The Housing Bust: Who Done It?

As all lawyers know, when we ask people to testify in court, we ask that they swear to tell the truth, the whole truth and nothing but the truth. Why the legal gobbledygook? Answer: because as we lawyers also know, letting witnesses tell the truth while omitting selected parts of the story, enables them to leave their listeners with a false understanding of what really happened. We were reminded of this verity while reading Harold Meyerson’s op-ed in the L.A. Times of July 25, 2012, p. A13, entitled A Tale of Two Cities, in which Mr. Meyerson, a fully credentialled grandee of the Washington Post editorial pages, purports to inform us what brought Stockton and San Bernardino low, and caused them to file for bankruptcy.

You think it was municipal improvidence? A failure to control spending and to maintain reasonable municipal reserves for a rainy day? Overly generous salaries of unionized municipal workers? Unfunded pension liabilities? According to Mr. Meyerson, the answers are no, no, no and no. So who done it? It was the banks “that flooded these cities with subprime mortgages that were resold into the high-flying securities market,” says Mr. Myerson. Make no mistake, we are no apologists for banks. They deserve a lot of blame for what transpired, and many of their managers haven’t been properly punished for their misdeeds. But to blame “the banks” alone, as Meyerson does is to tell a partial truth, and thereby to conceal important causative factors in the “bubble” calamity that befell this state.

What’s missing in Mr. Meyerson’s narrative is the role of government, which was implicated in this disaster up to its eyeballs. So let’s take a look at that by asking two questions. First, why would bankers — who, whatever you may think of them, appear to be rational people — squander their money by handing it out as “subprime loans” to people who had no realistic prospects of repaying them? Were those bankers crazy? Like a fox. The explanation of their behavior is no mystery, and had Mr. Myerson bothered to read the printed output of his competitor, The New York Times, he would have been fully informed in the premises, as we lawyers are wont to put it. It was there in black and white, way back in 1999. Speaking in the context of assessing Fannie Mae’s prospective difficulties, were it to continue to expand its holdings of risky subprime loans, the Times cautioned over a decade ago:

“Fannie May, the nation’s biggest underwriter of home mortgages, has been under increased pressure by the Clinton administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth 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 savings and loan industry in the 1990s.” Steven A. Holmes, Fannie Mae Eases Credit To Aid Mortgage Lending, N.Y. Times, Sep. 30, 1999.

And so, that “increased” government pressure motivated bankers to keep lending because they could sell their junky mortgages to Fannie and such, collect their fees, and bear no risk of default, that now being Uncle Sam’s problem. Or so it seemed.

A few years later came the stern warning of Gretchen Morgenson, one of our favorite financial reporters, who in 2004 wrote an article entiteld Housing Bust: It Won’t Be Pretty, N.Y. Times, July 25, 2004, at p. 1 (Sec. 3). The title says it all. And let’s not forget David Leonhardt, Is Your House Overvalued? N.Y. Times, May 28, 2005, at p. B1. So the fact that risks were mounting and things were beginning to spin out of control was no secret. While bankers surely took advantage of the situation, it was not entirely their doing. They were responding to pressure from Washington in order to avoid the dreaded sin of “redlining” and — on pain of being charged with discrimination — were pressured to keep on lending to people who had no prospects of repaying their loans, or even of servicing them for any significant period of time. Fairness, don’t you know.

Which is why bankers did not keep those “subprime” loans as part of their loan potfolios, but instead sold them to bundlers who used “tranches” of this junk as security for bonds they issued and sold to greedy investors who evidently gave no real thought to the question of why these bonds offered such high yields.

