Category: Franklin Raines

The trouble with lending to the poor

An op-ed titled, “A Wall Street Trader Draws Some Subprime Lessons: Michael Lewis,” appeared on Bloomberg today:

So right after the Bear Stearns funds blew up, I had a thought: This is what happens when you lend money to poor people.

Don’t get me wrong: I have nothing personally against the poor. To my knowledge, I have nothing personally to do with the poor at all. It’s not personal when a guy cuts your grass: that’s business. He does what you say, you pay him. But you don’t pay him in advance: That would be finance. And finance is one thing you should never engage in with the poor.

After the subprime debacle, a small, but growing minority is questioning the wisdom of two decades of public policy promoting home ownership for low-income families. In an August 22 WSJ op-ed titled, “Payback,” Holman W. Jenkins, Jr. recalls how a number of these bad seeds were planted during the Clinton administration:

Everybody talks about moral hazard. A wisp of memory came to mind last week. Then-Fannie Mae chief Franklin Raines visited The Journal years ago and entertained himself by mocking editorial writers who assume that establishing that a policy is economically inefficient is enough to establish that it’s unwise.

He yukked it up quite a bit, in fact, noting that voters are perfectly entitled to assert values other than those of the market, namely that homeownership is a social blessing and should be encouraged with subsidies. And so we’ve done with tax subsidies, lending subsidies and a concerted set of policies by Bill Clinton’s HUD to move low-income people out of rental units and into homes they own. His goal, which was achieved, was to lift the homeownership rate from 64.2% to 67.5% of households.

This brings to mind an interview of Raines that appeared in the June 30, 2003 issue of BusinessWeek:

What Fannie Mae does is important to the country and to home buyers. And we do it, I think, very well.

(Btw, the interview is a classic with such quotes as “We are compulsive about managing risk,” right before fessing up to an accounting mess that cost over a billion dollars to clean up, three years of financial statements not provided investors, and eventually Franklin Raines his job. Don’t shed any tears for Raines: For his troubles he made nearly $100 million in 8 years of running the ship at Fannie Mae.)

In “Payback,” Jenkins goes on to cite a study questioning the wisdom of a policy that ignores basic economics:

A home financed by a mortgage is not just an asset. It’s also a liability. We owe thanks to Carolina Katz Reid, then a graduate student at University of Washington, for a 2004 study of what she dubbed the “low income homeownership boom.” She considered a simple question — “whether or not low-income households benefit from owning a home.” Her discoveries are bracing:

Of low-income households from a nationally representative sample who became homeowners between 1977 and 1993, fully 36% returned to renting in two years, and 53% in five years. Suggesting their sojourn among the homeowning was not a happy one, few returned to homeownership in later years.

Even among those who held on to their homes for 10 years, the average price-appreciation gain was 30% — less than if their money had been invested in Treasury bills. This meager capital gain was about half that enjoyed by middle-income homeowners.

A typical low-income household might spend half the family income on mortgage costs, leaving less money for a rainy day or investing in education. Their less-marketable homes apparently also tended to tie them down, making them less likely to relocate for a job. Ms. Reid’s counterintuitive discovery was that higher-income households were “twice as likely to move long distance if they’re unemployed.”

Almost needless to add, the great squarer of circles for middle-income homeowners, the mortgage-interest deduction, won’t turn a house into a paying proposition for those with little income to shelter.

His conclusion:

Bottom line: Homeownership likely has had an exceedingly poor payoff for millions of low-income purchasers, perhaps even blighting the prospects of what might otherwise be upwardly mobile families.

Yet in the political realm, bad ideas never seem to die, but instead are embraced and expanded by future politicians. President Bush took ownership of the “American dream” concept with the euphemism “ownership society.” And when that dream turned to nightmare, he pandered to the peasants with bailouts and an increased role for Fannie Mae and Freddie Mac. As Jenkins wrote in a September 5 WSJ op-ed:

You’ll know Washington is doing for housing what it did for New Orleans (subsidizing uneconomic decisions) if it now heeds countless pleas to expand the mandate of Fannie Mae and Freddie Mac to refloat the housing market and refinance underwater loans. Their lending already has grown much faster than the economy, much faster than housing demand, channeling a current $1.5 trillion in artificially cheapened capital into the housing market.

The underlying problem in the housing market is that, after two decades of easy credit funnelled into the home, prices are too high for the expanded pool of homeowners to afford. More of the same – promoting home ownership at any cost for those least able to afford it – can only exacerbate the current mess.

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