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There is no doubt that reductions in mortgage-underwriting standards were at the heart of the subprime crisis, and Fannie and Freddie's losses reflect those declining standards. Yet the decline in underwriting standards was largely a response to mandates, beginning in the Clinton administration, that required Fannie Mae and Freddie Mac to steadily increase their mortgages or mortgage-backed securities that targeted low-income or minority borrowers and "underserved" locations.
The turning point was the spring and summer of 2004. Fannie and Freddie had kept their exposures low to loans made with little or no documentation (no-doc and low-doc loans), owing to their internal risk-management guidelines that limited such lending. In early 2004, however, senior management realized that the only way to meet the political mandates was to massively cut underwriting standards.
The decision by Fannie and Freddie to embrace no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for example, total subprime and Alt-A mortgage originations were $395 billion. In 2004, they rose to $715 billion. By 2006, they were more than $1 trillion.
... more than half of the mortgage losses that occurred in excess of the rosy forecasts of expected loss at the time of mortgage origination reflected the predictable consequences of low-doc and no-doc lending. In other words, if the mortgage-underwriting standards at Fannie and Freddie circa 2003 had remained in place, nothing like the magnitude of the subprime crisis would have occurred.
Read the whole thing. HT: Russell Redenbaugh
1 comment:
That's one cause. However, the housing price bubble was already underway in 2004. The no-doc sub-prime additions threw more fuel on an already blazing fire.
IMO, there was a massive shift of investment capital into real estate after the stock market crash of 2000. Investors sought safe investments. Real estate was thought to be safe.
Also, the weaker US dollar created an incentive for additional foreign demand for US real estate. Since these buyers valued their investments in terms of their stronger currencies, they caused dollar denominated values to soar because they could pay more dollars with less Euros, for example. This added demand to the real estate markets.
All of this occurred in a low interest rate environment. The Fed was fighting the recession of 2000-2001. Prices had already risen significantly thereby justifying higher appraisals and dangerous loan amounts to qualified buyers who could properly document their incomes.
When the GSE's loosened their underwriting standards, it was akin to pouring gasoline onto a large bonfire. However, by late 2006, mortgage REIT's like Thornburg were already failing to produce enough operating income to sustain their dividend. Also, by that time, home builders had run out of new buyers and were simply building out their backlogs.
On the securitization side, don't forget that investors were constantly demanding higher yields than the banks and the federal government were offering. Pensions needed higher yields for their actuarial assumptions. Institutions and individuals simply wanted to earn more than a few specks of dust in interest on their deposits. Real estate securities were deemed safe because real estate itself was deemed a tortoise like investment. Sub-prime mortgages fed into this demand for yield.
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