How Fannie n' Freddie Got Fucked Up

The Washington Post has a good article in today's edition noting that for years people pointed out the warning signs regarding Freddie Mac and Fannie Mae. Thing was, too many people in Congress and the government had a piece of the action. So rather than pursue any kind of reform that would ensure the companies were solvent, they bullied and intimidated the people who dared raise any warnings:

From a Washington think tank to the halls of Congress, from the Treasury to the Federal Reserve, from the Clinton to the Bush administrations, critics of the government-sponsored mortgage giants have long argued that they were allowed to operate with financial cushions that were too thin to support their far-reaching financial risks.

The critics argued that regulators should be empowered to require deeper capital cushions at Fannie Mae and Freddie Mac, but their persistent efforts were thwarted in the face of the companies' formidable lobbying. Many members of Congress defended the companies, contending that efforts to rein them in were tantamount to an assault on housing.

They were quite brazen about it too:

The political battle lines were drawn by 2000, when a senior Clinton administration official called on Congress to take steps that might have diminished the companies' special status. Treasury Undersecretary Gary Gensler also urged that regulators be given more power to set capital requirements for Fannie Mae and Freddie Mac.

The companies fought back.

"We think that the statements evidence a contempt for the nation's housing and mortgage markets," Freddie Mac spokeswoman Sharon J. McHale said at the time.

Even after Freddie Mac was shown to have manipulated earnings, Congress remained deadlocked over legislation to create a stronger regulator. Opposing one such bill in 2004, Sen. Charles E. Schumer (D-N.Y.) argued that a hostile regulator could use the proposed powers to choke the companies.

When a federal regulator accused Fannie Mae of cooking its books to increase bonuses, lawmakers lined up to denounce the regulator. Rep. William L. Clay Jr. (D-Mo.) said a House panel had no business holding a hearing on the matter -- "unless this is truly a witch hunt." Fannie Mae was later found to have overstated profits by $6.3 billion.

Former representative Richard H. Baker (R-La.), who chaired a subcommittee that oversaw the companies, struggled for years to rein them in and tried to show they were being managed for the enrichment of their executives. When Baker obtained data on Fannie Mae pay, a lawyer for the company threatened him with personal liability if he made it public, Baker recounted last week.

Also worth checking out, Mickey Kaus' dismantling of Paul Krugman's recent column on the matter.

How Hillary's Mortgage Plan Is All Wrong

Hillary Clinton is proposing that on "Day One" when she is president she will freeze foreclosures for 90 days and freeze interest rates on mortgages.

Such "freezing" breaks one of the most important assumptions that underlie American prosperity: the enforceability of contracts. Re: the subprime debacle, lenders lent money to lendees at below-market interest rates knowing that they would either: a) get their money back at higher rates in futures years, or 2) the lendee would pay a penalty for getting out of the loan early and make the lender whole. Government mandated re-setting of terms for mortgage contracts would mark a new low for interference, be unconstitutional, and would likely result in higher costs for all home buyers as lenders need to compensate for their loss of contract enforcement.

Slate's take on this here.

Government Policies Caused the Mortgage Crisis. Do We Trust Them to Solve It?

The biggest factor that drove the housing bubble and subsequent mortgage industry collapse is the IRS code that allows for mortgage interest to be tax deductible. That policy also allows property owners to itemize deductions, which, without being a property owner, is a pretty hard thing to do.

So should we be surprised that so many Americans were trying desperately to be homeowners when the tax code puts renting at such an economic disadvantage? What is wrong with renting, anyway?

The Fed has proposed new tough laws on lending that will hurt consumers. I propose instead that mortgage brokers, who were the real bad players in this debacle, operate under a self-regulatory organization such as stock brokers do under NASD. Under NASD, brokers have a "suitability" requirement. I would prefer to see all options of loans available to the consumer with a bit more of responsibility on the part of the brokers.

IRS to the Foreclosed: Don't Forget You Owe Us Money

The foreclosure wave has just started. It is a mess and will get worse. I don't agree with Hillary Clinton's $1 billion proposal to bail out those who took on bad loans as a bailout would be paid by everyone who took out responsible loans and also renters, who are already disadvantaged by the IRS code.

But the IRS is the shark in the water in this issue, as they tend to be. The IRS view is that if a creditor forgives a loan to a debtor, then the amount of that forgiveness is taxable income to the debtor. Wow and yikes! And how ruthless. As the NY Times reported today,

Two years ago, William Stout lost his home in Allentown, Pa., to foreclosure when he could no longer make the payments on his $106,000 mortgage. Wells Fargo offered the two-bedroom house for sale on the courthouse steps. No bidders came forward. So Wells Fargo bought it for $1, county records show.

Despite the setback, Mr. Stout was relieved that his debt was wiped clean and he could make a new start. He married and moved in with his wife, Denise.

But on July 9, they received a bill from the Internal Revenue Service for $34,603 in back taxes. The letter explained that the debt canceled by Wells Fargo upon foreclosure was subject to income taxes, as well as penalties and late fees. The couple had a month to challenge the charges.

