The US Government Intervention In The Market For Homeownership

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The U.S. Government’s intervention in the market for homeownership in 1932 was appropriate for the Government and for potential homeowners. Prior to stepping in, only short-term (3-10 years), non-amortizing loans with lower LTV ratios (60%) were available and, at that time, the country was in the midst of the Great Depression thereby triggering substantial defaults on home loans. The 1932 intervention created the Federal Home Loan Bank (“FHLB”) which funded financial institutions with short term lending; borrowers could then make the dream of homeownership a reality. Since more government lending programs were introduced into the system, the government had to develop a way to minimize losses should homeowners fall into foreclosure. As a result, the US Congress passed the 1934 National Housing Act, which further promoted homeownership by providing a system for insuring loans to protect lenders against defaults by borrowers. In brief, the 1932 Government’s intervention served as a catalyst that sparked legislation in order to make the process of purchasing a home easier and available to a majority of the population.

II. Government Sponsored Corporations The intervention allowed those borrowers who would not typically qualify for a mortgage (pre-1932) the facility to purchase a home. In 1938, the creation of the government-sponsored corporation, FNMA or Fannie Mae, expanded homeownership because its purpose was to serve as a facilitator for secondary market mortgage. FNMA also allowed private lenders to issue more loans because they could then be sold in the secondary market. In retrospect, Fannie Mae basically provided the foundation for creating more high-risk loans, thus increasing the quantities of loans. In 1968, Fannie Mae became a publicly traded government corporation, which allowed the US government not to include it on the federal budget. Ginnie Mae was established in 1968 when the government transferred its portfolio of government insured FHA mortgages to a wholly-owned government corporation. Freddie Mac actually started creating mortgage-backed securities (“MBS”) that sold as share of the pooled loans to investors. These three corporations supported the secondary market for residential mortgages and assisted mortgage funding for low and middle-income families taking into consideration the geographic distribution of mortgage funding for under-served geographic sectors. These corporations helped the government promote sub-prime lending thereby facilitating mortgage loans with high loan-to-value (“LTV”) ratios.

III. Sub-Prime Mortgages and Impact
The government’s promotion of sub-prime and high LTV mortgages created additional risks for lenders and the holders of MBS.
There is clearly an added risk by granting loans to people with lower incomes, unstable employment history, high debt to income levels and inadequate funds for down payments. The government encouraged sub-prime lending with the Depository Institution Deregulation and Monetary Control Act of 1980, which eliminated interest rate caps which allowed lenders to charge higher rates to sub-prime borrowers. The higher the interest rates, the higher the mortgage payments for sub-prime borrowers. This increased the risk of holders of mortgage-backed securities.

The Housing and Community Development Act of 1981 also encouraged sub-prime lending, allowing FHA borrowers with poor credit to obtain mortgages with high LTV ratios. This added more risk to MBS because it allowed people who did not qualify for conventional mortgages to obtain mortgages. By 2004 almost 70% of U.S. citizens owned homes; however, by the end of 2005, 37.6% of total mortgage originations were sub-prime. The additional risks of sub-prime lending were seen when the housing market began to slow. The sub-prime market saw an increase in late payments, defaults and foreclosures. In March 2007, 13% of sub-prime borrowers were late on payments by 60 or more days. The
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