The Big Lie Lives On


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The Big Lie just won’t die. The Big Lie, of course, is The Government Made Me Do It theory of the financial crisis, that the housing bubble whose collapse set off the crisis was the product of government policies encouraging affordable home mortgage credit.

A video emerged recently of presidential candidate Mike Bloomberg espousing the Big Lie, and incredibly, the New York Times is running an op-ed that defends the Big Lie. Most of the op-ed comes verbatim from a new book by Christopher Caldwell.  It’s a remarkably misleading piece about government affordable housing policy. I get that Caldwell isn't a housing finance expert, and his book is a trade book on the welfare state, but this is exactly the sort of silliness that happens from drive-by analysis. I'm pretty sure that the Times wouldn't run unsourced climate denial claptrap, but this is the housing finance equivalent. Let me highlight three examples.  

First, Caldwell writes that HUD “required that low-income loans make up 50 percent of the G.S.E.s’ portfolio”.  FALSE.  Caldwell wrongly conflates low-to-moderate income (a group that includes median income borrowers!) with low-income borrowers and ignores that the GSEs met a substantial part of their goals for lower-income consumers by financing rental properties that had nothing to do with the bubble.

To oversimplify a bit, the housing goals require the GSEs to ensure that various percentages of the units whose purchase they finance qualify under three separate goals:  a low-to-moderate income (LTMI) goal, a special affordable goal, and an underserved area goal. A mortgage could count for more than one goal, and the goals were calculated by number of dwelling units, not dollar amount, so a modest property got the same as a fancier one. 

Only one goal, the LTMI goal ever exceeded 50%, but LTMI is not the same as low income. It is everything up to median income for the area adjusted by household size. LTMI does not necessarily include any low income households. Today, for example, in San Francisco it would include a 4-person household with an income of $96,000. Not wealthy, but hardly poor either. Given that the very wealthy do not get mortgages and that the mass affluent are often in the market for mortgages larger than the GSEs are allowed to finance (jumbos), the LTMI market has always been part of the GSE market.  Thus, in 2006, Fannie Mae met a third of its LTMI goal with households at 80%-100% of area median income. 

Now, the special affordable goal is properly characterized low-income, with low-income defined as up to 80% of median income. Today that’s a household earning $77,000 in San Francisco.  The special affordable goal was never set at over a quarter of units financed. Virtually every mortgage that qualified for special affordable also qualified for the LTMI goal, so to the extent that the LTMI goal exceeded the special affordable goal, it was filled almost entirely with mortgages to borrowers earning at least 60% of median. Moreover, Again, on the lower half of the income spectrum, but well above the poverty line. Indeed, it is important to keep in mind that the poor generally don’t get mortgages, as they cannot save for even modest down payments.

As for the underserved areas goal, it is not keyed to borrower income, but to the availability of mortgages in the area in the past. While meant to channel mortgages to capital starved areas, it also financed yuppies’ purchases of properties in gentrifying urban neighborhoods. 

Even more important, perhaps, is that the GSEs, got the same housing goal credit for financing a mortgage for an owner-occupied single-family residence as for each rental unit in building with a multi-family mortgage.  Thus, financing the purchase of a 100 unit low-income rental apartment building would have the same effect as financing the purchase of 100 single family homes. The GSEs were able to cover a large part of their goals for through financing multi-family rental buildings. For example, in 2006, Freddie Mac met over half of its special affordable goal with rental units.  Financing rental properties is an activity with zero connection with the housing bubble. But you wouldn’t know that from the advocates of the Big Lie, who would have you believe that the affordable housing policies were forcing the GSEs to put welfare recipients into McMansions.

Second, Caldwell writes that “The G.S.E.s’ underwriting standards became those of the whole industry.”  WRONG. Caldwell has to make this move in order to explain why the GSEs were somehow responsible for the real carnage, which took place in the private-label securitization-financed market. The problem is that the contagion wasn't from the GSEs to private-label, but the other way around, which is pretty easy to prove. The GSEs lost enormous market share during the bubble years (2003-2006). The market shifted dramatically in those years from the GSEs to unregulated private-label securitization. The GSEs only regained market share in 2007—once home prices were already declining from their spring 2006 peak. If the GSEs were leading the way in dropping underwriting, they would not have lost market share. Instead of leading the race-to-the-bottom in underwriting standards, the GSEs lagged behind and then because of shareholder pressure they tried to play catch-up.

As it happened, the loss rates on GSE mortgages were way lower than for private-label securitizations. The epicenter of the crisis was private-label securitization, and private-label securitization to the extent it had meaningful underwriting standards was not copying the GSEs.   

And finally there’s this unsourced gem in the Caldwell piece:  “By 2007, high-risk mortgages made up 22 percent of the G.S.E.s’ portfolio, up tenfold from a decade before.”  COME AGAIN? I have no idea what Caldwell means by a “high-risk” mortgage; that is not a standard category of mortgage loans. Perhaps there's some source he's interpreting to mean "high-risk," but I suspect it's based on the presence of a single feature in the loan, without considering the totality of the loan. In any case, looking at 2007 is a totally misleading picture, as the GSEs went chasing shite in 2007 in a way that they had never done previously, and the 1997 baseline ignores the impact of automated underwriting (that had only started to be deployed) that allowed the GSEs to safely take a more nuanced (and less discriminatory) view of risk. 

Let’s be clear: the scholarly consensus is that government affordable housing policy had little to do with the financial crisis. The Big Lie still has currency in conservative political circles and their affiliated think tanks (for the Big Lie fits well with their priors that the government shouldn't intervene in markets), but there’s just no serious scholarship that supports it. There are five fundamental problems with the Big Lie, and they aren’t going to go away from mere repetition of the Big Lie: 

  • There is no empirical evidence whatsoever that supports the Big Lie. To the extent that any studies have found connections between affordable housing policies and home prices (and these studies’ findings have been contested), the magnitude of the impact found by the studies has been exceedingly small. But since when has evidence ever mattered when a theory supports someone’s priors?
  • The Big Lie cannot explain why the bubble started when it did (2003), as all of the government policies it points to were in place well before then.
  • The Big Lie cannot explain why housing finance shifted sharply from GSE securitization to private-label securitization starting in 2003.
  • The Big Lie cannot explain the parallel bubble in commercial real estate. Fannie and Freddie finance multi-family residential mortgages.  But there is no government role whatsoever in office buildings, industrial facilities, and shopping malls.  So why was there a bubble in all of these property types, which were financed heavily through private-label securitization?
  • The Big Lie cannot explain the parallel housing bubbles that emerged in some, but not all European countries (Denmark, Ireland, Netherlands, Spain, UK) despite incredibly different housing finance systems and different methods for government support of homeownership.

Bottom line: if you’re pushing the Big Lie, you need to have some sort of answer for these five issues. Otherwise, you’re blowin’ hot air, and respectable publications shouldn’t be giving space to folks who do that.