What were they (we) thinking?

If you are reading this today, we can only assume that the world did not (has not, may not?) come to an end. (The annoying thing about having to turn in an column 10 days before it is published is that you can never know with absolutely certainty that the world as we know it won’t come to an end before the Business Journal comes out.) This is certainly good news, considering all the dire, hysterical prognostications foisted upon us by the chairman of the Federal Reserve, the secretary of the Treasury, the president of the United States and 80 percent of the pundits who make their living spouting opinions about what will or will not happen on Wall Street.

However, the antics in the financial markets over the past several weeks have certainly made for interesting theater, rivaling any new reality show the networks could think up. In a bizarre twist on the “Survivor” plot, we have been urged to tune in tomorrow to see if Lehman Brothers will be voted out of existence (they were), to see what will happen to Merrill Lynch (they joined the Bank of America team), and to learn the fate of AIG (which formed an alliance of sorts with the federal government in which they still get voted off the financial island.)

But this was small potatoes indeed, compared to the grand finale that played out when – according to the experts – ALL the players who ever played were in danger of being kicked off the island all at once, taking our money and our jobs and our 401k accounts with them! Talk about high drama, it was absolutely riveting, as our heroes in Washington, D.C., dug in at the Capitol in a last-ditch effort to beat back the forces of financial darkness and resolve this desperate crisis once and for all. I guess it was the least they could do, seeing it was our heroes in Washington who created the mess in the first place.

That’s right. We are in this mess today precisely because back in 1995 Congress mandated changes to the Community Reinvestment Act (originally passed in 1977 under the Carter administration and intended to stop a practice called “redlining,” in which lenders refused to lend money in financially distressed neighborhoods). The 1995 changes drastically liberalized the criteria lenders could use to make loans. The idea behind the changes was to make it even easier for people with low incomes and/or bad credit to qualify for mortgages so they could participate in the American dream of home ownership. Oh, and it would also create billions of dollars in new money to boost the economy.

It worked like a charm! During the next few years, billions and billions of dollars in loans flowed into what we know now as the subprime market. Other related rules changes made it possible for two quasi-federal mortgage agencies known affectionately as Freddie Mac and Fannie Mae to reduce to only 2.5 percent the amount of reserves they needed to keep on hand to back the amount of loans they had outstanding. These organizations eventually ended up guaranteeing more than $12 TRILLION in mortgages, with only 2.5 percent of that amount in their reserve fund to guarantee the organizations could remain solvent.

I know this is a lot to take in, so let me make it a bit more personal. Peggy and I were able to buy our first home back in 1975, just three years after we were married; however, we were only able to do this because her grandfather — who for many years was the president of a South Texas savings and loan — gave us the money for a down payment as a wedding present. You see, back in those days, lenders would only give you a mortgage for up to 80 percent of the value of the property, requiring borrowers to somehow come up with the other 20 percent in cash.

Of course, some banks – especially small community banks — have never strayed from that policy, but the revisions to the Community Reinvestment Act made it possible for mortgage brokers to do more — a lot more. Because of the Act, up until just very recently, many young couples with steady jobs and decent credit were able to qualify for “first-time homebuyer programs” that waived most of that down payment, along with most of the closing costs. Well, these costs were not waived, exactly; they were rolled back into the amount to be financed, making the whole mortgage more expensive. 

But wait, there’s more. Lenders also started making “no doc” loans, meaning that as long as your credit was decent, you could receive a mortgage without documenting that you had the income to make the payment (no bank statements, pay stubs or tax returns). Of course, the interest rate on these loans was higher, but it certainly made the process simpler. Oh, and it also flooded the system with people who couldn’t really make their mortgage payments. 

Does this sound a little bit crazy to you?

What if Congress decided that Federal Drug Administration research and testing regulations were making it too expensive and too slow to get new drugs to market? What if they decided to solve the problem by mandating the FDA cut the research and testing requirements for new drugs to only three months, with no testing at all on humans? What if thousands of people started dying as a result? Bingo. Now you have a pretty good idea of what happened when the revised Community Reinvestment Act went into effect.

Of course, this all sounds really horrible now, especially surveying the terrible damage that has been done. Through the excesses of the Community Reinvestment Act, Congress basically ripped up a hundred years of sound lending principles. Their goal seemed noble at the time: help people buy a home who otherwise could not afford one while, at the same time, juice the economy with billions of dollars in free money. It was the most disastrously successful public policy in history.

So, what will happen now? It is too soon to tell. Maybe the economy won’t collapse after all. Maybe the government will even end up turning a profit on the billions of dollars worth of bad real estate loans it is about to buy (and no, you won’t see a penny of that money, I promise). Maybe this will eventually be only a small footnote in history, after all is said and done. Maybe your 401k portfolio will eventually recover.

There are only two things I know for sure. From now on, you better bring your own money to the table if you want a mortgage, because the free money is gone. And maybe the next time someone says, “Hi, I am from the government and I am here to help you,” you will slam the door in his or her face. There has never been any such thing as a free lunch or a free mortgage. Our country is going to be living out that painful lesson for the next 10 years, if we are lucky.

English is a Marble Falls resident and an instructional design manager.