Housing and Fannie Mae: FDR's American Dream

0:00Well, if we know anything about Austrian Business Cycle Theory and what it teaches us, is that a depression is what clears away the excesses of the previous boom. And if we've had an excess in anything during the last boom, it was in houses. Over a million houses were lost to foreclosure last year. Last month, one in every 355 homes in America received either a default or an auction notice or were seized by creditors. This despite many of the moratoriums on foreclosures right now. So the economy is desperately trying to heal.

0:45It's desperately trying to clear away these excesses. And we've seen this very much in California where Guarantee Bank of Austin recently demolished 16 finished homes, brand new homes, down in Victorville. I might add that Guarantee Bank failed last Friday, but their deposits were picked up by a Spanish bank. So I'm sure the Spanish bankers maybe know what to do a little better than the guys down in Austin, but these are homes that were sold from $280,000 to $350,000, brand new, never been lived in, and they just went ahead and tore them down.

1:32You may have seen the video of it on YouTube. But this isn't the only example. Here in California, there's only over 9,400 homes, projects of 9,400 homes, that have been stopped, have been halted, essentially at the house stage or at the finished building lot stage. 250 residential developments here in California have been stopped, and the residential meltdown

2:37tax credit if you buy another new, redundant new home from the state of California, which we know how flush the state of California is at the moment. So we've got this tremendous overhang, the demand for homes appears to be somewhere around 300,000 a year, yet 500,000 new homes are being started. Now until recently, home ownership in the United States was only a dream for most people. Most people didn't buy homes. From 1900 to 1940, fewer than half of all Americans owned their own home. Home ownership rates fell in three of the first four decades of the 20th century.

3:24And the difference was, whereas today if a young person gets a job and some steady income, They will immediately obligate themselves for 30 years and go out and buy a new home. Now their great grandfathers would have saved money for 30 years and then bought a house for cash eventually. But this has been turned completely on its head. And how did this all happen? How did this boom in housing, this subsidy for housing happen, whereas 70% of Americans and now own their own home. And Thomas Segrou, who's a history and professor at the University of Pennsylvania, puts it quite succinctly, we are a nation of homeowners and home speculators because of Uncle Sam.

4:17Before 1929, the government played very little role in the housing market. In fact, the only legislation there was, was in the tax code of 1913 where you were able to deduct your mortgage interest but other than that they didn't become involved if you got a mortgage it was you had to put 50% down the the loan would only go for three to five years and there was a stigma attached right I mean there was a stigma if you had a mortgage the fact when people paid off their mortgage there was a mortgage burning parties I don't know about you but I haven't ever been invited to a mortgage burning party so on top so so what you had was two types of homeowners the wealthy who paid cash or you had working people who were able to buy some land and build their own home that's that's the way housing was and even the rich rented because they felt like there was there was better uses for their cash than to tie it up in a home but this all

5:23It's all changed in the Depression. It's all changed. New housing starts had felled 95% between 1928 and 1933. Half the mortgages were in default. And no matter what you read, the truth is Herbert Hoover did not sit idly by. He signed the Federal Home Loan Bank Act in 1932, and that was just one of the many government intrusions into the housing market. In his first 100 days, FDR introduced the Homeowners Loan Act of 1933, and that was to extend relief to homeowners who couldn't pay their mortgages. There were 1,000 urban mortgages being foreclosed on a day. The bill created the Homeowners Loan Corporation that provided loans at 5% interest and lengthened repayment schedules to help out foreclosed buyers.

6:18I would think by now this is all sounding very familiar, right? The government loans were capped though, it was only for middle income or poorer people, so they capped these loans at $20,000, which doesn't sound like much, but when you translate it into $2,009, that's about $320,000. Now when he signed the bill, Roosevelt urged lenders to institute a moratorium on foreclosures According to a recent biographer, Adam Cohen, who's quite taken with FDR, by the way, he said this new law was a great success. The HOLC was soon to hold one-fifth of all urban mortgages.

