The leading Republican candidates for president have embraced an explanation of the financial crisis that has been rejected by the chairman of the Federal Reserve, many economists and even three of the four Republicans on the government commission that investigated the meltdown.
Both former House Speaker Newt Gingrich and former Massachusetts Governor Mitt Romney lay much of the blame on U.S. government housing policies, saying they led to the real estate crash that almost brought down the banking system and has cost homeowners $6.6 trillion since 2006.
Unregulated private lenders who sought profits in risky subprime loans were bigger contributors to the crash than federal housing policy, critics of the Republican argument say. They also point to simultaneous housing bubbles in other countries beyond the reach of U.S laws and surges in the value of non-housing investments such as corporate bonds.
“It’s just completely wrong,” said Joseph Gagnon, a former Fed economist who’s now a fellow at the Peterson Institute for International Economics in Washington.
While the candidates’ view may be in the minority, it has stoked a debate over the government’s role in the economy that’s central to the 2012 presidential campaign. President Barack Obama cited Wall Street misdeeds last year in signing the most comprehensive new financial regulations in more than 75 years. Republicans vow to repeal that law, which includes provisions aimed at curbing abusive mortgage industry practices.
The Republicans say the federal government pressed banks to make risky housing loans under a 1977 law called the Community Reinvestment Act, helping inflate home prices and ultimately sparking the crash.
“The reason we have the housing crises we have is that the federal government played too heavy a role in our markets,” Romney said in a Nov. 9 Republican debate. “The federal government came in with Fannie Mae and Freddie Mac, and Barney Frank and Chris Dodd told banks they had to give loans to people who couldn’t afford to pay them back.”
Gingrich has suggested jailing Frank, the former chairman of the House Financial Services Committee, and Dodd, who headed the Senate Banking Committee until his retirement this year.
That was before Bloomberg News reported on Nov. 16 that the former speaker had privately been paid $1.6 million to $1.8 million as a consultant for Freddie Mac.
The Community Reinvestment Act can’t explain why house prices in the U.K., Ireland, Spain and France doubled earlier this decade and almost doubled in Australia. All have suffered steep losses since then, with Ireland’s home prices dropping 38 percent by December 2010 from the 2006 peak.
Nor did Fannie Mae and Freddie Mac, the mortgage companies seized by the government in 2008 after their stake in subprime loans pushed them to the brink of collapse, have anything to do with commercial real estate, where prices rose by 91 percent in the seven years to October 2007. Housing prices increased by 107 percent between January 2000 and July 2006, according to the S&P/Case-Shiller Composite-20 Home Price Index.
Losses on subprime mortgage-backed securities didn’t start shaking financial institutions until 2007, three decades after the CRA was introduced and 15 years after affordable housing goals were established for Fannie Mae and Freddie Mac.
The companies were required by a separate 1992 law to increase purchases of mortgages given to low- or moderate-income borrowers to 50 percent of their total in 2001 from 30 percent in 1993.
The CRA was enacted to combat “red-lining” by lenders that often refused to serve low-income borrowers. Under the law, government regulators evaluate banks’ provision of credit and use their performance in approving mergers.
At the bubble’s peak in 2005-06, only 6 percent of all subprime loans involved lenders or borrowers governed by the law, according to Federal Reserve data. “The available evidence seems to run counter to the contention that the CRA contributed in any substantive way to the current mortgage crisis,” Fed economists Neil Bhutta and Glenn Canner wrote in 2009.
Still, if Republicans are overstating housing policy’s role in causing the crisis, the administration has done little to address shortcomings in the home-finance system, including Fannie Mae and Freddie Mac, whose losses have cost taxpayers $169 billion to date and could total $311 billion by 2014, the Federal Housing Finance Agency said in October.
“You all said you all would come forth at the beginning of this year with a real proposal” to reform the system, Senator Bob Corker, a Tennessee Republican, said of the administration at a Dec. 6 Senate Banking Committee hearing. “The year is almost over and you have not done that.”
The Securities and Exchange Commission on Dec. 16 charged Fannie Mae and Freddie Mac’s former chief executives and four other top officials with securities fraud, alleging they deliberately understated the companies’ exposure to subprime loans by hundreds of billions of dollars. Without admitting or denying liability, the two companies agreed not to contest the charges and to cooperate in the SEC’s cases against the individual executives.
