The current financial crisis did not happen because investment companies were dealing in derivative products that no one understood (the simplistic general Democratic explanation), nor was it a result of an abnormal growth in homeownership rates in the United States (the simplistic general Republican explanation). The real reason for our current crisis is that our economic leaders allowed Fannie Mae and Freddie Mac to mismanage mortgage rates and thus mismanage a substantial portion of our “debt economy” for more than twenty-five years.
Here are the facts that back up this statement. Exhibit 1 shows a 12-month running average plot of Freddie Mac single family fixed rate mortgages against the 12-month running average of the CPI between 1972 and 2008 (nearly the full period of time mortgage-backed securities had been issued prior to the recent financial crisis).
...For the last 27-years (almost the full time for a 30-year loan to mature), inflation as measured by the CPI has averaged 2.99%, yet only very recently have long-term rates begun to come into sync with long-term inflation. With mortgage-rates set so far above what they should have been set in 1983, Fannie Mae and Freddie Mac were allowed to establish a policy that slowly lowered mortgage rates year after year, in effect allowing us to enjoy one refinancing cycle after another so that their mortgage portfolios could grow and grow and grow.
...One, the Federal Reserve was asleep at the wheel. Even though we may revere our esteemed Reserve economists; the Federal Reserve never understood mortgage debt, nor did they ever question mortgage rate policy. Instead, the Fed simply received regular reports from Freddie Mac telling them what the current GSE mortgage rate policy was. The Fed either was ignorant or played ignorant while we added nearly $7.5 Trillion in “new mortgage debt” during the fifteen-year period between 1992 and 2007. Talk about Keynesian economics! Any Reserve Chairman of the Great Depression era would have been envious of what Alan Greenspan was allowed to get away with while collecting accolades—and that does not include the stimulus that was being added during his reign from our Government’s deficit spending and growth in our “national debt”.
Two, demand for Mortgage-Backed Securities, was always there. MBSs have always served as one of the best “risk free” hedges against inflation. An 18% MBS when compared against a 3% long-term inflationary perspective is an extremely attractive product, as is a 14% MBS, as is a 10% MBS. Need I go on? Anyway, what could be safer than investing in American housing? The stock market carries risk, does it not, or have we forgotten what happened in 2000-2001?
So for twenty-five years we Americans took advantage of mortgage rate mistakes made by the GSEs going back as far as the early 1980s to live off our houses and build up our debt to unreasonable levels, while the executives at the GSEs gloated over their growing MBS portfolios and their “well-deserved” bonuses. The money-making machines that the GSEs owned were the envy of Wall Street bankers, so they, too, joined into the game. After all, housing prices would never fall—another gross misconception made by our elite financial leaders. _BI
And Barney just laid the foundation for yet another round of the same bubble, starring the same players as the last bubble of devastation.