Government Housing Policies in the Lead-up to the Financial Crisis: A Forensic Study
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The major cause of the financial crisis in the U.S. was the collapse
of housing and mortgage markets resulting from an accumulation of an
unprecedented number of weak and risky Non-Traditional Mortgages (NTMs).
These NTMs began to default en mass beginning in 2006, triggering the
collapse of the worldwide market for mortgage backed securities (MBS)
and in turn triggering the instability and insolvency of financial
institutions that we call the financial crisis. Government policies
forced a systematic industry-wide loosening of underwriting standards in
an effort to promote affordable housing. This paper documents how
policies over a period of decades were responsible for causing a
material increase in homeowner leverage through the use of low or no
down payments, increased debt ratios, no loan amortization, low credit
scores and other weakened underwriting standards associated with NTMs.
These policies were legislated by Congress, promoted by HUD and other
regulators responsible for their enforcement, and broadly adopted by
Fannie Mae and Freddie Mac (the GSEs) and the much of the rest mortgage
finance industry by the early 2000s. Federal policies also promoted the
growth of over-leveraged loan funding institutions, led by the GSEs,
along with highly leveraged private mortgage backed securities and
structured finance transactions. HUD's policy of continually and
disproportionately increasing the GSEs' goals for low- and very-low
income borrowers led to further loosening of lending standards causing
most industry participants to reach further down the demand curve and
originate even more NTMs. As prices rose at a faster pace, an
affordability gap developed, leading to further increases in leverage
and home prices. Once the price boom slowed, loan defaults on NTMs
quickly increased leading to a freeze-up of the private MBS market. A
broad collapse of home prices followed.
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