20090301 Lining the Road to Hell

How do things that are well intentioned turn so terribly wrong? Well it happens all of the time. Sometimes the things which start out the most benignly end up doing the most damage.

Case in point: in the mid-1970’s America was coming to grips with the fact that it had not always treated minority groups very fairly. The practice of “red lining” was particularly on peoples’ minds. “Red lining” was an unwritten policy of making such minorities could not get a loan to buy a home in a “decent” neighborhood. That is, of course, blatant discrimination. Legislation was passed in 1977 to make sure that banks treated everyone equally when evaluating home loan applications.

Flash forward twenty years. While some banks behaved honorably, others feared offending some of their larger customers and had a track record that was questionable at best. The office of Housing and Urban Development announced that it would use a new interpretation of the law and begin enforcing a system of quotas based on census data. If any lending institution was found to not meet the quota level for any minority, it would be subject to legal proceedings.

Move ahead a few more years and the public interest group ACORN began hiring lawyers to sue banks rather than merely reporting the banks to HUD. Banks begin very closely monitoring percentages of minorities living in regions, percentages of minority groups applying for loans and percentages of each minority group approved for loans. In some cases, banks needed to find minorities who were not necessarily looking for a loan. It increasingly became more and more important to bankers that they make loans to every minority group even if some of those loans might fail, after all the banks insured all of their loans. Once the standards for receiving a loan began to fail, it suddenly became easier for anyone to qualify.

As loans were made that were less and less secure, being able to insure tem became more and more important. A.I.G. became the world’s largest insurer by daring to venture into areas that others feared to attempt. As long as the troubled loans remained a small percentage and the rest of the market remained stable then there would be a few write offs but profits would still be made. But nothing exists in a vacuum.

When loans became easier to get, more people were able to buy houses. When more people were able to buy houses, the price of houses went up. The size of the loans that were approved began to increase. This cycle repeated for a little while before speculators fresh from the internet bubble took notice. They needed a place to put money and house prices were having a boom and they poured their money into the market driving prices up further. More and more people were making money in the housing market and it started getting fashionable. TV programs that showed people buying and flipping houses abounded on TLC, DIY and HGTV. Buying houses for no money down was preached as the way to get rich.

A person with a modest mortgage who had a fifty percent equity stake based on his or her purchase price saw the value of their home double or triple. Suddenly they had a seventy-five or eighty percent equity stake and they felt wealthy. Lenders, who knew they were sitting on riskier loans than they historically had, saw the increased equity in their customers’ homes and encouraged home owners to borrow off of this equity. Unfortunately, the act of issuing shaky loans is what inflated those home equity values so the home equity loans did not help prop up the lending structure, it magnified the underlying problem.

I wish I could say that this is the only arena that a situation like this has arisen but I check out the news everyday and I see the exalted leaders of this great nation crafting well meaning ideas into law with no foresight into what changes they are creating. It seems like no corner of our lives is safe from this kind of interference.