The Credit Crunch and Market Meltdown

Now we know the answer to two questions that anyone who lives in DC has been asking for years: how can so many people afford such expensive homes and how the hell are my middle-class friends bankrolling such expensive home renovations? The answer: easy and dumb credit.

The Dow is down 270 points as I write, mortgage and corporate credit markets are in chaos and even French banks are taking a hit.

How can we fix this mess and prevent it from happening again? Hillary has it wrong. She has proposed a $1 billion fund to bail out the people who took on exotic loans that they no longer can afford. This would mean that Joe Renter and Joe 30 year fixed rate loan have to pay for the ill-advised excesses of their fellow citizens. It also creates a moral hazard, in which risk takers do not suffer the consequences of their risk-taking when it goes South, so they take on more risk. From Wikipedia, the definition of 'moral hazard':

Rescue operations carried out by governments, central banks, or consortiums of financial institutions can encourage risky lending, if lenders know that in case of serious problems they will not have to take losses.

One poster on a Wa Post web chat with Steven Pearlstein, that paper's economic guru, made another interesting point:

it's interesting to reflect that it used to be considered a scandal to withhold% loans from minorities, whereas now it is apparently reprehensible to extend too much credit.

To be intellectually honest, do the Feds want more or less credit available to the poor?

The federal government's policy of promoting home ownership versus renting also had a hand in this debacle. The IRS's treatment of mortgage interest as tax deductible makes people want to purchase a home for tax reasons and wildly inflates the cost of homes. That is insane and should stop.

I have two simple proposals that I think would protect consumers without interfering with the markets:

1. Mortgage documents ought to be written in plain English, just as SEC docs are required to be. Nowhere in my mortgage docs was something so simple as: this is a 30 year fixed rate with an interest rate of x% ever noted. I had to keep calling the lender on the phone to understand and clarify what I was getting into.

2. Mortgage brokers ought to be held to the same standards that stock brokers are. For most people, a mortgage is their biggest financial commitment, yet mortgage brokers have no professional commitment to give clients good advice. Stock brokers, in contrast, have a "suitability" requirement that is enforced by the NASD. They can be fined and disbarred for recommending a financial commitment that is "unsuitable" for the customer. This is a simple reform that could be governed by a non-Federal entity and would protect borrowers as it does stock investors.

Congress Creates the Subprime Mortgage Mess (and ACORN too)

The market for subprime mortgage loans is melting down and regulators, lawmakers and consumer groups are all pointing the fingers of blame, none of that at themselves. Hmm.

So, what power of forces created this mess? Here is Leo's tour of l'histoire.

Low interest rates: As inflation ebbed in the 1990s, the Fed lowered interest rates to historical lows so that in 1994 the rate on a 30 year fixed mortgage was only 5%. For some perspective, the rate on a same loan in 1984 was 15% and in 2000 was 8.75%. When interest rates fall, housing prices shoot up. The reason is that about 80%+ of a monthly fixed mortgage payment is interest so low interest rates enable people to afford much more house, pushing up house prices to record levels. While overall monthly payments did not increase nearly so much as the prices, the downpayment requirement did, which shut more and more people out of a traditional mortgage with 20% down.

The mortgage brokerage industry: Commercial banks are highly regulated and often do not resell the loans the make so they are therefore conservative about the loans they issue. A cottage industry of independent mortgage brokers and lenders like New Century (which just filed for bankruptcy) emerged to meet the demands of people who could not get traditional loans through banks because they didn't have downpayments, had bad credit or couldn't really afford the homes they wanted. Mortgage brokers, like most brokers, are incentivized to move products and push the most expensive ones. Unlike stock brokers, though, they are not regulated in any real sense and have no "suitability" requirement, meaning that the loans they write must be suitable to the client. Considering that for most people their home is their biggest investment, this is a big regulatory lapse.

Congress and the tax code: Congress tends to point fingers at catastrophes that are of their own making and this case is no different as they point fingers and call for reform.Yet Congress is itself very much to blame by creating a tax code that favors home owners to the detriment of renters. The mortgage interest tax deduction makes taxpayers feel that they are throwing away money on rent and therefore need to buy something, at almost any cost. In a market in which prices keep increasing, that feeling becomes almost desperate. For those with high incomes, the MITD is the only deduction that doesn't phase-out. This means that if you make more than 150K per year you lose the ability to itemize completely and deduct, say, charitable contributions or medical expenses unless you have a mortgage, in which case you can itemize. So if you are giving money to Harvard, you better have a mortgage. The MITD also inflates the value of housing by the rate of the tax code (peaking at 35%), causes just about everyone to feel desperate to own, even if it does not otherwise make sense for them, causes urban sprawl, and makes many people buy more than they should, creating the demand for subprime loans.

Housing advocates: While groups like ACORN are outraged about the subprime mess, they, like Congress are not looking within as to how wise it is to push just about everybody into home ownership. Instead, they attack "financial apartheid" without ever questioning whether home ownership is suitable for every single American, regardless of stability and financial/personal circumstances.