From the American dream to … bailout America:
How the government loosened credit standards and led to the mortgage meltdown
Compiled by Edward Pinto, American Enterprise Institute
In the early 1990s, Fannie Mae‘s CEO Jim Johnson developed a plan to protect Fannie‘s lucrative charter privileges bestowed by Congress. Ply Congress with copious amounts of affordable housing and Fannie‘s privileges would be secure. It required ―transforming the housing finance system‖ by drastically loosening of loan underwriting standards. Fannie garnered support from community advocacy groups like ACORN and members of Congress. In 1995 President Clinton formalized Fannie‘s plan into the National Homeownership Strategy. President Clinton stated it ―will not cost the taxpayers one extra cent.‖
From 1992 onward, ―skin in the game‖ was progressively eliminated from housing finance. And it worked – Fannie‘s supporters in and outside Congress successfully protected Fannie‘s (and Freddie‘s) charter privileges against all comers – until the American Dream became Bailout America.
TIMELINE
Credit loosening
Warning
HUD Commission complains ―Fannie Mae and Freddie Mac‘s underwriting standards are oriented towards ‗plain vanilla‘ mortgage‖
1991 1991
[Read More]
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 [Read More]
Countrywide and Fannie Mae join forces to originate ―flexibly underwritten loans‖ [Read More]
Congress passes the inaptly named ―Federal Housing Enterprises Financial Safety and Soundness Act.‖ Rather than protecting
taxpayers from having to bailout Fannie and Freddie, affordable housing mandates planted the seeds leading to future bailout [Read
1992 1992
Fannie approves ACORN‘s loan program, allowing for ―downpayments of the lesser of $1000 or 3%.‖
Fannie Mae commits to transform housing finance system and plans $1T in lending to low and moderate income borrowers [Read More] Fannie's Trillion Dollar Giveaway [Read More]
Fannie proceeds with 3% down loans over objection of chief credit officer [Read More]
HUD‘s National Homeownership Strategy commits lending industry to weakened underwriting standards, including further
reductions in downpayments [Read More]
1993 1994 1994 1994 1995
Fannie and Freddie are creating mega-liabilities with miniscule capital to support it [Read More]
HUD study complains Fannie and Freddie‘s credit guidelines are more likely to disqualify borrowers with low incomes, limited
wealth, and poor credit histories [Read More]
1996 1997
Flexible underwriting standards are nothing more than standards that lead to bad loans [Read More] Fannie eases credit to increase lending; increases risk of taxpayer bailout [Read More]
1998 1999
FHA leads the way with looser lending standards [Read More]
Fannie‘s CEO, Franklin Raines, announces new $2 trillion ―American Dream Commitment‖ on top of earlier $1 trillion commitment HUD imposes massive increases in Fannie and Freddie‘s affordable housing mandates, calls for deeper push into subprime [Read
More]
2000 2000 2000
Franklin Raines, Fannie‘s CEO, calls for ‖bending financial markets to serve the families buying [newly built] homes [Read More]
Easy credit creating bull market in housing [Read More]
CEO of government sponsored Fannie Mae cites government agency FHA as its only competitor for public funding of housing [Read
More]
2000 2001 2002
Countrywide‘s Mozilo calls for the elimination of downpayments, announces expansion of its ―House America‖ commitment to $600
Having met $3 trillion in previous commitments, Fannie‘s CEO, Franklin Raines, announces plans to renew and expand ―American
2003 2004
HUD trumpets ―revolution in affordable lending‖ [Read More] HUD rulemaking imposes massive increases in Fannie and Freddie‘s affordable housing mandates, calls for Fannie and Freddie to ―reach deeper into the subprime market‖ [Read More]
2004 2004
Fannie‘s Franklin Raines tells national lender group: ―We have to push products and opportunities to people who have lesser credit
2004
By the end of 2005 there could be a perfect storm of delinquencies [Read More]
National Association of Realtors reports 46% and 19% of first-time buyers and repeat buyers respectively nationwide put down no
money. NAR President Thomas Stevens isn‘t worried [Read More]
2004 2006
HUD finds ―the sharp rise on mortgage delinquencies and foreclosures the result of rapid growth in loans with high risk of default
Financial Crisis Inquiry Commission ignores the government‘s efforts to promote flexible underwriting standards throughout the
mortgage industry. During the boom low delinquency rates reduce losses, making loans appear less risky to investors.
