As we near the fifth anniversary of the 2008 financial crisis, we should now have the critical distance to distinguish the real causes from the stereotypical villains, namely, Wall Street greed and unfettered competition. The latter culprits are officially blamed in the 2010 Dodd-Frank Act putatively designed to prevent another crisis: it's called the Wall Street Reform and Consumer Protection Act. The act is unequivocal: Wall Street caused the problem, consumers were harmed, and the federal government is here to help.
But in a free market — fettered by a reliable rule of law but little political micromanaging — would you expect "NINJA" loans to exist? These notorious loans were available to some borrowers with "no income, no job or assets" as late as 2007. Even if we assume that lenders are fueled by avarice, is it likely they would give out loans that they have little reason to believe will be repaid? Surely not. Something clearly had scrambled the normal market incentives in the mortgage bazaar. That something was a wide range of mandated "affordable housing goals," enacted over a couple of decades across many government departments, all designed to increase homeownership among lower income Americans.
The whole story is a long one, but the basic facts are simple. Thanks to the work of Edward Pinto and Peter Wallison of the American Enterprise Institute, and later to the SEC, we now know that as a result of these efforts to expand homeownership, by 2008 about 27 million mortgages were "nontraditional" and relatively risky loans. That was half the mortgages in the United States.
The numbers alone suggest Washington's visible hand. The government-sponsored (and now government-owned) enterprises Fannie Mae and Freddie Mac held 12 million of those loans — which they bought on the secondary market under stiff federal quota requirements. FHA and other federal agencies (such as the Veterans Administration and Federal Home Loan Banks) held 5 million, and Community Reinvestment Act and HUD programs had another 2.2 million. That's a total of 19.2 million risky loans held by entities controlled by or within the federal government, leaving 7.8 million for Countrywide, Wall Street, and so forth.
Let that fact sink in, because this is the one that shatters the mythology surrounding the financial crisis. Two-thirds of all risky loans in the system, we've since learned, "were held by the government or entities acting under government control," and they existed largely because of aggressive government housing policy.
The large-scale effect — a meltdown in the financial sectors involved in mortgages and mortgage securities — is known to all. The effect on private financial virtues has been largely ignored.
All things being equal, homeownership correlates with many good things. On average, people who own rather than rent their homes commit less crime, perform better in their jobs, vote, take more interest in their community, and keep up better with house maintenance. Homeownership is also a perennial element in the American Dream. So it's easy to understand why legislators and presidents would want to encourage homeownership among lower-income earners. But beneficial government policy attends not merely to good intentions but to tangible consequences. That requires careful economic reasoning. Affordable housing policies failed that test.
In housing policy, politicians left, right, and center made the classic mistake of confusing correlation with causation. There's a difference between merely having property you've gotten easily and disciplining yourself so that you can acquire and keep it, just as there's a difference between earning a million dollars from hard work and winning a million dollars in the lottery.
Since homeownership had correlated with fiscally virtuous behavior, policymakers imagined that they could boost such behavior by boosting homeownership. But mere ownership doesn't magically make people financially wise, capable, or virtuous. Instead, in a country with property and other basic rights, wise and virtuous behavior makes it possible for people to accumulate enough capital and credibility to be able to get a home loan. This incentive has spurred a virtuous circle among countless American immigrants. The dream of buying a house encouraged good financial practices, hard work, and thrift. Once people owned their homes, they valued them all the more because of what they'd had to do to get them in the first place. The equity they put into the loan spurred them to stay on the straight and narrow.
In a healthy housing market, people get a mortgage loan because of what they have already done — they've worked hard, kept their jobs, paid their debts, delayed gratification, and saved for a down payment. In this virtuous circle, wise behavior makes it possible to acquire a home, and acquisition of a home reinforces wise behavior.
When government short-circuited that loop of incentives, a vicious circle of bad financial decisions was the result. A meltdown was inevitable.