NCPA - National Center for Policy Analysis

New Lending Standards May Spark Another Financial Crisis

January 26, 2015

What caused the 2008 financial crisis? It wasn't greed or deregulation, says Michael Barone at National Review: it was government policy that promoted lax lending standards.

What happened?

  • The federal government encouraged banks to give mortgages to aspiring homebuyers with poor credit.

  • At the same time, it required that a certain portion of mortgages (30 percent) purchased by Fannie Mae and Freddie Mac be those risky mortgages. That requirement was eventually raised to 56 percent.

  • Fannie and Freddie -- which previously had only purchased mortgages when buyers made down payments of 10 percent to 20 percent -- began purchasing mortgages with just 3 percent down payments, and sometimes zero down payments, in order to meet those requirements.   

The result? A ton of "subprime" mortgages. In 2008, over half of all U.S. mortgages were subprime. Moreover, three-quarters of those mortgages had been purchased by Fannie and Freddie or government agencies.

Barone explains that the low down payment requirements led housing prices to rise, because buyers could afford larger homes without putting down more money. Eventually, the bubble burst, and when housing prices fell, the mortgage-backed securities market did too.

These policies were instituted in the name of improving homeownership for low-income households. While the homeownership rate increased, government policies distorted the market and led to a financial panic.

Have we learned our lesson? Barone is not so sure: Fannie and Freddie announced in December that they will again purchase mortgages with just 3 percent down payments.

Source: Michael Barone, "Could the Financial Crisis Repeat Itself?" National Review, January 20, 2015.

 

Browse more articles on Economic Issues