(CNSNews.com) – Another housing bubble is “very likely if we don’t change our policies,” warns Peter Wallison, a former member of the Financial Crisis Inquiry Commission (FCIC), which investigated the "avoidable" 2008 financial meltdown.
“It’s going to happen again because we’ll have the same kind of housing market again,” explained Wallison, who is currently co-director of financial policy studies at the American Enterprise Institute (AEI).
Just six years after the overheated housing market bubble burst, triggering the Great Recession, Fannie Mae and Freddie Mac, which are still under government conservatorship, have been told to accept 3 percent downmortgages and to turn over a percentage of every loan they process to a government trust fund for affordable housing.
Didn't you write that Fannie and Freddie’s lowering of underwriting standards to help people buy houses they couldn’t afford was “the root cause” of the financial crisis? CNSNews.com asked Wallison.
“Yes, unfortunately, they have been more or less directed by their government regulator to accept these 3 percent down payment mortgages, and that is very much along the lines of what they were doing before,” Wallison replied.
“In fact, by the year 2000, they were beginning to accept zero down payment mortgages. So they’re not yet at the point where they are doing the things that were as bad as they were doing before, but a 3 percent down payment mortgage is a pretty weak mortgage,” he pointed out
How can Fannie and Freddie, which were established to stabilize the nation’s housing market, justify doing the same things that triggered a market collapse just six years ago? CNSNews.com asked him.
“Well, one of the reasons this is possible today is that the American people really do not understand what caused the financial crisis and the role of Fannie and Freddie in that,” he replied.
“As long as the idea is around that it was the banks on Wall Street and the financial institutions in general that caused the financial crisis, the American people will not understand that it was government housing policy – just the kind of thing that we’re talking about now - which caused the crisis.
“So we wait until we have another crisis, because the government is doing the same thing that it was doing before.”
But repeating the same mistake is not likely to end well, he added.
“So I think if we continue along these lines, [another housing market crash] is certainly a possibility,” Wallison told CNSNews.com. “You cannot have a housing system where people are getting mortgages that they can't afford to sustain.
“And in fact, it’s very bad for families to be lured into a situation where they are given a mortgage that over time they are unable to pay. Eventually it results in eviction. And when that happens, it’s not only bad for that family, it’s bad for everyone in the neighborhood where that family lived because it drives down the values of all the homes and all the mortgages in that area.
“So this is a very bad government policy, but one that the government will continue to pursue because it adds to what the government thinks of as the prosperity in the country because it increases home sales.
“And it is true that initially, it increases home sales, but over time it results in too many people owning homes that they can’t afford to keep up, they can’t afford to pay for, and we have another financial crisis.”
Wallison’s new book, “Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again,” which will be released in mid-January, “attempts to show that beginning in 1992, the government adopted policies, at least for Fannie Mae and Freddie Mac, that caused them over time to reduce their underwriting standards so substantially that the result was a very large number of very weak mortgages,” he told CNSNews.com.
In the book, Wallison cites a 2006 memo from a Fannie Mae staffer who wrote: “Everybody understood that we were now buying loans that we would have previously rejected but our mandate was to serve low-income borrowers. So that’s what we did.”
The sub-prime loans bought by Fannie and Freddie, which at the time “were the most highly leveraged financial institutions on the planet,” were subsequently the first to default, triggering the collapse of the housing market.
“By the year 2008, more than half of all mortgages in the United States were sub-prime or otherwise very weak mortgages. And of that half, three quarters were on the books of government agencies, principally Fannie Mae and Freddie Mac,” Wallison told CNSNews.com.
“So what we see from just that one fact is that the demand for these very poor-quality mortgages, the ones that failed and caused the financial crisis, was the responsibility of the government. The government had created a demand for those mortgages. That’s what it’s doing again with these 3 percent rules,” he said.
Wallison also refuted the oft-repeated claim that Fannie and Freddie have paid back all of the $187 billion in bailout money they received from the government.
“No, they haven’t. They haven’t paid anything back to the Treasury,” he told CNSNews.com. “They have paid back more in interest than they were lent, but when you pay back a loan, you also have to pay back the principal. That they haven’t paid back. So they still owe the federal government about $187 billion.”
Does this mean that Fannie and Freddie are in no shape to take on more risky, low-down-payment loans? CNSNews.com asked Wallison.
