Interesting article in today’s WSJ discussing one of our favorite talking points: The actual causes of the housing boom and bust and of the credit crisis:

"Fannie and Freddie do share some of the blame for the mortgage and housing bust. They recorded a combined $14 billion of losses in the 12 months ended June 30, largely because they lowered their credit standards and purchased or guaranteed dubious home loans."

I would clarify this by noting that the change in loan standards by Fannie Mae and Freddie Mac occurred in 2005 — by that time, housing sales (but not prices) had peaked, and the die was already cast.

Some more factual details"

"But "they weren’t the leaders in lowering credit standards," said Andrew Davidson, a mortgage industry consultant in New York who has done work for Fannie and Freddie and also criticized them for taking excessive risks. He noted that the worst-performing mortgages are those that were originated by subprime lenders and packaged into securities sold by Wall Street, rather than by Fannie and Freddie. And while loans for low-income people — programs championed by Democrats as well as many Republicans — have contributed to Fannie and Freddie’s losses, they aren’t the biggest part of the problem."

OIt goes far far beyond subprime and Alt-A: Much of the problem is a combination of over building and terrible lending standards. (I’m unsure which came first). Consider the areas where there was enormous excess capacity — now huge unsold inventory — aimed at wealthy exurbs. These include SoCal, South Florida, Arizona, and Las Vegas.

Dan Gross points out that:

"Many of the biggest flameouts in real estate have had nothing to do with subprime lending. WCI Communities, builder of highly amenitized condos in Florida (no subprime purchasers welcome there), filed for bankruptcy in August. Very few of the tens of thousands of now-surplus condominiums in Miami were conceived to be marketed to subprime borrowers, or minorities—unless you count rich Venezuelans and Colombians as minorities. The multi-year plague that has been documented in brilliant detail at IrvineHousingBlog is playing out in one of the least subprime housing markets in the nation."

None of these were Fannie/Freddie related — and they are now the biggest housing problem areas in the nation.

As I have been writing here for many years now, there were a 1,000 things that led to the current crisis. However, I have chosen to focus on, in priority of significance, causation and impact, items # 1-10.  Other people seem to wish to focus upon items #67, 219, and 467.

As Hagery correctly notes in the Journal piece, the GSEs are targets in a political, not economic debate. My motivation is a desire to get to reality — what actually caused the mess,a nd how we can clean it up. The people focusing on the 96th causative factor seem to be motivated by something much less honorable . . .



Fannie, Freddie Share Spotlight in Mortgage Mess
WSJ, OCTOBER 16, 2008

Subprime Suspects
Newsweek, Oct 7, 2008


Real Estate and the Post-Crash Economy
Thoughts from the Frontline, December 29,  2006

The Ongoing Impact of the Housing Sector   
Investor Insight, Aug 27 2007, 11:50 AM

A Memo Found in the Street
Uncle Sam the enabler
Barron’s MONDAY, SEPTEMBER 29, 2008

Category: Credit, Economy, Politics, Real Estate

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

23 Responses to “Who Were the Leaders in Lowering Credit Standards?”

  1. Tim in Iowa says:

    Maybe if you keep avoiding the word “derivatives” they’ll just go away. It’s like talking about WWII without mentioning Germany or the Nazis. But you’re in good company. I think both O’Cain and McBama went the entire debate without mentioning the word either. At least McBama could tell you what they are, but he’d have to consult Goldman Sachs on what his policy is on them.

    Aren’t only about 10% of the mortgages bad. So why the $700 gagillion “bailout”?


    BR: Tim, I’ve discussed derivatives a bajillion times. (I cannot rewrite my entire wold view every post)

    To review the prior commentary on Derivatives, go here:

  2. dead hobo says:

    Speaking of credit, let’s talk about hedge fund borrowing with respect to the potential effects it is having on the market today and the markets that will follow.

    Does anyone know the percentage of hedge funds that use massive leverage? Of those, what do/did they invest in?

    I’m particularly interested in commodities and commodity related investments and hedge funds that over-leverage. I am sure that the ocean of money that pumped up oil and other commodities came from borrowings of easy money, and that one of the reasons that commodity prices are now falling is that there is no longer too much money chasing too few commodities.

    The unknown is if prices will skyrocket again after the healthy sell off? My guess is no, at least for a couple of years. Credit will probably go to where it is useful as opposed to where it is most risky and detrimental to society as a whole. But this is only my guess.

