nomic theory—a theory that supports neither a relatively unfettered market in housing financenor heavy government involvement in the formof broad, explicit on-budget subsidies for hous-ing. This third-way theory asserts that housingfinance markets do not function well withoutextensive, pervasive prudential regulation. Fur-ther, government-imposed social lending goalsare needed to meet the shortage of “affordable”housing loans, mitigate racial discriminationby lenders against prospective borrowers, andboost the availability of cheap fixed-rate mort-gage credit. The FCIC and Obama administra-tion reports implicitly support this narrative,attributing systemic regulatory failure to ideo-logical bias and implying that lenders and inves-tors are systemically racially biased, incompe-tent, ignorant, irrational, and panicky.The FCIC report spends only 10 of its 662pages addressing social lending mandates, con-cluding that “these (housing) goals only con-tributed marginally to Fannie’s and Freddie’sparticipation in those (risky) mortgages.”
TheObama administration report also finds nofault with these goals, only shareholders’ reck-less pursuit of profit in meeting them. But notall FCIC members agreed. Peter Wallison wrotean independent dissent to the FCIC report, argu-ing that these goals alone explain why the GSEswould reduce and virtually eliminate down pay-ments—bypassing private mortgage insurance—and weaken underwriting guidelines.Private-label mortgage-backed securitiza-tion financed many of the subprime loans. Mostof these were securitized by large investmentbanks—which, in the wake of the financial cri-sis, all merged to become more stable universalbanks—that most believe are “too big to fail.” Thepolitical distortions enabling private-label securi-tization were quite similar to those of GSEs, butthis market would likely not have gotten startedwithout GSE leadership in laxity and massivesupport of the housing price bubble.If the third-way narrative is correct, then gov-ernment intervention promotes competitionamong actuarially sound firms. But excessiveprotection reduces competition. If social lendingquotas are just an attempt to deliver off-budgetcross-subsidies from lower-risk mortgage borrow-ers (who pay their implicit mortgage insurancepremiums and seldom default) to higher-riskborrowers, then competition from unconstrainedproviders must be suppressed or else it will resultin too much money being lent to too many high-risk borrowers. This leads to politically manipu-lated and protected crony capitalist enterprisesand/or government monopolies. Moreover, theimplications go well beyond mortgage finance toother mandatory government-run financial pro-grams, e.g., Social Security “pensions” and Medi-care “health insurance.”The implicit third-way conclusion that U.S.mortgage markets work so much worse thanthose in all other market economies as to war-rant a higher level of government control andlegal mandates is shocking. This paper exam-ines that government intervention, explaininghow it increased over the last quarter-century inpursuit of high-minded homeownership goals.This paper argues that policymakers, in pur-suit of those goals, pushed the GSEs to extendriskier and riskier loans, and that private-labellenders also turned to risky mortgages after thepool of qualified prospective borrowers becameextremely shallow as a result of previous govern-ment efforts to broaden homeownership. Theresult was a housing finance market heavily slanted toward making poor-quality, actuarially unsound loans—a situation that would inevita-bly end in a financial crisis.
Social Lending Goals andthe Antecedents of the Crash
Social lending goals for housing in the UnitedStates date back at least to the Home MortgageDisclosure Act (HMDA) of 1975 and the Com-munity Reinvestment Act (CRA) of 1977. TheHMDA and CRA purportedly reflected a con-cern that bankers were not lending enough inthe local communities or neighborhoods, whichwere typically characterized by ethnic and/orracial concentrations. Lending goals for FannieMae were introduced about the same time andfor the same purpose.The theory behind these goals was that therewas a sufficient supply of creditworthy borrowers
The politicaldistortionsenablingprivate-labelsecuritizationwere quitesimilar to thoseof GSEs, butthis marketwould likely not have gottenstarted withoutGSE leadershipin laxity andmassive supportof the housingprice bubble.