The Future of Homeownership

Brooklyn Law Notes - Fall 2018I wrote a short article, Restoring The American Dream, for Brooklyn Law Notes. It is based on my forthcoming book on federal housing finance policy. It opens,

Two movie scenes can bookend the last hundred years of housing finance. In Frank Capra’s It’s a Wonderful Life (1946), George Bailey speaks to panicked depositors who are demanding their money back from Bailey Bros. Building and Loan. This tiny thrift in the little town of Bedford Falls had closed its doors after it had to repay a large loan and temporarily ran out of money to return to its depositors. George tells them:

You’re thinking of this place all wrong. As if I had the money back in a safe. The money’s not here. Your money’s in Joe’s house…right next to yours. And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others. Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can.

Local lenders lent locally, and local conditions caused local problems. And in the early 20th century, that was largely how Americans bought homes.

In Adam McKay’s movie The Big Short (2015), the character Jared Vennett is based on Greg Lippmann, a former Deutsche Bank trader who made well over a billion dollars for his employer betting against subprime mortgages before the market collapse. Vennett demonstrates with a set of stacked wooden blocks how the modern housing finance market has been built on a shaky foundation:

This is a basic mortgage bond. The original ones were simple, thousands of AAA mortgages bundled together and sold with a guarantee from the U.S. government. But the modern-day ones are private and are made up of layers of tranches, with the AAA highest-rated getting paid first and the lowest, B-rated getting paid last and taking on defaults first.

Obviously if you’re buying B-levels you can get paid more. Hey, they’re risky, so sometimes they fail…

Somewhere along the line these B and BB level tranches went from risky to dog shit. I’m talking rock-bottom FICO scores, no income verification, adjustable rates…Dog shit. Default rates are already up from 1 to 4 percent. If they rise to 8 percent—and they will—a lot of these BBBs are going to zero.

After the whole set of blocks comes crashing down, someone watching Vennett’s presentation asks, “What’s that?” He responds, “That is America’s housing market.” Global lenders lent globally, and global conditions caused global and local problems. And in the early 21st century, that was largely how Americans bought homes.


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Disturbing Reminders about Rating Agencies in Brummer’s New Article


Some disturbing reminders in The New Politics of Transatlantic Credit Rating Agency RegulationMajor rating agencies (CRAs)

generally did not verify the information used to determine the creditworthiness of the products they rated. Plus new models for rating subprime mortgages assumed that housing prices would continue to increase and the model did not consider the declining quality of the loans themselves. And even where signs did begin to arise, bonds were rated at specific intervals, and not necessarily in reaction to crisis, effectively preserving the long life of artificially inflated ratings. By giving MBS and CDOs high ratings, CRAs essentially encouraged investment in these products. The impact: “Of all mortgage-backed securities it had rated triple-A in 2006, Moody’s downgraded 73% to junk”. Similarly, 80% of CDOs rated AAA by S&P from 2005-2007 were downgraded below investment grade by 2009. Well over a third ended up defaulting, wrecking havoc on the financial system and causing the downfall of scores of financial institutions, including behemoths AIG and Lehman Brothers.  (13-14, citations omitted)