Deconstructing claims about the mortgage crisis

Yet again I'm fighting with GOP partisans about what caused the mortgage crisis. The GOP partisans will say something like this: [click through to see comments]

"The crash was a direct result of Democrat policies forcing/allowing very risky lending. Get your history correct."

I won't repeat their entire narrative of how Dems forced banks to make risky loans to minorities, which were funneled through Fannie and Freddie, put the government on the hook, and all that bad paper caused the financial crisis of 2008 and subsequently the long recession.

Here's what I think happened, with me trying to be as fair as possible and without evidence to back each individual piece.

1. CRA (Community Reinvestment Act) forced banks to end their discriminatory redlining practices. This was a good thing. Banks had to loosen some of their lending standards. Perhaps there were quotas, and if so, I don't know if the quotas were fair or not. 
2. The results of CRA were good, so the programs were expanded, probably too much.
3. The managers of Fannie and Freddie wanted to collect higher salaries more in line with other majors bankers, so they lobbied for changes to allow them to become publicly traded companies. 
4. Somewhere along the way, Fannie and Freddie became big contributors to Democratic campaigns. That made it politically expedient for Dems to protect them and the GOP to attack them.
5. Other banks, such as the Wall Street firms, saw the kind of money Fannie and Freddie were earning, and wanted a big piece of it. They lowered their lending standards and flocked into the subprime market. (This bit is ignored by the GOP. See below.)
6. The GOP raised alarms about mortgage lending in 2003-2005, focusing exclusively on Fannie and Freddie, and ignoring the same or worse practices of the big banks. The Dems circled the wagons and defended Fannie and Freddie. 

That pretty much sums up the reason behind the GOP narrative about CRA, Fannie, Freddie, and the Dems causing the financial crisis.

What the narrative leaves out other players who had a much larger role in the financial crisis. The big banks envied the profits that Fannie and Freddie were raking in due to their unfair advantage in borrowing. The big banks went after the highest profit area, which was subprime lending, and they inflated number of mortgages a great deal. But all this occurred within a decades-long housing boom, a boom in mortgages, a boom in home equity lending, and a housing price bubble. I frankly don't know how much of the crisis was due to poor lending standards and how much was due to the housing bubble, or whether anyone can unscramble those pieces. However, it clearly wasn't all due to Fannie and Freddie.

Yet, when you read some explanations (like this), it seems that it was all Fannie/Freddie's fault:

"Moral hazard was everywhere and endemic. The biggest source was in the GSEs [Fannie and Freddie]. The GSEs were entirely moral hazard."

I have my own warnings: Beware of explanations that don't discuss the roles of private banks. Beware of explanations that don't have graphs. Graphs invariably show that private banks were huge players in the subprime mortgage business.

Image: ritholz.com

Beware narratives that say Fannie and Freddie weren't part of the problem. If that were true, why did they need almost $187 billion in bailout money?

Remember that the GOP weren't the thwarted would-be heroes. They went after Fannie and Freddie for political reasons, while using lending concerns as the pretext. This becomes clear when you realize that the GOP warnings completely ignored the even larger problems brewing at the big banks. The Dems, likewise, defended Fannie and Freddie for partisan political reasons. The alarms that should have been heard and heeded were smothered by politics. 

What I haven't worked out yet is why a crisis in bad housing securities became a more generalized financial crisis. There are plenty of explanations I could give off the top of my head, but I'm not sure they're right. I also don't know the role of other financial inputs such as collateralized debt obligations (CDOs) or credit default swaps. Understanding that may be beyond my capabilities. Frankly, I don't even know where to start to research on those aspects of the financial crisis. But I've researched enough to clearly declare bullshit on some of the claims, and back it up with solid data. Solid data - this is a good thing.

