Shaun Donovan was Barack Obama’s first secretary of Housing and Urban Development, (HUD). Of course, two of his predecessors as HUD secretary under President Clinton - Henry Cisneros (#11) and Andrew Cuomo (#16) - played enormous roles in causing the financial crisis. Ironically – and symbolic of the revolving door nature of our political elites - Donovan was succeeded as HUD secretary by Julian Castro, the mayor of San Antonio, Texas; a position once held by the spectacularly inept Henry Cisneros.
As Barack Obama’s first housing secretary and the first housing secretary of the post-Lehman Brothers financial crisis, Donovan was forced to answer questions concerning the crisis’ origin. It is not unnatural to think that the media would be able to connect the dots - all one of them - between President Clinton’s central plan for housing with the subsequent collapse of the housing market. While this never happened, Donovan was forced to occasionally weigh in on the role of the affordable housing mandates in the crisis. The affordable housing mandate gave HUD the power to require Fannie and Freddie to issue 42% of their mortgages to low and moderate income borrowers. Later, under Andrew Cuomo, HUD increased this requirement to 50% and thus sealed the fate of the US economy. Prior to the affordable mandate, only about 30-35% of Fannie/Freddie mortgages went to low and moderate income borrowers. When all the additional mortgages to low and moderate income borrowers went bad, the loan losses incurred by Fannie and Freddie were in the hundreds of billions!
The obvious relationship between the huge increases in loan volume to low and moderate income borrowers driven by the affordable housing mandate and the subsequent financial crisis was not obvious to Shaun Donovan. Here is Donovan on the role the affordable housing mandate didn’t play in the financial crisis;
“The vast majority of mistakes that were made – poor underwriting standards, underpriced risk and insufficient capital with inadequate regulatory or investor oversight – closely mirror those made in the private-label securities market where affordability goals were simply not a factor.”
The “affordability goals” referred to here is simply HUD’s affordable housing mandate. Unsurprisingly, an argument this economically inane was echoed by Paul Krugman of the New York Times and Princeton. Essentially the defenders of the GSEs and the affordable housing mandate are claiming that the actions of the most dominant companies in a market, Fannie and Freddie in the mortgage market, can’t affect the profitability or business practices of other companies in that same market. A review of the airline industry will show how baseless this argument is.
There is a saying in the airline industry attributed to Gordon Bethune, former chairman of Continental Airlines, now part of United. It states, “You are only as smart as your dumbest competitor.” For discussion purposes assume you operate an airline and a competitor starts to offer flights between New York and Los Angeles for $75. The average airline passenger won’t draw a major distinction between different carriers in terms of service. If one carrier is offering much lower fares between the same two destinations, then the average airline passenger will almost always fly on the airline offering the lower fares. With so much of your own costs tied up in crew salaries and aircraft you will be forced to compete with these lower prices. Your cost structure may not allow you to meet your competitor’s fares, but you will certainly have to significantly reduce your fares to compete. This dynamic explains the boom and bust profitability cycle that the airline industry is known for. The entrant of a single competitor dedicated to lowering prices to increase market share will change the business conditions for all the airlines it competes with. Consequently, for most airlines their most widely traveled route is the one in and out of bankruptcy court! There is a saying in the investment community that states, “If the Wright brothers had any idea of how much money would be lost by airline companies, they never would have invented the airplane.”
The dynamics in the mortgage industry during the bubble years were no different than the theoretical discussion of the airline industry. The entire mortgage market was influenced by the affordable housing mandate. It is impossible to quarantine the disastrous influence of the affordable mandate between those institutions governed by the mandate, Fannie/Freddie, and those institutions that weren’t. The argument made by the Paul Krugman’s and Shaun Donovan’s of the world that the incompetence of any one company in a market, much less the absolutely most dominant company in a market, can’t ultimately impact the profitability of other companies in that market is absolutely ludicrous. Arguments like this – which are founded on the belief of a completely static business environment where companies act independently of one another - find particularly fertile ground in the minds of people with no real-world, practical business experience. It should be noted that in Paul Krugman’s case the ignorance this lack of practical, real-world business experience – not counting his service to Enron as a consultant anyway – is exacerbated by the political prism through which he views everything.
See William Apgar (#1) for the scale of the losses incurred by Fannie/Freddie. See Kit Bond (#6) for more information on the affordable housing mandate. See Bill Clinton (#12) for more information on his central plan for housing. See Barney Frank (#21) for more information on how the nation’s elites constantly leap to each other’s defense regardless of the obvious nature of their myriad mistakes. See Paul Krugman (#31) for the enormous fallacy that lies at the root of his – and the economic establishment’s – silly ideas.