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American Enterprise Institute - Why The Next Housing Crisis Is Already Underway

By Donna S. Robinson | March 22, 2012

American Enterprise Institute

Like a cancerous tumor that just won't go away, another housing crisis is growing ever larger. It's a debt tumor, fed by the blood that flows in the form of government insured mortgages which are in essence nothing more than taxpayer backed guarantees for Fannie, Freddie, USDA, and FHA, to name a few.

This article quotes heavily from the work of Mr. Edward Pinto, A Resident Fellow of The American Enterprise Institute, and a former executive of Fannie Mae. The entire 15 page report is available here if you'd like to read his detailed analysis. (Thanks to Mr. Pinto for kindly providing me with a copy of his testimony.)

Mr. Pinto has an excellent insight into the problems inherent in government insured mortgage programs, the "politicizing" of U.S. housing policy, and how this led to the first housing crisis. His analysis of what he has termed "the government mortgage complex", demonstrates why the proposed government solutions to the current crisis are not going to solve the problem, but will merely add another housing crisis to the existing one. He also demonstrates why the current crisis continues to drag on, and shows that it's largely because of misguided government policies and political deal making that fail to address the underlying causes, while attempting to please a variety of special interests, from "affordable" housing advocates and the finance and banking industry to the real estate industry itself.

Edward Pinto

As a long time participant in the residential real estate industry, I've witnessed the development of many of the programs highlighted in Mr. Pinto's testimony to the committee. I was a member of the National Association of Realtors at the time they were lobbying for expansion of FHA, a real estate investor when Option-ARM's were invented, and I've seen people buying $300,000 houses with government insured loans, then using sheets for curtains and card tables for furniture. I've also had a close up view of the damage that has been done by well meaning government policies that had major unintended consequences. And watching the government repeat the same mistakes again makes me cringe, knowing that the massive debt involved could render a fatal blow to the U.S. economy.

Here are a few of the essential details given in Mr. Pinto's testimony:

"The failure of the housing market to recover is the direct result of two errant policy initiatives.
First, broad affordable housing mandates that started in the early 1990s along with other government policies drove an unsustainable home price boom. This was due to an unprecedented loosening of loan underwriting standards—a core goal established under HUD’s 1995 National Homeownership Strategy.

Once the housing market collapsed, many of these same supporters of loose lending effortlessly switched gears and undertook a multi-year effort to delay and prolong the market clearing process. Much of this effort has focused on rewarding millions of borrowers who overleveraged their homes. Neither massive amounts of government spending nor innumerable government interventions have led to robust economic growth or hastened a housing market recovery. In fact evidence is mounting that a recovery has been impeded.

While the failure of these twin initiatives should be a cautionary tale, beware. Their supporters are now moving on to promote the view that housing finance is a civil right requiring equal outcomes and therefore loan underwriting standards are inappropriate. Many inside HUD and the Justice Department share this view. This will turn housing finance into yet another entitlement, this time controlled by the Government Mortgage Complex.1 While purporting to help low- and moderate-income borrowers and minorities build wealth through home ownership, it will instead place them in harm’s way. The FHA wants to expand its lending practices that are so destructive to borrowers and neighborhoods alike."

Politicized Lending Phase 1: Affordable Housing Mandates and the National Homeownership Strategy

"The first policy—the decades’ long effort to loosen underwriting standards—fomented the crisis and immeasurably deepened it. The following testimony from 1991 before the Senate Banking Committee is revealing:

"Lenders will respond to the most conservative standards unless [Fannie Mae and Freddie Mac] are aggressive and convincing in their efforts to expand historically narrow underwriting."

Testimony of Ms. Gale Cincotta representing National People’s Action before the U.S. Senate Committee on Banking, Housing, and Urban Affairs on February 28, 1991.

"About five years before this testimony, I was an executive at Fannie and met with Ms. Cincotta. I advised against asking Fannie to undertake a broad national program of expanded underwriting standards and warned that it would be no more successful than the failed efforts by the FHA that Ms. Cincotta was complaining about.

Think for a moment about the full import of this testimony. First, that Fannie, Freddie and lenders generally had conservative standards in 1991. Second, Fannie and Freddie would need to be aggressive and convincing in loosening their standards. The very next year, Congress passed the misleadingly named “Federal Housing Enterprises Financial Safety and Soundness Act of 1992”. The race to aggressively loosen lending standards was on. In the years following, numerous others policies promoting so called “flexible and innovative” underwriting standards were adopted, led principally by HUD. These include the National Homeownership Strategy, expansion of CRA, and HUD’s Best Practices Initiative.

The result was first created a boom in and then the collapse of the housing market. Excessive leverage as evidenced by reduced down payments as shown in Chart 1 was a leading factor in the boom."

"...For proof, [that such destructive policies are still in place], we need look no further than the Fed’s approval of the recent acquisition of ING Direct by Capital One Financial Corporation. It is well known that mega-bank deals require “concessions to win the support of consumer groups and community activists and the Cap One-ING deal was no exception.”4 Capital One committed to a $180 billion CRA commitment. This included an agreement to originate FHA loans to borrowers with FICO scores as low 580.5 My estimates are that the FHA’s recent loans with a FICO score of 580–599 have an estimated claim rate of nearly 30 percent."

"Rather than avoiding such destructive lending, the FHA is planning a major expansion. It is projecting that by FY 2015 about 44 percent of its 30-year term purchase loans will have a FICO below 660, nearly double the rate in FY2011. This policy has the potential to be dangerous for both borrowers and neighborhoods..."

It's interesting to me that while there are numerous housing market and investment analysts such as Edward J. Pinto of The American Enterprise Institute, Laurie Goodman at Amherst Securities, Peter Schiff of Euro Pacific Capital, and myself, who have been warning for years of problems with current housing market policy, the special interest groups continue to be unaware of their own short sighted policies. With the broader mortgage market almost entirely funded by government insured loans now, an expansion of loose underwriting standards, as detailed in this report, will almost certainly result in more severe pain for the housing industry.

Yet, the entire real estate industry seems to be like a cancer patient on morphine. Oblivious to how close we are to death, as long as we can do everything in our power to numb the pain.***

Editors Note: More specifics to come in Donna's next article, as she provides details on how government insured loans are expanding "subprime lending" at taxpayer expense.
Donna S. Robinson is a 16 year veteran of the real estate industry and a staff writer for Realty Biz News. She is an active real estate investor who also provides coaching and consulting services to individual investors, investment companies, real estate agents and brokers. You may join her email list on her website at or call her office at 888-915-9968. 

Donna S. Robinson has been involved in the real estate industry since 1996. A licensed agent and real estate investor, she is a recognized expert on residential real estate investing. Her course, "Fundamentals & Strategies For Real Estate Investing" is approved for CE credit by the GA Real Estate Commission. She has authored several books on real estate investing, and consults with residential investment companies. She also offers coaching services to real estate investors.

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