By Peter J. Wallison
We can all agree that the financial crisis was caused by a "mortgage meltdown" mostly among subprime and other risky mortgages. But what neither The Big Short nor its greed narrative tells us is why there were so many of these mortgages in the financial system to begin with. The answer: It was not Wall Street.
In June 2008, just before the crisis, more than half of all U.S. mortgages - 31 million loans - were subprime or otherwise risky. Of these, 76 percent were on the books of government agencies, primarily the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. This shows, without question, that the government created the demand for these deficient loans.
Because of their government backing, Fannie and Freddie were the dominant players in the U.S. mortgage market. They did not make loans themselves but acquired mortgages from banks and other lenders. These were held in their portfolios or sold off to investors with a GSE guarantee.
Before 1992, Fannie and Freddie accepted only prime mortgages: The borrower made a down payment of 10 percent to 20 percent and had a FICO credit score of at least 660 and debts that were less than 38 percent of income after the loan. The market was stable with this foundation, but the homeownership rate in the United States had been stalled at 64 percent for 30 years. By insisting on acquiring only prime loans - it was argued - the GSEs left a vast number of low-income Americans frozen out of homeownership.
Thus, in 1992, Congress required Fannie and Freddie to acquire an annual quota of loans that had been made to low- or moderate-income borrowers. Initially, 30 percent of all loans the GSEs acquired in any year had to be made to home buyers who were at or below the median income where they lived.
The Department of Housing and Urban Development raised the goal to 50 percent between 1993 and 2000, and 56 percent between 2001 and 2008. This occurred in both Democratic and Republican administrations.
Accepting increased numbers of risky mortgages caused the GSEs' insolvency in 2008 and their takeover by the government that year. Fannie later reported that in 2008, it was exposed to $878 billion in these deficient mortgages, which caused 81 percent of its losses that year. Freddie's exposures and losses were proportionately the same.
The connection between these numbers and the financial crisis is unavoidable. Because the GSEs dominated the mortgage market, when they reduced their underwriting standards to meet the affordable-housing quotas, the rest of the market followed. Soon, borrowers who could have afforded prime mortgages were getting loans with zero down payments. The result was an enormous housing price bubble, and when the bubble began to deflate, borrowers who could not meet their mortgage obligations were unable to refinance their loans. The number of defaults was unprecedented. This was the mortgage meltdown.
Government blunders turned it into a financial crisis. First, the government rescued Bear Stearns, a Wall Street investment bank, in March 2007, creating expectations that it would rescue other big firms if they got into trouble. But when Lehman Brothers - a firm much larger than Bear - weakened, the government let Lehman fail. This upended the market's expectations, creating doubt about the safety and soundness of every firm. The result was an unprecedented panic that we know today as the financial crisis.
This is not the kind of story that Hollywood likes - no greed, no evildoers - just very bad government policy combined with serial government blunders. We should see the "greed narrative" for what it is: first an effort to support the enactment of another bad policy - the job-destroying Dodd-Frank Act - and then to keep it fully in force. The Big Short is entertainment, not the truth.