This blog is the second in the Bipartisan Policy Center’s series on the 2008 financial crisis a decade later.
A decade ago, the federal government was forced to take unprecedented steps to shore up the financial system. Interventions like the Troubled Asset Relief Program or TARP were deemed necessary to calm markets and stabilize financial institutions. What must be remembered is that the crisis on Wall Street was precipitated and amplified by a crisis on Main Street. The bursting housing bubble helped trigger the financial crisis and a severe recession. Unemployment surged, nearly $11 trillion in household wealth vanished, and nearly 4 million families lost their homes to foreclosure.
The government launched many housing programs to help mitigate the pain and spur a recovery, but their efficacy continues to be the subject of fierce debate. Many, including BPC’s Housing Commission, have analyzed these efforts to learn from them. Summarized below are four key federal policy responses to the crisis on Main Street and what we have learned.
1) Maintain the Flow of Mortgage Credit
During the housing bubble, prices rose dramatically, fueled by demand, speculation, and exuberance. After the bubble burst, prices fell over 27 percent nationally from their peak in late 2006. Housing demand fell, mortgage delinquencies rose, and a glut of housing stock flooded the market. As financial institutions struggled to survive, they cut back on all types of lending. In response, the federal government acted to promote the continued flow of mortgage credit, including through Federal Reserve purchases of mortgage-backed securities (MBS) and the placement of troubled mortgage giants Fannie Mae and Freddie Mac under government control, known as conservatorship.
What We Learned: These countercyclical measures preserved the flow of mortgage credit better than other types of lending, such as loans for small businesses. However, other factors pushed financial institutions to restrict mortgage lending to those with only the most pristine credit histories: regulatory uncertainty, repurchase risk, the high costs of servicing delinquent loans, and persistent fears of litigation. Though conservatorship achieved its short-run goals of stabilizing mortgage markets and promoting financial stability, it was intended to be a temporary solution. Fannie Mae and Freddie Mac were major players in the financial crisis and massive, multidimensional cases of the “too big to fail” problem. Letting a decade pass without progress toward a resolution has been a core policy error, even if reform in the immediate aftermath of the crisis may not have been possible or preferable. In 2013, BPC’s Housing Commission laid out a comprehensive, bipartisan blueprint for a new and safer system of housing finance. Despite congressional attempts to pass legislation aligned with the commission’s work, Fannie Mae and Freddie Mac remain in conservatorship, risking taxpayer losses in another market downturn. Congress remains far from deciding their ultimate fate.
2) Stimulate Housing Demand
Along with efforts to maintain the flow of mortgage credit to creditworthy borrowers, policymakers sought to rekindle demand for homebuying. Congress passed, expanded, and extended tax credits for homebuyers in 2008 and 2009, increasing demand temporarily and easing the fall of house prices. The intent of such tax credits was to attract homebuyers to the market in order to increase home sales, reduce inventories, reduce pressure on housing prices, and establish a bottom for the housing market as a whole. The Obama administration also sought to broadly boost job and economic growth through fiscal stimulus. While the primary goal of such measures was not to heal the housing market, improved economic conditions were expected to translate into the release of “pent-up” demand for housing and stave off foreclosures.
What We Learned: It is now clear that implementing to spur housing demand had, at best, small and mostly temporary effects on housing activity. House prices continued to fall after a cursory bump. Economists and lawmakers were still concerned about the slow pace of the housing recovery years after these efforts. For example, then-Federal Reserve Vice Chair Stanley Fischer in 2014 highlighted “the unusual weakness of the housing sector during the recovery period,” noting several headwinds left unaddressed, including the lingering glut of distressed properties.
3) Modify and Refinance Mortgages
Many measures were taken and subsequently revised to encourage lenders to modify payment plans and other terms on troubled mortgages or to refinance “underwater” mortgages (loans exceeding the market value of homes) to avoid foreclosure. This included the Home Affordable Modification Program (HAMP), which used TARP funds to incentivize financial institutions to make participating homeowners’ mortgage payments more affordable. According to a HUD report, nearly 11.1 million mortgage modifications and other forms of mortgage assistance arrangements were completed from April 2009 to November 2016. Support for mortgage modifications allowed households to reduce debt service and benefit more directly from macro policies mentioned above.
What We Learned: The impact and efficacy of these programs is perhaps the most debated of all the key responses to the crisis. Yet there is one point of agreement; the mortgage servicing industry was not equipped with the systems, staffing, and knowledge to directly assist struggling borrowers on such a large scale. These problems were made worse, at times, by insufficient, missing, or nonexistent loan documentation and legal responsibilities to maximize investor returns.
Still, there are varying opinions on what, if anything, should have been done differently to better assist borrowers burdened by debt and plagued with plummeting home values. The dramatic fall in home values left many households with very high levels of debt relative to the value of their assets. Some argued that this so-called “debt overhang” created a need for household deleveraging—i.e., the forgiveness of that debt—which would have boosted consumer spending and supported a faster economic recovery. Adherents to this line of thinking often argued for a robust federally supported principal reduction program, particularly for underwater borrowers.
Others argued that well-intentioned initiatives like HAMP backfired. In their view, foreclosure mitigation programs were only successful insofar as they allowed borrowers to afford their mortgage payments sustainably over the long term. For example, because a significant portion of HAMP participants defaulted again and still entered foreclosure, some communities may have been prevented from rebounding more quickly.
While researchers, regulators, bankers, and other stakeholders continue to learn the lessons of these key programs, industry practices and standards changed for the better through this experience. Many millions of borrowers were also aided by modifications and refinancings, though whether these programs were the best course of action continues to be disputed.
4) Curb Risky Mortgage Practices
Among the many factors contributing to the severity of the housing and financial crises, any complete analysis must note the contribution of abusive and predatory mortgage products and relaxed mortgage underwriting. In response to these practices, several regulatory safeguards and consumer protections were put in place through the Dodd-Frank Act to make the housing market safer and more resilient.
What We Learned: A broad lesson from the crisis is that the U.S. regulatory and supervisory structure was weak and not well-matched to the risks of the financial system at the time. In that sense, action was clearly needed to correct those weaknesses—and many would argue it did successfully curtail predatory and risky lending. While the Dodd-Frank Act endeavored to address key failures, it may have also had unintended consequences. As noted before, financial institutions largely restricted mortgage lending to those with the most pristine credit histories after the crisis for a variety of factors. Many housing industry stakeholders have argued that the prolonged lack of certainty in promulgating regulations after the passage of Dodd-Frank added costs, encouraged lenders to further tighten credit, and may have delayed housing markets from recovering.