Political Incentive for Home Ownership
If we were to read any newspaper articles or access any media reports post the subprime mortgage debacle, we were sure to find the banks and other corporations being blamed. Corporate greed was the highlighted fact in this financial catastrophe. However, there was a neglected aspect too.
Many commentators have believed that corporate greed was not the starting point of this crisis. Instead, the starting point was based on political motives. In simple words, that is to say that the government is as responsible for the subprime crisis as the banks were, if not more!
Lets explore this point of view and the debate surrounding it in this article.
Community Reinvestment Act
The center point of the case against the government has been a legislation called the Community Reinvestment Act. This legislation was not new in the nineties or early 2000s. Rather it was enacted by President Jimmy Carter in 1997. However, until Bill Clintons regime, it was like a toothless tiger. Bill Clintons government made drastic changes to this act. Many commentators believe that these changes were what ended up in the disaster a few years later. Lets have a closer look at the Community Reinvestment Act
- Alleged Discrimination: There were allegations from many political leaders that banks were redlining certain neighborhoods. Redlining meant drawing an imaginary line around certain neighborhoods and refusing to grant loans and other financial services to the residents who stayed there. Most of these neighborhoods were inhabited by minorities like African Americans and Hispanics. Therefore, there was a widely held belief that the White people in charge of the banks were doing this redlining on purpose to keep the minorities oppressed.
Banks have reacted to this allegation by denying it vehemently. They stated that their lending practices did not have any ulterior racial motives. They were lending more and more to minorities such as Asian Americans and Indian Americans. Banks expressed their concern over the crime rates and lifestyle in these neighborhoods. They were of the opinion that lending to the residents of these neighborhoods regardless of their race was a risky proposition. Hence the redlining which was meant to justify the increased risk.
- Lower Lending Standards: The banks arguments did not go down too well with the government. The government looked at some statistics which stated that while 89% of the loan applications were approved for white borrowers there acceptance rate was only 72% for the minorities such as African Americans and Hispanics. Therefore the government ordered the banks to lower their lending standards as a part of incorporating the minorities more into the financial system.
One of the biggest issues surrounding this debate was the fact that many African Americans and Hispanics did not have a regular job. Therefore there was no job history to verify and mitigate the risks. Documents such as salary slips were not available for many of these people. The government therefore ordered the banks to accept self verified statements of income from these borrowers and make loans accordingly! This practice was under heavy criticism later when the crisis unfolded and lower lending standards were blamed.
- Norms to be Met: The governments directions on this lending were legally binding. Banks were subject to regular audits regarding the race of the borrowers they lend to. A certain minimum percentage had to be from the minority community. If these standards were not met, banks were penalized monetarily and the growth of their branches was stalled. Hence, banks had no option but to comply with these lending standards.
The government interference with bank lending did not stop with the Community Reinvestment Act. They had created three special quasi government agencies called Freddie Mac, Fannie Mae and Ginnie Mae. The job of these agencies was to buy loans from the commercial and trust banks and then securitize them. These agencies played a huge part in the crisis and left the taxpayers pockets short by billions of dollars. However, we will discuss that in detail in the next couple of articles.
When the subprime mortgage crisis actually occurred, there was wide spread debate about the true cause. When Community Reinvestment Act was brought into question, some of the proponents of this act, particularly the minorities reacted by vehemently lashing out facts. A couple of them are as follows:
- Commercial Loans: A big chunk of the loans that went bad were subprime commercial mortgage loans. This means they were used to finance commercial real estate and not residential which was under the purview of the Communities Reinvestment Act. Hence, they believed that the banks were making false accusations and deflecting blame since the government never forced them to make bad commercial loans!
- Statistically Invalid: Also, minority leader pointed out to the lack of statistical evidence to back up the claims being made against the legislation. They stated that the rates of delinquency amongst minority borrowers were only 6% higher than the Whites and hence the blame cannot be laid on the act. A wide variety of such statistics were exchanged back and forth. However, nothing has been conclusively proven.
The United States government had made home ownership a highly politicized agenda. The government was literally forcing people to buy homes and made home ownership a measurable fact which was used by leaders in their election campaign.
Well, it cannot be proven with facts that such government policies were indeed responsible for the crisis. However, it definitely raises a question? Is it the governments job to assist people in obtaining houses? Or is it an issue best left to the markets?
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- Subprime Mortgage Crisis: An Introduction
- Dot Com Bust: Starting Point of Subprime Mortgage Crisis
- Political Incentive for Home Ownership
- The Case Of Freddie Mac, Fannie Mae and Ginnie Mae
- Advantages to Freddie Mac, Fannie Man and Ginnie Mae
- Types of Mortgages
- Types of Mortgages from Borrowers Point of View
- Mortgage Products - Negative Amortization & Home Equity Line of Credit
- The New Mortgage Landscape
- The New Mortgage Landscape: Conflict of Interest
- New Age Financial Securities - Mortgage Backed Securities & Credit Default Swaps
- Collateralized Debt Obligations and Tranching
- Benefits of Collateralized Debt Obligation (CDOs)
- Subprime Crisis: Problems Caused by Accounting
- The Self Reinforcing Housing Loop
- Integrated Financial Systems
- Credit Market Freeze
- Borrower Approach vs Collateral Approach
- How Reverse Mortgage Works ?
- Reverse Mortgage: Pros and Cons
- The Big Bust Washington Mutual (WaMu)
- General Motors and the Subprime Crisis
- The Return of Subprime Mortgages
- The Big Subprime Bust
- Executive Compensation and Sub-Prime Mortgage Crisis
- The Big Fall: Lehman Brothers
- The Big Fall: Bear Stearns