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By now, most agree that the real estate crisis that precipitated the credit crunch and current economic malaise resulted from two things: Improper lending standards and unrealistic expectations. Sadly, in the midst of the worst economic downturn and, of course, just before an election year, it looks as if the government is going back to its old, and by now disproven, playbook: subprime lending. “The 1977 Community Reinvestment Act (CRA) requires banks to make loans in all the areas they serve, not just the wealthy ones... At the Justice Dept., a new 20-person unit dedicated to fair lending issues received a record number of discrimination referrals from regulators in 2010 and has dozens of open cases, according to a recent agency report. Potential penalties can reach into the millions of dollars. "We are using every tool in our arsenal to combat lending discrimination," Thomas E. Perez, the assistant attorney general for the Civil Rights Div., told a conference of community development advocates in Washington in April.”
The political push to place those who cannot afford homes into them has been with us for over 30 years now. Although the passage of the 1977 Act fell under the Carter Administration, every subsequent administration has promoted the cause of home ownership. President Bill Clinton maintained that agenda with the 1999 Financial Modernization Bill, also known as the Gramm-Leach-Bliley Act, citing that it "establishes the principles that, as we expand the powers of banks, we will expand the reach of the [Community Reinvestment] Act." President George W. Bush, who requested elimination of down-payment requirement for Federal Housing Administration (FHA) loans, endeavored to put everyone into their own home. Congress has done its part too, passing numerous legislative changes since the CRA’s first bill. The goal: increase the philosophically (and politically) pleasing level of home ownership. Politicians serve the promise, and voters eat it up.
As the recent real estate bubble popped, many cited — notably in hindsight — the impractical and sometimes predatory lending practices of subprime dealers as an impetus of the 2008 collapse. Greedy lenders were demonized, while “uninformed” borrowers were spared accusations. Sure, the unrealistic belief that house prices would continue to climb, coupled with the widespread use of complex securitized products (spearheaded by Fannie Mae and Freddie Mac in the early 1980s by the way), contributed to the rise and fall of real estate. Still, the ultimate cause undoubtedly was unsustainable lending standards.
It seemed that the entire banking system, borrowers included, learned their lesson from the past crisis. Banks are recapitalizing by rationally increasing their lending standards and working through poor loans from the past, and individuals are doing what they can to tighten their belts and clean up their own balance sheets. Now, authorities are compelling them to return to what got the economy here in the first place.
Political elections aside, the biggest issue here is the philosophical belief that everyone can and should own a home. The opposing point-of-view is obviously not a popular position because if it was, we — politicians, lenders, and borrowers alike — would not attempt to revive dead ideas.
Yes, it is a sad realization that many cannot afford all the expenses of owning a home and will be deprived of the satisfaction of having a home, rather than renting a house, but it is even more depressing that we are going down a dead end road and subjecting all parties to foreseeable failure.
Subprime lending and the unfortunate consequences are not relegated to real estate. Today, we hear the same arguments regarding for-profit schools and student loans. Are drop-out rates and failure to repay such loans indicative of greedy for-profit educational institutions fleecing unaware yet aspiring students? Or are they illustrative of the segment to which politics direct the lending? The logic behind government-backed and therefore under-priced lending is to extend credit to those who otherwise pose too much risk as borrowers. Still, targeted borrowers do not have access to credit because they are credit, including default, risks; lending to such men and women is NOT being restricted on the basis of color, race, gender, age, or lack of perceived humanity. They just are not given credit because they have been determined to be unable to repay; an estimation proven again and again.
However, if we must continue to cling to dreams of universal home ownership, we must also be willing to understand that losses will inevitably result. When you extend too much credit at a cost that is not fully reflective of credit risk, both borrowers and lenders will end up on the losing end. The impossible dream of general home ownership is not reflective of our values of society, but as a condition of economic demographics.
So, where does this leave us? Opinions on subprime lending — for real estate and education — appear to stem from politics and value judgments instead of economics, and until we equate increased lending restrictions with increased lending risk, rather than as a sign of prejudice, we will make little progress. Still, if we, as a society, make the decision that all subprime lending should be a value-based decision and not a question of economics, we must set realistic expectations and prepare ourselves, both emotionally and financially, for the losses that will predictably occur.
Dan Dellegrotti
May 12, 2011
Disclosure:
"Long Sallie Maes"
Without the support of government-backed loans, I would have not received the benefits of an undergraduate and graduate education.
Source:
[www.businessweek.com]
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That reminds me of Jeremy Grantham's response when asked if we would learn anything from this turmoil:
"We will learn an enormous amount in the very short term, quite a bit in the medium term, and absolutely nothing in the long term. That would be the historical precedent."