[Peter Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute. His book on the financial crisis, “Hidden In Plain Sight: How the U.S. Government’s Housing Policies Caused the Financial Crisis and Why It Can Happen Again”, was published today by Encounter Books. The following article by Peter was written for RealClearMarkets.]
From the time it was first proposed by the Obama administration early in 2009, the legislation that eventually became the Dodd-Frank Act was opposed by Republicans in Congress. It got no Republican votes when it passed the House and only two Republican votes when it passed the necessary procedural vote in the Senate.
The reason for this nearly unanimous Republican opposition is simple: the key provisions of the act bore little relationship to the actual causes of the crisis. Indeed, the record shows that in designing and adopting the act neither the Obama administration nor the Democratic Congress made any effort to understand why there was a financial crisis in 2008 or the role of the government’s housing policies in bringing it about.
The necessary information was certainly available. Fannie Mae and Freddie Mac became insolvent in September 2008, and were immediately taken over by their regulator as conservator. Thus, when the Obama administration came into office in January 2009, it had access to all the financial information of both firms.
In August 2009, now under the government’s supervision, Fannie published the first reasonably complete credit report on its mortgage exposures. This showed that 81 percent of Fannie’s 2008 losses had come from its exposure to both subprime loans (loans in which the borrower had a FICO credit score of 660 or lower) and other loans that were particularly risky because they had low or no downpayments or other deficiencies. This should have been a surprise; up to that point, most people thought Fannie only acquired prime loans. Further inquiry would have shown that Freddie Mac had suffered similar losses for the same reason. Because it was now in charge of Fannie and Freddie, the administration had this information well before it was published.
In June of 2008, this and other data showed that there were 31 million subprime and other risky mortgages in the US financial system, amounting to 56 percent of all US mortgages. Of the 31 million loans, 76 percent were on the books of government agencies, primarily Fannie and Freddie (about two-thirds) but also FHA, the Veterans Administration, and others. This showed incontrovertibly that it was the government-and not the private sector-that had created the demand for the vast majority of these loans.
If the administration and Congress had really wanted to know what happened in the financial crisis, the information was at hand. The data cited above made clear that the overwhelming majority of the losses in the mortgage meltdown had come from subprime and other risky loans. If Fannie and Freddie had suffered 81 percent of their losses because of these mortgages, the defaults on these loans were what had driven down housing prices 30-40 percent all over the United States.
Any serious effort to understand the crisis would have asked at this point why government agencies held so many subprime and other risky mortgages, and that inquiry would have turned up the affordable housing goals, adopted by Congress in 1992. These required Fannie and Freddie, when they bought mortgages from banks and other originators, to meet a quota: 30 percent of those mortgages had to be made to borrowers at or below the median income in the communities where they lived. Data from HUD, which administered the goals, would have shown the administration and Congress, had they been curious, that HUD had gradually increased the quota to 50 percent in 2000 and to 56 percent in 2008.
Anyone in the administration who was interested would have realized that as the quota was increased Fannie and Freddie were required to reduce their underwriting standards; it was simply impossible to meet the increasing affordable housing goals for borrowers below median income while maintaining their traditional prime mortgage standards. By 1995, they were accepting loans with 3 percent downpayments, and by 2000 loans with zero downpayments.
From that point on, the analysis would have been easy. Because Fannie and Freddie were the dominant players in the housing finance market, when they reduced their underwriting standards lenders were compelled to follow suit. Mortgage lending is competitive, and consumers went to the lenders that offered the easiest terms. Any observer would have understood why Countrywide, formerly a minor league subprime lender, ultimately became one of the largest mortgage originators in the US. It was the principal supplier to Fannie and Freddie.
But neither the Obama administration nor Congress was interested in this analysis. The narrative they adopted, and sold to the American people, was that Wall Street and other large financial institutions had taken excessive mortgage risks because they had not been sufficiently regulated. Fannie and Freddie, as HUD secretary Donovan later told Congress, bought all those subprime loans for profit or market share. The government’s role, and the affordable housing goals that drove down underwriting standards, were conveniently ignored.
The conclusion one should draw from this is that the Dodd-Frank Act is illegitimate. Although the American people were told that the act was a response to the 2008 financial crisis, and was intended to prevent similar financial crises in the future, neither the administration nor Congress ever made any effort to determine what actually caused the crisis. Instead, the narrative that drove the Dodd-Frank Act was concocted to achieve an ideological purpose: to impose greater regulation on the US financial system.
Just last week, Treasury Secretary Jack Lew wrote in an op-ed: “Given how far we have come…it is hard to understand the efforts of some to undermine our ability to protect consumers and taxpayers from excessive risks taken by financial institutions.” The false narrative will never be abandoned until the American people know the truth.