7:04The FHA was created a year later, in 1934, to set standards for home construction and it instituted 25 and 30 year mortgages and cut interest rates. And then four years later FDR created the Federal National Mortgage Association, Fannie Mae, and this created a secondary market for mortgages. They were given the mandate to help make homeownership more available throughout the United States. Set up as a publicly traded company, but with a federal charter. And these programs all worked in a hurry. It didn't take long, by 1950, 55% of Americans owned their own home.

7:50By 1970, homeownership was 63%. And then beginning in 1992, Congress pushed Fannie Mae and Freddie Mac. Freddie Mac is kind of like Fannie's little brother. It was founded in 1970 to expand, again, the secondary mortgage market, and in 92, Congress pushed them to increase their purchases of mortgages going to low and moderate income borrowers. For 1998, the Department of Housing and Urban Development, HUD, gave Fannie Mae and Freddie The explicit target, 42% of their mortgages were to go to borrowers with income below the median for their particular area. They began means testing, who was going to be able to get a mortgage.

8:37That target was increased to 50% in 2000 and 52% in 2005. And between 2000 and 2005, Fannie and Freddie met their goals every year, Funding hundreds of billions of dollars worth of loans, many of them sub-prime, adjustable rate, made to borrowers who bought the houses with less than 10% down. In 1997, Bear Stearns did a first securitization of the Community Reinvestment Act loans. We heard a little bit about CRA loans earlier from Tom. These are loans made in low-income areas. You get a map from the government, they tell you where low income people live and you're to direct your loan dollars there and if you don't hit a certain threshold then banks typically don't do well on those type of exams and it keeps you from branching, keeps you from expanding your bank so bankers do the smart thing and make loans in those areas.

9:44So over the next ten months, Bear Stearns issued 1.9 billion CRA mortgages backed by Fannie and Freddie. And CRA was then strengthened in 1995, leading to an 80% increase in the number of bank loans going to low and moderate income families. Politicians loved the increase in home ownership and the rising home prices kept default rates Unusually Low. So everybody won. Fannie and Freddie were doing great. They're allies on Capitol Hill, thought they were great, and everybody was rolling in dough. Then as if this wasn't enough, Fannie Mae launched the American Dream Commitment in 2000. They were to provide $2 trillion in private capital for 18 million underserved Americans to own In 2001, over 51% of Fannie's financing went to low and moderate income households, and that was to aid them because, as one fan of Fannie Mae wrote, these people were victims of predatory lenders.

11:02Fannie Mae allows additional flexibility in underwriting new loans for people trapped in abusive loans. I don't know if you've ever been trapped in an abusive loan, but it's tough to deal with. 2004, Fanny has expanded the American Dream Commitment pledging to help six million families become first-time homeowners over the next decade. Of course, rationalizing home ownership is something that Fanny May and its friends on Capitol Hill always have to do. And so they said one survey of consumer finances found that low-income homeowners have a net worth 12 times that of renters at the same income level.

11:48Other studies found that children of homeowners are more likely to graduate from high school, college. I mean, I don't know how you could draw a nexus between those two things, but that's what they say. They're more likely to go and own a home of their own. So, if you grew up in a household that's a renter, chances of home ownership are just virtually nil according to these people. Also shows that home ownership keeps communities attractive, safe and vital, generating higher property values and other economic activity. Of course, what they mean here is higher property taxes is what they're after. Of course, there's always been a problem, even when you lower rates and you make the In 2003, President Bush signed into law the American Dream Down Payment Act, otherwise known as the ADD Act.

12:54So this is the American Dream Down Payment Act of 2003, and it was to help 40,000 families with their down payment and closing costs. And this is to further strengthen America's housing market. Now when the bill was signed, the housing market was on fire. I mean overall starts had, in that month of December of 2003, the annual starts were nearly a million seven. In 2007, there had been a 17% increase in the number of housing starts since the previous year. So this isn't something that the housing market needed. But for political purposes, the American Dream Down Payment Act was put into place.

