Aftermath. Thomas E. Hall

to play a major role for years to come. Cigarette taxes have been around since the 1860s and will likely be with us for as long as people smoke cigarettes. State minimum wage laws first appeared in the early 1900s, and the original federal law was put in place in 1933 as part of the New Deal. Given the ongoing demands that workers should earn a “living wage,” we can expect minimum wage supporters to advocate not only for keeping the law but for continuing increases in the minimum wage. The final case is alcohol Prohibition. Although it ended in 1933 because the unintended consequences were so devastating, it has major applications to the war on drugs, which has been an explicit policy of the U.S. federal government since the early 1970s.

      Several individuals assisted on this project. J. David Ferguson, D. Christopher Ferguson, William Hart, and Kenneth Ashley read drafts of chapters and offered valuable comments. I also benefited greatly from discussions with Charles Moul, James Brock, and Michael Winrow on a variety of topics. Graduate students Matt Mauck, Neel Shivdasani, and Heather McHone proofread and checked references. And my wife Christine read chapters and made comments, along with providing a loving and supportive environment. Any errors are my responsibility. Financial support for this project was provided by Miami University.

      This book is dedicated to the memory of my late brother, James Ashley Hall.

1. Introduction

      While driving along a residential street in the United States, you can often tell which homes are occupied by their owners and which by renters. Usually, but not always, the owner-occupied houses are better maintained, the lawns are well tended, and there is an absence of clutter on the property. Rentals often have a rougher appearance. The main reason for this difference is that owner-occupiers have a strong incentive to take care of their house and land because they live there. Absentee landlords maintain properties, but their incentive to do so is lessened somewhat since they do not occupy the premises. Tenants have even less incentive to be concerned with maintenance.

      The benefits to society from homeownership are well known. In addition to the maintenance factor, owner-occupiers have a greater vested interest in the well-being of their community. They are more likely to care about the quality of local schools, roads, and parks. Homeowners are also more stable residents in the sense that they move less often than renters. Also, since house prices have generally risen over time, homeownership has helped raise Americans’ wealth. With these points in mind, wouldn’t it be great if all American families owned their own home?

      The advantages of homeownership have long been accepted in the United States, which is why the U.S. government pursues policies to promote it. This effort began in earnest during the 1930s when President Franklin Roosevelt’s New Deal created various programs and agencies that encouraged homeownership: the Federal Housing Administration to insure home mortgages; the Federal National Mortgage Association (Fannie Mae) to buy mortgages insured by the Veterans Administration; the Federal Home Loan Banks to provide assistance to the savings and loan industry, which was the primary source of mortgage lending; the promotion of 30-year mortgages to lower monthly payments and make homes more affordable; the Home Owners’ Loan Corporation that refinanced mortgages in default. In addition, since its inception the federal income tax code has allowed the deduction of mortgage interest from income when calculating taxes. Due in part to these various government programs, the U.S. homeownership rate, which is the proportion of U.S. houses occupied by their owners, rose from 44 percent in 1940 to 63 percent in 1970.¹

      After 1970, the growth of homeownership slowed, reaching 66 percent in 1980 before dropping back to 64 percent by the mid-1980s. It remained at that level for roughly the next 10 years. During that time, some Americans expressed concerns that homeownership was not equal across racial groups. Citing the fact that homeownership was more prevalent among whites than nonwhites, banks were accused of “redlining,” an alleged practice whereby they do not issue loans to individuals or businesses in certain sections of cities. Since minorities disproportionately occupied the areas where redlining was said to be taking place, the implication was that banks were practicing discriminatory lending. This claim received support in 1992 when the Federal Reserve Bank of Boston released an influential study that reported that “black and Hispanic mortgage applicants in the Boston area were more likely to be turned down than white applicants with similar characteristics” (Munnell et al. 1992, 42).²

      Evidence of discriminatory lending and the implication that minorities were being excluded from homeownership led to enhanced efforts by the U.S. federal government to promote home buying. In 1992, Congress passed the Housing and Community Development Act, which “essentially gave [the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)] a mandate to purchase lower-quality mortgages” (Acharya et al. 2011, 32). Fannie Mae and Freddie Mac are government-sponsored enterprises that purchase mortgages; after 1992, they bought increasing quantities of subprime mortgages, which are loans to higher-risk borrowers.³ Another important factor was the 1995 amendment to the Community Reinvestment Act, which urged banks to increase lending to low-income Americans. If banks failed to meet the standards they were not subject to explicit penalties, but lending data would be made available to community groups. The implied threat was that if banks did not step up lending to minorities, then community groups would find out and organize protests and boycotts of the banks.

      These laws helped create a situation that was a disaster waiting to happen. Mortgage lenders issued loans to high-risk borrowers and collected origination fees for doing so. The lenders then sold the mortgages to financial institutions, which were often Fannie Mae or Freddie Mac. If the borrowers defaulted on these mortgages, the losses would be incurred not by the original lenders but instead by the U.S. taxpayers through a government bailout of Fannie Mae and Freddie Mac, or of private banks that were also purchasing these mortgages. This ability to originate and then sell high-risk mortgages is a big reason that the absurd “no-doc” loans came into being. No-doc loans were home loans to borrowers who were not required to provide documentation of their income or assets. It is highly unlikely that such risky loans would have been made without originators being able to unload the risk onto someone else.⁴

      The sorry state of affairs was made even worse by the financial industry, which was busy creating volatile financial instruments (credit derivatives) against these mortgages, and in some cases betting the institutions’ fortunes on the assumption that housing prices would continue to rise. The Federal Reserve was also a big part of the problem because it maintained low interest rates during the first half of the 2000s, which encouraged Americans to borrow. Throughout that period, the government regulatory agencies in charge of monitoring the situation raised few alarms.

      The expansion in mortgage lending helped raise the demand for houses, and the price increases that resulted were exceptional. Nationally, house prices rose more than 100 percent from 1995 to 2006. This large and sustained increase led to speculative buying, which further increased demand (Case and Shiller 2003). Large numbers of Americans amassed paper fortunes in real estate. The U.S. government’s efforts to promote homeownership were working: the homeownership rate rose from 64 percent in 1995 to 69 percent in 2004.

      However, as we know now, those policies to promote homeownership had major unanticipated effects. The housing boom eventually played out as prices peaked in 2006 and then began to decline, slowly at first, then rapidly by 2008. Falling prices caused many homeowners—especially those who had purchased their homes near the peak in prices—to owe more on their mortgage than their house was worth (a situation called “negative equity” or “underwater”). This unpleasant financial position led some homeowners to abandon the premises and stop making payments on their mortgages. In addition, when prices started to fall, fewer potential buyers saw housing as a speculative investment. Meanwhile, further pressure was placed on the housing market by the upward adjustment of interest rates on adjustable-rate mortgages issued during the boom as low introductory “teaser rates” expired. As a result of these and other factors, the demand for houses fell while the supply continued to increase (as homes being constructed during the boom were completed), causing prices to plummet. Large-scale mortgage defaults occurred, which led to losses by the financial institutions holding those mortgages. The result was the 2008 financial crisis.