Fannie and Freddie tab is $146B and rising

USA-1 said:

To blame the meltdown on the Community Reinvestment Act is totalt nonsense. The sub-prime debacle has many causes, including greed, lack of and ineffective regulation, failures of risk assessment and management, and misplaced optimism. But CRA is not to blame.

First, the timing is all wrong. CRA was enacted in 1977, its companion disclosure statute, the Home Mortgage Disclosure Act (HMDA) in 1975. While many warned against bad subprime lending before the turn of the millennium, the massive breakdown of underwriting and extension of risky products far down the income scale-without bothering to even check on income-was primarily a post-2003 phenomenon. To blame a statute enacted in 1977 for something that happened 25 years later is quite a stretch.

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Secondly the punishment for being in the bad books of the CRA is to have a review done of its standing according to the CRA and use that information as part of decision making regarding allowing mergers or takeovers to occur. It did not prevent mergers but was only taken into consideration when wanting to merger or takeover other banks.

Also companies like Countrywide, Ditech etc, the ones that made the majority of subprime loans were not subject to the CRA to begin with

USA-1 said:

Actually it was a short process. Greenspan lowered interest rates and Bush tried to make everyone a home owner. The chart proves it.
I work in the housing industry and we trippled our workforce after 9/11 to keep up with the artificial demand created by those two boneheads.
It should have never happened.

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When specifically were the feds interest rates too low? The fed does not look at specifically housing inflation when they decide monetary policy. So when was the fed funds interest rate so far out of line that it was causing an obvious harmful level of inflation in the CPI?

Also, banks don't decide the 30 year fixed morgage rate by looking at the overnight federal funds rate either. They determine the interest rate based on inflation expectations and demand for securities. The fed does determine monetary policy so lets focus on inflation. If interest rates were "too low" in the housing market this implies expectations for inflation were low at the time. Doesn't this seem to contradict your claim that the fed funds rate was "too low," since this would be causing unneeded inflation?

drz-400 said:

When specifically were the feds interest rates too low? The fed does not look at specifically housing inflation when they decide monetary policy. So when was the fed funds interest rate so far out of line that it was causing an obvious harmful level of inflation in the CPI?

Also, banks don't decide the 30 year fixed morgage rate by looking at the overnight federal funds rate either. They determine the interest rate based on inflation expectations and demand for securities. The fed does determine monetary policy so lets focus on inflation. If interest rates were "too low" in the housing market this implies expectations for inflation were low at the time. Doesn't this seem to contradict your claim that the fed funds rate was "too low," since this would be causing unneeded inflation?

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Depends on how you measure inflation, and where the money that is being created from "too low "interest rates is going. If the measurement of inflation does not take into account the direct rise in housing prices the inflation rate will not pick up on that part of the economy that is inflating.

As for the period of too low interest rates

Try late 2001-2005. 2005 if I recall correctly was the time when the fed started to raise rates fairly aggressively.

Lord Tammerlain said:

Depends on how you measure inflation, and where the money that is being created from "too low "interest rates is going. If the measurement of inflation does not take into account the direct rise in housing prices the inflation rate will not pick up on that part of the economy that is inflating.

As for the period of too low interest rates

Try late 2001-2005. 2005 if I recall correctly was the time when the fed started to raise rates fairly aggressively.

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2001 - 2005 we were recovering from a recession. There was a negative output gap and cyclical unemployment. Furthermore the inflation rate as measured by the CPI was like at or under 2% (with the exception of late 2002 - early 2003) until mid 2004. After mid 2004 there was a jump in inflation, the output gap was almost gone, we were settling near the natural rate of unemployment, and the fed began raising interest rates.

By looking at the taylor residuals one could see that the fed set their interest rates lower than this rule would suggest. Now if we use other measures of inflation other than the headline CPI number, maybe the core cpi or the feds alternate calculation, or the gdp deflator the residuals become smaller. Nothing says the fed has to or should follow the taylor rule, but it can be used as a rule of thumb when speaking of these things. But if we take for granted, the feds rates were too low because they were lower than the taylor rule, there is no evidence this would have changed the outcome of the housing bubble. Consider some evidence from the rest of the world:

NolaMan said:

Fannie didn't actually make the loan, but they bought the loans and essentially insured them, and they got tax incentives to do so. According to the WSJ, in 1996, HUD set a goal for Fannie Mae and Freddie Mac that at least 42% of the mortgages they purchase be issued to borrowers whose household income was below the median in their area. This target was increased to 50% in 2000 and 52% in 2005.

Before this, beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate income borrowers.

I think it is dodging the issue to argue that Fannie did not give any of these loans, and ignore that they were were basically required by the government to purchase billions of dollars worth of these loans, thus driving up demand.

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Fannie and Freddie dealt with conforming loans, so of course they lended primarly to low and middle income borrowers.

Of course they drove up demand. Why else would we securitize loans made by banks? Banking without securitization became unprofitable in the mid 1980's.

drz-400 said:

Fannie and Freddie dealt with conforming loans, so of course they lended primarly to low and middle income borrowers.

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And ultimately those who really should never have gotten a loan to begin with.

Of course they drove up demand. Why else would we securitize loans made by banks? Banking without securitization became unprofitable in the mid 1980's.

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So, driving up demand for loans that should never have been made is not a good thing, especially when it all hits the fan so to speak.

NolaMan said:

And ultimately those who really should never have gotten a loan to begin with.



So, driving up demand for loans that should never have been made is not a good thing, especially when it all hits the fan so to speak.

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I regret using the word demand. If demand for home loans was what was driving the increase in quantity of loans we would have seen interest rates increase, and judging by the size of the bubble, they would have done so considerably. I think a larger component of the financial crisis did not come from demand for loanable funds.

Lets look at the CPI (base year 1983/84). I think in most places the peak house prices were in mid 06. Lets start at year 2002 since this is when the trend for home prices really began steepening and the bubble first started to take shape.
CPI Jan. 2002:177.1
CPI jun. 2006::202.9

((202.9 -177.1)/177.1)x100 = 14.568/4 = 3.642

So inflation average inflation was 3.62% per year.

The nominal interest rate for a 30 year home in 2002 was around 7%. In jun 2006 it was around 6.5%.

So the real interest rate in 2002 was 3.38% and in mid 2006 it was 2.88%. Real interest rates declined. This suggests that an the supply of loanable funds was increasing. This seems strange considering the US national and personal savings rates were not really at very high levels. So I would suggest that large capital inflows (as a result of our large current account defecit) resulted in this increase of loanable funds. The interest rate dropped because of a shift in the supply curve, more loans were made at lower interest rates. This caused a shift in the demand for houses to right and an increase in house prices. Thats my theory for the housing bubble. Subprime of course played a role, fannie and freddie were involved, but they were all part of a much bigger picture. This in my opinion is why we saw housing bubbles arise in a large part of the rest of the developed world as well.