Government policies and the subprime mortgage crisis covers the United States government policies and its impact on the subprime mortgage crisis of 2007–2009. The U.S. subprime mortgage crisis was a set of events and conditions that led to the 2008 financial crisis and subsequent recession. It was characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages. Several major financial institutions collapsed in September 2008, with significant disruption in the flow of credit to businesses and consumers and the onset of a severe global recession.
Government housing policies, over-regulation, failed regulation and deregulation have all been claimed as causes of the crisis, along with many others. While the modern financial system evolved, regulation did not keep pace and became mismatched with the risks building in the economy. The Financial Crisis Inquiry Commission (FCIC) tasked with investigating the causes of the crisis reported in January 2011 that: "We had a 21st-century financial system with 19th-century safeguards."
Increasing home ownership has been the goal of several presidents, including Roosevelt, Reagan, Clinton, and George W. Bush.Whitehouse-President Hosts Conference on Minority Home Ownership-October 15, 2002 Some experts say the events were driven by the private sector, with the major investment banks at the core of the crisis not subject to depository banking regulations such as the CRA. In addition, housing bubbles appeared in several European countries at the same time, although U.S. housing policies did not apply there. Further, subprime lending roughly doubled (from below 10% of mortgage originations, to around 20% from 2004 to 2006), although there were no major changes to long-standing housing laws around that time. Only 1 of the 10 FCIC commissioners argued housing policies were a primary cause of the crisis, mainly in the context of steps Fannie Mae and Freddie Mac took to compete with aggressive private sector competition.
Failure to regulate the non-depository banking system (also called the shadow banking system) has also been blamed. The non-depository system grew to exceed the size of the regulated depository banking system,Geithner-Speech Reducing Systemic Risk in a Dynamic Financial System but the investment banks, insurers, hedge funds, and money market funds were not subject to the same regulations. Many of these institutions suffered the equivalent of a bank run,The Economist-Shine a Light-March 25, 2010 with the notable collapses of Lehman Brothers and AIG during September 2008 precipitating a financial crisis and subsequent recession.
The government also repealed or implemented several laws that limited the regulation of the banking industry, such as the repeal of the Glass-Steagall Act and implementation of the Commodity Futures Modernization Act of 2000. The former allowed depository and investment banks to merge while the latter limited the regulation of financial derivatives.
Note: A general discussion of the causes of the subprime mortgage crisis is included in Subprime mortgage crisis, Causes and Causes of the Great Recession. This article focuses on a subset of causes related to affordable housing policies, Fannie Mae and Freddie Mac and government regulation.
Legislative and regulatory overview
Deregulation, excess regulation, and failed regulation by the federal government have all been blamed for the subprime mortgage crisis in the United States."Financial Crisis Inquiry Commission Report"
Conservatives have claimed that the financial crisis was caused by too much regulation aimed at increasing home ownership rates for lower income people. They have pointed to two policies in particular: the Community Reinvestment Act (CRA) of 1977 (particularly as modified in the 1990s), which they claim pressured private banks to make risky loans, and HUD affordable housing goals for the government-sponsored enterprises ("GSEs") — Fannie Mae and Freddie Mac — which they claim caused the GSEs to purchase risky loans,Michael Simkovic, "Competition and Crisis in Mortgage Securitization" and led to a general breakdown in underwriting standards for all lending. As early as February 2004, in testimony before the U.S. Senate Banking Committee, Alan Greenspan (chairman of the Federal Reserve) raised serious concerns regarding the systemic financial risk that Fannie Mae and Freddie Mac represented. He implored Congress to take actions to avert a crisis. The GSEs dispute these studies and dismissed Greenspan's testimony.
Liberals have claimed that GSE loans were less risky and performed better than loans securitized by more lightly regulated Wall Street banks. They also suggest that CRA loans mandated by the government performed better than subprime loans that were purely market-driven. They also present data which suggests that financial firms that lobbied the government most aggressively also had the riskiest lending practices, and lobbied for relief from regulations that were limiting their ability to take greater risks. In testimony before Congress both the Securities and Exchange Commission (SEC) and Alan Greenspan claimed failure in allowing the self-regulation of investment banks. Further, the five largest investment banks at the core of the crisis (including Bear Stearns and Lehman Brothers) were not subject to the CRA or other depository banking regulations, and they did not originate mortgages.NYT-Agency 04 Rule Let Banks Pile Up New Debt-October 2, 2008
The Financial Crisis Inquiry Commission issued three concluding documents in January 2011: 1) The FCIC "conclusions" or report from the six Democratic Commissioners; 2) a "dissenting statement" from the three Republican Commissioners; and 3) a second "dissenting statement" from Commissioner Peter Wallison. Both the Democratic majority conclusions and Republican minority dissenting statement, representing the views of nine of the ten commissioners, concluded that government housing policies had little to do with the crisis. The majority report stated that Fannie Mae and Freddie Mac "were not a primary cause of the crisis" and that the Community Reinvestment Act "was not a significant factor in subprime lending or the crisis." The three Republican authors of their dissenting statement wrote: "Credit spreads declined not just for housing, but also for other asset classes like commercial real estate. This tells us to look to the credit bubble as an essential cause of the U.S. housing bubble. It also tells us that problems with U.S. housing policy or markets do not by themselves explain the U.S. housing bubble."
