How the US government stoked the subprime mania

July 31, 2012

Free Market Foundation

Many believe that wild greed and market failure led America into this sorry mess. What is missing is the role politicians and policy makers played in creating artificially high housing prices, and artificially reducing the danger of extremely risky assets, says Russell Roberts, a professor of economics at George Mason University and a scholar at the Mercatus Center.

Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate-income borrowers:

For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target 42 per cent of their mortgage financing had to go to borrowers with income below the median in their area; the target increased to 50 per cent in 2000 and 52 per cent in 2005.

For 1996, HUD required that 12 per cent of all mortgage purchases by Fannie and Freddie be “special affordable” loans, typically to borrowers with income less than 60 per cent of their area’s median income.

That number was increased to 20 per cent in 2000 and 22 per cent in 2005; the 2008 goal was to be 28 per cent.

Between 2000 and 2005, Fannie and Freddie met those goals every year, funding hundreds of billions of dollars worth of loans, many of them subprime and adjustable-rate loans, and made to borrowers who bought houses with less than 10 per cent down.

By pressuring banks to serve poor borrowers and poor regions of the country, politicians could push for increases in home ownership and urban development without having to commit budgetary dollars. Another political free lunch, says Russell.

What can we learn from this, asks Russell? Beware of trying to do good with other people’s money. Unfortunately, that strategy remains at the heart of the political process, and of proposed solutions to this crisis.

Source: Russell Roberts, How Government Stoked the Mania; Housing prices would never have risen so high without multiple Washington mistakes, Wall Street Journal, October 3, 2008.

For text: http://online.wsj.com/article/SB122298982558700341.html

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 07 October 2008