Home ownership and mortgage crisis

Freddie Mac and Fannie Mae are now off the big board. These two entities were the main power for many to realize their American Dream. Now they are gone after the mortgage crisis. We can't help to thoughts who caused whom, the crisis or the entities? A brief history of US home ownership policies may help to think. Nonetheless, it is not easy to answer.


In 1918, the government encouraged middle class home ownership by "Own Your Own Home" campaign. Home ownership or further, real estate investment, was considered a hedge against inflation. Home ownership rose from 40% in 1940s to 65% around 1990s, when a plateau was reached around 1960s. The peak was in mid 2004 with 69.4%. This is attributed to government-back mortgage plan. We should look at the trend more closely.
Prior to 1994, home ownership hovered around 64% constantly. After 1994, it started moving upward consistently.

When the first President Bush was in power, a bipartisan effort to increase home ownership was proposed to meet the goal of American Dream Downpayment Initiative. This initiative went into law officially in 1993 when President Clinton came to power. No administration would oppose such proposal. The law allowed to provide up $200M to support home ownership among low-income first-time home buyers by helping to pay closing costs and down payments. Such policies were attributable to pressure on the Department of Housing and Urban Development (HUD) to implement them.


Sooner or later, conservative lending rules gave ways to "creative" ones. Starting from 3% mortgage to 0% mortgage, more and more mortgage banks hurried to provide loans to low-income households and especially minorities. Adding to the tide, arguably, the change of the Community Reinvestment Act of 1977 also played a role, in which banks were rated based on how much lending they did in low-income neighborhoods. Good CRA's are important for banks to get approval from regulators to sign off mergers, expansion, and branch openings. Around the time, Fannie and Freddie were pushed to allow previously disqualified customers to be qualified for loans. Also, securitization of subprime loans was allowed since then.

To flow such pressure more efficiently, the first such securitization of subprime loans, about $385M, was underwritten in Oct 1997 by now defunct Bear Sterns and First Union Capital Markets (now became Wells Fargo). Freddie and its AAA rating guaranteed the payments on the securities. Suddenly, the risk of low-income households on mortgage shifted to investors because of this. The performance of these securities was so great: its return was about 7.5% compared to low interest rate from the Fed. Banks flurried into deals like that.


Let's see what statistics says about home ownership in big cities to see who actually can afford it. The data is from Federal Reserve Bank. For example, in San Diego, home ownership dropped to 55% from the peak of 63%. But households with positive equity in their homes were between 35% and 39%. A worse case is Las Vegas, where only 15% to 19% home owners have positive equity out of total 59% total owners. Such puffy data, not surprised, can be linked to high foreclosure rate in Las Vegas.

However, HUD denied the role of loosening lending roles along the path. It is really not a one-man show: see how many bankers got rich from CDO's and MBS's. What apparent is that the policies were skewed and the death of Fannie and Freddie. CRA's should be under review, for example, as a lesson learned from the crisis.