Government Housing Policy: The Sine Qua Non of the Financial Crisis

Download PDF The mortgage meltdown and ensuing financial crisis were the result of an unprecedented accumulation of weak and risky Non-Traditional Mortgages (NTMs). By mid-2008 about one-half of outstanding all loans were NTMs.  NTMs are those with low or no downpayments, increased debt ratios, impaired credit, reduced loan amortization, and other changes in underwriting standards as compared to traditional loan standards that were commonplace in the early 1990s. The early 1990s is the appropriate benchmark since shortly thereafter government policies required the broad-based introduction of “flexible underwriting standards.”

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (the GSE Act) and HUD’s 1995 National Homeownership Strategy launched a classic race to the bottom based on credit flexibilities. HUD assured broad compliance by drafting virtually the entire mortgage industry. Most significant was the policy to largely eliminate downpayments for targeted borrowers. As the government demanded more and more such lending, particularly those with incomes below 80 percent of median and special target groups, virtually the entire industry responded by moving further and further down the demand curve and out the risk curve. FHA, Fannie, Freddie, banks, subprime lenders, Alt-A lenders, first-time buyers, repeat buyers, and cash-out refinance borrowers all became much more highly leveraged. Moral hazard became rampant as downpayments and initial equity disappeared throughout much of the housing finance system.