The Housing Bubble

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A report from the LA Times. “The third day of hearings into the subprime mortgage mess highlighted the difficult task of the Financial Crisis Inquiry Commission in ferreting out the causes of the worst fiscal morass since the Great Depression. The session was similar to the first two days, in which those at the center of the crisis — such as former Federal Reserve Chairman Alan Greenspan, top Citigroup Inc. executives and banking regulators — deflected blame for the huge amounts of subprime mortgages that helped crash the housing market.”

“On Friday, two former Fannie Mae executives testified that the legislatively mandated mixed mission of the former government-sponsored enterprises — increase affordable housing and make a profit for shareholders — drove it so deeply into subprime and other risky mortgages that there was no way out when the real estate bubble burst.

“‘This extraordinary upheaval in the economy, and in the mortgage market in particular, challenged Fannie Mae in ways that would have been difficult to overcome, regardless of any business decisions that preceded the crisis,’ said Daniel H. Mudd, who served as Fannie Mae CEO from 2004 to 2008.”

“‘Ultimately, the companies were not the unwitting victims of an economic down cycle or flawed products and services of theirs,’ said Armando Falcon Jr., former head of the Office of Federal Housing Enterprise Oversight, which regulated Fannie and Freddie. ‘Their failure was deeply rooted in a culture of arrogance and greed.’”

The Wall Street Journal. “At the hearing, commissioners honed in on why Fannie executives made their ill-fated decisions to loosen underwriting standards and increase their exposure to riskier ‘Alt-A’ loans for borrowers with good credit but little documentation of income or assets. Fannie and Freddie’s market share fell rapidly beginning in 2003 as private nonbank lenders were fueled by Wall Street’s desire to bundle and sell mortgages as securities. One internal Fannie document made public on Friday showed how executives in 2005 considered a ’stay the course’ strategy to try to steer the market back to traditional products such as the 30-year fixed-rate mortgage.”

“But executives ultimately decided that new, riskier loans were ‘not a fad, but a growing and permanent change’ in the mortgage market that the companies couldn’t ignore, Mr. Mudd said. The company opted to strike a ‘middle course’ by trying to offer less-risky versions of Alt-A loans. ‘Could we really sit out?’ said Robert Levin, a 27-year Fannie veteran who retired in 2008. ‘That’s what we were grappling with.’”

“Alt-A loans accounted for just 9% of Fannie’s loan guarantee business, but represented nearly 40% of credit losses in the fourth quarter of 2009. Nearly 23% of Alt-A loans originated by Fannie Mae in 2007 were 90 days or more delinquent at the end of 2009. Even if Fannie hadn’t stepped up its exposure to the riskier loans, ‘they still would have taken a huge hit,’ said Thomas Lawler, a former Fannie economist who retired in January 2006, in an interview. ‘But would it have been this big? Well, good god, no.’”

“James Lockhart, the former federal regulator who placed the companies into conservatorship in 2008, told the panel it was unrealistic to expect policy makers to design a perfectly regulated housing-finance system. ‘We need to take some of this and put it back in the private sector,’ he said.”

“But Mr. Mudd, who was alternately contrite but firm, said it was unlikely that a fully privatized mortgage market could be ‘logistically accomplished in our lifetimes.’”

The Times Online. “Mudd said in prepared testimony to the inquiry: ‘Maintaining the delicate balance between profitability as a private company and service to a public mission became impossible. ‘When (house) prices crashed far beyond the realm of historical experience, it became ‘The Pit and the Pendulum,’ a choice between horrible alternatives.’”

“Armando Falcon, former director of the Office of Federal Housing Enterprise Oversight (OFHEO), which previously regulated the GSEs, told the inquiry, ‘Fannie and Freddie executives worked hard to persuade investors that mortgage related assets were a riskless investment, while at the same time covering up the volatility and risks of their own mortgage portfolios and balance sheets.’”

“James Lockhart, another former director of OFHEO, told the inquiry he had warned as early as July 2006 that Fannie Mae and Freddie Mac represented major systemic risk because their GSE status allowed them to borrow cheaply and take on legally massive amounts of leverage. At they same time, they resisted all outside efforts to reign them in. He said: ‘The GSE structure itself was flawed. It allowed the companies to be so politically strong that for many years they resisted the very legislation that might have saved them.’”

“While all of the witnesses pointed to flaws in GSEs, their fate remains in the balance. The Senate is debating legislation aimed at tightening regulation of banks and capital markets. The House of Representatives has already approved a bill along those lines. Analysts expect Congress to send a final bill to President Barack Obama this year. But it will lack a plan for reshaping the GSEs.”

