Vision Credit Education, Inc.

A NY Times article written by Steven Holmes on September 30, 1999 documented the changes at Fannie Mae that may be the root cause of the current financial crisis. What began as a pilot program to help encourage homeownership from somewhat less qualified applicants exploded into a subprime buffet by mortgage lenders using exotic mortgages that initially increased profits. The warnings in the article are eerie predictors of the collapse of the U.S. financial sector.

We know that there were merits in the pilot program, and in the subsequent rollout to other lenders. By relaxing the standards on the mortgages it bought, Fannie Mae allowed for homeownership among borrowers that did not meet traditional guidelines for a conventional mortgage.

The problem was that Fannie Mae and Freddie Mac both were pressured into buying mortgages that included terms that were predatory in nature. Widespread use of exploding ARMs, negatively amortizing mortgages and interest only mortgages caused many homeowners to soon find themselves in dangerous situations. They are unable to afford their mortgage payments and they are unable to sell due to a lack of equity.

Now that the mortgage crisis has carried over into our nation’s financial institutions, it is important to reflect on how we got to this point of crisis. Additionally, it is important to find out why we ignored the warnings before we created this disaster. Steven Holmes made the following ominous statement in his article:

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

The Times article also made reference to a statement by an economist that studied the potential impact of easing credit restrictions:

“From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. “If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

These statements summarizes the increased risk and the consequences that could result from the easing of credit criteria prior to the subprime frenzy and subsequent meltdown. However, I doubt that even Holmes or Wallison could have predicted the levels of abuse surrounding exotic loan products.

The types of mortgages pushed on ignorant borrowers were unconscionable. Some homeowners had zero possibility of affording the mortgage payments beyond a couple of years. Others fell delinquent almost immediately.

Some homeowners were tricked into mortgages that resulted in huge balloon payments. They would have no money to pay these, and their credit situation would make a refinance impossible.

Other lenders encouraged flipping of mortgages, so that new fees could be added each time. The result was the fleecing of any equity from the home.

One of the most blatant causes of the subprime collapse was the use of “no doc” loans. Famous for requiring no substantiation of income or assets, these have since been nicknamed NINJA loans.

The government failed to protect homebuyers by allowing abuses by lenders and brokers. Additionally, they fostered an environment for such abuses by pressuring Fannie and Freddie to buy those mortgages. Eventually, these mortgages became the toxic base for today’s collateralized debt obligations (CDOs). There is no definitive answer as to the value or risk of many CDOs, and it appears that government intervention will be necessary to contain the damage made possible by its initial intervention.

Related Links

True Sources of Financial Crisis

1999 NY Times Article: Fannie Mae Eases Credit to Aid Mortgage Lending