The Wallison Dissent
By Arnold Kling
In his dissent from the Financial Crisis Inquiry Commission majority report, Peter Wallison writes,
in other developed countries–many of which also had large bubbles during the 1997-2007 period–the losses associated with mortgage delinquencies and defaults when these bubbles deflated were far lower than the losses suffered in the United States when the 1997-2007 deflated.
Wallison, as you may know, is one of the few experts wanting to put most of the blame for the crisis on government pressure on Freddie, Fannie, and the banks to reduce lending standards. One of the criticisms leveled at this view is that it is impossible to blame U.S. housing policy for foreign housing bubbles. As you can see, Wallison’s comeback is that foreign housing bubbles did not produce as much financial devastation, because mortgage credit standards were not as heavily compromised as in the U.S. (I would add that some of the devastation at European banks was due to their holdings of U.S. mortgage securities.)
Later, Wallison writes,
Fannie and Freddie had already acquired at least $701 billion in NTMs [nontraditional mortages] by 2001. Obviously, the GSEs did not have to follow anyone into NTM or subprime lending; they were already the dominant players in that market before 2002. Table 7 also shows that in 2002, when the entire PMBS [private mortgage-backed securities] market was $134 billion, Fannie and Freddie acquired $206 billion in whole subprime mortgages and $368 billion in other NTMs, demonstrating again that the GSEs were no strangers to risky lending well before the PMBS market began to develop.
That is how he handles the claim that Freddie and Fannie innocently followed the evil private market into high-risk lending.
Later, he writes,
of NTMs outstanding on June 30, 2008, identified government agencies and private organizations required by the government to acquire, hold, or securitize NTMs as responsible for two-thirds of these mortgages, about 19 million. The table also identifies the private sector as the securitizer of the remaining third, about 7.8 million loans. In other words, if we are looking for the buyer of the NTMs that were being created by originators at the local level, the government’s policies would seem to be the most likely culprit. The private sector certainly played a role, but it was a subordinate one.
But did regulated institutions make these loans in pursuit of profit?
Profit had nothing to do with the motivations of these firms; they were responding to government direction. Under these circumstances, it should be no surprise that underwriting standards declined as all of these organizations scrambled to acquire the same low-quality mortgages.
However, a major point of Wallison’s piece is that the proportion of NTMs among all mortgages issued from 1998-2007 is much higher than most people realize. Something like half of all mortgages. However, I believe that this in turn implies that the the holdings of NTMs at regulated institutions were higher than was necessary to meet government goals for loans to target populations.
Still, Wallison effectively documents that the Department of Housing and Urban Development deliberate set out to cause a weakening of underwriting standards. This effort was successful, and until recently it was a source of pride for HUD officials.
Wallison’s view is despised by most officials and commentators on the left and the center. The result is that he has really sharpened his case in order to meet his critics. It is a very impressive piece of work.
Moreover, if Wallison’s estimate (which in turn comes from Ed Pinto) of the number of the number of risky mortgages is correct, then this has implications for the current outlook. In particular, we are still quite far from reaching the bottom in the housing and mortgage market. Even if the attempts to rewrite mortgages had reached their goals–and they have failed miserably to do so–they would have been only a drop in the bucket.
If the housing and mortgage crisis drags on past 2013 or so, I would view that as a strong indication that Wallison and Pinto have uncovered something very important. In any case, his dissent is a significant document. I am not saying that it is the final word on the subject. But no one should dismiss his views without first reading his paper.