Second. Whether you sell mortgages or hot dogs, you have to have customers. So what was it that drove the unending stream of Californians, eager to pay outlandishly higher and higher prices for their homes, into the arms of increasingly predatory lenders? Some of it, of course, was supply and demand, but there was more to it. Californians with any sense of local history remember how in the not too recent past, it became a given that to buy a good (but not necessarily fancy) home in a good neighborhood over time became a road to riches — paper riches, anyway. Apart from market forces, “many economists say that [income tax laws] had a noticeable impact, allowing home sales to become tax-free windfalls.” David Leonhardt, 1997 Tax Break on Home Sales May Have Helped Inflate Bubble, N.Y. Times, December 19, 2008, at p. A1. And so they did.

Other government policies that caused home prices to soar, propelling would-be home buyers into the arms of less and less scrupulous lenders, consisted of the impact of land-use laws. Small, entry-level homes that were all the rage in the 1950s and transformed even working and lower middle-class America into a home-owning society, ceased to be built due largely to NIMBY opposition and local governments’ acquiescence in it. Better family homes that went for mid-five figure prices in the 1960s soared into the high six figures and beyond. Why? Among other things, because of restrictive government regulations that constricted supply even as demand for housing in desirable places was growing apace. Many Californians came to understand that if they wanted a nice home, it was then or never. Don’t take our word for this. Prominent Dartmouth land economist, William A. Fischel, demonstrated in his 1995 book, Regulatory Takings: Law, Economics, and Politics, particularly in Chapter 6, entitled Capitalizing on Land Use Regulation: Evidence from California, that the ongoing surge in California home prices was being caused by restrictive government regulations. He was not alone. Two Presidential Commissions on Housing reached the same conclusion. And the California courts’ policy of see no evil, hear no evil and speak no evil, when it came to judicial review of land-use regulations, no matter how extreme, intensified the effect. As the late Richard Babcock, the then dean of the nation’s land-use bar (and coincidentally, a supporter of government land regulations) put it: “In California the courts have elevated government arrogance to an art form.” And it was California Supreme Court Justice William P. Clark, Jr., who pointedly noted in his dissent in Agins v. Tiburon, 24 Cal.3d 266 (1979) that California judges’ uncritical endorsement of extreme land-use regulation policies would inevitably lead to a socio-economic cleavage between well-housed, affluent Californians and others. Which is just what happened, although neither Justice Clark nor anyone else at the time could predict how high California home prices would soar before the “bubble” popped. But the byproduct of it all was that those who wanted a piece of the American dream — a family home in the suburbs — had to pay more and more as time went on, and had no choice but to resort to increasingly sharp lending parctices. The rest is history.

So before you give municipal unions a free pass, and join Mr. Meyerson’s denunciatioin of only the banks, before you voice the deserved criticism of greedy bankers, irresponsible mortgage brokers and bundlers, and of reckless home buyers who took on bigger debts than they could handle, or who foolishly refinanced their increased home equities in order to spend the money on good living, (all of whom bear a heavy responsibility for the mess we are in), do recall the role of government policies. Recall the anger directed by the Clinton administration, its allies, and the media at the lending industry for its “redlining” practices of denying credit to people living in areas that were down on the socio-economic scale, and who in the lenders’ honest judgment could not meet traditional credit standards. These people didn’t have the opportunity to use the best credit cards to build credit like they do now. Could it be that those old fashioned, flinty-eyed bankers were right when they at first refused to lend large amounts of money to people whose economic status suggested an inability to service their loans, even if in the end those bankers yielded to government pressure that they do so? Luckily nowadays you can get the help of companies like Upturn Credit and make sure your credit score is up to scratch, so that you’re never turned away by lenders, but in days gone by it wasn’t so simple and loans were not as easily accessible as they are now. Take a look at the Donkey Finance loan comparison to see just how accessible loans are in the current climate.

So, as they used to say in Fractured Fairy Tales on the Rocky and Bullwinkle cartoon show, sometimes things are exactly what they appear to be. And when people appear to lack the funds to buy pricy homes, it would seem to be only prudent not to lend them large sums they can’t begin to pay back, partticulaly in bad times which — as taught in the Bible by way of Joseph’s interpretation of Pharaoh’s dream — come upon us sooner or later. The rest is commentary.