Will the housing bubble burst? Our socialist mortgage system and easy money policy have created a dangerously inflated housing bubble that, if pricked, could take the economy down with it.
The twin engines pumping credit into the housing market are the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), which collectively own or guarantee 70 percent of all American mortgage debt--roughly four trillion dollars. Fannie and Freddie are "Government-Sponsored Enterprises" (GSEs), nominally private institutions backed by the "full faith and credit" of the U.S. government. This means, in essence, that the taxpayer is on the hook to bail them out in the event they succumb to widespread mortgage defaults or some other financial cataclysm.
Fannie and Freddie also enjoy direct federal subsidies, which in 2000 amounted to more than $10 billion. And until recently, they were provided with a $2.5 billion emergency line of credit with the Treasury Department--a relatively minuscule amount, to be sure, but one that created the perception that Washington wouldn't allow them to fail. GSEs are the very embodiment of corporatism--the economic component of fascism. Their profits are privatized, their risks are subsidized, and their losses are socialized.
Fannie was created in 1938 as part of President Franklin D. Roosevelt's Reconstruction Finance Corporation. It was intended to expand the ranks of home ownership by purchasing mortgages made by banks to low-income Americans. Those loans are then bundled into marketable securities.
In 1968, amid a torrential outpouring of red ink resulting from the Vietnam War and Great Society welfare programs, Lyndon Johnson "privatized" Fannie Mae in order to move it off-budget. It thereby became a GSE, a nominally private financial institution. In 1970, the Nixon administration created a second federally subsidized housing lender, Freddie Mac, supposedly to compete wire Fannie Mae. But rather than being competitors, Fannie and Freddie have become a quasi-governmental cartel, with predictable consequences for the housing market.
Prior to 1989, observed Benjamin Wallace-Wells in the April Washington Monthly, "Fannie and Freddie's market share was limited by their ability to attract investment capital." In that year--despite the accumulating financial fallout from the failure of federally backed Savings & Loans across the country--Congress enacted "technical changes that made Freddie and Fannie much more attractive to investors, and able to draw much more capital. Under the new rules, for instance, they were allowed to customize securities at different levels of risk and return to meet more precisely the demands of different sectors of the capital market. Then, too, bank regulators let pension funds and mutual funds class Fannie's debt as low-risk." But the most significant factor, of course, has been the Federal Reserve's loose money policies, which kept interest rates at rock bottom.
The results were entirely predictable: "[D]uring the 1990s, investors practically threw money at Fannie Mae and Freddie Mac, which became enormously, steadily profitable," continues Wallace-Wells. "The GSEs used the new capital to buy up every mortgage they could, and banks were only too happy to sell off the mortgage paper.... Fannie and Freddie went from buying mostly mortgages for low-end homes to those of the middle- and upper-middle class. And [their] share of the nation's conventional mortgage debt has swelled, to more than 70 percent today, double its share in 1990."
The GSEs' cartelization of the mortgage market, he warns, "has profoundly undermined the discipline that once kept housing prices in check." With banks able to sell off mortgages to the federally backed GSEs, the mortgage loans were perceived as essentially risk-free, and countless borderline or unqualified applicants were approved. And rampant demand caused housing prices in many markets to soar to wildly inflated levels.
"Banks and other mortgage lenders are not watching home prices carefully because they rarely hold onto the mortgage paper they create--they just sell it upstream to mortgage investors," warned John R. Talbott, a housing analyst at UCLA's Anderson School of Business. "It is a dangerous situation indeed when neither home buyers nor the institutions that finance them are concerned with the ultimate price being paid...."
Commentator Thomas Allen, who refers to himself as a "recovering refugee worker," observes: "Immigration is one of the main engines of growth for the giant mortgage lending institutions. And few companies have more openly tied their fortunes to immigration than Fannie Mac and Freddie Mac. In fact, Fannie hawks its shares by promising potential investors that there will be '30 million more Americans by 2010....'" According to Allen. "Fannie reports are filled with happy stories of government-dependent CBOs [community-based organizations] or organizations such as La Raza and Chicanos Por La Causa partnering with Fannie Mae, private lenders and factory chicken processors to make money for the private sector participants and keep the ethnic lobbies employed."
Thus it's not surprising that the Fannie Mae Foundation is a major supporter of open borders. In January 2002, for example, it sponsored the "National Immigration Forum" in Washington, D.C., where the participants included representatives of La Raza, the Mexican-American Legal Defense and Education Fund, the ACLU and other radical legal activist groups--as well as representatives of the Bush administration.
