Subprime Prediction

Many of the current economic woes can be traced to the sub-prime mortgage mess--and like many catastrophes, this one had a tiny start with the Community Reinvestment Act (CRA). Our own Senator William Proxmire had a hand in the CRA's development in the 1970s.


But like a little snowball the CRA didn't amount to much until the 1990s. A decade ago there was pressure to increase home ownership among minorities and low-income consumers.

A September, 1999 New York Times article by Steven Holmes was prophetic. Here is an excerpt.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''


In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times.

But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison, a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''


Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

It took more than the CRA, the Clinton administration push and the greed of Fannie Mae to get us in this mess. There is considerable documentation surrounding the players (including mortgage lenders, Fannie Mae, Congressional influence peddling, Federal Reserve interest stimulus, shoddy rating agency work, inadequate regulatory supervision, ignorant or greedy consumers and more)--yet, isn't it quite prophetic that Peter Wallison so aptly foreshadowed this coming crisis?