The Nightly Business Report. “Staphanie Dhue, NBR Correspondent: In 2005 when the housing market was still booming, the companies were embroiled in accounting scandals and losing market share to Wall Street firms. In response, Fannie and Freddie dove aggressively into riskier mortgages, backing more alternative loans and buying sub-prime mortgage-backed securities.”

“Mudd: ‘If you’re not making money, you’re not driving profits, you’re not increasing revenues, you’re also unable to grow your capital and therefore, you’re unable to participate in the — in the marketplace…The government-sponsored enterprises were able to balance business and mission when home prices were rising. They could perform when home prices were flat. They could survive a 30-year flood, but not 2008.’”

“Dhue: Regulators say they didn’t have the tools to rein in the mortgage giants. Fannie and Freddie lobbied heavily against any regulation that would shrink their portfolio or require higher capital. James Lockhart oversaw the firms from 2006 to 2008. He says they resisted raising capital when the financial crisis hit. Lockhart, ‘The boards were much more focused on profitability. They felt that that was their fiduciary responsibility to the shareholders and the mission was a distant not even second.’”

“Jeffery Brown: Fannie Mae, and its sister organization, Freddie Mac, were government-chartered, but private companies, set up to buy mortgages from lenders and package them into securities sold to investors. And, by 2008, the two agencies owned half the country’s $11 trillion in mortgages. But when the housing market collapsed, so did Fannie and Freddie, and the government was forced to step in, a move that’s so far cost taxpayers $126 billion.”

“We turn to Andrew Jakabovics, associate director of housing and economics for the Center for American Progress, and Edward Pinto, a longtime consultant to the financial service industry. He was chief credit officer at Fannie Mae in the late 1980s.”

“Jakabovics, ‘They were actually not as responsible as a lot of people would think. I think that the real problem here was the creation of an unregulated mortgage market. Wall Street was funneling trillions of dollar through unregulated channels into private-label securities. These were largely where the subprimes were. And what ultimately happened was the GSEs, Fannie Mae and Freddie Mac, were losing market share. They are government-chartered, but they were also shareholder-owned. And so they basically put short-term profits ahead of long-term safety and soundness responsibilities. And they basically sort of followed everybody else down the rabbit hole.’”

“Pinto: ‘It goes back to the early 1990s and a number of federal housing policies that were put in place that pushed very low down payment lending and other loosening of underwriting. Fannie and Freddie were leading that charge starting in the early 1990s. And that eventually, along with all the advantages that they had, led to a tremendous disruption of the market, which culminated in 2004, with the subprime market really ballooning, and following the lead for low down payments and higher risk.’”

“Jakabovics: … (Fannie Mae) was ultimately privatized largely because of the interest to get them off the government balance sheet for the reasons of the Vietnam War…Their bread and butter was actually guaranteeing these mortgages. It’s only when they sort of decided to chase Wall Street and chase the profits that they really got into problems.’”

“Pinto: ‘Something went wrong with the original model was they — in 1992, Congress hard-wired the amount of capital they needed. And they were tremendously overleveraged. And that is really what drove the market off a cliff.’”

“Brown: So, the government comes in at the end of 2008. What has happened since? What shape are these organizations in? What are they doing in terms of lending now? Pinto: ‘Well, in terms of what shape they’re in, they have losses that are, for the foreseeable future based on the business that they did in 2004, ‘5, ‘6, ‘7 and 8. Recently, they are the secondary market..they account for 95 percent of all the lending in the United States is guaranteed by the federal government.’”

“‘So, we have a nationalized market in terms of housing finance. And the challenge is going to be how to undo that. But, right now, that’s the role that they are performing. They have been turned into public policy vehicles…What I think should happen is, there needs to be a plan to bring private capital back into the housing market. And that needs to be done by slowly phasing Fannie and Freddie out…’”

“Brown: ‘…particularly at a moment like this, when the country still is in a housing crisis, to — you have to figure that into this debate, right, in terms of what — the role for a Fannie Mae. Pinto: ‘Absolutely, although the general view is — and this is what was the problem as we got to this crisis — there were calls for requiring Fannie and Freddie to have more capital. Fannie and Freddie fought that. Many of the industry participants fought it: It’s not the right time. We can’t do it now.’”

“‘And it seems like it’s never the right time. And, so, I think we need to start figuring out how we reintroduce the private sector back into the process. It is going to be a slow process. We have really sort of almost destroyed the system in bringing it back. It is not going to be simple.’”

“Jakabovics: ‘I think it’s going to be a slow process…the administration is going to be coming out with a set of questions, I believe next week, asking for input as to where people think that the — this process should go, in part because they need to move slowly because there is a tremendous amount of money at stake.’”