Summary of links:

• Biased blame on Fannie/Freddie with no graphs. It was so balanced it was reposted by the American Enterprise Institute think tank. (In case you missed it, that was sarcasm.)
• Lots of graphs, but less mention of Fannie/Freddie. Less biased, but still some, probably.
• Another graph showing involvement of Fannie/Freddie and asking questions about their role.
• My previous posts on this topic here and here.
• Testimony before a committee with a biased name (see below). However, this introductory paragraph floored me:

"Government housing policy failed homeowners and taxpayers and it is important to understand why. The GSEs contributed to the meltdown. The direct cause of the crisis was the proliferation of poorly underwritten and risky mortgage products. The majority of these products, and the most risky products, were funded through private label securitization." [emphasis added]

Finally, putting the conclusion before the research and evidence, presented to you by the House Republicans. You've got to love the balls it takes to do this:

Update 3/19/18. Of course partisan hacks still pretend the mortgage crisis was all due to those miserable Dems. Here's a reminder of who wasn't the boogeyman. Oh God, I wish the liars would stop.

Revisiting the mortgage crisis

Blaming the other side for the mortgage crisis is an ongoing game, though at a lower pitch than before. A newly published economic study is again focusing attention on the causes, though the study fails to look at the whole picture.

The good thing about this study is that it's gotten people commenting again. That's given me the chance to learn more. This post was my gateway to looking at the issue again, and deserves a mention. However, it is also too narrow in scope-- it focuses only on the thesis that banks should have priced risk better, and it's not the fault of CRA that they didn't.

The real feast is in the comment page of this brief post. Especially worthwhile are the comments of Steve Sailer, a journalist/blogger who frequently writes about the preferable outcomes and values of white American culture and provides evidence to back it up. To some, that makes him a racist. Maybe he is, but he still has points that are important to consider.

These are some facts (or possible facts) that I learned from his comments:

1. The Clinton administration "threatened" Countrywide, a mortgage lender, with heavy regulatory pressure if they didn't lend to more low-income borrowers. 
2. The regulatory environment favored robust low-income lending when mergers were evaluated for approval. Bankers who were sceptical were effectively weeded out.
3. Steve Sailer isn't an ideologue who is trying to put all the blame on one quarter.

These comments discuss how CRA and similar policies changed mortgage lending practices to make it easier for low-income and minority borrowers to get home loans. These changes are part, but only part, of the huge developments in mortgage lending, including all kinds of new mortgages and the packaging of mortgages as securities.

It is clear that the Democrats liked the outcome of more minorities getting home loans. Republicans liked it too, and "the ownership society" became one of their slogans. It was good that more minorities and lower-income people were able to become homeowners and enjoy those benefits such as building equity.

What is unfair is how some conservatives are now trying to place all the blame on Democrats and their policies. This is a lie. Though there definitely was pressure from Democrats, including the Clinton administration, to increase minority lending, it is hardly the largest cause of the crisis. A fair accounting looks at many factors, not just CRA, Fannie, Freddie, and what Dems did. This was only part of the action, not even close to the whole rotten edifice.

We should be trying to figure out what policies were good or neutral, while identifying others that were problematic. This applies to all areas, including low-income lending, underwriting standards, rating agencies, and securitization. However, we may not be able sort the good practices from the bad because the horribly overheated housing market confounded everything.

Most important, let's all learn some lessons from this horrible crisis. And please, let's not use it just to bash "the other side."

Untold suffering

Image: washingpost.com

Update 1/24/14. "The Dems caused it" is still a favorite claim. So in arguing it yet again, I found this great article about how the Bush administration and the Supreme Court hampered states from trying to prevent the crisis they foresaw. Also, here's a good exchange between two data heavyweights, though there's no resolution of their differences. [Sadly, those comments are no longer available.]

Let me say clearly: Dems made this worse, Republicans made this worse, Fannie and Freddie made this worse, but most of all it was the Wall Street banks. Anyone who ignores some of the players is lying and it's probably for political reasons.

Update 3/27/14. Still a favorite claim. I tried to find out how 'liar loans' [stated income loans] started. I didn't find the answer, but I found this testimony from 2006.

Update 3/28/14. More great testimony here, but don't stop at the title because it's misleading. Follow-up post here.