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sponsored mortgage buyers Fannie Mae and

wise) that it should buy up and then raze excess

Freddie Mac; pointedly refusing to moderate

houses and condos, or proposals to admit a

the moral hazard problem of implicit guaran-

large number of new immigrants, house prices

tees or otherwise rein in the hyper-expansion of

and activity in the U.S. housing construction

Fannie and Freddie; and increasingly pushing

industry are going to remain depressed for a

Fannie and Freddie to promote affordable

while. The process of adjustment, already well

housing" through expanded purchases of non-

under way but not yet completed, requires

prime loans to low-income applicants.

house prices to fall and workers and capital to

The Federal Housing Administration was

be released from the construction industry to

founded in 1934 to insure mortgage loans

find more appropriate employment elsewhere.

made by private firms to qualifying borrowers.

Correspondingly, an adjustment requires the

For a borrower to qualify, the FHA originally

book value of existing financial assets based on

required--among other things--that the bor-

housing to be written down and workers and

rower provide a nonborrowed 20 percent down

capital to be released from writing and trading

payment on the house being purchased. Pri-

mortgages to find more appropriate employ-

vate mortgage lenders like savings banks con-

ment elsewhere. No matter how painful the

sidered that to be a low down payment at the

adjustment process, delaying it only delays the

time. But private down payment requirements

economy's recovery.

began falling toward the FHA level. The FHA

reduced its requirements below 20 percent.

Mandates and Subsidies to

Private mortgage insurance arose for non-FHA

Write Risky Mortgages

borrowers with down payments below 20 per-

cent. Apparently concerned for bureaucratic

reasons with preventing its "market share"

In 2001, the share of existing mortgages

from shrinking too far, the FHA began lower-

classified as nonprime (subprime or the inter-

ing its standards to stay below those of private

mediate category "Alt-A") was below 10 per-

lenders. By 2004 the required down payment

cent. That share began rising rapidly. The non-

on the FHA's most popular program had fall-

prime share of all new mortgage originations

en to only 3 percent, and proposals were afoot

rose close to 34 percent by 2006, bringing the

in Congress to lower it to zero.5 Mortgages

nonprime share of existing mortgages to 23

with very low down payments have had very

percent. Meanwhile the quality of loans with-

high default rates.

in the nonprime category declined, because a

The Community Reinvestment Act, first

smaller share of nonprime borrowers made 20

percent down payments on their purchases.4

enacted in 1977, was relatively innocuous for

The expansion in risky mortgages to under-

its first 12 years or so, merely imposing report-

qualified borrowers was an imprudence fos-

ing requirements on commercial banks regard-

tered by the federal government. As elaborated

ing the extent to which they lent funds back

in the paragraphs to follow, there were several

into the neighborhoods where they gathered

ways that Congress and the executive branch

deposits. Congress amended the CRA in 1989

encouraged the expansion. The first way was

to make banks' CRA ratings public informa-

No matter how

loosening down-payment standards on mort-

tion. Further amendments in 1995 gave the

painful the

gages guaranteed by the Federal Housing

CRA serious teeth: regulators could now deny

Administration. The second was strengthen-

a bank with a low CRA rating approval to

adjustment

ing the Community Reinvestment Act. The

merge with another bank--at a time when the

process, delaying

third was pressure on lenders by the Depart-

arrival of interstate banking made such

it only delays the

ment of Housing and Urban Development.

approvals especially valuable--or even to open

The fourth and most important way was sub-

new branches. Complaints from community

economy's

sidizing, through implicit taxpayer guarantees,

organizations would now count against a

recovery.

the dramatic expansion of the government-

bank's CRA rating. Groups like ACORN (the

5