In a recent blog article entitled “It’s the Housing Sector Stupid”, super talented real estate webmaster SEOMack gives editorial analysis of the problems which led to the foreclosure crisis, along with proposed solutions for moving forward into a housing recovery. While I agree with the hypothetical solutions, the root causes of the foreclosure problem were pulled from far-right field. A response is in order.
SEO Mack begins by framing George Bush the unsung hero who was defeated by a Democratic Congress in his efforts to more strongly regulate Fannie Mae and Freddie Mac. He says that George Bush first raised the alarm for stiffer Fannie/Freddie regulation in 2001. Even if that is true, it was the Republicans who had control of the Congress at that time, so placing blame on Democrats for protecting their “sacred cow” Fannie/Freddie does not make sense. It was not until 2006 that Democrats were elected to a majority in Congress, and by that time foreclosures in San Diego and nationwide were already well underway.
The fact is that the banking deregulation which led to the foreclosure crisis originated under the Republican Congress in the 1990’s. The banking industry lobbied hard throughout the 1990’s to overturn the banking regulations that had been imposed by the Glass Steagall Act which had been enacted in 1933 in response to the bank failures which caused the Great Depression. Senator Phil Gramm (R-TX) was the primary sponsor of the Gramm-Leach-Bliley Act of 1999. It was Senator Gramm’s bill which ultimately caused the massive foreclosure crisis in the current decade.
The Glass Steagall Act had wisely forced banks to separate their lending and investment businesses. The banks hated this law which had protected American people from a Depression-style financial disaster for nearly 70 years. Exactly why they hated the law was not immediately clear in 1999, but it became clear during the early 2000’s. In 1999, despite resistance from Democrats in Congress, President Clinton caved to Republican pressure and signed the Gramm-Leach-Bliley Act into law. The banks were again free to get into the securities business.
The banks immediately began a big push to write mortgages that no longer had to be secured by the federal government (Fannie/Freddie). Just about anyone could get a loan, with our without documentation of employment or the ability to repay. No down payment was needed. The banks issued the mortgages, collected the lender fees, and immediately repackaged the mortgages into “Mortgage Backed Securities” (MBS) which were sold at even greater profit to unwitting investors. Home values were rising, so the MBS’s were peddled as “safe” investments which offered much higher returns than were available through more traditional safe investments. The banks shopped and paid ratings agencies to give AAA ratings to these securities, and the illusion was complete.
Returning to SEOMack’s blog article, where does the President Bush’s criticism of Fannie/Freddie fit into this picture? It’s pretty simple. The bankers who backed President Bush didn’t like competition from Fannie and Freddie. The banks needed to make as many loans as possible because the demand for MBS’s was astronomical. Hedge funds, pension plans, foreign governments and other large institutions bought as many MBS’s as they could get their hands on. If Fannie/Freddie wrote the loans, then that meant fewer mortgage backed securities. President Bush was more than happy to play along.
In many markets the Fannie/Freddie competition was negligible because property values were well above the Fannie/Freddie loan limits. From 1999 to 2006, of all the buyers I helped purchase homes in San Diego CA, a total of ZERO purchased San Diego area homes with FHA Fannie/Freddie financing. In 1999 the Fannie/Freddie loan limits ranged from $115,200 in low cost areas to $208,800 in high cost areas. In 2000 these limits were increased to a range of $121,296 to $219,849. In January 2004 the loan limits were increased to the range of $160,176 up to $290,319. In all of these years prices of San Diego homes were well above these levels. The same was true in most major real estate markets. Fannie/Freddie was only a player in middle-America, but the banks couldn’t stand the competition even there.
With the onset of the down real estate cycle in 2005 and the first round of foreclosures in 2006 and 2007, mortgage lending by private banks ground to a halt. It stopped because no one any longer wanted to purchase the Mortgage Backed Securities, and the banks couldn’t, and never intended to, hold the mortgages on their own. The federal government was forced to step in and raise the Fannie/Freddie limits so that there wouldn’t be a total shut down of the real estate markets.
Wisely, the FHA loan limits were increased all the way to $417,000 for a conforming FHA loan, and a second type of FHA loan was created… the “super-conforming” FHA loans which are available all the way to $729,750 in the most expensive areas of the country. Arguably, there is still room for an even higher FHA loan ceiling. In San Diego the FHA loan ceiling is currently $697,500, which is only sufficient for entry-level and mid-level home purchases. Prospective buyers of San Diego luxury homes must still rely on banks and private investors, and the loan guidelines for jumbo loans remain very strict. This explains the slowdown of luxury home sales and continued downward pressure on prices at the upper end of the San Diego real estate market.
The massive government injection of funds into the banks was supposed to relieve Fannie/Freddie of the burden of supplying all of the mortgage loans. Unfortunately the banks have not cooperated. They have taken the money and quietly said “Thank you very much.” But they still aren’t lending much or any of the money that they received from Uncle Sam and the taxpayers. It is a travesty, and further regulation is needed to solve that problem. The Obama administration is on the right track. Housing is a huge component of the economic recovery, and Fannie/Freddie can’t do it alone.
Moving to the portions of SEOMack’s article on which we agree…
We must restore confidence in the housing sector. This is already happening in San Diego, where multiple offers and overbids on San Diego homes has again become more of the rule than the exception. There is upward pressure on prices at the entry level and mid-range of the San Diego real estate market. Even Zillow, which historically has undervalued properties, is now registering price increases in many San Diego neighborhoods.
People need to be educated about historic real estate cycles and trends. We’ll emerge from this downturn and home values will recover. Houses are a great investment in the long run. Walking away from a mortgage because of fear of equity loss is unethical and short sighted. People who can afford to pay their mortgages should be encouraged to stay in their homes. They will see long-term gains, but only if more people (all people) in the United States play by the rules. Greed is a terrible thing… for banks, for individuals, and for our country.