.
So now, the report said, the FHA and White House are working “to develop new policies to make clear to banks that they will not lose their guarantees or face other legal action if loans that conform to the program’s standards later default.”
Left on the hook for the defaults would be the taxpayers.
FHA Commissioner Carol Galante said her organization also is urging lenders to look at “compensating factors” into account, including savings, in order to lend to more.
“It’s important you look at the totality of that borrower’s ability to pay,” she said.
The warning by the Financial Inquiry Commission’s Wallison about what happened in 2007 could be considered.
“Congressman Frank was one of the leaders of the effort in Congress to meet the demands of activists like ACORN for an easing of underwriting standards in order to make home ownership more accessible to more people. It was perhaps a worthwhile goal, but it caused the financial crisis when it was done by lowering mortgage underwriting standards,” Wallison wrote.
The commission report said there’s plenty of blame to go around over the lower standards and resulting crash.
“Many mortgage lenders set the bar so low that lenders simply took eager borrowers’ qualifications on faith, often with a willful disregard for a borrower’s ability to pay,” the commission said.