The government‘s encouragement of weakened loan standards promoted a race to the bottom and led to the origination of
unprecedented quantities of risky loans
2010 2010
Reforming US housing finance [Read More]
2011
In the news
The Washington Post | Fannie‘s Perilous Pursuit of Subprime Loans
The New York Times | Mortgage Giant Overstated the Size of Its Capital Base The Washington Post | Treasury to Rescue Fannie and Freddie The New York Times | $700 Billion Bailout Plan Wins Approval
The New York Times | Adding Up the Government‘s Total Bailout Tab
USA Today | Congress Passes $787B Economic Stimulus Bill
CBS News | Docs Show Countrywide‘s Cozy Ties to Fannie Mae
Bloomberg | Fannie, Freddie May Draw $363 Billion, FHFA Says San Francisco Chronicle | Human Nature Often at Odds with DC-Backed Loans
The Wall Street Journal | The End of Fannie Mae
2008 2008 2008 2008 2009 2009 2010 2010 2011 2011 2011
The Washington Post | What a Plan to Replace Fannie and Freddie Should Include
From the American Dream to … Bailout America
Supplemental Material
AEI | From the American Dream to … Bailout America 1
1. In the early 1990s, Fannie Mae’s CEO Jim Johnson developed a plan to protect Fannie’s lucrative
charter privileges bestowed by Congress. Ply Congress with copious amounts of affordable
housing and Fannie’s privileges would be secure. It required “transforming the housing finance system” by drastically loosening of loan underwriting standards. Fannie garnered support from
community advocacy groups like ACORN and members of Congress. In 1995 President Clinton
formalized Fannie’s plan into the National Homeownership Strategy. President Clinton stated it “will not cost the taxpayers one extra cent.” ACORN and others were anxious to cash in on
millions of dollars from affordable housing initiatives. Members of Congress were eager to take credit for the trillions of dollars in new lending from loosened standards, receive copious campaign contributions, placate groups like ACORN, and in return were willing to protect Fannie
and Freddie’s charter privileges against all comers. Fannie used its power over the mortgage market to gain the support of lenders like Countrywide. By 1995 Johnson’s plan was embodied in the “National Homeownership Strategy” and extolled by President Clinton: i
“And I can say without knowing that I'm overstating it, that if we succeed in doing this, if we succeed in making that number happen, it will be one of the most important things that this administration has ever done, and we're going to do it [raise the
homeownership rate to a record 67.5% by 2000+ without spending more tax money.”
He then added for emphasis:
“Our home ownership strategy will not cost the taxpayers one extra cent. It will not require legislation. It will not add more Federal programs or grow Federal bureaucracy.”
Over the next 16 years underwriting standards across the nation were progressively loosened. At the same time Fannie Mae and Freddie Mac’s charters withstood all efforts to be reined in. During boom periods low delinquency rates reduce losses and tend to promote a progressive weakening of lending standards. The governments push for weaker standards was akin to dynamiting the housing finance system. Financial and economic collapse ensued turning the American dream into the American nightmare.