“That’s exactly right, and the taxpayers ought to be thinking about this, because it’s the taxpayers that have paid for the rescue of Fannie and Freddie. And if Fannie and Freddie again fail because they have bought so many of these poor-quality mortgages, who do you think is going to have to make up the difference?” he responded. “It’s going to be the taxpayers again.”
“But as long as the taxpayers are not complaining, the government will go ahead and do this. And one of the reasons the taxpayers are not complaining is they don’t really understand the connection between what Fannie and Freddie were doing through the 1990s and into the 2000s, in terms of buying very poor-quality mortgages. They don’t understand the connection between those poor-quality mortgages and the financial crisis that caused them to fail.”
FCIC’s final majority report, which was released in 2011, “blames the conditions in the financial system; I blame 27 million subprime and Alt-A mortgages – half of all mortgages outstanding in the U.S. in 2008… No financial system, in my view, could have survived the failure of such large numbers of high-risk mortgages once the bubble began to deflate,” Wallison wrote in his minority dissent.
“If you look at what entity created the demand for these very weak sub-prime and other poor-quality mortgages, 76 percent were on the books of government agencies, which is clear proof to my mind and to anyone who thinks about it that the government created the demand for those mortgages,” he told CNSNews.com.
“So that’s the reason I dissented from the final report of the FCIC, because they were blaming the private financial system for the crisis, when it fact it was the government’s action that created the weakness in the mortgage system.”
Federal Housing Finance Agency [FHFA] director Melvin Watt, who oversees the two mortgage giants, recently ordered Fannie and Freddie to make annual contributions to a low income housing fund for the first time since the 2008 crisis. The annual contribution from the two giant government-sponsored entities (GSEs), which together guarantee about 90 percent of all mortgages in the U.S., is estimated to be between $300 and $700 million.
“On November 13, 2008, the Director of the FHFA temporarily suspended the allocation of funds…and the temporary suspension has remained in effect since that date,” Watt wrote in a December 11 letter to Timothy Mayopoulos, CEO of Fannie Mae and Donald Layton, CEO of Freddie Mac.
However, beginning in 2015, both will be required to set aside “an amount equal to 4.2 basis points of each dollar of unpaid principal balance of its total new business purchases” for single and multi-family mortgages administered by the Housing Trust Fund (HTF) and the Capital Magnet Fund (CMF) “until further notice.”
“The decision by the FHFA to fund the National Housing Trust Fund and the Capital Magnet Fund will bring millions of dollars to New York for rental housing and is a step in the right direction to help ensure that hardworking New York families have safe and affordable places to live,” Sen. Charles Schumer (D-NY) said in a Dec. 11 press release.
But former HUD undersecretary Ken Blackwell, now the director of the Coalition for Mortgage Security (CMS), says FHFA “is the last agency that should be entrusted with a slush fund.”
Wallison noted that the same government policies intended to help lower-income Americans purchase homes were actually making it harder for them to do so.
“These very low-quality mortgages do cause housing prices to rise, and we had a huge bubble in housing prices that began in 1997 and continued through 2007. And one of the reasons for that is that mortgages were given away with very low down payments.
“Let’s take an example: If you have $10,000 to buy a house, you can buy a $100,000 house if the down payment requirement is 10 percent. But if they lower the down payment requirement to 5 percent, then you can buy a $200,000 house. So what is happening is that when you lower underwriting standards, more people can bid for more expensive houses. And a result of that is that housing prices go up, and they become much more expensive to low-income people.”
The solution is not more of the same, he pointed out.
“We have to go back to sound underwriting principles, the kinds of principles that were in place before the government changed its policies in 1992. And that would mean a 10 to 20 percent down payment, a good credit score, and a very good debt-to-income ratio. If that’s about 38 percent, and your credit score is 660 or above, and you put down 10 percent on a house, that is a solid mortgage. And in normal times, the default rate on such a mortgage is less than 1 percent.
“But during the financial crisis, we had default rates on some of the best mortgages that Fannie and Freddie were making up at 13 to 17 percent. Once we loosen these underwriting standards, so that anyone who wants a home is able to buy one despite a past record of defaulting on obligations, or despite the fact that the buyer does not have a substantial down payment, we end up with a very unstable system.
“That’s what happened to us in 2008 and that’s what we should try to prevent in the future.”