Prologue
More Americans should own their own homes, for reasons that are economic and tangible, and reasons that are emotional and intangible, but go to the heart of what it means to harbor, to nourish, to expand the American Dream.
—William Jefferson Clinton,
forty-second president of the United States, November 1994
The president of the United States was preaching to the choir when he made that proclamation in 1994, just two years into his first term. Facing an enthusiastic crowd at the National Association of Realtors' annual meeting in Washington, D.C., Clinton launched the National Partners in Homeownership, a private-public cooperative with one goal: raising the numbers of homeowners across America.
Determined to reverse what some in Washington saw as a troubling decline of homeownership during the previous decade, Clinton urged private enterprise to join with public agencies to ensure that by the year 2000, some 70 percent of the populace would own their own homes.
An owner in every home. It was the prosperous, 1990s version of the Depression-era "A Chicken in Every Pot."
With homeownership standing at around 64 percent, Clinton's program was ambitious. But it was hardly groundbreaking. The U.S. government had often used housing to achieve its public policy goals. Abraham Lincoln's Homestead Act of 1862 gave away public land in the nation's western precincts to individuals committed to developing it. And even earlier, during the Revolutionary War, government land grants were a popular way for an impoverished America to pay soldiers who fought the British.
Throughout the American experience, a respect, indeed a reverence, for homeownership has been central. The Constitution, as first written, limited the right to vote to white males who owned property, for example. Many colonists came to America because their prospects of becoming landowners were far better in the New World than they were in seventeenth- and eighteenth-century Europe.
Still, Clinton's homeownership plan differed from its predecessors. The strategy was not a reaction to an economic calamity, as was the case during the Great Depression. Back then, the government created the Home Owners' Loan Corporation, which acquired and refinanced one million delinquent mortgages between 1933 and 1936.
On the contrary, the homeownership strategy of 1994 came about as the economy was rebounding from the recession of 1990 and '91 and about to enter a long period of enviable growth. It also followed an extended era of prosperity for consumer-oriented banks during most of the 1980s when these institutions began extending credit to consumers in a more "democratic" manner for the first time.
Rather than pursue its homeownership program alone, as it had done in earlier efforts, the government enlisted help in 1995 from a wide swath of American industry. Banks, home builders, securities firms, Realtors—all were asked to pull together in a partnership made up of 65 top national organizations and 131 smaller groups.
The partnership would achieve its goals by "making homeownership more affordable, expanding creative financing, simplifying the home buying process, reducing transaction costs, changing conventional methods of design and building less expensive houses, among other means."
Amid the hoopla surrounding the partnership announcement, little attention was paid to its unique and most troubling aspect: It was unheard of for regulators to team up this closely with those they were charged with policing.
And nothing was mentioned about the strategy's ultimate consequence—the distortion of the definition of homeownership—gutting its role as the mechanism for most families to fund their retirement years or pass on wealth to their children or grandchildren.
Instead, in just a few short years, all of the venerable rules governing the relationship between borrower and lender went out the window, starting with the elimination of the requirements that a borrower put down a substantial amount of cash in a property, verify his income, and demonstrate an ability to service his debts.
With baby boomers entering their peak earning years and the number of two-income families on the rise, banks selling Americans on champagne hopes and caviar dreams were about to become the most significant engine of economic growth in the nation. After Congress changed the tax code in 1986, eliminating the deductibility of interest payments on all consumer debt except those charged on home mortgages, the stage was set for housing to become Americans' most favored asset.
Of course, banks and other private-sector participants in the partnership stood to gain significantly from an increase in homeownership. But nothing as crass as profits came up at the Partners in Homeownership launch. Instead, the focus was on the "deeply-rooted and almost universally held belief that homeownership provides crucial benefits that merit continued public support." These included job creation, financial security (when an individual buys a home that rises in value), and more stable neighborhoods (people don't trash places they own).
In other words, homeownership for all was a win/win/win.
A 1995 briefing from the Department of Housing and Urban Development did concede that the validity of the homeownership claims "is so widely accepted that economists and social scientists have seldom tested them." But that note of caution was lost amid bold assertions of homeownership's benefits.
"When we boost the number of homeowners in our country," Clinton said in a 1995 speech, "we strengthen our economy, create jobs, build up the middle class, and build better citizens."
Clinton's prediction about the middle class was perhaps the biggest myth of all. Rather than building it up, the Partners in Homeownership wound up decimating the middle class. It left Americans in this large economic group groaning under a mountain of debt and withdrawing cash from their homes as a way to offset stagnant incomes.
It took a little more than a decade after the partnership's launch for its devastating impact to be felt. By 2008, the American economy was in tatters, jobs were disappearing, and the nation's middle class was imperiled by free-falling home prices and hard-hit retirement accounts. Perhaps most shocking, homeownership was no longer the route to a secure spot in middle-class America. For millions of families, especially those in the lower economic segments of the population, borrowing to buy a home had put them squarely on the road to personal and financial ruin.
Fueled by dubious industry practices supported by many in Congress and unchecked by most of the regulators charged with oversight of the lending process, the homeownership drive helped to plunge the nation into the worst economic crisis since the Great Depression.
Truly this was an unprecedented partnership.