    If oil stabilizes in the $60 range for a while then I think it will be safe to jump into stocks again at the deep end. But if oil takes off according to the theory of Boone that demand is 87 mil bpd and supply is only 85 mil bpd then cash is king.

    Any insights on credit and hedge funds in general and commodities in particular?

  3. CNBC Sucks says:

    The people focusing on the 96th causative factor seem to be motivated by something much less honorable . . .

    Electing John McCain?

    Don’t leave us hanging like that, Bar, or I am gonna kill the suspense.

  4. D. says:

    I still think that at the top of the list is the fact that our entire system is based on growth when growth in the Western world is getting unsustainable.

    Easter Island is the perfect example. Who cut down that last tree? The obliteration of their resources must have been incremental until, woops, someone had to cut down that last tree!

    No matter what regulation you put in place, when the system is not sustainable, power hungry people will change the rules to keep it going.

    It’s like those pounds and wrinkles, they just creep up on you until suddenly you notice them in a picture.

    I think it was the natural evolution of the world economy and not much could be done. Just like no matter how much you outlaw homosexuality, pre-marital sex and prostitution, you’re still going to get it but more of it will be underground.

    But human beings have trouble figuring out what’s under their sphere of influence and what isn’t so for the next few years we’re going to be looking for the culprits and putting in all kinds of measures. Then in a few years, things will calm down and we’re going to think that we did good work when the system would have found some balance even if we had not touch a thing! And of course, the people in charge by that time will get all the kudos.

    Life is one big joke.

  5. D. says:

    Aren’t only about 10% of the mortgages bad. So why the $700 gagillion “bailout”?
    10% now, if we actually have the right numbers. It’s going to be getting worse. Especially with CRE starting to kick in.

    Don’t forget about leverage on leverage…

    Let’s use an example. When banks were selling these mortgages they were essentially realizing 15 years or 30 years of earnings up front and inflating earnings. Investors loved the growth and boosted the multiples. Investors were so in love with the banks that many of them probably borrowed to buy tocks and called their broker who put them in a mutual fund with financials. So we ended up with more than one loan “backing” the same assets.

    The mutual funds company was doing so well that it went from a valuation of 3% of asset to 10%. It was doing so well that it caught the eye of aprivate equity fund who borrowed money and did an LBO to buy it. So now we have 3 loans “backed” by the same assets!

    The whole system is completely perverted as we don’t know how many loans are still backing these same defaulting assets!

  6. dead hobo says:

    Back to oil for a moment … a simple analysis using econ 101 principles, or maybe even high school economics, can provide a strong argument that the recent high price of oil was a total fraud.

    Until recently, the nymex contracts for oil used to be actively traded out for 8 years. If the near contract budged a few cent or more, the far contracts traded in like amounts almost immediately. Near and far contracts were almost identically priced. It was obviously a very active market and the trades were probably managed as a strategy by a few deep pocketed traders.

    Today, the major activity appears to be in the near contracts and the spread between near and far is over 10%. Far contracts appear to have little activity comparatively.

    Logically, if the Theory of Boone was a reality, people would be locking in the far contracts at the low $80s or the intermediate contracts in the $70 in mass numbers. If $300 oil is coming soon, $85 oil locked in today would be a gift. $60 oil would never arrive in the far contracts, even if it somehow made it to the near ones. Demand and activity in the far contracts would be tremendous today. So, where is it?

    Since the price of oil is falling dramatically on a slight fall in demand, and since there is significantly less money chasing oil as a commodity or the price of oil as a derivative, this is circumstantial evidence that those who claimed the price was going to the stratosphere because of the Theory of Boone were either gullible or part of the plan to hype oil and make money off the rising prices.

    It wasn’t supply and demand for the use of oil that made oil prices choke us all, it was supply and demand for trading in oil. The supply of credit was the increase in the money supply necessary to cause common, ordinary, Milton Friedman style inflation.

    As the WSJ said today, the lowering price of oil is going to put far more money into the pockets of people that any stimulus check could possibly do. And still lowering price will be the gift that keeps on giving.

    So, if I am right, the availability of easy credit for investors who speculate in oil prices is the big unknown. If it returns, then the demand for rising oil prices will return. Wasteful credit will finance it and willing sellers will happily accommodate. If, however, credit is allocated to those with productive uses,then oil will remain low in price until the economy improves to the point that wasteful credit is again available to those who hype oil.

