Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram G. Rajan Read Free Book Online Page B

mortgage lending to subprime ZIP codes is associated with higher house-price growth in those ZIP codes. Indeed, over the period 2002–2005 and across ZIP codes, house-price growth was higher in areas that had lower income growth (because this is where the lending was focused). Unfortunately, therefore, all this lending was driving house prices further away from the fundamental ability of household income to support repayment. The consequence of all this lending was more default. Subprime ZIP codes experienced an increase in default rates after 2006 that was three times that of prime ZIP codes, and much larger than the default rates these areas had experienced in the past.
    Could the increased borrowing by low-income households have been driven by need? After all, I have argued that their incomes were stagnating or even falling. It is hard, though, to imagine that strapped households would go out and borrow to buy houses. The borrowing was not driven by a surge in demand: instead it came from a greater willingness to supply credit to low-income households, the impetus for which came in significant measure from the government.
    Not all the frenzied lending in the run-up to the recent crisis was related to low-income housing: many unviable loans were made to large corporate buyouts also. Nevertheless, subprime lending and the associated subprime mortgage-backed securities were central to this crisis. Without any intent of absolving the brokers and the banks who originated the bad loans or the borrowers who lied about their incomes, we should acknowledge the evidence suggesting that government actions, however well intended, contributed significantly to the crisis. And the agencies did not escape the fallout. With the losses on the agencies’ mortgage portfolios growing and hints that investors in agency debt were getting worried, on Sunday, September 7, 2008, Henry J. Paulson, secretary of the treasury, announced what the market had always assumed: the government would take control of Fannie and Freddie and effectively stand behind their debt. Conservative estimates of the costs to the taxpayer of bailing out the agencies amount to hundreds of billions of dollars. Moreover, having taken over the agencies, the government fully owned the housing problem. Even as I write, the government-controlled agencies are increasing their exposure to the housing market, attempting to prop up prices at unrealistic levels, which will mean higher costs to the taxpayer down the line.
    The agencies are not the only government-related organizations to have problems. As the crisis worsened in 2007 and 2008, the FHA also continued to guarantee loans to low-income borrowers. Delinquency rates on those mortgages exceed 20 percent today. 43 It is perhaps understandable (though not necessarily wise) that government departments will attempt to support lending in bad times, as they play a countercyclical role. As Peter Wallison of the American Enterprise Institute has pointed out, it is less understandable why the FHA added to the subprime frenzy in 2005 and 2006, thus exacerbating the boom and the eventual fall. 44 Delinquencies on guaranteed loans offered then also exceed 20 percent. The FHA will likely need taxpayer assistance. The overall cost to the taxpayer of government attempts to increase low-income lending continue to mount and perhaps will never be fully tallied up.

Summary and Conclusion
     
    Growing income inequality in the United States stemming from unequal access to quality education led to political pressure for more housing credit. This pressure created a serious fault line that distorted lending in the financial sector. Broadening access to housing loans and home ownership was an easy, popular, and quick way to address perceptions of inequality. Politicians set about achieving it through the agencies and departments they had set up to deal with the housing-debt disasters during the Great Depression. Ironically, the same organizations