The 'affordable housing ideology' dominated the American housing market for thirteen years and ultimately destroyed it. It was introduced by President Clinton in 1995 as the National Home Ownership Strategy against a background in which a report produced by the Federal Reserve Bank of Boston (1992) argued that they had identified systematic discrimination against minorities in bank lending.
Both the results and the methodology were severely criticised at the time, but that did not prevent it from being extremely influential at the time. When Clinton announced the strategy, he stressed the benefits to families and to society as a whole, since extending home ownership would create a more stable and neighbourly society.
However, committed as he was to a balanced budget, he cut spending on public housing, and instead substituted a strategy which would transfer the costs to the private sector and away from the taxpayer. The route chosen was to amend the Community Reinvestment Act so that banks would obtain an 'outstanding' rating if they increased their loans to carefully defined low income groups. This legislation took effect at the same time as that allowing interstate banking for the first time. Banks had to have an 'outstanding' rating before their regulators gave them permission to engage in a merger or acquisition.
That was the first step towards the goal of a further 8 million families being able to purchase their own homes by the year 2000. In the year 2002, Bush hoped to extend home ownership by a further 5 million by the end of the decade.
The second step was to use Fannie Mae and Freddie Mac to make sure that the banks had enough money to lend to minorities and poor families by buying the loans the banks made. The government set out the proportion of loans to families on moderate, low and very low incomes. That proportion was ratcheted up every three years, until by 2008, it was over 50%.
Fannie Mae and Freddie Mac were extraordinary institutions, as they were owned by private shareholders but had to fulfil the government's housing policy: home ownership for all. So they purchased mortgage loans made by lenders and packaged them into mortgage-backed securities, which were sold to investors along with a guarantee that the principal and interest on the underlying mortgage would be paid in full.
They also invested in mortgages and mortgage-backed securities but as their portfolios grew and grew over the years so the anxieties over the size and risks of their portfolios grew. To fund their activities, they issued debt securities that were sold to investors worldwide, including foreign central banks.
Politicians supported Fannie and Freddie as they thought this was the best way of making sure that the banks had the funds to lend and reducing the costs of mortgages for poor families. They refused to see the dangers of low deposits, low or non-existent credit scores and no or low documentation of incomes or incomes consisting of welfare payments. Fannie and Freddie were grossly mismanaged, weakly regulated, whilst senior executives made millions.
The subprime loans had been packaged by Fannie and Freddie into mortgage-backed securities, which were then repackaged in to collateral debt obligations, and sold throughout the world. The very complex instruments, seeming such an innovative way of distributing risk, now stood in the way of price discovery, freezing the market. The sheer size of the US market and its central role as an investment destination contributed to the rapid spread of the crisis.
Fannie and Freddie were taken into conservatorship by the Government in September 2008. That has not saved them, for the problem has been hidden Fannie Mae currently guarantees mortgages totalling $3.5 trillion and Freddie $2.00 trillion, but these are excluded from the budget calculations in a ruse that does not work in the end. They continue to receive bailouts from the tax payer now totalling $183bn. The risks are still there, as they are for many banks, and therefore governments, throughout the world.
As for the lessons to be learnt? Politicians must learn that banks should not just be used for social engineering. The regulators in the USA could not agree on a suitable definition of subprime lending, even though it was surely obvious from the start that increasing home ownership for families with low or very low incomes would result in vast numbers of subprime mortgages, but many players in the market were blinded by the affordable housing ideology.
But the perils have still not been understood in the USA, or in Cameron's recent plan to extend home ownership with a 5% down payment for 100,000 new build homes but where the government is the ultimate, mortgage guarantor. Will they never learn?
For a special offer on Oonagh's book allowing you to purchase it for only £25 plus postage, email Charlotte.Hoare@bloomsbury.com with the code FMFM2012