  7. kuros says:

    I have been waiting for this discussion to come up…I have lived in Sarasota Fl and now live there part time (sold home made money bought in St. Louis will rent in Fl for the winter) any who…it really burned me up when they even suggested and than were bold enough to say that the real estate crisis was caused by minorities buying homes…Ya right in Sarasota…yes there have been mexicans buying a few homes here and there but the majority were of the following example..Nathaniel Place…I lived across a street from this Vision Home development scam (it is NOT sold out) They took a very large lot with a circa 1960′s ranch home on it (tore that down) and crammed 12 poorly built homes on it …I was there every scam of the way… when a few of the homes were built I played buyer and talked with the re agent… you want a pool want crown moulding ..extra..hell if I asked for another cable outlet it was probably extra…now here is the kicker check out what these saps paid for these homes… I’m form Florida..and from Sarasota…I know what the land is really worth and the home value. Not long after people moved in I took a drive into the mess and saw a boy about 7 yo driving his little electric hummer around the street…sad very sad

  8. Concerned Citizen says:

    Dead Hobo, the symtom, not the cause. And if your going to argue against the methodology of the oil pits – cme, nymex, etc., I think your barking up the wrong tree. Sure, there is always going to be traders piling-on at the end of a move, just like anti-bodies pile-on, at the end of a cut!

    CDS’s, and CDO’s, etc….those are the elephants that broke/is breaking the camels back.

  9. rathipon says:

    The basic problem is housing prices became unsustainably high. BR proposes that lax lending standards are the primary reasons this happened. I am an attorney that handled quite a few residential transactions in the NYC/LI area over the course of the past 5 years. I didn’t see many 100% LTV loans until the middle of 2006, by which time much of the home price appreciation had already occurred. Granted, this is based upon my own anectdotal observations, but I would be willing to bet that the data backs this up.

    My own feeling is that lax lending standards, as BR suggests, were a major causative factor of the housing bubble, or at the very least, the fuel of the bubble towards the end. However, the ‘ownership society’ promoted by both parties, including deduction of mortgage interest, Fannie and Freddie, and Greenspan’s bad interest rate policies, were the catalyst. We didn’t see significant loosening of lending standards until the bubble was already half inflated.

  10. Concerned Citizen says:

    BR, that latest commercial on CNBC that is running, making “Creamer the Cramer,” out to be a hero is sickening! It really show’s his own hubris – chutzpah… Wow! talk about being stero-typical.

  11. D. says:

    dead hobo:

    Here is another way of looking at it…

    I followed the Cdn oil patch for a number of years and one thing is that their first goal is to reserves and get that barrel of oil out of the ground asap. They need the cash flow for capex. They can’t stop because of natural decline rates so you know that they will always produce as long as it’s cash flow neutral.

    Throughout the 90s, if you added royalites, G&A/boe, operating/boe and finding costs you got to around 18-20$. That corresponds to the WTI throughout that same period.

    So last year, I picked a few conventional oil producers and I got to 40-50$ per barrel. 18$ oil is gone but there is still plenty of 40-50$ oil to be drilled.

    I think peak oil is true but we still have a couple of cycles before we run out of the black stuff. And when it happens it will happen just like the last tree on Easter island got cut down!

  12. dead hobo says:

    Concerned Citizen,

    My argument is the same as yours. Easy, wasteful credit and exotic financial instruments caused the oil problem along with the housing, and CDS problem.

    The only difference is that the Theory of Boone muddies the waters about the reasons for high oil. The Theory of Boone claims oil shortages cause high oil prices. I believe that the increased supply of money to trade with creates a demand for trading, and willing sellers will happily raise prices to accommodate.

    On a side note I think this vindicates Art Laffer and Larry Kudlow. This is a quintessential example of Supply Side Economics in Action. Supply creates it’s own demand. Say’s law is TRUE!! The supply of credit creates a demand for trading in oil prices, which ultimately raises the price of oil and motivates even more trading in the price of oil. Tell Laffer and Kudlow they were right all along.

    Also, the oil problem will rectify itself far more easily than the other credit related problems.

  13. dead hobo says:

    D, no argument. Please note that Qatar is using $43 oil as a budget figure in their national plans.

  14. dead hobo says:

    Last Post:

    Here is the Theory Of The Dead Hobo:

    The increased supply of money to trade with creates a demand for trading, and willing sellers will happily raise prices to accommodate

  15. Donkei says:

    Maybe $70 oil will get T. Boone Pickens to shut up. That would be a collateral benefit.

