The immediate effect of Garn-St. Germain, as I said, was to turn the thrifts from a problem into a catastrophe. The S.& L. crisis has been written out of the Reagan hagiography, but the fact is that deregulation in effect gave the industry — whose deposits were federally insured — a license to gamble with taxpayers’ money, at best, or simply to loot it, at worst. By the time the government closed the books on the affair, taxpayers had lost $130 billion, back when that was a lot of money.Here, Krugman, the economist, simply doesn't know his economic history. He purports to blame this act for the explosion of such aggressive loans as no money down loans. Of course, this is totally baseless. First, FHA has always been around and it always required only 3% down. Second, sub prime had been around long before this act. The explosion of sub prime had to do with a man named Lew Ranieri who created and innovated the process of mortgage securitization. This lead directly to mortgage backed securities. Please note, I don't blame Ranieri for this crisis anymore than I blame Reagan.
But there was also a longer-term effect. Reagan-era legislative changes essentially ended New Deal restrictions on mortgage lending — restrictions that, in particular, limited the ability of families to buy homes without putting a significant amount of money down.
These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980 the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped.
Second, sub prime was always a place where folks could go to for little and no money down loans. Remember, sub prime offered significantly higher rates. As such, there had to be something that it offered to attract business. One of those things was the ability to put little or no money down.
When I first entered mortgages, no money down sub prime loans were fairly popular. They were also carefully contructed. Never could you get a no money down loan without proving income for instance. Bankruptcies, foreclosures, a lack of credit depth and far too many previous lates were often also deal killers. Also, credit scores were required to be relatively high, 660 or so.
That all changed at the end of 2003 and the beginning of 2004. From then until the end of 2006, sub prime loans became more and more aggressive and less and less restrictive to no money down loans. By the end of 2006, it was not uncommon to get a no money down loan without proving income with as low a credit score as 620.
In fact, it wasn't the explosion of no money down loans per se that created this crisis, but rather, that explosion while forgiving other risk factors. None of this had anything to do with the obscure act that Krugman is fixated with. As I have said over and over, I believe this was directly related to the Fed's lowering the Fed funds rate below one percent and keeping it there for nearly two years. This allowed banks to borrow cheaply. Real estate was the only thing moving then and so banks put a great deal of money there. Since they then had more money than loans, they wound up creating new ones.
Krugman has been on a tear against deregulation since this crisis started. Yet, Krugman mistakes one very important point. It wasn't deregulation that caused any of this to begin with. It was in fact a lack of enforcement. Most of these stated loans were done fraudulently. Fraud was always illegal. It wasn't as though the government made a new rule that allowed someone to lie about how much income they made. They didn't. They just didn't enforce this critical regulation. Had mortgage professionals faced any penalty for systematic fraud most of this wouldn't have happened. So, as Krugman goes on a tear about the evils of deregulation, he misses the point entirely. This wasn't caused by deregulation but a lack of enforcement.