Ever since FDR’s New Deal initiative, Democrats have gathered electoral support through the distribution of federal program dollars.  They justify their spending by saying it is done to pursue “social justice” and “fairness.”  The great political value of these concepts is that they are open-ended; they do not imply, nor do they allow, any limits.

While Republicans have struggled to convince voters that open-ended federal spending will eventually hurt working Americans and the poor, the mortgage crash of 2008 may provide such an opportunity.  This is because the mortgage changes promoted by the standards of social justice and fairness had a clear beginning, middle, and implosive end.

The social justice rationale was expressed in the 1992 Boston Federal Reserve paper Mortgage lending in Boston, which concluded that racial discrimination alone was responsible for the low number of mortgage approvals granted to black and Hispanic home loan applicants.  The report recommended: “lenders, community groups, and regulators must work together to ensure that minorities are treated fairly.”ⁱ

But the Boston Federal Reserve did not recommend specific financial guidelines that should be used to qualify borrowers; no method of measuring fairness was suggested.  Previously, banks required mortgage applicants to meet the traditional loan qualification standards known as the three Cs: credit, collateral, and capacity.

This study was embraced and used as a rationalization for the politicization of mortgage underwriting standards.  Neighborhood groups such NPA and ACORN, ⁱⁱ who had been demonstrating for years for social justice in housing, used this study to lobby Congress, with much success: Fannie Mae gave these groups financial grants.  In 1993 ACORN created a $55-million lending program financed by fourteen major banks.ⁱⁱⁱ  Private banks such as J.P. Morgan and Chase gave these community groups hundreds of thousands of dollars in donations so the groups would not demonstrate against them and damage their public images.

Following these developments, traditional home mortgage lending standards were gradually undermined by a series of federal policy changes and actions^iv noted by Pinto.  Fannie Mae and other federal agencies began to lower down payment requirements.  Eventually, buyers needed only to put down 1% to 3%, and ultimately 30% had zero down payments.^v  Subprime mortgages were virtually nonexistent before the 1990s.^vi  Anyone who doubts that federal agencies had the authority to lower down payment requirements need only recall how federal bureaucrats wrote 20,000 pages of regulations to impose the Affordable Care Act on Americans.

Eventually this reached Wall Street: when Wall Street investment firms purchased bundles of MBSs – mortgage-based securities – based on these non-traditional or subprime loans, the loans were not listed as subprime.^vii  The highly risky nature of these MBS bundles was intentionally hidden from Wall Street investment firms. 

When the 2007 recession hit and subprime borrowers couldn’t make their mortgage payments, the whole house of cards fell down.  That the federal government knew these loans were improperly made was proven by the fact that the federal government bailed out the banks for their MBS losses with TARP money.  Even while the loans were being made, Chris Dodd added an amendment to the 1992 FDICIA law that gave protection to investment banks and insurance companies.^viii  It is not unreasonable to see federal bailout actions as an admission of collusion.

Peter Wallison worked with Fannie Mae.  Edward Pinto was the chief financial officer of Fannie Mae for three years.  Both are now fellows at the American Enterprise Institute and have documented how the government was responsible for creating the unprecedented number of subprime loans.  Today, 27 million, or half of all outstanding mortgage loans, are subprime.^ix 

In two ways, federal government policies made this happen: 1) banks were pressured, from several angles, to make loans to unqualified borrowers, and 2) investment banks and mortgage lenders were quietly promised they would be bailed out -- i.e., they could sell the bad mortgages to the federal agencies.

Given that the authors of “Guaranteed to Fail” stated that this setup was destined to fail,^x it is difficult to understand how the government can blame the private capital market for the mortgage meltdown.

Liberal critics cannot say that banks destroyed the economy with their excessive corporate greed, since if their corporate greed had been in place, those 27 million subprime loans would not have been made.  Nor would greed have compelled Wall Street to purchase MBSs guaranteed to fail. 

Those who claim that corporate greed bankrupted itself are in a clearly contradictory place.  Only the federal government spends without cognizance of loss, since it can pass losses onto future generations of taxpayers.  And since the federal government holds over a trillion dollars in interest-sensitive debt,^xi  consumers will be hurt when inflation rises, and the Federal Reserve raises interest rates to reduce inflation.  The Federal Reserve has its hands tied as a result of the subprime mortgage debacle.

Since 2008, when social justice and fairness caused the mortgage meltdown, virtually every American’s home has lost value.  Tens of millions have lost jobs and/or are earning less money.

The essential difference between private and public financial planning is that federal spending programs do not record losses.  This practice allows progressive politicians to reassure voters that losses will not defund people programs.  This is supported by their “tax the rich” rhetoric, which intentionally creates the illusion that government has an infinite amount of money.  And of course, to justify it all, they constantly attack Republicans, as part of their incessant campaign strategy to convince voters that only they have the moral qualifications to help the most needy.

But this concept of inoculation from loss, when forced upon major sectors of the private economy by federal regulators, creates fiscal crises on a national scale.  It will be repeated again and again through ObamaCare and the long-term monetary effects of QE3.

With subprime mortgages, the Democratic Party forced the private sector to disconnect itself from risk appraisal to expand Democratic social justice programs.  This allowed Democrats to take credit for extending housing programs to the poor while shifting the huge national costs onto the private sector, cleverly making the private sector appear responsible. 

In the long run, the results prove two things: 1) the real economy cannot disconnect itself from a measure of loss risk, and 2) unrestrained spending on federally mandated social justice programs creates losses and hardships for the middle class and poor.

Notes

i. Boston Fed. p. 44.

ii. Pinto 2010b, p. 3.

iii. Fund, pp. 49-50.

iv. Pinto 2010b, p. 1.

v. Pinto 2010a, p. 180.

vi. Archarya p. 45.

vii. Pinto 2010b, p. 1.

viii. Reckless pp. 404-42.

ix. Wallison p. 6.

x. Archarya p. 4.

xi. Id. p. 110.

References

Archarya, V., Richardson, M., Van Nieuwerburgh, S., and White, L. J. (2011) Guaranteed to fail. Princeton, N.J.: Princeton U. Press.

Boston Federal Reserve, Mortgage lending in Boston: Interpreting HMDA data. Working paper No. 92-7, Oct. 1992.

Fund, John. (2008). Stealing elections. New York: Encounter books.

Morgensen, Gretchen and Rosner, Joshua. (2011). Reckless endangerment: How outsized ambition, greed, and corruption led to economic Armageddon. New York: Times Books.

Pinto, Edward. (2010a). www.aei.org/papers/economics/financial-services/housing-finance/government-housing-policies-in-the-lead-up-to-the-financial-crisis-forensic-study/

Pinto, Edward. (2010b). www.aei.org.papers/economics/fiscal-policy/triggers-of-the-financial-crisis/

Wallison, Peter. (2011). www.aei.org/economics/fiscal-policy/dissent-from-the-majority-report-of-the-financial-crisis-inquiry-commission-paper/