The Financial Crisis Inquiry Commission's Report, supported by politicians, regulators and the vast majority of U.S. economists, blames private sector "market failure" for the crisis. Wrong. U.S. housing policy was the essential catalyst and regulatory malfeasance the enabler.
Commissioner Peter Wallison, author of the dissent to the FCIC report, and his American Enterprise Institute crew put the blame on the entire scope of U.S. financial sector housing policy. Oonagh McDonald, a British economist, politician and regulator of the highest rank, does the same in her just-published book, somewhat mistitled "Fannie Mae and Freddie Mac: Turning the American Dream into a Nightmare."
By the end of 2002, the run-up in U.S. house prices had reached an historic peak in real terms, and the housing boom would normally have turned to bust. John Taylor, the renowned Stanford economist, argues that the Fed prolonged the boom by holding down the Fed Funds rate for another two and a half years. By then the house price bubble was inflated to about five times the historic maximum and many speculators had turned bearish, but prices still continued inflating. By 2006 the entire supposedly "unregulated"market was betting a crash couldn't happen until housing prices began falling enough to precipitate defaults. The massive and increasing presence of government-sponsored enterprises – immune to market discipline – kept the bubble inflated.
Housing policy had geared up the nation's mortgage origination machine to make loans that were extremely risky in the best of circumstances. After the housing boom of 2000-2004 the pool of qualified borrowers had been virtually depleted and loans with virtually no borrower equity, funded at the peak of the house price bubble during 2005-2007, were more likely than not to default.
The affordable housing goals at F&F ramped up to well over half their volume in the last decade. But the Community Reinvestment Act housing quotas first imposed on banks in 1978 were raised even more. CRA had never amounted to more than modest regulatory extortion for getting approval to do what regulators should have encouraged in the first place: branching, merging and acquiring. Community action groups were able to extract lending pledges amounting to millions in the late 1970s and early 1980s, later growing to billions in the late 1980s and early 1990s. Then with the passage of the Riegle-Neal Interstate Banking and Branching Act in 1994 banks scrambled to be the first in the queue, and by making CRA ratings public the Clinton Administration increased the leverage of community action groups such as Acorn who then extracted about $5 trillion in CRA commitments, almost $4 trillion of which came due during the subprime lending bubble. Additionally, the administration adopted a national homeownership strategy to raise the ownership rate from 65% - where it had remained for three decades immune to GSEs growing from virtually zero to 50% of the home mortgage market - to 70%, requiring lax underwriting and low-no down payments.
The expected returns never justified the risk – that's a silly myth circulated by regulators and politicians. But banks had multiple profit centers to cover losses and the benefit of regulatory approval had historically been worth the cost. F&F were also very profitable in the 1990s due to their agency status, but to maintain profitability they took on interest rate and credit risk while ramping up leverage.