Historian: Housing Nominee Mel Watt Helped Spawn the Subprime Crisis

by Hans Bader on May 6, 2013

in Bailout Watch, Economy, Legal, Politics as Usual, Zeitgeist

In the Daily Caller, historian and presidential biographer Charles C. Johnson writes that “Housing nominee Mel Watt helped create the subcrime crisis.”  Watt has been nominated by President Obama to be director of the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac.  As John Berlau discussed earlier, Watt’s record also flunks privacy, transparency and government-accountability tests.

As Johnson notes, while in Congress, Watt “pushed government programs to help welfare recipients buy homes during the creation of the subprime mortgage bubble,” ultimately at taxpayer expense.  “Watt, a 20-year Member of Congress from North Carolina’s 12th district, also had a hand in programs allowing borrowers with poor credit to buy homes with no down payment.”  Later, “millions of bad borrowers defaulted on their loans, setting off a market crash that wiped out nearly 40 percent of the net worth of Americans.”  As Johnson points out, “Watt, alongside then-Rep. Barney Frank, D-Mass., blocked Bush administration efforts to reduce Fannie and Freddie’s overexposure to subprime loans” in 2003.  “In 2007, a full year after the real estate market peaked and began to plummet under the weight of millions of mortgage defaults, Watt and Frank co-sponsored a bill forcing Fannie and Freddie to meet even higher quotas for affordable lending and to invest in an “Affordable Housing Fund” for inner city communities.”  As Johnson observes, “Many of those risky loans ultimately led to the housing bubble and financial crisis.”

Pressure on lenders and the mortgage giants to promote affordable housing — ratcheted up during the Clinton administration — led to the mortgage meltdown.  Earlier, in the New York Times, I discussed the role played by the government-sponsored enterprises, Fannie Mae and Freddie Mac, in spawning the financial crisis and burdening taxpayers to the tune of hundreds of billions of dollars. The two mortgage giants bought up risky sub-prime mortgages partly  to satisfy government affordable-housing mandates, as even the liberal Village Voice found in its investigative reportingNew York Times reporter Gretchen Morgensen, and AEI’s Peter Wallison, also have written about the role of the mortgage giants, and the affordable-housing mandates they put up with in exchange for their legally privileged status, in spawning the 2008 financial crisis.

Banks and mortgage companies have long been under pressure from lawmakers such as Watt — as well as regulators — to give loans to people with bad credit, so as to provide “affordable housing” and promote “diversity.”   That played a key role in triggering the mortgage crisis, judging from a New York Times story. It noted that “a high-ranking [Congressional] Democrat telephoned executives and screamed at them to purchase more loans from low-income borrowers.”  The executives of government-backed mortgage giants Fannie Mae and Freddie Mac “eventually yielded to those pressures, effectively wagering that if things got too bad, the government would bail them out.”  But they realized the risk: “In 2004, Freddie Mac warned regulators that affordable housing goals could force the company to buy riskier loans.”  Ultimately, though, Freddie Mac’s CEO, Richard F. Syron, told colleagues that “we couldn’t afford to say no to anyone.”

Later, after the loans went sour, taxpayers had to bail out Fannie Mae and Freddie Mac, at a cost of $170 billion.  Unlike the private banks, these government-backed mortgage giants have not repaid their bailouts. Their dominant role was reinforced and expanded by the 2010 Dodd-Frank Act, which imposed mortgage rules on their competitors that they were exempt from, leaving them free to traffic in mortgages that better-managed private institutions cannot touch because of Dodd-Frank.  Democratic lawmakers blocked attempts to reform Fannie Mae and Freddie Mac, as they continued to buy up risky mortgage loans at taxpayer expense.  The Obama administration rewarded managers of Fannie and Freddie for promoting its political agenda with $42 million in pay.

Watt, a staunch partisan, would replace Ed DeMarco, the non-political current head of the FHFA.  Under pressure from the Obama administration, DeMarco has signed off on some bailouts for certain mortgage borrowers, such as reductions in interest payments for certain borrowers, and debt forgiveness for certain delinquent mortgage borrowers willing to do short sales and get out of the house.

But DeMarco has resisted bailouts on a vast scale, such as massive principal reductions for people just because they are behind on their mortgage.  Last July, he concluded any purported economic benefits of principal reductions would be outweighed by the costs of inducing borrowers who could pay their loans to default.  DeMarco also was  concerned about the unfairness of reducing mortgage principal for delinquent borrowers who lived beyond their means, when others who have sacrificed to stay current would receive no similar bailout.  As a result, although the Obama administration engineered bailouts for delinquent borrowers (including speculators) whose loans were held by various private banks, there has not been a general bailout for borrowers whose mortgages are held by the government-backed mortgage giants Fannie and Freddie.

Some backers of the Obama administration have pushed for a trillion-dollar mass mortgage bailout, to try to drive up consumption and reduce saving, which they believe would provide a short-term boost to the economy (and the administration’s political fortunes).  Never mind consumption is higher than before the 2008 financial crisis, but investment, business investment in particular, has lagged.  (The Obama administration consistently has sought to raise taxes on investment income, and Watt repeatedly voted to raise taxes on investment income while in Congress).

Watt likely will dramatically expand bailouts, at taxpayer expense.  As the Washington Post noted on May 3, Watt is a “favorite of congressional Democrats and liberal housing policy advocates whose top priority for Fannie and Freddie is not long-term but short-term: to underwrite more aggressive loan modifications, including principal reductions,” at taxpayer expense.  (The administration has carried out only a limited number of bailouts at taxpayer expense, including bailouts that benefited irresponsible people who, despite ample incomes, saved so little money that they made only a tiny downpayment, and thus later ended up with negative equity in their homes.).

As the Washington Post notes, what is needed is “a permanent fix to the mortgage-finance system. That means winding down Fannie and Freddie and building new structures free of their design flaw — socialized risks and privatized profits. President Obama’s Treasury Department urged such a solution more than two years ago but has yet to propose legislation.”  Mel Watt is unlikely to propose any such solution, since doing so might undercut his ability to pursue the failed policies he promoted in the past — policies that helped trigger the 2008 financial crisis.

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