“There’s confidence in institutions, as well as in the federal government at stake, and I think particularly from a perspective of foreign investors, a lot of money comes into this country through the mortgage-backed securities issued by Fannie Mae and Freddie Mac. And to suddenly turn that off or to create new entities that people don’t have comfort with, I think would be incredibly problematic.’”

“‘And, so, if you have a political process that kind of takes lurches to the right, lurches to the left, that leads to spooking the markets. And that is, I think, the last thing we can afford.’”

From Barron’s. “In case anyone tells you different, Dan Mudd, former CEO of Fannie Mae, is definitely NOT contrite. Mudd goes on… Congress and various Presidential administrations prevented Fannie from diversifying in the mortgage business away from the secondary to the primary market, even though that’s where the profits were going; government pushed Fannie into taking 50% of its business from home owners whose income was below the median; and all this at the same time he had to please shareholders to keep bringing in capital to support mortgages.”

“And when all hell broke loose in 2008, Fannie was required to clean up the mess in mortgages. ‘As crisis became havoc, Fannie Mae was called upon by the Administration and Congressional leaders from both sides of aisle [sic] to refinance subprime borrowers who could qualify for a fixed rate loan.’”

“He also defended what Fannie had accomplished: ‘In the days when the yawning gap in homeownership between white and minorities was an issue of national concern, Fannie and Freddie Mac narrowed the difference. Fannie Mae did this while earning a competitive return.’”

“His parting shot? ‘Government entities created to support homeownership as a social good will tend to socialize the risk to all taxpayers. Purely private companies will tend to exercise their fiduciary responsibility to pass the costs and the risks to homeowners. Hybrid organizations will be left to balance conflicts between taxpayers, homeowners, and shareholders. There are no simple answers.’”

The San Diego Source. “Last week, former federal chairman Alan Greenspan was testifying on Capitol Hill. Sounds like the old days, but things were quite different and he is no longer considered the hero he once was. Mr. Greenspan was blamed for the subprime crisis and the fall in real estate. The panel’s chairman Phil Angelides, who was a former California gubernatorial candidate, who I will point out lost, stated, ‘You could have, you should have and you didn’t in regards to Fed action on raising interest rates.’”

“I for one am glad Mr. Angelides didn’t get into office for California; I think things would be a whole lot worse than they are now. What Mr. Angelides doesn’t understand is that it wasn’t low interest rates that were the problem. It was Fannie Mae and Freddie Mac.”

“Subprime loans are not something new; they have been around for a while. The problem: Before 2003, around 70 percent of the loans that were made in subprime were fixed loans, and get this, the borrow could really afford the monthly payment. They may not have had the down payment or have a high credit score, but they could afford the monthly out go each month based on a fixed monthly payment. After 2003, there was too much loose lending with the ‘liar’ loans and to be frank, people just getting in over their heads. Even if you have high interest rates with loose lending standards you will still have the same train wreck down the road.”

From ABC News. “During the boom, cash-out refinancings were the unofficial currency of bubble states from Florida to California, beloved by mortgage brokers as a way to persuade existing homeowners to take out new loans repeatedly. As home values surged, the sales pitch was a slam-dunk: Borrowers could refinance their homes at extremely low interest rates, and based on newly reappraised property values get more cash in their hands than they might earn in a year. Sure, these were teaser rates that would adjust upward after two years, but brokers routinely assured borrowers they could just refinance again before that happened.”

“Homeowners and mortgage brokers weren’t alone in their addiction to the cash that flowed from homes-as-ATMs. The entire U.S. economy was right there with them. One of Alan Greenspan’s lesser-known contributions to the annals of the credit crisis was a pair of studies he co-authored for the Fed, sizing up exactly how much Americans borrowed against their home equity in the bubble and what it was they were spending their newfound (phantom) wealth on.”

“Greenspan estimated that four-fifths of the trifold increase in American households’ mortgage debt between 1990 and 2006 resulted from ‘discretionary extraction of home equity.’”

“Only one-fifth resulted from the purchase of new homes.”

“In 2005 alone, U.S. homeowners extracted a half-trillion-plus dollars from their real estate via home-equity loans and cash-out refinances. Some $263 billion of the proceeds went to consumer spending and to pay off other debts.”

From Bloomberg. “Asked in a Bloomberg TV interview about a possible bubble in China, former Federal Reserve Chairman Alan Greenspan said there were ’significant bubbles in Shanghai and along the coastal provinces’ and ’some of that in the hinterlands.’”

“He of the Can’t-See-a-Bubble-In-Advance School now recognizes region-specific bubbles halfway around the world?”

“Greenspan told Bloomberg TV that neither he, nor anyone at the Fed, heard about problems brewing in the banking system. That’s patently false. I know for a fact that regulation and supervision division staff at some of the Federal Reserve District Banks reported risks and irregularities to the Fed in Washington.”