President Bush, in the name of "compassionate conservatism," has sought to expand subsidies for minority mortgage applicants. "Low interest rates have encouraged a housing boom here in America--and that's good, that's good," declared the president at a photo-op in front of an Hispanic-owned business in California last October. "And even though home ownership is at near-record highs, we've got too many of our fellow citizens who happen to be minorities who don't own a home. Seventy-five percent of the Anglos in America own a home; the minority home ownership in America is below 50 percent."
Accordingly, Mr. Bush signed into law the "American Dream Down Payment Act," a $200 million-a-year welfare program that "will help low-income Americans to afford the down payment and closing costs on their first home." In addition, the president called for making "zero down payment loans available to first-time buyers whose mortgages are guaranteed by the Federal Housing Administration," which he claimed would "help about 150,000 families buy homes in the first year alone."
Pop, Pop, Pop
It's an invincible principle of economics that we get more of what we subsidize. Federal subsidies of the mortgage industry, predictably enough, led to an explosion of mortgage lending to debtors who otherwise wouldn't have qualified (recent immigrants being a very good example). This, in turn, has artificially stimulated housing demand and artificially inflated housing prices.
As a result, noted Robert J. Samuelson in the April 19 Newsweek, "Homes fetch 30, 50 or even 100 percent more than they did a few years ago.... Since 2000, the national median price for existing homes has increased 23 percent to $170,000, and many gains are much larger: 31 percent in Boston to $413,000; 64 percent in Los Angeles to $355,000; 32 percent in Minneapolis-St. Paul to $200,000; and 74 percent in West Palm Beach to $241,000...." Housing industry analysts estimate that 15-30 percent of all homes nationwide are overvalued.
Even more telling are various measurements of home price-to-annual income ratios. Nationwide, that ratio is a reasonable 2.4:1. However, in some areas that ratio reaches unsettling levels--8.3:1 in California, 5.9:1 in Massachusetts, and 10.1:1 in Hawaii. "In California," writes Wallace-Wells, "a middle-class family with two earners each making $50,000 a year now owns, on average, an $830,000 home." Similar conditions can be found in twenty major metropolitan areas across eight states. "In the late 80s," he recalls, "the last time these eight states saw price-to-income ratios this high, the real estate market collapsed."
"What makes the current frenzy especially dangerous is that every relevant institution has an incentive to play along," continues Wallace-Wells. "Who, after all, is likely to say stop? Not the realtors. Not the banks, any longer. Not Fannie and Freddie ... who are turning vast profits on the backs of the bubble. Certainly not the Federal Reserve or the Treasury Department, while the economy depends on a sustained housing boom."
But indications are rife that the boom is about to bust.
"The Clinton boom was built on three unsustainable bubbles," pointed out Dean Baker, co-director of the Center for Economic and Policy Research, almost exactly one year ago. "One of them, the stock bubble, has already burst. The other two bubbles--the dollar bubble and the housing bubble--are still with us. The dollar bubble is starting to deflate, and the housing bubble is perhaps just now reaching its peak."
Since Baker printed those observations, the collapse of the "dollar bubble" has accelerated. Widespread, Enron-style accounting fraud at Fannie and Freddie may prick the housing and mortgage-refinancing bubble as well.
In March 2002, St. Louis Federal Reserve President William Poole warned that Fannie and Freddie "hold capital far below that required of regulated banking institutions." This is unsettling news indeed to those who understand just how little capital is required by regulated banks, given the universal practice of "fractional reserve banking." But Poole had even grimmer warnings to offer: "Should either firm be rocked by a mistake or by an unforecastable shock, in the absence of robust contingency arrangements the result could be a crisis in U.S. financial markets."
That crisis was actually underway even as Poole spoke--but it didn't go public until a year later.
In June 2003, Freddie Mac was forced to own up to $5 billion in misrepresented earnings over the previous three years. Ordinarily, this type of accounting chicanery would result in a criminal probe of the corporation's financial and executive leadership; this is especially true in the wake of the Enron, Tyco, WorldCom and Global Crossing scandals. But as GSEs, Fannie and Freddie are effectively immune to such repercussions. Leland Brendsel, Freddie's chairman and CEO during the accounting scandal, was forced to resign, as was his immediate successor, Gregory J. Parseghian. But neither of them faced criminal prosecution. Nor were federal prosecutors provoked by subsequent disclosures of accounting irregularities at Fannie Mae.
