A great example of how we got to the credit-market meltdown

A great example of how we got to the credit-market meltdown
Ed Morrissey
Sep 25, 2008

http://hotair.com/archives/2008/09/25/a-great-
example-of-how-we-got-to-the-credit-market-meltdown/

It’s one of the hidden success stories of the Clinton era. In the great housing boom of the 1990s, black and Latino homeownership has surged to the highest level ever recorded. The number of African Americans owning their own home is now increasing nearly three times as fast as the number of whites; the number of Latino homeowners is growing nearly five times as fast as that of whites.

Under Clinton, bank regulators have breathed the first real life into enforcement of the Community Reinvestment Act, a 20-year-old statute meant to combat "redlining" by requiring banks to serve their low-income communities. The administration also has sent a clear message by stiffening enforcement of the fair housing and fair lending laws. The bottom line: Between 1993 and 1997, home loans grew by 72% to blacks and by 45% to Latinos, far faster than the total growth rate.

Requiring banks to serve their low-income communities. That’s shorthand for taking on more risk and lowering what had been standard prerequisites for purchasing homes. Normally, lenders would have demanded at least 10% down, and preferred 20%, and demonstration of stable income, of which the mortgage payments would not exceed 30%. Under threat of prosecution for bigotry, lenders had to start taking less-qualified borrowers as clients.

But the government had a way for them to spread that risk throughout the investment community:

In 1992, Congress mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. Operating under that requirement, Fannie Mae, in particular, has been aggressive and creative in stimulating minority gains.

Congress told the two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, to buy up the paper and transform these marginally-qualified loans into what’s known as mortgage-backed securities (MBS). The purchase of these loans made them much more attractive to lenders, who rushed to create more of them. Fannie and Freddie then kept buying the paper and turning them into MBSs and selling them to investors, who assumed that the government would back the GSE securities Congress mandated into existence.

Thanks to this massive intervention in the lending marketplace, what followed was utterly predictable for anyone who had ever completed Econ 101 at a junior college:

The massive influx of new home buyers drove up housing prices.

The rising prices pushed borrowers and lenders into adjustable-rate mortgages to allow the purchase of homes for no down, on the premise that the rising prices (which reacted to massive new demand) would allow them to refinance before the ARMs adjusted to their maximum, at which point borrowers would refinance with the new-found equity as their down payment to get better rates and lower monthly payments they could afford.

Housing prices rose so quickly that builders invested in new houses on a massive scale to produce inventory to meet the demand.

As long as prices continued to rise, and as long as the two GSEs kept issuing the MBSs, investors kept buying them - with their government backing.