Friday, April 27, 2012

The government and the housing bubble

It is generally agreed that the current economic downturn was triggered by the collapse of the housing bubble. But, what caused the housing bubble? In a report released today, the American Enterprise Institute (AEI) traces it back to a couple of Clinton era decisions, one of which was to nearly eliminate downpayments:
In 1995, expanding the idea in the Best Practices Initiative, HUD issued a policy statement titled “The National Homeownership Strategy: Partners in the American Dream.” . . . . The paper then made clear that reducing down payments would increase homeownership: “Lending institutions, secondary market investors, mortgage insurers, and other members of the partnership should work collaboratively to reduce homebuyer downpayment requirements. Mortgage financing with high loan-to-value ratios should generally be associated with enhanced homebuyer counseling and, where available, supplemental sources of downpayment assistance.”

HUD’s policy was successful. In 1989, only 1 in 230 homebuyers bought a home with a down payment of 3 percent or less, but by 2003, 1 in 7 buyers was providing a down payment at that level and by 2007, the number was less than 1 in 3. The program’s contribution to the reduction in home equity and the subsequent increase in leverage is obvious. [Emph. added]

But that wasn't enough.  Another Clinton-era policy required banks to provide still more risky loans to “underserved communities”:

Another government policy that weakened the housing market before the financial crisis was the Community Reinvestment Act (CRA), which  required banks to make mortgage credit available in “underserved  communities” in the bank’s area of operations. Originally enacted in  1977, the act initially required banks only to reach out to these  communities. The results did not satisfy the act’s supporters, and in  1995 new regulations went into effect that required banks to make loans  in underserved communities even if the loans did not meet their normal  lending standards. These were not quotas in a formal sense, but  examiners were supposed to assess whether individual banks were making  the required effort, as shown by actual loans on their books.

The CRA is enforced through regulators’ refusals to grant bank  applications of various kinds. A bank that receives an unfavorable CRA  rating, for example, could be denied regulatory approvals for merger and other expansions.[Emph. added]

Not only did these policies create an unstable financial system, they did not even achieve the claimed goal of a high ownership rate:
Despite all the government’s “help,” the United States has higher  mortgage rates in relation to the risk-free rate than other developed  countries and a homeownership rate that falls in the middle among these  same countries.
AEI finds that the US is "the only developed country with a major government role in housing policy" and warns that "the policies that caused the financial crisis are still in force." 

PREVIOUSLY on the housing bubble/mortgage crisis:
Occupy movement demands banks provide free money
Rep. Speier rewrites history on mortgage regulations
Financial crisis in review
Barney Frank and the collapse of housing prices
How we got in this economic mess
Those who do not learn from history

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