13:40And the administration said at the time, the strong housing market is beneficial for communities across the nation. And the families have been refinancing due to the lowest mortgage rates in 45 years, saving hundreds of millions of dollars a month in their home payments, and the U.S. homeownership rate was 68.4% in the third quarter. That was the highest level ever at that point. And Bush recognized that the biggest barrier to homeownership was this down payment. This idea that you had to actually save money, accumulate money to put down toward a house. So they wanted to make that go away. And I remember when I was in Las Vegas, I'd go to housing conferences.

14:26And I remember a gentleman from Countrywide. Remember Countrywide? Used to be a pretty big outfit. And he stood at the podium and said the biggest barrier to home ownership is down payment and we're going to make that go away. and they pretty much did. So then with this whole down payment thing being passe, between 1997 and 2005 we all know what happened to house prices. They doubled and the subprime mortgage market was not only born but it was nurtured and Fannie and Freddie played a significant role in the explosion of these subprime mortgages and subprime mortgage backed securities.

15:11Without the implicit government guarantee of the GSEs, the sub-prime market just would have never taken off. Homeownership jumped again in 1994 to 64 percent, 2004 it was 69 percent, and again the result was increased loans to low-income, high-risk borrowers. But of course Bill Clinton and George W. Bush trumpeted the rise in ownership as it occurred. And not only were they laid to lean out billions in cheap money, they were good corporate citizens at Fannie Mae. The Business Ethics Magazine, 100 best corporate citizens, every year contained Fannie Mae. In fact, they were number one in 2004 as the best corporate citizen in America.

16:00They also performed well in Fortune's Best Companies for Minorities, Women's Working Working Mothers List for Best Companies for Working Mothers. They made that list. They made the list for the American Benefactors List as the most generous companies in America. So Fannie Mae was doing everything. They were lending money to poor people, to get houses, live in the American Dream, and they were great corporate citizens. I mean, nothing could go wrong. But then, 2004, they were caught cooking the books. The Office of Federal Federal Housing Enterprise Oversight alleged widespread accounting errors at Fannie Mae. James Lockhart, the Director of the Office of Federal Housing Enterprise Oversight, commented that, quote, the image of Fannie Mae as one of the lowest risk and best in class institutions was a facade.

16:59Our examination found an environment where the ends justified the means. Senior management manipulated accounting, reaped maximum undeserved bonuses, and prevented the rest of the world from knowing." The flagrant accounting errors went back at least into the 90s, an article that Karen DeCosta wrote on Mises org, when the company was improperly deferring expenses in order to boost revenue, and it paid out huge bonuses to top executives. So Fannie Mae did the smart thing. If you're being questioned about your financials, what should you do? Stop filing them. And that's what they did.

17:45Stop filing financials with the SEC. Of course, try to be another public company and get away with that. So since 2004, they were constantly behind in their filing of financial statements. And these financial shenanigans took place despite the prestigious board of directors that they had. They had a former Reagan Chief of Staff, they had lobbyists, former aide to Nixon, a Reagan Secretary of Labor, U.S. Trade Representatives, top economic advisor, President Bush. So they had a very esteemed Board of Directors while this was going on. But they had friends on Capitol Hill, it's good to have friends.

18:32One of those friends is a financial expert, he must be because he heads up a committee in Washington, Barney Frank. He quoted a saying when he was talking about Fannie Mae and their troubles, quote, I worry frankly that there's a tension here. The more people in my judgment exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see. I think I think we see entities that are fundamentally sound financially and withstand some of the disaster scenarios, unquote. Another financial expert, Maxine Waters, said during the same hearing, If it ain't broke, why do you want to fix it? Have the GSEs ever missed their housing goals? Unquote.

19:24And of course Christopher Dodd, Senate banking committee member, he said, I will just briefly say, Mr. Chairman, obviously, like most of us here, this is one of the great success stories of all time. And we don't want to lose sight of that and what has been pointed out by all of our witnesses here, obviously. The 70% of Americans who own their own home today, in no small measure, do because of the work that's been done here. Well, if we fast-forward today, Fannie and Freddie only exist because of the support of the taxpayer. Now, when I wrote this a week or two ago, the stocks were trading at a buck.

