BANKTHINK

Regulation – Not Lack Thereof – Led U.S. into Financial Crisis

Pundits and politicians, including President Obama, used the recent anniversary of the Lehman Brothers collapse to once again blame a lack of government regulations for causing the financial crisis.

The great tragedy of the financial crisis, however, was not that Washington regulations failed to prevent it, but instead that Washington regulations helped lead us into it.

Federal policies designed to expand homeownership in an "off-budget" fashion encouraged lending to people who bought homes they could not afford to keep. Perhaps not surprisingly, a federal government which lives beyond its means tragically encouraged American families to do the same.

One of the most damaging of those initiatives has been the Community Reinvestment Act, which was undertaken with good intentions but is today in need of repeal. Proponents of CRA-like mandates have maintained that only a small portion of subprime mortgage originations are related to the CRA. However, though they may be small in volume, CRA loan mandates remain large in precedent. They inherently required lending institutions to abandon their traditional underwriting standards to comply with this government mandate. CRA implicitly put the government's "Good Housekeeping Seal of Approval" on such loans.

Along with CRA, no one should forget the central role Fannie Mae and Freddie Mac played in sparking the crisis. These private companies were awarded monopoly powers by Congress in exchange for meeting certain affordable housing goals. Fannie and Freddie exploited their congressionally granted charters to borrow at discounted rates and ultimately dominated the secondary mortgage market. They wildly inflated their balance sheets and personally enriched their executives via implicit (now explicit) government backing not to mention via the cooked books that allowed politically connected executives to make off like bandits with what their regulator described as "ill-gotten bonuses in the hundreds of millions of dollars."

Given their prominence in the market, investors and underwriters came to believe that if Fannie or Freddie touched a loan, it was safe, sound, secure and most important, "sanctioned" by the government.

More than 70% of subprime and alternative-A mortgages that led to the crisis were backed by Fannie and Freddie, the Federal Housing Administration and other taxpayer-backed programs. If anyone is looking for a root cause of the financial crisis, this is it.

Yet, despite the inherent dangers in such transactions, Fannie and Freddie's congressional supporters encouraged them to roll the dice a little bit more. Well, they did, and the result was the mother of all bailouts nearly $200 billion and the worst financial crisis since the Great Depression.

But when it came time for Congress to address the crisis, the Democrats produced a bill that failed to tackle its root causes. Nowhere in the Dodd-Frank Act's 2,300 pages will you find one single reform to Fannie or Freddie. Instead, Dodd-Frank leaves them in a state of perpetual federal conservatorship. As a result, hardworking taxpayers today back nine of every 10 new residential mortgage securitizations and taxpayers are on the hook for more than $5 trillion in mortgage guarantees.

What you will find in Dodd-Frank, however, are provisions that make bailouts permanent, enshrine "too big to fail" into law and give Washington bureaucrats more power, more authority and more control over personal financial decisions that Americans should be making for themselves. Dodd-Frank will prove to be every bit as far-reaching in its harmful consequences as the Democrats' radical plan for "fixing" the nation's healthcare system Obamacare.

While Democrats were voting for Dodd-Frank and its 400 new regulations, they were voting against the alternative put forth by House Republicans: the Consumer Protection and Regulatory Enhancement Act. Our proposal would have ended taxpayer bailouts and restored market discipline. It would have put the government-sponsored enterprises on the path away from taxpayer reliance and transitioned our secondary mortgage market toward free market competition and it would have streamlined the complex regulatory structure for enhanced enforcement of consumer protection laws and safety and soundness.

So five years after the crisis and three years after the passage of Dodd-Frank, where do we go from here?

For starters, both parties and the president should work together to create a sustainable housing finance system, end the bailout of Fannie and Freddie and phase out their failed business model. That's exactly what House Republicans have proposed to do with the PATH Act, which stands for Protecting American Taxpayers and Homeowners.

The PATH Act passed the Financial Services Committee in July. It creates a sustainable housing finance system by limiting government control of the mortgage market, putting private capital at the center of the mortgage system and giving homebuyers more informed choices about their mortgage options. The PATH Act includes reforms to save the FHA from insolvency and preserves the 30-year fixed-rate mortgage. In fact, for the first time the FHA would be specifically required to offer a 30-year fixed-rate insurance product under the PATH Act.

The PATH Act is our best chance to create a housing finance system that is sustainable for homeowners, taxpayers and our economy.

Rep. Jeb Hensarling, R-Texas, is chairman of the House Financial Services Committee.

Comments (22)
greed-gentleman is a much overlooked factor. no risk--not one person has been found guilty of any violation during the mortgage crisis.

with Corker style bill in place very little of this would have happened.

look at the most recent Title One stats and this will prove me right.


allen hardester
410-997-1115
Posted by ahardester@verizon.net | Tuesday, September 24 2013 at 12:54PM ET
I agree with getting rid of CRA since it's inception it has caused many financial institutions a great amount of concern/harm (remember ACORN). The government pressing everyone to make loans to the underserved/underbanked population, that in most cases did not deserve/qualify for a mortgage in the first place, created justification for lose standards and 100% financing. (this was the beginning of the sub-prime mess)I disagree however, with phasing out FNMA FHLMC and creating the so called PATH Act by putting "private capital" at risk. The Big Banks would simply step in and control the marketplace increase price, dictate terms,make the rules and no one would be safe from the greed factor.
Posted by mtgbk | Tuesday, September 24 2013 at 1:33PM ET
Hensarling has the story right. It's too bad the Reagan Administration didn't end the GSEs as the President's Commission on Housing recommended when it was still feasible.
Posted by kvillani | Tuesday, September 24 2013 at 1:54PM ET
Fannie and Freddie have been a disaster for MANY years. Their leadership and management have been very weak and overpaid,and their lack of sound lending standards has devastated the mortgage marketplace. Unfortunately, much of their terrible underwriting was encouraged by the politicians who thought everyone should own a home-whether they could afford it or not.
It will take years-and a strong political will- to re-balance the mess they created.
Posted by Big Bob | Tuesday, September 24 2013 at 1:57PM ET
I am so tired of reading this right-wing fable. If the mortgage crisis was caused by forced lending to poor peole (read minorities), how do you explain that the worst hit areas were Las Vegas, Phoenix and Miami? Sure there are plenty of poor people there, but the majority of defaults were by amateur and profesional "flippers" not poor families who owned homes they "shouldn't have." I'll grant you there were a lot of those, but for every Detroit there was an Atlanta where commercial real estate speculators failed in droves. Or homes out ion the Califonia desert.

You might also look on the default rates among mortgage pools. If the GSEs were to blame, why were the highest default rates in mortgages generated and packages by Wall Street firms?

Look, failure is an inherent part of capitalism. It's not a bad thing. Accept it.
Posted by FrankBird | Tuesday, September 24 2013 at 2:02PM ET
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