    Anybody in the real estate mortgage business during the boom knows full well that Fannie and Freddie weren’t hardly the cause. I was/am and saw first-hand the insanity that pervaded the transactions.

    Take a list of failed mortgage companies: Ameriquest, New Century, WaMu, etc. I did closings where all of these entities were the ultimate lenders, and the transactions were all garbage–especially Ameriquest, which was particularly aggressive.

    Ameriquest did a loan once for a blind man on disability to buy his house back from a foreclosure sale. The poor guy went from one sleazy slum lord to another, with thousands of dollars of fees tacked on for good measure. I felt like I needed a shower after the closing. I soon after quit doing business with Ameriquest.

    They (Ameriquest, et. al) were most definitely not lending to the guy because ACORN or the CRA required them to. They were doing it because they knew they could sell the loan downstream, even if the chances, given the oppressive terms of the loan, of repayment were practically non-existent. They got their fees (often 10% or more of the loan balance) and laughed all the way to the securitization desk.

    The true source of the problem was too much money. The massive trade deficits needing to be financed played a role, but Greenspan’s loose money policy probably played a bigger one.

    Fannie and Freddie were late to the subprime game. The loans funded by them were, until about 05-06, straight A stuff. Their main client, CFC, was a big client of mine and the retail branch I worked with didn’t do anything remotely approaching the antics of Ameriquest or New Century, et al. No buying people out of foreclosure or bankruptcy or the like.

    It was only later in the game that CFC got involved in subprime in a big way (about 04-05), but that was all handled by a division completely separate from the one doing what the business refers to as “conforming” loans. The standards for conforming loans remained pretty much the same, until recently.

    In the last year or so, underwriting standards have fallen precipitously–conforming loans seem not much different than the Ameriquest loans of yesteryear. But that’s what happens when Uncle Ben and Emperor Hank pull out the checkbook. This is going to get more interesting still, it seems.

  16. D. says:

    Wthe last year or so, underwriting standards have fallen precipitously–conforming loans seem not much different than the Ameriquest loans of yesteryear. But that’s what happens when Uncle Ben and Emperor Hank pull out the checkbook. This is going to get more interesting still, it seems
    When they announced they would be guaranteeing all money market funds up to 50B, my first thought was “Wow, I have to get myself a MM fund to manage. No work involved. I could just fill it up with all the highest yielding crap and get mega bonuses for beating my benchmark… no risk guaranteed!

    Man, this is going to get ugly.

  17. Tuck says:

    This link from 1996 details how Fannie and Freddie were already lowering loan standards in cooperation with Acorn Housing Corp.

    “Early on AHC recognized the need to bring in the secondary market and private mortgage insurers, if these new underwriting standards were to succeed. In response to ACORN pressure, Fannie Mae created the Fannie Mae/ACORN Pilot, which allows Fannie Mae to purchase AHC counseled mortgages using the more flexible AHC style underwriting. This flexibility was a major step forward for Fannie but also required participation by private mortgage insurers who are typically the least progressive link in the home buying chain. To date, four of the major mortgage insurers have signed on to the AHC program: MGIC, CMAC, GE, and UGI.”

    Read the whole thing, in it, Acorn gives credit to the CRA for allowing them to browbeat the banks into drastically lowering their lending standards. They also describe how that wasn’t enough, they had to get Fannie and Freddie to lower their standards too, and they succeeded.

    Don’t take my word for it, take Acorn’s. They describe the entire process at the link above.

  18. cloudy says:

    the lax(er) lending standards of 2005 on were needed to stoke the fuel of higher home prices to keep the game going that had started with the beginning of lax lending standards in the earlier 2000s.

    anyway, I am not a fan of Ben Stein, but I stumbled across this 2/10/08 NYT article where he comes out against deregulation and the repeal of Glass-Steagall! I’ll be darned.

    “BUT something else was missing here. Since the era of Ronald Reagan, we have been told by powerful groups that regulation is bad and that our economy will grow like magic if we take it away. So regulation was removed from savings and loans, and they were looted mercilessly.

    The Glass-Steagall Act was repealed so that large commercial banks could get into selling investments, and we got the near ruin of immense banks. And regulation of the mortgage-based securities was confined to a boilerplate that says everything and means nothing. And the cheerleaders in Washington say, “Now we need even less regulation!” And the Supreme Court, that highest judicial body in the land, just spoke through its cloaks most deep and distinguished, and severely limited the ability of shareholders to file federal class-action suits against investment banks that help a company accused of committing fraud.”

