Democratic Myth No. 3: They want to return to same practices that got us into this mess

The following article originally appeared in Human Events on October 8, 2012

Editor’s Note: This analysis is the third in a five-part series on Democrats’ mythical sound bites by Andrew Puzder, an economic adviser to Mitt Romney and CEO of CKE Restaurants, which employs about 21,000 workers. The second installment was entitled “Democratic Myth No. 2: Those Who Have Done Well Should Pay Their Fair Share.” The first installment was “Democratic Myth No. 1: GOP Is to Blame for Failure of Obama’s Job Policies.” President Obama has often asserted that “there are some [people] who seem to be suffering from a kind of collective amnesia. After all that’s happened, after the worst economic crisis, the worst financial crisis since the Great Depression, they want to return to the same practices that got us into this mess.” In one form or another, the President and his surrogates often echo this myth with great enthusiasm, apparently believing that repetition and zeal can give a false statement both substance and veracity. By any rational standard, they’re wrong. Yet, as previously noted, in the wrong hands an oft-repeated myth can become more effective than the truth. This “return us to the same practices that got us into this mess” mythical sound bite raises two questions. First, what were the “practices that got us into this mess”? Second, which of the candidates wants us to “return” to those practices? A truthful answer reveals quite clearly that President Obama is the one suffering from amnesia on the cause of our continuing economic crisis and that he is either unaware of or consciously misrepresenting Gov. Romney’s policies. Contrary to the myth, the “practices” that led to the 2008 economic crisis were, in large part, a byproduct of government-centered policies similar to those President Obama advocates and antithetical to Gov. Romney’s free enterprise-centered policies. So, what caused the 2008 economic crisis? As most people are at least somewhat aware, there was a real estate bubble and in 2008 the bubble burst, bringing our financial system to its knees. Understanding how this real estate bubble came into being, why it burst and why our financial institutions were so vulnerable goes a long way towards explaining the cause of the 2008 economic crisis. Sub-prime home loans Beginning in the late 1990s, lenders making sub-prime home loans significantly increased the number of qualified borrowers to whom they would lend thereby increasing demand for homes and causing a surge in housing prices that peaked in about 2006. In 2008, this housing price bubble burst as these sub-prime borrowers began to default on their mortgage loans. Our financial institutions were heavily reliant on elevated real estate values and on borrowers generally continuing to make their mortgage payments. When real estate values plummeted and large numbers of borrowers began defaulting, a number of financial institutions had to raise capital sufficient to offset the decline in the value of their real estate related assets. Some (Lehman Brothers, Bear Stearns, Citigroup, etc.) were unable to do so and either went out of business or the government bailed them out with Troubled Asset Relief Program (“TARP”) funds. This was hardly a shocking result. Sub-prime loans are by definition loans to people who are likely to have difficulty repaying them. This is why they are called “sub-prime.” Exacerbating the situation, many of these loans were adjustable rate mortgages that started with “teaser” or below-market interest rates that would go up over time. Lenders designed these rates to entice sub-prime borrowers with an interest rate at which they could at least temporarily make mortgage payments they would otherwise have difficulty making. With lenders easing credit standards below anything our economy had ever experienced, the demand for homes outpaced supply and prices soared. Housing prices in the United States soon exceeded any rational relationship to actual value. The teaser rates expired, massive numbers of homebuyers defaulted on their mortgages, lenders foreclosed and home values plummeted. This resulted in outstanding mortgage balances exceeding the value of the underlying homes, even where the borrowers were making the payments, causing additional mortgage defaults, and the real estate bubble burst. Why were subprime loans made? One might well ask why rational profit motivated lenders would make loans to individuals who (i) lacked sufficient incomes to repay them (ii) at below market interest rates knowing that such individuals would be unable to make the payments when the teaser rates expired. There are two answers to this question and both involve the federal government requiring or, at the very least, encouraging, subsidizing and facilitating such loans. First, the Community Reinvestment Act requires lenders to invest in depressed and minority neighborhoods. Second, and more importantly, the primary lenders sold their sub-prime loans transferring to the purchasers the risk that borrowers might default. The purchasers were often either Fannie Mae and Freddie Mac, two Government Sponsored Enterprises (“GSEs”), or private sector investors (generally financial institutions) that purchased securities comprised of sub-prime loans bundled and sold as secured highly rated bonds. As almost prophetically stated in a 1999 New York Times article entitled “Fannie Mae Eases Credit to Aid Mortgage Lending:” “Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits. * * * “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.” Five years later, the Times again expressed concern in an article aptly entitled “Housing Bust: It Won’t be Pretty,” stating that: “[E]ven small declines in home prices could hurt the economy. ‘The precise degree of the vulnerability isn’t going to be clear until we see house prices slow,’ Mr. Wilson [a senior global economist at Goldman Sachs] said. ‘You’ve never seen consumers this stretched, operating at levels of leverage we’ve never experienced before. House prices are starting at a level that is pretty high relative to what we think fair value is going to be, and the economy as a whole has gotten a lot more sensitive’ to housing-related spending.” As such, what appeared to be a very positive government-supported social goal (home ownership for the underprivileged) was putting our entire economy at risk. Proponents of this policy soundly criticized anyone who attempted to point this out or who advocated regulatory oversight of Fannie and Freddie. In 2004, Representatives Maxine Waters, Barney Frank, Gregory Meeks, and others attacked one regulator from the Office of Federal Housing Enterprise Oversight for merely pointing out the problem with the GSEs.

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