THE subprime mortgage crisis isn’t over. On the back of misguided government policies, taxpayers in the US and UK remain on the hook for huge sums. The ideology of affordable housing must end.
It took just 13 years to destroy the American mortgage market with devastating effects for the rest of the world. The process began in 1995, when President Clinton introduced the national home ownership strategy, aiming to extend home ownership to a further 8m families by 2000. The affordable housing ideology was born. Lenders were encouraged to provide mortgages for everyone, adopting flexible underwriting standards so that they could lend to people who wouldn’t otherwise be able to buy their own homes. Relevant incomes could be welfare payments, unemployment benefit or child support. Borrowers did not need to have good credit scores and deposits were as low as 3 per cent.
Fannie Mae, the Federal National Mortgage Association, and Freddie Mac, the Federal Home Loan Mortgage Corporation, played a pivotal role in the US housing market. They were owned by their shareholders, but subject to public policy goals. They did not make loans themselves, but bought loans made by banks and other lenders. Targets for the proportion of loans made to low and moderate-income families and very low-income families were set by their mission regulator, the housing and urban development department.
Fannie and Freddie were able to issue debt cheaply, as their debt was thought to have an implicit government guarantee. The market believed in the implicit guarantee, which Fannie and Freddie did little to discourage (although their charters explicitly stated that their debt did not have the full faith and credit of the US government). Fannie and Freddie borrowed cheaply from a wide range of investors, including foreign central banks, and made a profit on their guaranteed fees. During the 1990s, James Johnson, chief executive of Fannie, announced a trillion-dollar commitment for targeted housing finance for 10m poor families. His successor, Franklin Raines, went further, ensuring that Fannie entered into partnerships with a wide range of lenders, of which the largest was Countrywide Financial. Countrywide teetered on the verge of bankruptcy in 2008, when Bank of America bought it for $4.1bn.
For the UK, the damage was done when banks bought mortgage-backed securities, credit default swaps, and collateralised debt obligations backed by mortgages of dubious quality – but which were at the time given triple-A ratings by the rating agencies. The ratings were taken for granted, until falling house prices, higher interest rates and increasing numbers of foreclosures exposed the real extent of the risks. Banks were unwilling to lend to each other, not only in the US, but throughout the world. That was the beginning of the financial crisis from which we all continue to suffer.
Fannie and Freddie are still in existence, under conservatorship. They still require state support: $183bn at the last count. And their mortgage loan guarantees totalled $3.2 trillion for Fannie Mae and $2 trillion for Freddie Mac at the end of 2011. Given the ailing mortgage market, no one knows the extent to which such guarantees may be called upon. Because the guarantees are off balance sheet it does not mean that they are not there, or that one day they will not come back and bite us all.
But the danger doesn’t only come from the US. Prime Minister David Cameron, when announcing a £930m injection into the housing market, said he wanted to make the “dream of home ownership” a reality for everyone. The limited scheme for 100,000 first-time buyers involves cutting deposits to 5 per cent, with the builders and the government sharing the risks of buyers defaulting. Taxpayers could face a maximum of £1bn in liabilities – much more if the scheme was extended.
Governments need to wake up to the fact that it is not possible, however desirable, for all to own their own homes. The past 13 years of American affordable housing ideology shows that only too painfully.
Dr Oonagh McDonald is a former Labour MP and board member of the FSA. Fannie Mae and Freddie Mac: Turning the American Dream Into a Nightmare, is published by Bloomsbury Academic.