No Good Deed Goes Unpunished?

By now you’ve probably heard about the lawsuit the Federal Housing Agency has brought against 17 banks for allegedly selling fraudulently valued mortgages to investors during the housing boom. The lawsuit specifically targets mortgage-backed securities bought by Fannie May and Freddie Mac, two government sponsored entities (GSE), who are partially nationalized banks. The level of stink and hypocrisy that exists on these lawsuits is vomit-inducing.

Fannie and Freddie were established at different times, but their initial purpose was to provide local banks with federal money to help finance home mortgages so as to increase levels of home ownership and affordable housing. During the early 90’s, Congress voted to change the charter of Fannie and Freddy to require that these GSE’s meet “affordable housing goals”, which were established (and increased) each year by HUD and approved by Congress. During the late 90’s there was heavy pressure on the GSE’s to increase their portfolios with greater numbers of inner-city originating loans which were already targets of the Community Reinvestment Act (in a nutshell, the CRA was the private sector equivalent of HUD mandates, specifically targeting communities and classes of people politicians considered “underserved”). Private banks were already feeling the pinch of the CRA requirements, so they pressured the GSE’s to reduce the lending standards of the mortgages they’d provide financing for, which the GSE’s did, and thus began the push into subprime lending.

Due to the historically low interest rates (as established by the Federal Reserve) and a desire to maintain earnings, during the early 2000’s the banks had to increase the quantity of loans, which meant heavily reducing underwriting standards and changing the loan products offered, products the GSE’s wouldn’t initially finance (aka securitize). Once the GSE’s realized they were losing some significant market share to private label securitization companies (typically investment banks), the GSE’s reduced their standards to compete and started a huge buying spree of these riskier, more profitable securities -- ARMs, interest-only loans, negative amortization loans, etc... Because of the huge increase in the supply of cheap financing, interest rates started to rise. When these loans began to reset, the borrowers couldn’t afford the new payments. And due to a lack of equity in their homes (many purchased homes with 100% financing) they couldn't re-finance either, so the homeowners were forced to default. Those defaults pushed down the price of homes, which accelerated the decline, and the rest is recent history.

The sad part is that a degree in rocket science wasn't necessary to figure out this was coming. Alarm bells were being sounded as far back as 1999, and yet in 2005 Representative Barney Frank, faced with pressure to reform the GSE’s, stood in front of Congress proclaiming the soundness of both the GSE’s and the housing market itself, claiming the housing market was not going to be another dot com bubble. Other prominent politicians who shared Frank’s view included Rep. Christopher Dodd, then-Senator Obama and then-Senator Clinton. Where’s their culpability in all this? Why aren’t we holding them publicly responsible for their actions? They’re as guilty as the bankers, if not more so. Public servants are supposed to be held to higher standards than those of us in the private sector.

I have no doubt that the diminished lending standards adopted by the banks, the desire for a quick buck, and the belief that home prices would never drop lead to a great deal of fraud; and I have no problem with lawsuits being filed regarding the perpetration of fraud. What I do have a problem with is the hypocritical position of the government filing the lawsuit. Our government set the stage for all this to happen. They’re the ones who forced the banks to lend to people that wouldn’t have qualified for a mortgage under normal conditions. They’re the ones who kept the interest rate at historic lows allowing for a flood of capital to enter the market. Their partial ownership of the GSE's empowered them to interfere with the housing market, but at the same time opened the US taxpayer to massive liability (we've given more bailout money to Fannie and Freddie than any other private bank that has been lambasted in the news). And when the whole thing blew up in our collective faces, only capitalism and the private banks are blamed. The message here is whether you do or don't do what the government says, you'll suffer the consequences.