Acorn, Fannie Mae and the Housing Bubble: Who is Responsible?

In a recent WSJ piece, Edward Pinto links the housing bubble to liberal advocacy groups like Acorn.  The argument goes something like this: government polices aimed at increasing home ownership forced entities like Freddie Mac to lower lending standards and acquire large amounts of risky mortgages.

“The flood of CRA and affordable-housing loans with loosened underwriting standards, combined with declining mortgage interest rates—to 5% in 2003 from 10% in early 1991—resulted in a massive increase in borrowing capacity and fueled a house price bubble of unprecedented magnitude over the period 1997-2006.”

Groups like Acorn lobbied for “innovative and flexible” lending practices and helped “ignite” the housing bubble. Acorn is a large political advocacy group that pushes issues for low-income earners.  Pinto links Acorn’s efforts to increase homeownership to the recent housing bubble and financial crisis.

Does he have a case? First we should recognize his bias.  Mr. Pinto was chief credit officer at Fannie Mae from 1987-1989. Not surprising then that he would defend his former professional affiliation.  However, a massive increase in loans made without due diligence over the past 15 years is an undeniable cause for collapse.  As Pinto points out, loans made with less than 5 percent down increased from 9 percent in 1991, to 29 percent in 2007.  Default rates also increased.  Government-sponsored enterprises’ high-risk loans faced a 10.3 percent default rate.

Bankers and regulators should have known better.  Barney Frank, Chairman of the Financial Services Committee, argued to switch the focus from home ownership to rental properties.  This would have isolated the mortgage industry from reckless lending practices.  He made his argument back in 2002.

Lack of due diligence is the real crime here.  Why did the nation’s largest mortgage lenders ignore a fundamental principle of finance?   The answer to that question will help us avoid another meltdown.  You cannot blame a poverty-advocacy group for a banker’s lack of competence.  Yes, policies aimed at increasing homeownership failed.  But that is only part of the puzzle.  Financial innovation, de-regulation, derivatives, Glass-Steagall, China and Fed policy where other factors.

Though I agree with Pinto’s analysis, blaming community groups for advocating loose lending standards is a bit harsh.  Bankers need to take some responsibility.

Tom Powell

 

Stimulus, Growth and Recovery: The Debate Continues

There is growing intelligent dissent to the administration’s stimulus policy.  Critics argue that recent growth is the result of market principles.  Edward P. Lazear wrote Monday in the WSJ, that he forecasted a return to growth without stimulus spending.  He goes on to argue, along with others, that  housing programs have had questionable results.  Lazear said that Uncle Sam is fibbing about job growth as well, reporting job retention as if it where job creation.  John Irons of the Economic Policy Institute agrees.  The administration has an incentive to report positive unemployment numbers- the most popular, but also misunderstood indicator.

Unemployment is only part of the overall picture.  Other improving indicators reported this week tell us that the economy is turning around-but for whom? It depends on how you define growth.  A technical definition says that growth is positive GDP.  That means little to most people.  Real growth, theoretically, is an improvement in living standards for the entire country.  That’s why Main Street understands the unemployment rate.  Accordingly, the media use it as the sole judge for growth.  The problem is, as Lazear mentioned,  job growth is the final component of recovery- behind financial stability and GDP growth.  Unemployment lags years behind an actual recovery.   If unemployment is a lagging indicator, Lazear cannot empirically link failed stimulus policy to persistent unemployment.  He says that the administration is ignoring job losses while inflating job creation numbers.  Isn’t he doing the same thing by ignoring market stabilization and GDP growth? 

BEA Released GDP Data This Week 

According to the BEA, GDP is up for a number of reasons.  Look closely at the report.  Exports rose 14 percent over last quarter and consumer spending rose 3.4 percent.  Market Watch reported that positive numbers where in part due to stimulus spending, but as I argued in the past, these gains are only temporary.  The purpose of the stimulus is to stabilize the economy so that private markets can function again.  There is no wider conspiracy.  The government will roll back stimulus as soon as it sees the return of private investment.  There is evidence of this already: government spending actually slowed by 3.5 percent.

Not all the news was good.  Personal income fell and prices rose.  Hopefully this is a temporary trend based on slight price increases and high unemployment.  However, as long as export growth remains positive, I see no need to fear 70s style stagflation.  

Savings and Long-Term Growth

According to the old Solow Model, a country’s savings rate is positively related to long-term growth.  Today, personal savings is around five percent, that’s up from around one percent just four years ago.  This bodes well for long-term growth in the US.  And now is a great time to invest.  As private investment (including people’s savings) replaces public spending in the next few years, markets will rebound.  Private investment will power an upswing in the business cycle, spark growth and reduce unemployment. The sooner the government rolls back stimulus, the better.  In the mean time, citizens can take advantage of great opportunities in real estate and other deflated markets.  This transfer of savings from a stock to a flow will jump-start the economy in way no stimulus could.  It would take tens of trillions of dollars in government spending to match the power of private investors.

Thomas J. Powell