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What Caused the Financial Crisis?

The financial crash from which America is still struggling to recover was, of course, reasonably complex. But the basics are not hard to understand: the federal government wanted to increase “access” to home ownership by encouraging banks to make loans to underqualified buyers–what would traditionally have been called bad loans. The government used a carrot-and-stick approach. The stick was constant pressure on banks to show that they were not “red-lining” but rather were taking their share of risk with respect to home loans. The carrot was Fannie Mae and Freddy Mac, who reassured banks that they could make bad loans without fear of the usual consequences, since those government-sponsored entities would take them off the banks’ books.

Liberals have tried to revise this history, but, as Conn Carroll writes in the Examiner, the facts are the facts:

[Michael] Bloomberg said, “it was not the banks that created the mortgage crisis. It was, plain and simple, Congress, who forced everybody to go and give mortgages to people who were on the cusp. … They were the ones who pushed Fannie and Freddie to make a bunch of loans that were imprudent, if you will.”

The usual suspects on the left went crazy. The New York Times Paul Krugman called Bloomberg an “ignoramus….”

Thanks to the widespread belief that the federal government would bail them out, Fannie and Freddie were able to borrow money at below-market interest rates.

This gave them a significant competitive advantage over private-sector firms which, by 1992, the two government-backed corporate entities had turned into an almost 70 percent share in the mortgage securitization market.

That same year, at the direction of the Congress, the Department of Housing and Urban Development began setting “affordable” mortgage goals for the agencies.

Countrywide was a growing force in the mortgage industry when it partnered with Fannie in 1992. But after Mozilo’s firm secured a steady government buyer for their loans, business exploded. Revenues went from $92 million in 1992, to $860 million in 1996, to $2 billion in 2000. By 2004, they were the nation’s largest mortgage lender.

The secret to Countrywide’s success was no mystery: They shredded standard industry lending practices, giving home loans to virtually anybody who asked. Fannie Mae not only knew this, Fannie rewarded it.

In 2000, the Fannie Mae Foundation honored Countrywide for “Outstanding Achievement” in the industry. The foundation’s 2000 annual report noted: “When necessary — in cases where applicants have no established credit history, for example — Countrywide uses nontraditional credit, a practice now accepted by [Fannie].”

Countrywide continued to be the biggest supplier of loans to Fannie Mae all the way through the height of the housing boom. In 2004, 26 percent of the loans Fannie bought were from Countrywide. In 2007, that number had risen to 28 percent. …

From 1992 through the height of the housing bubble, Fannie Mae and Freddie Mac used their monopoly position in the mortgage securitization industry to reward firms like Countrywide for making bad bets in the housing market. Countrywide’s success was a signal to other market participants to lower their standards as well.

Wall Street banks are not blameless for the financial crisis. But they were only responding to the incentives set up by the federal government.

If there is a single face of the financial crisis, it is probably Barney Frank, Fannie Mae and Freddy Mac’s chief Congressional patron, who shouted down all warnings and resisted all efforts to bring those agencies under control. It is probably too much to hope that Frank will be evicted from Congress any time soon, but in the meantime we can enjoy this song by Kathleen Stewart, “Frankly Barney:”

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