Why transform the housing finance system? From 1957-1997 the US experienced fairly stable housing prices, with no nationwide price decline in inflation adjusted dollars. There were two bubbles—around 1979 and 1989—which resulted in only regional losses. Up until 1992 the housing finance market had three generally distinct components: 1. the prime market dominated by Fannie, Freddie, thrifts, and banks (80% share), 2. the government subprime (FHA) market focusing on low downpayment home purchase loans to borrowers with high debt ratios and more marginal credit (10% share), and 3. a private subprime market focusing on loans with moderate to high equity levels (20+%) for cash out refinance and home purchases to borrowers with high debt ratios and more marginal credit (10% share). Once Fannie and Freddie were required, in 1992, to buy affordable housing loans, the market began to change in radical ways. Mortgage underwriting standards deteriorated significantly as the GSEs first moved to compete with FHA and then private subprime. This competition was driven by the fact that FHA and private subprime loans were rich in the types of affordable housing loans the GSEs were now being forced to acquire. An immense bubble began to grow in 1997, extending through 2006 during which time loan quality standards declined dramatically. The financial crash of 2008 resulted from the collapse of that bubble and the resulting losses on the subprime and Alt-A
AEI | From the American Dream to … Bailout America 2 loans that were acquired by Fannie, Freddie, FHA, and insured banks under the CRA (19.2 million) and the 7.8 million similar loans securitized as private label MBS.
The American Dream had become Bailout America.
Real Home Prices, 1890–2010
Compiled from Robert Shiller’s updated historical housing market data used in his book, Irrational
Exuberance (Princeton University Press, 2000; Broadway Books, 2001; 2nd edition, 2005). Data available at www.econ.yale.edu/~shiller/data.htm.
2. HUD’s Advisory Commission on Regulatory Barriers to Affordable Housing stated in its 1991
report:
“The market influence of Fannie Mae and Freddie Mac extends well beyond the number
of loans they buy or securitize; their underwriting standards for primary loans are widely adopted and amount to national underwriting standards for a substantial fraction of all
The Commission also found that:
“Fannie Mae and Freddie Mac’s underwriting standards are oriented towards ‘plain vanilla’ mortgages.”iii
3. 1991: “’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.’ This point was reinforced over and over again by other [community advocacy] witnesses.” U.S. Senate Committee on Banking, Housing, and Urban Affairs in 1991.iv
4. 1992: Countrywide and Fannie Mae join forces to originate “flexibly underwritten loans”:v
AEI | From the American Dream to … Bailout America 3
“The $1.25 billion of affordable-housing mortgages is the largest of its type to date and includes an innovative "second review" by Countrywide of mortgage applicants who do not initially qualify. Many of the affordable-housing loans will use Fannie Mae's Community Home Buyer's Program (CHBP). CHBP provides flexible underwriting criteria, including loans up to 95 percent of the home's value, with a provision for a 3 percent down payment by the borrower and a 2 percent contribution from gifts or other
assistance programs.”
5. 1992: Congress passes the inaptly named “Federal Housing Enterprises Financial Safety and
Soundness Act”.
Instead of requiring Fannie and Freddie to be operated in a safe and sound manner, the so called Safety and Soundness Act authorizes HUD to adopt ever increasing affordable housing mandates. As a result Fannie and Freddie must progressively loosen their underwriting standards and, for the first time, become competitors of FHA and subprime lending. Of course
that was Fannie’s original goal.
6. 1994 press release: “FANNIE MAE CHAIRMAN COMMITS COMPANY TO 'TRANSFORMING THE
HOUSING FINANCE SYSTEM'; VOWS COMPANY WILL PROVIDE $1 TRILLION IN TARGETED LENDING”vi
Selected provisions:
“Through Fannie Mae's commitment to transforming the nation's housing finance system, the
company will: reach out to every renter in America to provide the information they need to buy a home; break down arbitrary barriers to getting a mortgage; and do everything in its power to make the elimination of lending discrimination the number one priority of the housing finance system.”
“The ‘HomePath’ Initiative: This initiative encompasses one of the most far-reaching commitments ever made by the company: to eliminate any final "no" in the mortgage application process. It is Fannie Mae's goal that every person in America who seeks a home mortgage will have their loan approved -- or be placed on a path of review and home buyer counseling that potentially leads to loan approval, if they have the financial capacity to sustain homeownership. If an applicant's request for a mortgage is denied, he or she will get the information needed to understand what caused the rejection and what steps must be taken to move toward homeownership. Every Fannie Mae lender will be encouraged to conduct second reviews for all minority and low-income applicants.”