20:11But if you follow it, they're trading at two bucks for Fannie and Freddie. They had another rally yesterday, but in the local paper here, they say, Investors trade stocks of zombie companies. Of course, they're referring to Fannie and Freddie. And an analyst with Keith Brouette and Wood says, people have done well by trading them, but when it gets to the end of the road, these stocks are going to be worth zero. Now, Freddie announced its first quarterly profit in two years, but it wasn't enough to cover the dividend that it owes the government. Department. Despite the profit, besides the profit was only due because the GSC was able to revalue some of their assets and that created a gain of $5 billion.

21:04But starting next quarter they're going to go back to reporting billions in losses in the next quarter. It has serious delinquencies that have risen from 2.29% to 2.89% and Fannie's delinquencies has continued to rise from 3.9 from 1.36 from a year ago. Fannie has borrowed $46 billion from the government, while Freddie's debt to Uncle Sam is now $51 billion. So, meanwhile, the housing market, despite all this government intervention, has continued to sink. to Sink. A new report from First American Core Logic shows nearly a third of all mortgages are now underwater. That's 15 million loans. Now the negative equity is skewed in three states, Florida, Arizona, and Nevada. But a new Deutsche Bank report indicates that by 2011, 48% of all mortgaged Americans will be underwater. And Deutsche Bank lists 10 In cities where the projected percentage of mortgage borrowers underwater will be 90 percent or above, Fort Lauderdale, El Centro, California, Merced, Las Vegas, Bakersfield, Riverside, San Bernardino, by 2011 according to Deutsche Bank, 90 percent of their loans, mortgages

22:35would be underwater. But underwater is no problem for Fannie and Freddie. In July, the Two GSEs received regulatory approval to refinance mortgages at a loan to value as high as 125%. You remember when Alan Greenspan told everybody to go out and get an adjustable rate mortgage? Well now, in the words of Grant's interest rate observer, the government has blessed, subsidized and institutionalized the state of underwater home ownership. James Lockhart, who's running another agency now, Federal Housing Finance Agency, says, quote, the higher LTV refinancing will allow more homeowners to strengthen their finances by taking advantage of lower interest rates. But Dan Gertner at grants did the numbers, and he said the savings from modifications are tiny. He says you could save more money by switching to GEICO.

23:44But the GSEs can modify all they want. That doesn't mean distressed homeowners can or will pay. According to the June 30th edition of Mortgage Metrics Report published by the Comptroller of the Currency, 28% of all modified loans were 60 days past due within 60 days of being Modified, which means that more than one in four people who modified their loans because they couldn't pay, according to the original terms, didn't make a single payment after the loan was modified. So what has FDR's American dream given us? Dito Holzman explains in his book, The Ethics of Money Production, quote, the net effect of the recent surge in household debt is therefore to throw entire populations into financial dependency. The moral implications are clear. Towering debts are incompatible with financial self-reliance, and thus they tend to weaken self-reliance also in other spheres. The debt-ridden individual eventually adopts the habits of turning to others for help, rather than maturing into an economic and moral anchor of his family and of his wider community.

25:06Wishful thinking and submissiveness replace soberness and independent judgment. What about the many cases in which families can no longer shoulder the debt load? Then the result is either despair or alternatively scorn for all standards of financial sanity. As Hans-Hermann Hoppe pointed out in his book, Democracy, the God that Failed, savers are the ones who initiate a process of civilization by generating a tendency toward a fall in time preference. He and those that exchange with him, quote, mature from childhood to adulthood and from barbarism to civilization, unquote. But instead, with FDR's American and Dream. We have subsidized debt and in turn raised time preferences. Instead of encouraging savings and thrift, it has blessed, subsidized, and institutionalized personal fiscal insolvency.

26:13And this fiscal insolvency now threatens to lead this country to moral insolvency. Thank