Wall Street still gets the blame for the subprime crisis that triggered the Great Recession. But the unsustainable housing bubble took off in the mid-1990s, just as several unprecedented government housing policies were initiated.
In the 30 years up to 1995, the share of U.S. homes occupied by their owner was remarkably stable, usually between 63%-65%. But over the next decade, the homeownership rate soared from about 64% to more than 69%, until the housing bubble burst. The rate is now just over 65% and may still be dropping.
"Common sense suggests something happened in that 10-year period to raise homeownership rates to this unprecedented high level," said Mark Perry, professor of economics and finance at the University of Michigan-Flint and scholar at the conservative American Enterprise Institute. "The chart also shows that the rates were unsustainable.
Fannie, Freddie Mandate
The wheels were set in motion in the early 1990s when congressmen like Rep. Barney Frank, D-Mass., began pushing "affordable housing" goals. In 1992 Congress passed the Housing and Community Development Act that enabled the Department of Housing and Urban Development to impose affordable housing mandates on Fannie Mae and Freddie Mac, the quasi-private mortgage finance giants. They bought or guaranteed home loans, so their new mandate had a profound effect on the private mortgage industry.
The Clinton administration's HUD actually adopted affordable housing mandates for Fannie and Freddie in 1995. As a result, in 1996 they had to make 40% of the new loans they financed to borrowers with incomes below the national median. By 2000, the mandate was increased to 50%.
"In practice what this meant was Fannie and Freddie would have to loosen their underwriting standards so that they could back subprime loans," said Edward Pinto, resident scholar at the AEI. "It also meant they would have to take the money they made on their low-risk loans and use it to cross-subsidize their high-risk loans.
In 1995 the Office of Housing and Urban Development announced a National Homeownership Strategy. The result was a partnership with public and private mortgage players that ended up reducing underwriting standards dramatically.
This goal was to boost the homeownership rate to 70%. To get there, the partnership would use "flexible underwriting," which meant getting rid of down payments. Eventually it also included increasing the allowable debt-ratio of borrowers and lowering the standards for credit scores. This made far more potential borrowers eligible to purchase a home. The trade-off was a big increase in risky borrowers entering the housing market.
By 2000, Fannie and Freddie were financing loans with zero down payments. Not long after, the private mortgage industry began doing the same. By 2006, nearly 30% of all home buyers made no down payments. Back in 1990 less than 1% of buyers put 3% or less down.
Mortgage-backed securities enjoyed modest growth for much of the 1990s. But with Fannie and Freddie fueling massive loan growth — especially in subprime mortgages — the MBS volume exploded, from just under $1 trillion in 2000 to over $1.5 trillion in 2001, peaking at $3.2 trillion in 2003. The volume fell by more than $500 billion from 2007 to 2008 as the housing bubble burst.
Among other key government policy changes that fueled the housing bubble: CRA changes. The Clinton administration made key changes to the Community Reinvestment Act. Prior to then, the CRA judged banks on the efforts they made to make home loans to low-income borrowers. In 1995, regulators judged banks on how many loans they actually made. To make more such loans, banks had to engage in flexible underwriting.
American Dream Downpayment Act. President George W. Bush's American Dream Downpayment Act, passed by Congress in 2003, helped subsidize the down payment for lower-income borrowers.
While Wall Street undoubtedly played a large role in the housing crisis, it was politicians and public policy that set up the housing bubble in the first place.
Since the housing bust, the private mortgage-backed securities market remains near-moribund, but the Federal Housing Administration and other government agencies have beefed up their involvement, exceeding the bubble-era peaks.
The Obama administration has targeted banks for alleged predatory lending vs. minorities while simultaneously demanding that lenders step up activity in low-income areas.