The Government's Perfect Storm Caused the Financial Crisis

Kevin Villani's post "Yes, Subprime Crisis Was Government's Fault," did a superb job describing the U.S. government's housing policies and regulatory lapses that precipitated the financial crisis. But the problematic policymaking and regulatory inaction began well before 2002 and have been far more miscalculated.

At the end of September 1999, Fannie Mae capitulated to pressure from then-President Bill Clinton to ease the credit requirements on the loans it purchased.  Clinton's social agenda called for expanding homeownership amongst low- and moderate-income consumers.  He wanted banks to grant mortgages to consumers whose incomes, credit ratings and savings were not sufficient enough to qualify for conventional loans.  And he wanted those loans to require less money upfront.

In other words, the then-President wanted banks to make loans to people who could not afford them under credit criteria that had been proven over decades.  He wanted people to get into the loans with little or no money down.  And, he wanted banks to be able to dump the resulting junk off onto Fannie Mae and the other government-sponsored entities (GSEs).

At the time, Peter Wallison, then a resident fellow at the American Enterprise Institute, warned that, if  the GSEs failed, "the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry."

The following year, Federal Reserve governor Edward Gramlich warned that national banks were caught up in a mortgage frenzy and were contracting with nonbank lenders to lure huge numbers of low-income consumers into risky subprime loans. But he was unable to convince Fed chairman Alan Greenspan to stop fueling the housing market with historically low interest rates and investigate these growing mortgage-sourcing networks.

In 2001, then-Treasury undersecretary Sheila Bair tried to get subprime mortgage lenders to curb their high-risk programs and adopt a code of "best practices."  She also wanted them to let outside monitors verify their compliance.  Not surprisingly, the banks largely ignored her efforts.

In 2003, the Office of the Comptroller of the Currency began a pattern of invoking federal preemption to shield national banks' mortgage operations from state consumer protection laws, starting with the Georgia Fair Lending Act.  The OCC denied national banks were engaged in predatory lending and accused the states of enacting "very complicated laws that they applied not only to wrongdoers but to all sorts of institutions, including national banks."

Then New York State attorney general Eliot Spitzer warned that the OCC was providing "a road map to the bad guys on how to avoid prosecution and enforcement."

By 2004, the FBI was warning that the explosion in subprime mortgage lending, fueled by artificially low interest rates "was starting to attract shady operators and billions in losses were possible." The FBI official in charge of criminal investigations said, "it has the potential to be an epidemic." The government's response to his predictions was to continue cutting the FBI's budget to the point that, by 2007, it had barely 100 agents pursuing mortgage fraud.

So despite warnings of the potential dire consequences, a steady stream of government policies enabled and encouraged banks to make mortgages to people who could not afford them. Federal financial regulators protected banks' ill-conceived mortgage programs from state consumer protection laws.  Banks could unload their junk loans to Fannie Mae or to Wall Street.  And the Federal Reserve fueled the whole process with historically low interest rates.  A perfect storm that is not over yet.   And no one has been held accountable.