In a recent email to constituents, bearing the subject line “Wall Street’s bad behavior,” Ohio Sen. Sherrod Brown perpetuates a common misperception about the 2008 housing crash. The views expressed are at a minimum a misunderstanding, at worst a deliberate political obfuscation.
Brown started the email thus: “Almost five years ago, millions of Americans lost their homes, their savings, and their jobs to the economic calamity created in large part by megabanks on Wall Street.” The problem with this statement is that is, “in large part,” wrong.
While lenders certainly played a role in the housing crisis, it is arguable that the federal government played the most prominent role. Brown contends that “Wall Street” engaged in “predatory lending” and made “risky bets,” but lenders would not have behaved as they did without the manipulation of Brown’s congressional predecessors and colleagues.
The real roots of the housing crisis—and the current sub par performance of the general economy—can be found in the early 1990s with good intentions. Many in Congress wanted to expand home ownership and so pursued policies aimed at “affordable housing.”
Congress gave government sponsored enterprises like Freddie Mac and Fannie Mae affordable housing mandates. Both Freddie and Fannie buy mortgages from lenders, who can use the proceeds to make more mortgages, creating liquidity in the market. With an affordable housing mandate, both lowered the standards of loans they would buy from lenders.
Then, regulators began grading lenders on the extent to which they made loans to “underserved” segments of the population. The idea was to increase home ownership among minority groups and lower-income earners, but this necessarily meant that lenders made riskier mortgages. (In the course of doing so, lenders also started using exotic loan types like adjust rate mortgages.) If they didn’t, regulators wouldn’t let them expand into other states, buy smaller institutions, etc. And, of course, the riskier loans could most likely be sold to Freddie and Fannie.
So, essentially, lenders—“megabanks on Wall Street”—were effectively forced to take more risk in order to meet a goal set by the feds. While they could pass on some risk by selling loans into the secondary market, to Freddie and Fannie, some degree of risk remained. This led lenders to concoct exotic securities like collateralized debt obligations to hedge against risk and further spread it across the entire market.
Meanwhile, Congress and the executive branch continued pressuring lenders to slacken underwriting standards. Washington even started subsidizing down payments, which were once a requirement. Together, these policies both forced and incentivized lenders to aggressively and imprudently expand lending. After all, a lender is more likely to make a loan to a borrower with poor credit and unproved income without any skin the game if he or she can just sell that loan to someone else. Put another way, the feds made it to where lenders couldn’t have cared less about the quality of the mortgages they wrote.
Later, as demand pushed housing prices upward, the Federal Reserve entered the game by maintaining low interest rates for long periods of time. This incentivized borrowers to use largely unearned equity in their homes to take out home equity loans. Lenders, seeing values rising rapidly, made loans at high loan-to-value ratios, often over 100%, under the assumption that values would continue rising, thereby providing greater security.
In the middle of the last decade, reality set in. Demand slowed and the market peaked. Then borrowers (many of whom never should have had the mortgages they had) began defaulting. Within a few years, the underlying value of the mortgage-backed securities began to decline. Suddenly, few were buying homes, values were stagnant or falling, and too great a portion of mortgages were not performing (paying). Crisis set in, deepening what was a normal, cyclical recession.
As Sen. Brown put it, “Middle class families didn’t know that Wall Street was making risky bets on their dime.” True: middle class families as a whole probably didn’t know all of this was transpiring, but Washington surely did, because they, in fact, made it happen. Brown also wrote, “[P]redatory lending meant that millions of mortgages were about to go south,” as if the whole crisis were one event. Sure, predatory lending exists, but it only existed—if one can accurately use the label—in housing because of the strong arm of the federal government in pursuit of affordable housing.
Brown wrote, “And it was Ohio taxpayers who were left footing the bill.” This was true, and it was by design. The feds had instilled the belief that there was an implicit guarantee of Freddie and Fannie, meaning that the taxpayers would make them whole in the event of financial trouble; and that’s exactly what happened in 2008. So Sen. Brown can play to taxpayer anger over the Wall Street bailouts of 2008, but this was as his colleagues and predecessors designed.
In closing, Brown assures constituents that he is “committed to seeing that taxpayers in Ohio and across the country no longer need to fear that the economy can be driven into the ground overnight by Wall Street’s risky behavior.” This is simply disingenuous. Brown knows that the housing crisis didn’t develop “overnight” nor was “Wall Street’s risky behavior” the sole culprit—rather, it was Washington’s reckless disregard for reality and prudence that pushed the American housing market in this direction.
So while Sen. Brown can express outrage at the easy target—the visible actor—it wasn’t just “the banks” misguiding lenders down a yellow brick road to financial hell. It was the man behind the curtain, pulling levers, nudging lenders and borrowers to and fro to fit their own ideals. And it was folks like Sen. Brown hiding the behind the curtain, moving pieces around the board and playing voters against lenders, who really caused all of the chaos.
Brown promises that he and his colleagues are “still working to stop this kind of crash from ever happening again.” Perhaps they shouldn’t.