“New ‘Fannie Mae Partnership Offices”: Fannie Mae will open at least 25 new "Partnership Offices" throughout the country. Through these new offices, the company will form long-term partnerships with cities, rural communities, and other underserved areas that are committed to making affordable housing and homeownership opportunities available to more people. The new Partnership Offices will work with local lenders, public officials, housing organizations, non-profits, and others to expand the corporation's capacity to serve more people, especially minorities and new immigrants. Ten Partnership Offices will open in 1994.”
AEI | From the American Dream to … Bailout America 4
“Underwriting Flexibilities: The corporation is committed to ensuring that its underwriting guidelines are clear and flexible, and are applied equally to everyone. Substantial evidence, including findings in a study conducted by the Federal Reserve Bank of Boston, exists to show that while there is flexibility in Fannie Mae's guidelines, it is applied to white mortgage applicants more often than to minority applicants. A recent report of the federal Interagency Task Force on Fair Lending, made up of top officials of the ten federal agencies responsible for implementing and enforcing fair lending laws, urges lenders to be aware of ‘the provisions of the secondary market guidelines that provide various alternative and flexible means by which applicants may demonstrate their ability and willingness to repay their loans.’”
“Lenders have advised Fannie Mae that they need guidance on how to fully utilize the flexibilities in Fannie Mae's underwriting guidelines. Fannie Mae will take substantially greater steps to make sure that the flexibilities in its guidelines are appropriately utilized by all the company's lending partners. In addition, Fannie Mae will continually survey its mortgage lending partners to identify the loan characteristics and underwriting procedures in need of improvement and clarification.”
“Underwriting Experiments: Fannie Mae will commit $5 billion to test new underwriting approaches. The company will probe and test a variety of underwriting criteria that could make the mortgage finance system more accessible to minorities, low- and moderate-income families, central city and rural residents, and people with special housing needs. The corporation will systematically revalidate the components of its underwriting guidelines.”
The message from world’s largest mortgage investor was loud and clear. Over the next 12 years lenders and borrowers certainly got the message.
7. “Fannie Mae’s Trillion Dollar Giveaway: The government agency pledges money to low- and moderate-income home buyers”vii
8. Fannie introduces 3% down mortgage. It is implemented over the objection of Fannie’s chief
credit officer:
“Some senior executives, including the company's chief credit officer at the time, were opposed to the loans, in large part because a Fannie Mae experiment with 5% down loans in Texas in the early 1980s was disastrous, with one in four borrowers
defaulting.”viii
Editor’s Note: One in four borrowers defaulting would be matched nationwide by both FHA for its 2007 book year and by Fannie for its 2007 book year of loans with LTVs>=95% and/or a FICO<659.ix
9. In 1995 HUD announced its “National Homeownership Strategy”x, noting it had
“forged a nationwide partnership that will draw on the resources and creativity of lenders, builders, real estate professionals, community-based nonprofit organizations, consumer groups, State and local governments and housing finance agencies, and many others in a
AEI | From the American Dream to … Bailout America 5 cooperative, multifaceted campaign to create ownership opportunities and reduce the
barriers facing underserved populations and communities.”
The goal was to make:
“financing more available, affordable, and flexible [in order to]:
“Increase ownership opportunities among populations and communities with lower than average homeownership rates;
“Reduce downpayment requirements and interest costs by making terms more flexible, providing subsidies to low- and moderate-income families, and creating incentives to save for homeownership; and
“Increase the availability of alternative financing products in housing markets throughout the country.
In announcing its National Homeownership Strategyxi, HUD formalized and greatly expanded a long-standing policy goal – the reduction of downpayments:
“Lending institutions, secondary market investors, mortgage insurers, and other
