Dr. Benjamin Anderson was one of the most respected economists in the country when economics was a field that demanded respect. (With the rise of modern economics and modern economists like Paul Krugman, Ben Bernanke and all those now at the Fed, those days have long since passed.) Anderson famously described banking as "a regulated but private enterprise, not an instrument for economic, social and political experimentation by government." (1) Anderson also discussed the consequences of government interference in this regulated but private enterprise when he said, "the substitution of government policy in credit matters for the free exercise of banking judgement is one of the most dangerous things that can come to a country." (2, emphasis added)
Anderson developed these ideas more than 75-years ago. His conclusion concerning the dangers of government interference in lending were proven both correct and prescient by the housing bubble and financial crisis of 2008. This conclusion should also serve as a warning for the seemingly innocuous proposal from Bernie Sanders and (the indefatigable) Alexandria Ocasio Cortez to get the government back in banking services via that modicum of efficiency, the post office. To better understand all the risks associated with 'the substitution of government policy for the free exercise of banking judgement' a review of the most spectacular manifestation of these risks - the collapse of Fannie Mae and Freddie Mac - is the best place to start.
Fannie Mae was a Depression-era construct. Like all crisis interventions into the economy, Fannie Mae far outlasted the crisis which was the rationale behind its creation. The largest part of Fannie Mae was privatized in 1968 and an erstwhile competitor to Fannie, Freddie Mac, was conjured into existence by Congress in 1970. Fannie and Freddie were 'government sponsored enterprises' (GSEs). The government capitalized both companies but the companies were operated as private firms. For discussion purposes here, the business of the GSEs was to issue mortgages.
On May 02, 1995, President Bill Clinton announced his "National Homeownership Strategy." President Clinton was somehow able to establish a homeownership goal for the United States - and to three significant digits no less - 67.5%. The "heart" of his national homeownership strategy was "...100 proposed actions....These actions are designed to generate up to 8-million new homeowners by the year 2000." (3) Of course, viewed now, through the smoking rubble of the housing collapse and ensuing crisis, the 100 proposed actions of Bill Clinton's homeownership strategy now read like step-by-step instructions on how to destroy the United States.
At its core, President Clinton's homeownership strategy was nothing other than massive government interference in the mortgage market. Lending standards that had been developed over decades were radically overhauled in a few months. Nowhere was this radical overhaul more obvious than in the lending standards of the two GSEs - Fannie and Freddie. As a result of legislation from October 1992, the Orwellian named Federal Housing Enterprises Safety and Soundness Act (4), the Department of Housing and Urban Develpment (HUD) had the authority to establish how many mortgages the GSEs issued to low and moderate income borrowers, the so-called affordable housing mandate.
In 1993, just before HUD, a government agency, had the authority to direct the GSEs, presumably private companies, to lend to low and moderate income borrowers, 34% of Fannie Mae mortgages went to low and moderate income borrowers. For Freddie, the percentage was 30%. (5) As a result of the actions of President Clinton's two HUD secretaries, Henry Cisneros and Andrew Cuomo, these figures would be left in the dust. In December 1995, HUD Secretary Cisneros - who would later serve on the board of mortgage lender Countrywide and become a home developer himself - raised the percentage of GSE loans that had to go to low and moderate income borrowers to 42%. (6). However, the real damage was to come and it would be delivered by the current governor of New York, Andrew Cuomo.
To Cuomo, a power-mad politician who had zero experience in the mortgage industry, neither the inherently conservative nature of mortgage lending nor the enormous (and obvious) financial risks associated with the GSEs trillion dollar mortgage portfolios would stand in the way of his mad dash for more and more power. On October 31, 2000, Andrew Cuomo declared that fully 50% of GSE mortgages had to go to low and moderate income borrowers. This decision sealed the fate of the United States - the ramifications of this decision were that catastrophic.
Of course the only way to issue so many loans to people who until just a few years ago would not have qualified for them was to change the lending standards. Downpayments were slashed, job histories and credit reports become matters of no concern. After all, there was President Clinton's goal of 67.5% homeownership to meet. Here is Andrew Cuomo via the HUD PR machine on the 50% affordable housing mandate,
"Even with a record homeownership rate of 67.7%, there is still much more to be done. These new regulations (requiring the GSEs to issue 50% of their mortgages to low and moderate income borrowers) will greatly enhance access to affordable housing for minorities, urban residents, new immigrants and others left behind, giving millions of families the opportunity to buy homes or to move into apartments with rents they can afford. We acknowledge and appreciate that Fannie Mae and Freddie Mac have accepted this challenge." (7)
Some evidence of the huge default rates produced by Andrew Cuomo's edict of October 31, 2000 can be seen by the events of September 05, 2008. On that day, Fannie and Freddie were effectively declared bankrupt - they were actually placed into something called "conservatorship" - and each received $100-billion in capital from the Treasury to make good all their enormous losses. Later, on December 24, 2009 - a date obviously chosen to reduce public scrutiny - additional capital injections were authorized. In other words, the original $200-billion wasn't enough! See the Chart below for a plot of homeownership rates in the country. Note in particular the rapid - albeit of limited duration - ascent with the start of President Clinton's 'strategy' to increase homeownership. Note also the serial act of stupidity of the entire housing bubble era - Andrew Cuomo 50% edict to the GSEs.
The disastrous impact of the Clinton administration's interference in the housing market - particularly that of Andrew Cuomo - should have forever put to bed the notion that there is merit to involving the government in lending decisions. (The college lending fiasco is another example that works just as well as the housing bubble.) However, history - even history of a very recent vintage - is rarely sufficient reason to temper the ambitions of politicians, particularly zealots like Bernie Sanders and Alexandria Ocasio Cortez. Andrew Cuomo has never been questioned about his enormous and obvious role in the housing bubble. Let's hope that some tough questions start being asked of Sanders and AOC before their seemingly innocent public banking proposal morphs into a disaster to rival that of the housing bubble.
Sugar Land, TX
May 12, 2019
PS - As always if you like what you read, please consider registering with the site. It just takes an e-mail address, and I don't share this e-mail address with anyone. The more people who register with the site, the better case I can make to a publisher to press on with publishing my book! Registering with the site will give you access to the entire Confederacy of Dunces list as well as the Financial Crisis timeline. Both of these are a treasure trove of information on the crisis and the long-running problems that led to it.
(1) Economics and the Public Welfare - A Financial and Economic History of the United States, 1914-1946, Benjamin M. Anderson, Liberty Press, Indianapolis, IN, 1979, p. 10.
(2) Anderson, Economics and the Public Welfare, p. 176
(3) "The National Homeownership Strategy: Partners in the American Dream," U.S. Department of Housing and Urban Development, May 02, 1995, p. 11 https://docplayer.net/13837348-The-national-homeownership-strategy-partners-in-the-american-dream.html
(4) Orwellian because the act - rather than leading to the safety and soundness of the GSEs - led to their ultimate destruction
(5) US Housing Market Conditions Summary, HUD Prepares to Set New Housing Goals (Table 1), US Department of Housing and Urban Development, Office of Policy Development and Policy Research, https://www.huduser.gov/periodicals/ushmc/summer98/summary-2.html
(7) HUD Archives: HUD Announces New Regulations to Provide $2.4-trillion in Mortgages for Affordable Housing, October 31, 2000 https://archives.hud.gov/news/2000/pr00-317.html