  19. Whatever other points you may care to disagree with, T. Boone is right about using CNG for Vehicular Fuel.

    CNG, is Plentiful, and Homegrown!~

    The Technology has been well-proved over Decades, it works, and works well.

    Past that, to the point of the Post, its ownself: Who Were the Leaders in Lowering Credit Standards?

    BR has a preternatural blind-spot for the real answer: The Federal Reserve, in all ways, including the old adage: “Give me Control of a Nation’s Money, and I care not who makes its Laws.”

  20. kfizzle says:

    At this point I feel completely turned around. Can someone explain what role FRE/FNM **DID** play in the entire debacle, because I’m totally unclear on that now. Tell me what they did that caused them to go into conservatorship, or why it matters whether housing sales had peaked in 2005? Did they stop buying and securitizing at that point? If they had stopped (or slowed down), would we have avoided substantially more problems, or would it not have made a difference? I just can’t understand how the companies responsible for handling such a large percentage of that secondary market could not be considered crucial to spreading a problem. I think part of my (and many people’s) misunderstanding lies in semantics: For instance, I don’t “blame” the GSEs for the problem, in the sense that they are negligent, but people paint the picture that they had NOTHING to do with it, and I can’t understand how that is possible.

  21. OhNoNotAgain says:

    “Read the whole thing, in it, Acorn gives credit to the CRA for allowing them to browbeat the banks into drastically lowering their lending standards. They also describe how that wasn’t enough, they had to get Fannie and Freddie to lower their standards too, and they succeeded.”

    Bullshit. Point to the paragraph where they claim responsibility for *lowering* lending standards. They talk about how they worked towards getting lenders to use alternative measures of income for mortgages, but I don’t see where they talk about giving mortgages to unqualified individuals or families.

    You also seemed to miss this sentence:

    “From the lender’s perspective, the AHC counseled mortgage loans have turned out to be low risk loans with low delinquency rates.”

    But how can that be, if they’re *lowering* lending standards ?

    And what about those standards ? Well, I’ll be, there’s a link right on their page where you can read for yourself:

    Hmmm, here’s the money quote right at the top:

    “Creditworthiness, the ability to repay, and the value of the property are the major considerations in approving a loan.”

    Wow, that’s really radical stuff.

  22. While there are many causes for the current economic crisis, to give Fannie and Freddie almost a free pass is ludicrous. As just one example, why didn’t they crack down on the abusive down payment assistance “charities”. If Fannie and Freddie had maintained any sort of lending standards, it would have at least raised some important red flags for the folks making really insane loans. What next, are you going to minimize the blame that S & P, Moody’s, & Fitch deserve for giving investment grade ratings to toxic paper.

  23. Blissex says:

    «Tell me what they did that caused them to go into conservatorship,»

    A combination of 100-to-1 leverage and an however small but higher losses on mortages. Which was due to general conditions.

    «or why it matters whether housing sales had peaked in 2005?»

    Well, for one thing thye GSEs do not handle HELOCs, only first sales, and they only handled up to a certain size.

    «Did they stop buying and securitizing at that point? If they had stopped (or slowed down), would we have avoided substantially more problems, or would it not have made a difference?»

    A difference to what? To the bubble, no differenc e. The bubble was fed by extraordinarily wide availability of credit at extraordinarily low interest rates that drove house prices to 2-3 times their sustainable level and induced a lot of people to speculate in housing and to extract the newly minted equity in their homes via HELOCs, both of which things were keenly followed as real wages and even family budgets were strained.

    The GSEs were serving the healthier part of the market, and their market share went down significantly at the top of the bubble. So they were really a small factor. Their wider significance was just that their debt was widely held by foreign investors whose continued purchased of USA debt is absolutely crucial.

    As to the difference to the GSE themselves, well, had they stopped lending at 100-to-1 leverage that would have been nice, but their management and private investors would have never allowed that, backstopped as they felt by the USA.

    Look, the GSEs have been a small, relatively healthy part of the story.

    The big deal has been thoroughly corrupt rating agencies, investment banks and mortgage brokers, and overall a credit and deregulation crazy administration, first actively egged on by the thoroughly corrupt Republican majority for a decade, and then insufficiently restrained by a not-strong-enough (and somewhat corrupt) Democratic majority that followed.