Primer on Financial Meltdown

Here it is, boys and girls, the lowdown on what caused the financial meltdown we are experiencing on Wall Street and to a lesser degree on Main Street. This Wall Street Journal article by Professor Russell Roberts lays it all out.

While not denying the existence of greed among financiers, he spells out the extent to which the crisis is the direct result of Federal policy, aimed at increasing home ownership among those whose ability to pay is questionable or worse. That governmental culpability is sizable. The most damning quote is the following:

For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.

For 1996, HUD required that 12% of all mortgage purchases by Fannie and Freddie be "special affordable" loans, typically to borrowers with income less than 60% of their area's median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was to be 28%.

Between 2000 and 2005, Fannie and Freddie met those goals every year, funding hundreds of billions of dollars worth of loans, many of them subprime and adjustable-rate loans, and made to borrowers who bought houses with less than 10% down.

The median is the point above and below which equal numbers of people's incomes fall, think of it as the midpoint. So government required over a quarter of the loans to go to people whose income put them in approximately the bottom 30% of earners. These are borrowers whose financial applecart can be upset by a medical bill, a blown transmission, or a layoff. In short, people who absolutely should be renters, not owners. Then there is the Community Reinvestment Act:

The Community Reinvestment Act (CRA) did the same thing with traditional banks. It encouraged banks to serve two masters -- their bottom line and the so-called common good. First passed in 1977, the CRA was "strengthened" in 1995, causing an increase of 80% in the number of bank loans going to low- and moderate-income families.

Do yourself a favor and read the whole article. I share Professor Roberts' scorn for this "something for nothing" social engineering policy of the government.