The Lender of First Resort

The government is becoming the lender of first resort for American citizens who want life’s necessities, like education or housing.

Having essentially nationalized the market for college loans early in President Obama’s first term, the administration has finally come to the conclusion that the government will need to play the lead role in providing mortgages to U.S. homebuyers for the foreseeable future. More so than in the case of student loans, for which there was a functioning private market in place, the administration is probably right about housing. But that’s nothing to be proud of.

Last week, the government announced a policy shift designed to spark an increase in home lending. Melvin L. Watt, the new head of the Federal Housing Finance Agency, declared in a speech at the Brookings Institution in Washington that “Our overriding objective is to ensure that there is broad liquidity in the housing finance market and to do so in a way that is safe and sound,” The New York Times reported.

Watt, part of whose role is to oversee Fannie Mae and Freddie Mac, outlined measures that included preserving the relatively loose limits on the size of loans those entities will guarantee and further relaxing rules obligating banks to buy back distressed loans. This is something of an about-face, as the administration had previously expressed support for a plan to pull away from the housing market in favor of private lenders.

Though reaction to the announcement was mixed, the White House vocally backed Watt. Jay Carney, the White House press secretary, called the announcement “a meaningful step toward helping more Americans own their home and continued strengthening of the housing market.”

It is certainly simpler to focus on the announcement than to discuss the conditions that made such government support necessary in the first place.

Private lenders have been largely scared away from the housing market after the financial crisis of 2008, and not without reason. It was bad enough that lenders faced demands to refrain from foreclosing or to forgive principal on housing debts that were, after all, secured by homes that the borrowers mortgaged, and which said borrowers knowingly purchased at what turned out to be the peak of the market. It was even worse when borrowers, by the thousands, simply chose to strategically stop paying mortgages on which they owed more than their homes were worth, which effectively turned the banks from lenders into investment guarantors.

Then there was the overblown scandal over so-called “robo-signings,” in which lenders were vilified for taking paperwork shortcuts in order to keep up with the crush of defaulted loans, even though almost all of the borrowers in question had, in fact, stopped paying their debts.

But the coup de grace for private lending has been the six-year hunt for bankers to jail as punishment for their having had the temerity to meet the demand for millions of mortgage loans, and the securities into which the loans were packaged, prior to the crash. Not only has lending to home buyers become unattractive from a business perspective, it has become dangerous from a legal one.

Consider a recent article that appeared in The New York Times about Kareem Serageldin, a former executive at Credit Suisse who is serving 30 months in jail for his part in the financial crisis. The Times coverage questioned why Serageldin has been the only bank executive to serve jail time for his actions in the 2008 crisis. Whatever the answer, it certainly was not for lack of trying on the part of the government, which would have loved a few convenient, high-profile scapegoats to point to and say, “See? We got them,” at a time when public outrage ran high. While this did not happen, the feds have succeeded in extracting giant penalties from institutions that were mostly just meeting market demand; in a few cases, those institutions were actively trying to help officials resolve the crisis, such as when JPMorgan (JPM) acquired Bear Stearns and Bank of America (BAC) absorbed Countrywide and Merrill Lynch. Now the government wonders why lenders remain leery of a market the government’s own prosecutors stridently blamed them for not treating with sufficient caution.

Once upon a time, mortgage lending was a safe, quiet and predictable corner of the banking world. In the past decade it has turned into a form of Russian roulette. No wonder the surviving lenders are choosing to stop playing – or at least are insisting that the government take a few bullets out of the chamber.

The administration wants to oblige by loosening the standards under which private lenders can get government backing for their loans through Fannie and Freddie. But since the government has a well-established history of changing the rules at will and then looking for someone to punish for breaking those rules before they were changed, it is not going to be easy to attract private lenders back to the business.

They have all seen Charlie Brown try to kick that particular football one too many times.

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