Creativity Fails: How To Wreck The Housing Market
On June 5, 1995, at 11:50 A.M., in the East Room at the White House, President Bill Clinton delivered his speech “Remarks on the National Homeownership Strategy”, in which he stated: “The goal of this strategy, to boost home ownership to 67.5 percent by the year 2000, would take us to an all-time high, helping as many as 8 million American families across that threshold” (Peters, G., & Woolley, J. T., 1995). To facilitate such goal, President Clinton eliminated regulatory barriers and stimulated the financial sector to find creative ways of increasing home ownership of low-income Americans (Rajan, 2010, p. 36). In other words, the U.S. Presidency facilitated and stimulated financial market innovation to expand the housing market.
The Federal Housing Administration (FHA) guaranteed mortgages, typically focusing on the riskier contracts. By the year 2000, the presidency had cut the minimum down payment for home ownership to 3% (to qualify for the FHA insurance), increased the maximum mortgage value, and reduced by half the premiums paid by borrowers (Rajan, 2010, p. 37). Such measures were in line with the financial deregulation that the Clinton White House was sponsoring: he had urged the Democrat Congress leadership to ban the Depression-era Glass-Steagall Act (Staff, A., 2015). This legislation had for almost 80 years separated investment banking from commercial banking, and now commercial banks were allowed to enter into investment banking, and vice-versa (Senanayake, N., 2009). Furthermore, President Clinton promoted the deregulation of the derivatives market (Commodity Futures Modernization Act) and dissolved legislation that made bank mergers difficult (Staff, A., 2015). The result was a lot of financial innovation, with new loan products, particularly related to house financing.
The intentions of Democrat President Bill Clinton concerning the housing market were right; he wanted to allow poorer people into their homes – how can anyone oppose that? In fact, his successor from the Republican Party, President George Bush, Sr., found that idea and the financial innovation so good that he pushed them even further: “I believe owning something is a part of the American Dream, as well. () I saw with pride firsthand, [a new homeowner] say, welcome to my home. () He was a proud man.And I want that pride to extend all throughout our country” (Rajan, 2010, p. 37).
The Bush Presidency forced the Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac to increase to 56% of their assets in 2004 to guarantee low-income borrowers (Rajan, 2010, p. 38). Acharya, Richardson, Nieuwerburgh, & White (2011) mention that the Bush Presidency had a ‘split personality’ when dealing with GSEs. On the one hand, both Freddie Mac and Fannie Mae would support expanding home ownership. On the other hand, many administration officials – particularly financial market regulators – were alarmed at the systemic risk posed by GSEs as early as 2004, three years before the burst of the housing bubble (Acharya, Richardson, Nieuwerburgh, & White, 2011, p. 62).
Rajan (2010) mentions the increase of bad loans was the ferment of the housing bubble and the ensuing financial crisis. These were called ‘liar’ loans, for borrowers who would flat out lie about income or assets to guarantee their mortgages, and NINJA loans, where the word stands as an acronym for borrowers with ‘no income, no job, no assets’ (Rajan, 2010, p. 36). Banks would accept such borrowers because of the financial deregulation of the derivatives market promoted by President Clinton: they would pass the debt along in Mortgage-Backed Securities, an innovative financial product of the 2000s. The unregulated rating agencies (such as Moody’s or Fitch Ratings) used poor mathematical models to gauge risk. As a result, the front-end loan officers (who approved NINJA loans) pushed the risky assets to final investors who did not know what they were investing in (Senanayake, N., 2009). This was an unexpected outcome of the financial innovation in the housing market, fostered by Presidents Clinton and Bush.
The extreme liquidity of the real estate market made prices soar in the 2000s. In 2007, the housing bubble burst and prices corrected to more realistic levels. This result was very much in line with standard economic theory: the housing market is subject – like any other market – to the laws of supply and demand. Financial innovations offered easy money to poor borrowers, artificially inflating the supply of mortgage loans. Housing demand is obviously very high, as any tenant may attest. The artificial supply of loans brought house prices to an all-time high, but borrowers – who should in a normal market be renting homes or purchasing smaller abodes – still did not have the means to pay. In 2007, a price correction came and was dubbed the housing bubble burst. Furthermore, a big part of the overall financial market was dependent on real estate loans, because of the Mortgage-Back Securities (which origin is in the Clinton derivative deregulation, a sidelong financial innovation), and many banks and insurance companies fail in 2008 onwards, leading to the Great Recession of the late 2000s.
As we can see, the creative solution to the original problem (affordable housing) backfired in a terrible and hard way. A more modest, but still creative solution would be an incentive to long-term housing rental contracts. If borrowers are poor, they could have the FHA insurance not for the loans, but for long-term (such as ten-year contracts) rental payments. These new types of contracts could stimulate new housing, but in a softer way, as the ownership of houses would not be widespread but concentrated on landlords. Tenants would have greater security than standard, short-term rental contracts, but without a binding mortgage commitment. The overall effect on the housing market would be to lower real estate pricing, but in a more organic and slower way, allowing tenant to become homeowners in the long-run, with regular mortgages.
References
Acharya, V. V., Richardson, M., Nieuwerburgh, S. V., & White, L. J. (2011). Guaranteed to
Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance. Princeton,
NJ: Princeton University Press. Retrieved from Questia.
Rajan, R. G. (2010). Fault Lines: How Hidden Fractures Still Threaten the World Economy.
Princeton, NJ: Princeton University Press. Retrieved from Questia.
Senanayake, N. (2009, July 27). The 2007-2008 financial crisis- causes,consequences and
implications. Retrieved May 27, 2016, from http://www.openthesis.org/documents/2007-2008-financial-crisis-causesconsequences-594463.html
Peters, G., & Woolley, J. T. (1995, June 5). William J. Clinton: Remarks on the National
Homeownership Strategy. Retrieved May 27, 2016, from
http://www.presidency.ucsb.edu/ws/?pid=51448
Staff, A. (2015, June 22). 15 Ways Bill Clinton's White House Failed America and the World.
Retrieved May 27, 2016, from http://www.alternet.org/election-2016/15-ways-bill-
clintons-white-house-failed-america-and-world