Like the members of Russia's nomenklatura--the Communist political elite--Fannie, Freddie and friends are politically protected and essentially above the law. As the June 28, 2003 Detroit News pointed out, board members of Fannie and Freddie are drawn from a pool of "former White House aides, defeated candidates, other former officials and leaders of minority groups whom presidents have appointed over the years...."
In 1994, Dennis DeConcini, who was preparing to retire from the Senate, was told by Bill Clinton: "You've been a great friend, Dennis. What can I do for you?" "I told him I wanted to be on the board of Freddie Mac or Fannie Mae," DeConcini recalled in June 2003. Clinton granted that wish, appointing the former solon to a position on Freddie's board, where he reeled in huge sums in cash, stock and stock options. After five years on the gravy train, DeConcini--like many others--became a Washington lobbyist for Freddie.
Recent presidential nominees to the boards of Fannie and Freddie include such dubious luminaries as former Clinton cronies Rahm Emmanuel, Harold Ickes, Jack Quinn and Eli Segal. Bush appointees include such camp followers as Michelle Engler (wife of former Republican Governor John Engler); David J. Gribbin III, a longtime aide to Dick Cheney; regional re-election campaign director Molly H. Bordanaro; and Victor Ashe, a one-time classmate at Yale.
Representative Richard Baker (R-La.), chairman of the House Capital Markets Subcommittee, describes Fannie and Freddie as residing in "Enron territory," where there is evidence of "conspiracy or collusion to defraud from the very top...." But Fannie and Freddie differ from other corrupt corporations, continued Rep. Baker, in that they have the ability to "use millions from [their] federal subsidy for the sheer purpose of protecting it, by lobbying and influencing the very federal government that bestows it." And this is hardly the only corrupt use to which Fannie and Freddie's friends put their federal subsidies.
In June 2001, FM Watch, a financial industry watchdog group, published a report entitled Shuttered Dreams: How Fannie Mae and Freddie Mac Misspend the GSE Housing Subsidy. Among that study's findings was that 37 percent--or $3.9 billion--of the 2000 federal subsidy to Fannie and Freddie "is retained by [them] for shareholder profits.... This is the largest single use of the taxpayer subsidy. It does nothing to promote homeownership, and only serves to enrich private GSE stockholders."
Additionally, 29 percent, or $3.1 billion, "went to [Fannie and Freddie's] ... purchase of mortgages to refinance existing debt. This refinancing activity does not help Americans buy homes. Thus, 66 percent of the subsidy goes either to ... stockholders or refinancing activity...." Only five percent of the 2000 federal subsidy "is spent to create new home ownership opportunities for the bottom half of Americans by income."
Collapse and Nationalization
Last February, Fed Chairman Alan Greenspan pointedly warned of a liquidity crisis at both Fannie and Freddie that threatens to bring down the entire financial system. Greenspan prescribed a few "reforms," such as debt caps and stricter regulation of the GSEs. He also floated the incredible suggestion that homeowners consider switching from fixed-rate mortgages to adjustable-rate mortgages (ARMs), despite the fact that interest rates can only go in one direction--up.
Clearly, Greenspan anticipates the collapse of the Fannie/Freddie mortgage axis. Just as clearly, he understands that mortgage refinancing is practically all that sustains our national economy. Those homeowners who act on Greenspan's advice will be clobbered once rates begin to rise, as they inevitably must. And those who already have second (or third) mortgages face similar prospects when housing prices start to fall, as they inevitably must.
"Given the lateness of the hour, and the near-inevitability of the coming crash, there's really only one thing for concerned citizens to do," summarizes Benjamin Wallace-Wells. "Start assigning blame." For the political elite that brought us to this pass, the chief task is to insulate themselves against blame, and find some way to redistribute the financial consequences to the taxpayers.
In early April, the Senate Banking Committee approved a bill creating a new regulator for Fannie and Freddie with the power to take them into receivership in the event of insolvency. This measure, if signed into law, would provide the means to nationalize the mortgage industry in the likely event that Fannie and Freddie go bust. Were this to occur, the collapse of these quasi-governmental bodies would likely be depicted as an indictment of free-market capitalism. And the proposed remedy would be to jettison corporatist GSEs like Fannie and Freddie in favor of a more overt form of government control over the housing and mortgage industries.
Given that Fannie and Freddie have combined debts in excess of $1.7 trillion, a federal rescue effort would easily eclipse the savings-and-loan bailout. It would also, in all likelihood, puncture the housing and mortgage refinancing bubble supporting our economy--assuming, of course, that the bubble hasn't already burst of its own accord by then.
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|Author:||Grigg, William Norman|
|Publication:||The New American|
|Date:||May 17, 2004|
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