Magnifying the depth of the housing slump that contributed to the recession, the number of existing homes sold in the U.S. was revised down by an average 14 percent since 2007, the National Association of Realtors said today in Washington.
Threat From Government
The Republican message may dovetail more with public sentiment. In a Gallup Poll released on Dec. 12, 64 percent of respondents said “big government” is the main threat to the country, compared with 26 percent who said “big business.”
R.C. Hammond, a Gingrich spokesman, didn’t reply to two e-mails requesting comment. Andrea Saul, a spokeswoman for Romney, e-mailed several comments the candidate has made on the crisis, including a passage in his 2010 book “No Apology” that says responsibility for the 2008 panic shouldn’t “be laid solely at the feet of Wall Street and the private sector.”
Edward Pinto, a resident fellow at the American Enterprise Institute and former chief credit officer at Fannie Mae, said a 1995 push by President Bill Clinton to expand home ownership lowered mortgage-underwriting standards and encouraged private lenders to make ever-riskier loans.
Pinto blames community activists, Congress and Fannie Mae for “a race to the bottom” on lending standards, which meant that by 2007, 40 percent of home loans involved down payments of less than 3 percent. Competition from Fannie Mae and Freddie Mac drove lenders to ignore traditional safeguards such as loan-to-value, or LTV, limits and required down payments, he said.
“You look at the growth in mortgages you look at the leverage, the decline in LTVs -- you look at all of those things, and government’s fingerprints are all over it,” he said.
By 2008, almost half the nation’s 55 million loans -- 26.7 million -- were “high risk” or effectively subprime, according to Pinto, who uses his own methodology for loan classification. The nonpartisan Government Accountability Office says there were just 4.59 million subprime loans active as of the end of 2009.
“We are aware of such claims but have not seen any empirical evidence presented to support them,” Fed Chairman Ben S. Bernanke wrote on Nov. 25, 2008.
About 60 percent of all subprime loans were extended to middle- or higher-income borrowers or neighborhoods, then-Fed governor Randall Kroszner said in a December 2008 speech. Another 20 percent were given to low-income borrowers by nonbank lenders that weren’t subject to the anti-discrimination law.
No ‘Meaningful’ Contribution
Kroszner, a University of Chicago economist appointed to the Fed by President George W. Bush, said it’s “hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis.”
The Financial Crisis Inquiry Commission, established by Congress in 2009, concluded that “collapsing mortgage-lending standards and the mortgage securitization pipeline” were among several contributors.
“Problems with U.S. housing policy or markets do not by themselves explain the U.S. housing bubble,” former House Ways and Means Committee Chairman Bill Thomas, economist Douglas Holtz-Eakin and Keith Hennessey, a onetime White House economic adviser, wrote in a dissent.
Other analysts say the lure of profits, not government encouragement, prompted companies to get into subprime. From 2001 to 2005, private lenders’ share of mortgage-backed security issuance rose to 55.2 percent of the market from 19.7 percent.
Leading the Way
“The private sector led the way; there’s no question about it,” says Kathleen Engel, author of “The Subprime Virus” and a professor at Suffolk University Law School.
Even as the U.S. housing boom neared its peak in the middle of the last decade, bubbles were inflating elsewhere. High savings rates in Asian economies and Middle East oil-producers created a pool of capital searching for high returns.
Douglas Elliott, a former managing director at JPMorgan Chase & Co., said a quarter-century of strong financial market performance lulled investors into a false sense of security. Their risk appetite manifested itself in commercial real estate, high-yield corporate bonds and sovereign debt, not just housing.
“Commercial real estate seems to have been in a bigger bubble than residential real estate, and there was absolutely no intentional government policy to encourage commercial real estate,” said Elliott.
Likewise, creditors earlier in this decade saw almost no difference in lending to Germany or Greece. From 2003 through 2005, the average yield on German 2-year bonds was 2.44 percent compared with 2.5 percent on similar Greek debt. On Dec. 20, Greece had to offer investors a 146.6 percent yield to hold its debt while Germany paid just 0.21 percent.