Government Policies and The Subprime Mortgage Crisis - Legislative and Regulatory Overview

Legislative and Regulatory Overview

Deregulation, excess regulation, and failed regulation by the federal government have all been blamed for the late-2000s (decade) subprime mortgage crisis in the United States.

In general, conservatives have claimed that the financial crisis was caused by too much regulation aimed at increasing home ownership rates for lower income people. They have pointed to two policies in particular: the Community Reinvestment Act (CRA) of 1977, which they claim pressured private banks to make risky loans, and HUD affordable housing goals for the government sponsored enterprises ("GSEs") — Fannie Mae and Freddie Mac — which they claim caused the GSEs to purchase risky loans, and led to a general breakdown in underwriting standards for all lending.

Liberals present data that suggest GSE loans were less risky and performed better than loans securitized by more lightly regulated Wall Street banks. They also suggest that CRA loans mandated by the government performed better than subprime loans that were purely market-driven. They also present data which suggests that financial firms that lobbied the government most aggressively also had the riskiest lending practices, and lobbied for relief from regulations that were limiting their ability to take greater risks. In testimony before Congress both the Securities and Exchange Commission (SEC) and Alan Greenspan claimed failure in allowing the self-regulation of investment banks.

The Financial Crisis Inquiry Commission issued three concluding documents in January 2011: 1) The FCIC "conclusions" or report from the six Democratic Commissioners; 2) a "dissenting statement" from the three Republican Commissioners; and 3) a second "dissenting statement" from Commissioner Peter Wallison. Both the Democratic majority conclusions and Republican minority dissenting statement, representing the views of nine of the ten commissioners, concluded that government housing policies had little to do with the crisis. The majority report stated that Fannie Mae and Freddie Mac "were not a primary cause of the crisis" and that the Community Reinvestment Act "was not a significant factor in subprime lending or the crisis." The three Republican authors of their dissenting statement wrote: "Credit spreads declined not just for housing, but also for other asset classes like commercial real estate. This tells us to look to the credit bubble as an essential cause of the U.S. housing bubble. It also tells us that problems with U.S. housing policy or markets do not by themselves explain the U.S. housing bubble."

However, Commissioner Wallison's dissenting statement did place the blame squarely on government housing policies, which in his view contributed to an excessive number of high-risk mortgages: "...I believe that the sine qua non of the financial crisis was U.S. government housing policy, which led to the creation of 27 million subprime and other risky loans—half of all mortgages in the United States—which were ready to default as soon as the massive 1997-2007 housing bubble began to deflate. If the U.S. government had not chosen this policy path—fostering the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high risk residential mortgages—the great financial crisis of 2008 would never have occurred."