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...The federal indictments charge that real estate dealers, lending institutions, lawyers and some FHA officials had conspired to inflate the reported value of cheap houses and sell them at high prices to people who could not really afford them. The ultimate loser was the U.S. taxpayer, since FHA guaranteed the mortgages and was left holding the low-value houses when the owners defaulted on their payments.
Responsibility for preventing such abuses rests with HUD Secretary George Romney, whose department includes the poorly administered FHA. In an eloquent if self-serving speech, Romney tried to divert attention to the broader problems of the ghetto, noting that bad housing was a result rather than a cause of ghetto squalor (see box).
That in no way could excuse what the indictments contend has happened in New York, where a Brooklyn federal grand jury charged 40 individuals and ten firms with 500 specific criminal acts, including bribery, fraud, conspiracy and giving false statements to the Government. More indictments were expected, involving a possible loss to the Government of up to $200 million....
...A real estate speculator would buy a ghetto house for $10,000. He would find a poor but working black, induce him to buy the house for $200 down, and promise that monthly mortgage payments would be low, perhaps lower than his present rent. Before guaranteeing a mortgage, FHA would send an appraiser to check the value of the property. The appraiser, who was part of the conspiracy, would get $100 from the speculator for claiming that the property was worth $20,000, and would falsify the detailed seven-page FHA appraisal form. The buyer would agree to pay that price.
To get his mortgage, the buyer would be urged to inflate his own income in his application to the FHA, which is supposed to determine whether a purchaser can really afford the housing. He would sometimes do this by listing a job he did not really hold. The indictments claim that in some cases Dun & Bradstreet would verify this baseless credit rating. FHA would agree to stand behind the mortgage, and Eastern Service would lend the buyer the money. The buyer would then often discover that the house was badly in need of repair, or that the mortgage payments were higher than he expected...
Richard M. Nixon came to office in 1969, so it was left to a Republican administration, and Mr. Romney, to preside over the first mortgage-backed security sale in 1970, which they enthusiastically embraced. “This event,” Mr. Romney said, “marks a revolutionary step forward in our efforts to increase the funds available for mortgage financing.” But in an eerie prefiguring of the 2000s, the subprime lending program soon fell apart as predatory lenders and unscrupulous house flippers defrauded first-time buyers. The government found itself insuring mortgages on houses that could never be resold. After first denying the problems, Mr. Romney was ultimately forced to freeze the program in 1971. Yet even as the lending program ended, the mortgage-backed security sector blossomed, at least for higher-quality, middle-class homes. Securitization worked as an instrument to connect local demand and global capital.
Bypassing traditional bank deposits allowed money to come from almost anywhere: small-town banks, union pensions and European investors could all buy American mortgages. Lending on houses, at least for middle-class housing, became easier than ever before.
And that was the problem. While Mr. Romney may have stopped the fraud, he didn’t address the flip side of the urban crisis: the millions invested in mortgages was money not invested in business.
Small-business loans, however, still relied on those dwindling deposits and could not be securitized. Big corporations and small homeowners could rely on the surging global capital markets, while small business found itself crowded out.
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