Jack was renovating his bathroom. As he was working on the plumbing, his neighbor Sam stopped by. Sam was a very helpful fellow, and offered to assist Jack with the plumbing repairs. Jack was a bit skeptical about Sam’s plumbing experience since plumbing problems can be very expensive to fix, but Sam was positive that he knew what to do to help, so Jack handed him a wrench.
It soon became obvious to everyone but Sam that Sam’s efforts were causing real problems. When Jack noticed leaks in the pipes Sam was working on, and mentioned them to Sam, the only response he got was a preoccupied nod. Eventually, the leaking water began dripping through the ceiling from the bathroom into the kitchen. Now, not only did Jack have to go back and fix the improperly installed pipes in the bathroom, he had to replace part of his kitchen ceiling as well. Sam’s response to the increased damage was to insist that he help because he knew all about ceilings.
Sound like the plot of a National Lampoon movie on home ownership?
Unfortunately for the U.S. economy, this is exactly what has happened with the housing market.
The American banking industry has managed mortgages throughout our nation’s history. The price of housing historically had risen or fallen at about the same rate as the rest of the economy. The banks, which had to bear the risk for their loaning decisions, had developed and implemented standards for determining a prospective borrower’s ability to pay and had been issuing mortgage loans based on those standards.
In the 1970’s the government decided that those standards needed to be relaxed so folks who had not been able to get mortgages could do so. The Community Reinvestment Act (CRA) was passed in 1977, and banks were required by the federal government to market and grant loans to borrowers who had previously been ineligible. The bill also allowed banks to have one of 2 Government Sponsored Enterprises (Fannie Mae and Freddie Mac) underwrite the loans to soften the risk. In the debate over the passage of the bill, the banks testified that it would create a financial disaster.
The government did not listen.
In the 1990’s, new regulations were added to the Act. These regulations not only required banks to offer more and higher-dollar risky mortgages, they required the banks to actually write a specified number of these loans, with stiff penalties if they did not comply. This created an artificial bubble in the housing market, driving prices so far beyond inflation rates that many new home buyers found themselves with mortgages they couldn’t pay. Fannie Mae and Freddie Mac were restructured to allow them to cut their capital reserve requirements by 75%, so banks passed the loans to them. By 2007, these two groups owned or guaranteed nearly half of the U.S. mortgages – the bottom half.
Many people, inside Washington and in the banking industry itself, have been pointing to the growing problem for over 5 years. The government did not listen.
Instead, the Congress decided to give itself a 5 week vacation this summer.
Now there is a crisis – and the same government that created the problem by invading the banking industry is telling us that they can be trusted to fix it.
Perhaps they also know how to fix a kitchen ceiling.