Teaching the Crisis

I’m responsible to teach economics and current events to eighth graders - woven into a 20th century US History course - and this sub-prime mortgage crisis is the biggest story of the year. It’s complicated, charged with politics during election season, and nobody seems to understand the big picture. I plowed ahead anyway and started by asking my students how many of them had money in the bank. Nearly all did. “Do you know what banks do with the money you put in there?” I asked. Most realized that banks lend that money so people can buy houses, cars, businesses, and so forth. We discussed how banks make money by charging people more interest on loans than they pay to depositors like them.

Then I told them of the three houses my wife and I purchased or built, how much of a down payment we put on each, how much we borrowed for them - how we fixed up the first two, sold them, and used profits to pay for much of building our present house. I told them about our employment history, our credit rating, and the factors that made our mortgage contracts examples of “prime mortgages” because we never borrowed more than we could afford to pay back and never missed a payment. Then I explained that the economic crisis was caused by “sub-prime mortgages” - banks (encouraged by government) lend money to people who can’t or won’t pay it back, either because they borrowed too much, because they were unreliable, because they fell on hard times, or because they didn’t put any of their own money down and can walk away from their payment without losing anything.

Then I wrote on the board and explained that what sound like names for people are actually crude attempts to phonetically pronounce the acronyms for FNMA - the Federal National Mortgage Association, and FHLMC - the Federal Home Loan Mortgage Corporation, respectively. I explained that local banks negotiate mortgage contracts such as mine but have limited money to lend, so Fannie Mae and Freddie Mac buy those contracts. Mine was for $95,000 at 6% for fifteen years with monthly payments of $801.66 and my house was worth way more than that. My contract can be sold - and has been twice, to Bank America and again to Wells Fargo Bank. My contract is worth more than $95,000 because of the interest I pay. By selling it, my local bank made a profit and got more money to lend so others around here can buy and build houses. That keeps carpenters, plumbers, electricians, excavators, dry-wall contractors, and others busy, giving us a healthy economy.

Most students understood this much. Then it got more complicated.

Fannie Mae and Freddie Mac were created by government, I explained. Together, they control $6 trillion in mortgages - half of all American mortgages. When they buy a mortgage, they guarantee it - like a parent cosigning a loan for a teenager to buy a car. If the teenager doesn’t make payments, the parent must. When Fannie Mae or Freddie Mac wanted to sell sub-prime mortgages, few wanted to buy because they were such a bad risk by nature. So, Fannie Mae and Freddie Mac bundled sub-prime mortgages with prime mortgages. Those packages became “Mortgage-backed Securities” which could be sold and re-sold because buyers believed that if they failed, government would fix everything - be the parent making payments for delinquent teenagers, so to speak. Wall Street jumped on and rode the ensuing boom. So long as house prices continued rising, sub-prime mortgagees could flip their properties and even profit, but as soon as prices leveled off and then fell as they inevitably do, foreclosures skyrocketed and it all caved in. Businesses most heavily invested caved with it, including the allegedly private Fannie Mae and Freddie Mac. Neither the Republican Congress nor the Democrat Congress saw it coming and they should have. Neither Clinton nor Bush saw it either. Some individuals did, but they didn’t blow the whistle loudly enough. Anyway, nobody listened.

Who is responsible for sub-prime mortgages at the root of all this? There’s plenty of blame to go around, but it started with the Carter Administration’s “Community Reinvestment Act” in the seventies. Standards to screen bad borrowers were relaxed. Buyers flooded the market and prices went up in the 1980s housing boom. Then President Clinton ordered standards lowered still further in 1995 so more “minorities” and other low-income people could own homes. Welfare payments qualified as “income.” Even illegal immigrants got mortgages with no money down. Uncle Sam became Jolly John. All this triggered a second housing boom now gone bust. Trouble is, this bust is so big,“experts” predict it may bring us all down with it unless the federal government solves the mess it created. Are they Chicken Littles and Henny Pennys warning us the sky is falling? Government wants us to buy back those dubious securities for up to $700 billion and sort out good from bad, claiming taxpayers will get their money back and more. Others doubt it.

Nearly every student learned something about the problem, but none understood it all. Neither do senators, congressmen, or voters. Neither do I. Not fully. Still, many think government must do something. If we do, hopefully we won’t make things worse.