However, Commissioner Wallison's dissenting statement did place the blame squarely on government housing policies, which in his view contributed to an excessive number of high-risk mortgages: "...I believe that the sine qua non of the financial crisis was U.S. government housing policy, which led to the creation of 27 million subprime and other risky loans—half of all mortgages in the United States—which were ready to default as soon as the massive 1997–2007 housing bubble began to deflate. If the U.S. government had not chosen this policy path—fostering the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high risk residential mortgages—the great financial crisis of 2008 would never have occurred."
In a working paper released in late 2012 to the National Bureau of Economic Research (NBER) (the arbiters of the Business Cycle), 4 economists presented their thesis "Did the Community Reinvestment Act Lead to Risky Lending?" The economists compared "the lending behavior of banks undergoing CRA exams within a given census tract in a given month (the treatment group) to the behavior of banks operating in the same census tract-month that did not face these exams (the control group). This comparison clearly indicates that adherence to the CRA led to riskier lending by banks." They concluded: "The evidence shows that around CRA examinations, when incentives to conform to CRA standards are particularly high, banks not only increase lending rates but also appear to originate loans that are markedly riskier."Did the Community Reinvestment Act Lead to Risky Lending?"<https://www.nber.org/digest/may13/w18609.html> This paper has been criticized as being based a logical fallacy: that claims to "prove causality" are "impossible given their methodology". Additionally it was criticized for not considering an alternate explanation: "that bank officers deliberately make bad loans.""New Economic Perspectives"<http://neweconomicperspectives.org/2013/03/the-latest-failed-effort-to-blame-the-community-reinvestment-act-for-accounting-control-fraud.html>
Deregulation The FCIC placed significant blame for the crisis on deregulation, reporting: "We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets. The sentries were not at their posts, in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves. More than 30 years of deregulation and reliance on self-regulation by financial institutions, championed by former Federal Reserve chairman Alan Greenspan and others, supported by successive administrations and Congresses, and actively pushed by the powerful financial industry at every turn, had stripped away key safeguards, which could have helped avoid catastrophe. This approach had opened up gaps in oversight of critical areas with trillions of dollars at risk, such as the shadow banking system and over-the-counter derivatives markets. In addition, the government permitted financial firms to pick their preferred regulators in what became a race to the weakest supervisor." Similarly, a detailed report by the independent not-for-profit consumer watchdog organizations Essential Information and the Consumer Education Foundation identifies a dozen steps of deregulation that set the stage for the 2007-2008 meltdown, including: the 1999 repeal of the Glass-Steagall Act, which had prohibited commercial banks from undertaking investment banking operations (and vice versa); repeal of regulations banning off-balance sheet accounting practices, which entail accounting maneuvers that enable financial institutions to cloak their liabilities; preventing the Commodity Futures Trading Commission from regulating derivatives; the prohibition by the Commodity Futures Modernization Act of 2000 of the regulation of derivatives; adoption in 2004 by the Securities and Exchange Commission of "voluntary regulation" for investment banks; adoption of rules by global regulators to allow commercial banks to determine their own capital reserve requirements; refusal by regulators to prohibit rampant predatory lending and their ceasing of the enforcement of regulations that were already on the books that banned such lending practices; preempting, by federal bank regulators, of state consumer laws that restrict predatory lending; federal rules preventing victims of predatory lending from suing financial firms that purchased mortgages from the banks that had issued the original loan to the victims; expansion by Fannie Mae and Freddie Mac into the subprime mortgage market; ignoring of traditional anti-trust legal principles and thus allowing financial institutions to continue to expand and to merge, which led to the emergence of huge banking conglomerates that were deemed "too big to fail;" allowing private credit rating companies to score incorrectly the risks associated with mortgage-backed securities despite their conflicts of interest; the 2006 enactment of a statute to restrict regulation by the SEC of financial institution.