American Dream, Recurring Nightmare

Mortgage Meddling and Moral Hazard


In response to the U.S. government gearing up to go to war in Iraq again, in spite of the disastrous failure of the last war, Justin Raimondo recently tweeted: “American foreign policy is a recurring nightmare.”

The same, unfortunately, can be said for American economic policy as well. The Obama administration seems intent on making a recurring nightmare out of the Inception-style, artificially-induced “American Dream” of widespread government-supported home ownership.

The Department of Housing and Urban Development (HUD) announced in a press release earlier this month that “Preserving the Dream” was this year’s theme for “National Homeownership Month.” The press release is replete with both the right- and left-wing variants of “American Dream” rhetoric—the “Ownership Society” palaver of the Bush years and the egalitarian pandering of the Clinton era—all to justify continuing the disastrous policy of artificially expanding housing credit to as many people as possible, on the easiest terms possible. In particular, it highlighted its “Blueprint for Access” (BFA) document that it released earlier in the year, “outlining the additional steps the agency is taking to expand access to credit for underserved borrowers.”

This is all in keeping with the policy direction that the Obama administration announced over a year ago through its mouthpiece The Washington Post, in an article titled “Obama administration pushes banks to make home loans to people with weaker credit.”

The Federal Housing administration (FHA) offers lenders taxpayer-backed insurance against defaults for certain mortgages. However, HUD and the Justice Department have, especially since the housing crash, undertaken investigations of loans that go bad, and have, in addition to other penalties, withheld coverage from lenders if they uncover wrongdoing (the BFA calls these “back-end enforcement actions”).

The Obama administration, as expressed in the article, was concerned that such potential “desocialization” of losses was causing banks to add stricter requirements (known as “credit overlays”) that were restricting credit access to “underserved” (i.e., potentially insolvent) borrowers. Such a restriction is abhorrent to the administration, who wants to open the “American Dream” to as many people as possible so as to “help power the economic recovery.” So, as the WaPo article states:

“The FHA, in coordination with the White House, is working to develop new policies to make clear to banks that they will not lose their guarantees or face other legal action if loans that conform to the program’s standards later default. Officials hope the FHA’s actions will then spur Fannie [Mae] and Freddie [Mac] to do the same.”

The BFA refers to these FHA policies as “enhancements to our quality assurance processes.” (Emphasis added below.)

We want to work with lenders to provide clarity and transparency in FHA’s policies to encourage lending to qualified borrowers across the credit spectrum. We believe changing the way in which we provide policy direction and monitor lender compliance and performance better protects FHA and reduces uncertainty for lenders in their interactions with HUD. Our initial efforts are paying-off as some lenders are already beginning to reduce credit overlays.
As more lenders move in this direction, we want to create a policy and quality
assurance framework that ensures that underwriting quality and compliance with FHA’s requirements sufficiently protect FHA from manufacturing risk.

So basically, the FHA wants to maximize lending “across the credit spectrum” (especially, of course, to the “lower wavelengths” of that spectrum) by hand-holding lenders through compliance issues on the front-end (as opposed to “back-end enforcement”) so that they can (as the BFA says elsewhere) “confidently originate loans for a larger number of FHA-eligible borrowers.”

This, according to the BFA, keeps the FHA from “manufacturing risk” for the lenders. Of course, what the policy really does is “manufacture risk” for the taxpayer by shifting the loan portfolio risk away from lenders and onto us. It does this by making sure that, as much as possible, not a single socialized-risk, subprime loan goes unmade. They want to make it as easy as possible for lenders to put taxpayers on the hook.

This is all very ominous, because it is moral hazard that helped precipitate the last housing bubble and crash, which in turn inaugurated the financial crisis we are still suffering through. The implicit taxpayer backing of the mortgage GSEs (government-sponsored enterprises) Fannie Mae and Freddie Mac, as well as the “Too Big To Fail” philosophy underpinning the “Greenspan Put” and, later, the “Bernanke Put,” made mortgage lending (especially through mortgage-backed securities) seemingly a No Lose Bet. The bet had a tremendous upside of privatized profits (mortgage GSE shares paid dividends and were traded on the NYSE, and thanks to legislation during the first Bush administration, they were allowed to hyper-leverage their balance sheets), and almost no downside, thanks to the implicit guarantee of socialized losses in the case of major default.

This made the housing industry the Go-To Place for much of the Fed’s swelling sea of money sloshing around. The Fed’s inflation (although nothing compared to the quantitative easing going on now and since 2008), in unsustainably bidding down interest rates, overpriced future durable-good services, resulting in the the overpricing of homes anyway. But the moral hazard made this overpricing even worse, exacerbating the bubble.

Also exacerbating the bubble was the constant “American Dream” pressure, through both policy and jawboning, to lower mortgage lending standards of that era, on the part of both the Clinton administration (especially the “National Homeownership Strategy” at HUD, and the resuscitation of the Community Reinvestment Act) and the second Bush administration (especially the “Ownership Society” push).

Money-printing, “American Dream” policies and rhetoric, government-lowered lending standards, and moral hazard; this is a nightmare we’ve had before.

One clap, two clap, three clap, forty?

By clapping more or less, you can signal to us which stories really stand out.