You can't fix the mortgage mess if you don't understand what caused it.
That's not finger-pointing. That's common-sense.
A Biblical parable offers insight into why bad mortgage loans now threaten America's finances.
In Matthew 13, Jesus taught the parable of the wheat and the tares. Tares are weeds that resemble wheat. In the parable, a wheat field had deliberately been polluted by an enemy who sowed the seeds of the weeds intermixed with the wheat. Only after the plants were partly grown did the problem become apparent. The landowner's servants asked if they should go in and pull out the tares. He told them no:
Nay; lest while ye gather up the tares, ye root up also the wheat with them. Let both grow together until the harvest: and in the time of the harvest I will say to the reapers, Gather ye together first the tares, and bind them in bundles to burn them: but gather the wheat into my barn.
In other words, the inability to distinguish the good from the bad made it too damaging to separate them until the plants matured and were ready to be harvested.
Now America's good mortgages - 90 to 95 percent of home loans - are mixed in with bad loans, through Wall Street packaging that has sold them in groups that make it hard to distinguish the good from the bad.
We've all seen retailers sell things as a package, usually marked "Items not packaged for individual sale." These mortgages are akin to that.
The Bush administration proposed spending 700 billion tax dollars to buy those packages, not knowing which would be good loans and which would be bad - a plan that seems to be collapsing due to opposition in Congress and public outcry.
But who mixed the bad seeds in with the good ones, and why? How did mortgages to bad credit risks become so common?
Much has been made of how Fannie Mae and Freddie Mac - led by political insiders - provided a market to buy sub-standard and sub-prime home loans. That would take them off the hands of the original lenders, who could then use their capital to repeat the process by making further sub-prime loans. But what pushed the banks to make faulty loans in the first place?
Many of the bad seeds were sown 30 years ago by the Community Reinvestment Act of 1977.
As Harvard professor Hal S. Scott told a Heritage Foundation audience in 1995, "The Act can only be understood as pressuring banks to make non-market loans," a problem that he described as worsened by further Clinton administration regulations under the CRA. Scott went on to predict: "In the longer term, bank safety and soundness may be significantly eroded."
That was an understatement.
CRA started with a worthy-sounding goal: to enable low-income persons to buy a home of their own. So long as property values were rising, the risks of putting people in houses they couldn't afford remained dormant. But the bubble has burst.
While intact, the bubble empowered unscrupulous individuals. While cloaked in noble purpose, they processed loan papers for bad credit risks, knowing that Fannie Mae and Freddie Mac would buy the loans and take them off their hands. (Even after their recent takeovers, these institutions are still trumpeting their commitment to providing money for "affordable" housing, as they call it.)
What's at fault here was regulation, not deregulation.
Boston's Federal Reserve Branch led the way with a "manual" for lenders, which told them:
- "Lack of credit history should not be seen as a negative
- "Accumulating enough savings to cover the various costs
associated with a mortgage loan is often a significant
barrier to homeownership by lower-income applicants. Lenders may
wish to allow gifts, grants, or loans from relatives, nonprofit
organizations, or municipal agencies to cover part of these costs,"
- "Valid income sources [include] unemployment benefits."
The manual also reminded lenders that failure to loosen their standards could be a violation of federal equal opportunity laws, giving rise to actual damages plus punitive damages of up to $500,000.
The mortgage industry developed a term for many of the loans made under these standards - "liar loans," because falsehoods were readily accepted unquestioningly. Total lack of documentation from borrowers was rampant as well. A study from BasePoint Analytics earlier this year reported that as much as 70 percent of mortgage defaults involved fraudulent misrepresentations on loan applications.
But it didn't matter to those who snapped up the loans, re-packaged them and sold them to others. Now many institutions who bought them are holding "surprise packages" of unknown value.
Whatever else is done to fix the current mortgage crisis, the same mess could happen again unless this system is fixed.
Lending to bad credit risks isn't the only cause of the mortgage meltdown contaminating our economy, but not enough attention has been paid to the fact that government policies have encouraged lending to bad risks. Lenders faced government sanction if they didn't increase their lending to bad credit risks. Underwriting standards were weakened to comply with federal dictates.
Certainly, others deserve to share the blame - but the politicians who say they want to steer our economy to safety are also the group that steered it onto the shoals.
That's why every proposed solution needs to be studied carefully. It may be designed to solve the politicians' problems rather than the economy's.
Ernest Istook is recovering from serving 14 years in Congress and is now a distinguished fellow at The Heritage Foundation.
First Appeared in the WorldNetDaily