“Greenspan, who was never an academic economist, chose an academic forum last month to present his most detailed defense of his stewardship of monetary policy. It was low long-term rates, depressed by capital inflows, that were responsible for the bubble in residential real estate, he claims. Surely one of the hundreds of economists on the Fed staff could have explained to him that the long rate is the sum of the current and expected future short-term rates. If long-term rates are too low, jack up short-term rates more aggressively rather than in quarter-point increments. He can’t plead not guilty.”

“Greenspan says originations of adjustable-rate mortgages, which are geared off the federal funds rate, peaked two years before housing prices, absolving him of any blame. His numbers prove nothing. Just eyeball a graph of the federal funds rate and ARM volume as a share of total mortgages during the period in question. With the funds rate at 1 percent, the ARM share exploded from less than 15 percent in the first half of 2003 to a peak of 36.6 percent in March 2005, by which time the benchmark rate stood at 3 percent. Home prices peaked in the middle of 2006.”

“Lending standards were easing more quickly than the Fed was tightening. As short-term rates moved up, potential homeowners moved out — to 30-year fixed-rate loans. If those rates were too low for his taste, Greenspan should have raised the rate directly under his control.”

“Greenspan was a big cheerleader for adjustable-rate mortgages in 2004. He dismissed the idea that record household debt was a problem as long as people could service it, courtesy of his super-low interest rates. He repeatedly rejected the notion of a housing bubble, admitting belatedly that there might be some ‘froth’ in the residential real estate market.”

“He gave political support to the Bush tax cut in 2001 because — get this — unless the government reduced taxes, there would be no more Treasuries for the Fed to buy to conduct monetary policy! He refused to raise margin requirements in the late 1990s to defuse the technology-stock bubble, arguing publicly it would have no effect. (Privately, he acknowledged it would curtail the bubble but might nail the economy in the process.) He advocated a ‘risk management’ approach to monetary policy and failed to exercise even a modicum of risk-management during two asset bubbles on his watch.”

“To his credit, Greenspan warned about the bloated balance sheets of Fannie Mae and Freddie Mac. And he sniffed out the increase in productivity growth in the 1990s — and then did nothing to raise real interest rates. Greenspan can command high fees for speaking engagements and consulting work for select clients. He cannot write his legacy. History will do that for him.”

The Nevada Appeal. “I turned on CNBC Thursday morning to see Robert Rubin, former financial superstar and Treasury Secretary testify before the Financial Crisis Inquiry Commission about his role in the financial crisis. Rubin, a top executive at Citigroup when things began melting down, expressed regret about not knowing until late in the game about the subprime mortgage crisis or about the $43 billion in high risk-mortgage securities on Citigroups books.”

“He, like so many other Wall Street exec’s, passed the buck to the Citi trading desk who built up a mountain of risk, but thought they were acting in good faith. He also cited the ratings agencies (Moody’s and S & P) for rating what were 80 percent BBB-minus mortgages in the risky multitrenched securities as AAA and safe from default.”

“Also to blame were the mortgage brokers and banks lending to anyone who fogged a mirror and of course the borrowers themselves. Rubin, with vast experience in financial markets, admitted not picking up on warning signs about a serious potential crisis.”

“I have often said that I have seen greed gone wild many times before on Wall Street, but nothing compared to this. Could greed be the answer when so many failed to see what would happen when you lend people money that they cannot afford to repay? Was it just greed when those risky loans were packaged and sold to someone else (mostly Fannie and Freddie) to avoid personal exposure? Did just greed allow the very firms that packaged these complex financial products to provide the ratings agencies the models on how to rate them, and the ratings agencies did not question those models?”

“Those wanting to hedge their bets bought credit default swaps that transferred the risk of default to the insurance companies and the insurance companies said ’sure, no problem.’”

“Is it just me or does all of this seem like a bit of mass insanity coupled with a large dose of denial? Everyone knew what they were doing was risky, but the risk buck kept being passed and everyone considered their own exposure manageable.”

“Honestly, the biggest risk takers in this whole insane scheme made a fortune doing it and since these products were mostly unregulated (thanks to Congress), no one is going to jail. The pattern of the risk taker profiting while the average person pays (either by losses in their accounts or taxes as bailouts) continues on and on with little or no changes so far.”

“Mr. Rubin expressed his apologies Thursday for not knowing about the risks that Citi was taking until it was too late (or so he says). We have heard the same ‘I’m sorry’ from a lot of people who profited, and kept said profits from selling risky unregulated securities, but how sorry can they be? Obviously not sorry enough to return all the money.”