But what few have recognized is how the partners in the Clinton program embraced a corrupt corporate model that was also created to promote homeownership. This was the model devised by Fannie Mae, the huge and powerful government-sponsored mortgage finance company set up in 1938 to make it easier for borrowers to buy homes in Depression-ravaged America. Indeed, by the early 1990s, well before the government's partnership drive began, Fannie Mae had perfected the art of manipulating lawmakers, eviscerating its regulators, and enriching its executives. All in the name of expanding homeownership.
Under the direction of James A. Johnson, Fannie Mae's calculating and politically connected chief executive, the company capitalized on its government ties, building itself into the largest and most powerful financial institution in the world. In 2008, however, the colossus would fail, requiring hundreds of billions in taxpayer backing to keep it afloat. Fannie Mae became the quintessential example of a company whose risk taking allowed its executives to amass great wealth. But when those gambles went awry, the taxpayers had to foot the bill.
This failure was many years in the making. Beginning in the early 1990s, Johnson's position atop Fannie Mae gave him an extraordinary place astride Washington and Wall Street. His job as chief executive of the company presented him with an extremely powerful policy tool to direct the nation's housing strategy. In his hands, however, that tool became a cudgel. With it, he threatened his enemies and regulators while rewarding his supporters. And, of course, there was the fortune he accrued.
Perhaps even more important, Johnson's tactics were watched closely and subsequently imitated by others in the private sector, interested in creating their own power and profit machines. Fannie Mae led the way in relaxing loan underwriting standards, for example, a shift that was quickly followed by private lenders. Johnson's company also automated the lending process so that loan decisions could be made in minutes and were based heavily on a borrower's credit history, rather than on a more comprehensive financial profile as had been the case in the past.
Eliminating the traditional due diligence conducted by lenders soon became the playbook for financial executives across the country. Wall Street, always ready to play the role of enabler, provided the money for these dubious loans, profiting mightily. Without the Wall Street firms giving billions of dollars to reckless lenders, hundreds of billions of bad loans would never have been made.
Finally, Fannie Mae's aggressive lobbying and its methods for neutering regulators and opponents were also copied by much of the financial industry. Regulators across the country were either beaten back or lulled into complacency by the banks they were supposed to police.
How Clinton's calamitous Homeownership Strategy was born, nurtured, and finally came to blow up the American economy is the story of greed and good intentions, corporate corruption and government support. It is also a story of pretty lies told by politicians, company executives, bankers, regulators, and borrowers.
And yet, there were those who questioned the merits of the homeownership drive and tried to alert regulators and policymakers to its unintended consequences.
A handful of analysts and investors, for example, tried to warn of the rising tide of mortgage swindlers; they were met with a deafening silence. Consumer lawyers, seeing the poisonous nature of many home loans, tried to outlaw them. But they were beaten back by an army of lenders and their lobbyists. Some brave souls in academia argued that renting a home was, for many, better than owning. They were refuted by government studies using manipulated figures or flawed analysis to conclude that homeownership was a desired goal for all.
Even the credit-rating agencies, supposedly neutral assayers of risks in mortgage securities, quelled attempts to rein in predatory lending.
All the critics were either willfully ignored or silenced by well-funded, self-interested, and sometimes vicious opposition. Their voices were drowned out by the homeownership trust, a vertically integrated, public-private housing machine whose members were driven either by ideology or the vast profits that rising homeownership would provide.
The consortium was too big and too powerful for anyone to take on. Its reach extended from the mortgage broker on Main Street to the Wall Street traders and finally to the hallowed halls of Congress. It was unstoppable.
•••
Because housing finance was heavily regulated, government participation was vital to the homeownership push. And Washington played not one but three starring roles in creating the financial crisis of 2008. First, it unleashed the mortgage mania by helping to relax basic rules of lending that had been in place for decades. Then its policymakers looked the other way as the mortgage binge enriched a few and imperiled many. Even after the disaster hit and the trillion-dollar bailouts began, Congress and administration officials did little to repair the damaged system and ensure that such a travesty could not happen again.
This was a reckless endangerment of the entire nation by people at the highest levels of Washington and corporate America.
Barney Frank, the powerful Massachusetts Democrat and ardent supporter of Fannie Mae, summed it up perfectly back in March 2005. He had just delivered a luncheon speech on housing at the Four Seasons Hotel in Georgetown.
Walking up from the lower-level conference room where he had addressed the Institute of International Bankers, Frank was asked whether he had considered the possible downsides to the homeownership drive. Was he afraid, for instance, that easy lending programs could wind up luring many of his constituents into homes they could not ultimately afford? Was he concerned that, after the groundbreaking and ribbon-cutting ceremonies were forgotten, the same people he had put into homes would be knocking on his door, complaining of being trapped in properties and facing financial ruin?
Frank brushed off the questioner. "We'll deal with that problem if it happens," he barked.
Excerpted from Reckless Endangerment by Gretchen Morgenson and Joshua Rosner
Copyright 2011 by Gretchen Morgenson and Joshua Rosner
Published in 2011 by Times Books, an imprint of Henry Holt and Company
All rights reserved. This work is protected under copyright laws and reproduction is strictly prohibited. Permission to reproduce the material in any manner or medium must be secured from the Publisher.
