Wednesday, July 23, 2008

How Government Created the Mortgage Mess, II

How did the government help create the current financial mess? Let me count the ways.

In addition to federal laws that pressure lenders to lend to people they would not otherwise lend to, and in places where they would otherwise not invest, state and local governments have in various parts of the country so severely restricted building as to lead to skyrocketing housing prices, which in turn have led many people to resort to "creative financing" in order to buy these artificially more expensive homes.

Meanwhile, the Federal Reserve System brought interest rates down to such low levels that "creative financing" with interest-only mortgage loans enabled people to buy houses that they could not otherwise afford.

But there is no free lunch. Interest-only loans do not continue indefinitely. After a few years, such mortgage loans typically require the borrower to begin paying back some of the principal, which means that the monthly mortgage payments will begin to rise.

Since everyone knew that the Federal Reserve System's extremely low interest rates were not going to last forever, much "creative financing" also involved adjustable-rate mortgages, where the interest charged by the lender would rise when interest rates in the economy as a whole rose.

In the housing market, a difference of a couple of percentage points in the interest rate can make a big difference in the monthly mortgage payment. For someone who buys a house costing half a million dollars— which can be a very small house in many parts of coastal California— the difference between paying 4 percent and 6 percent interest would amount to more than $7,000 a year. For people who have had to stretch to the limit to buy a house, an increase of $7,000 a year in their mortgage payments can be enough to push them over the edge financially.

In other words, government laws and policies at federal, state and local levels have had the net effect of putting both borrowers and lenders way out on a limb.

~Thomas Sowell

15 Comments:

At 7/23/2008 6:45 AM, Blogger Bruce said...

I'm sure the government is a factor, but I've seen little compelling evidence delineating the impact. I have seen a NYT article that did cite differential foreclosure rates in black neighborhoods. But the article went on to say rates were higher despite similar income levels. IMO this doesn't absolve people from responsibility for taking out loans they can't pay. But if the mortgage companies are being rewarded with higher rates for more risk, then it comes back to them. Of course the NYT wants to say its not their fault because of the higher rates, so one part of the question devolves to what is the reason for the higher rates.

 
At 7/23/2008 7:50 AM, Blogger juandos said...

"so one part of the question devolves to what is the reason for the higher rates"...

Well it could be that potential homeowners were promising to pay those rates, right?

 
At 7/23/2008 8:12 AM, Anonymous Anonymous said...

In addition to federal laws that pressure lenders to lend to people they would not otherwise lend to

Sowell has already been debunked on that issue.


Since everyone knew that the Federal Reserve System's extremely low interest rates were not going to last forever, much "creative financing" also involved adjustable-rate mortgages, where the interest charged by the lender would rise when interest rates in the economy as a whole rose.

This is where the libertarians fall off the deep end with reductio ad absurdum. Bennie and the B-52s at the Fed have reduced administered interest rates back to the level of the "creative financing" era (circa 2004-2007)such that monthly payment resets are de minimus and likely will continue to have little effect on payment resets as it maintains near zirp interest rates or the zero bound in the near term.

However, LIBOR, the constant treasury index, other creative finance indices and mortgage/treasury spreads that mortgage originators contracted with the borrowers have not followed suit. Hmmm...ala Greenspan...a conundrum indeed.

state and local governments have in various parts of the country so severely restricted building as to lead to skyrocketing housing prices

The coastal communities have had strict zoning/building requirements forever.
Libertarian Texas has not, yet it is holding it's own when it comes to mortgage delinquency rates though. LOL

Once again, Sowell is blowing smoke.

 
At 7/23/2008 8:59 AM, Blogger Brian Shelley said...

Anon,

"Texas has not, yet it is holding it's own when it comes to mortgage delinquency rates though. LOL"

You are making an error in your analysis of default rates. Yes, Texas' default rate is fairly high, but it has been high for many years. Between 2005 and 2008 default rates in Texas have remained basically unchanged. Rates in California and other supply restricted communities have skyrocketed.

"The coastal communities have had strict zoning/building requirements forever."

Again, you are looking at this as a binary situation of with/without restrictions. All cities have restrictions, it's a matter of scale. If you read enough you will see that land use restrictions have been increasing significantly in the last decade.

At one extreme you have Houston with no zoning, but other restrictions. Some coastal cities have gone off the deep end with central planning that approximates the Politburo.

 
At 7/23/2008 9:00 AM, Anonymous QT said...

Anon.

What happens when you try to renew a mortgage for a home no longer worth the principle of the existing mortgage?

There are many sub-prime borrowers who have found that they cannot find any institution willing to finance a mortgage with insufficient collaterol. Reducing interest rates brings down payments on existing variable rate mortgages but does not solve this problem.

The answer for many homeowners is just to walk away. Why would you wish to continue to pay more for something worth less?

 
At 7/23/2008 9:07 AM, Blogger matt said...

There was clearly stupidity and greed all around - buyers for not understanding what negative amortization means, originators for accepting liar loans and outright fraud (see Indymac, Countrywide) investors for buying CDOs and MBSs, and regulators for not stopping this before TSHTF.

I would love to see a CD post and discussion about how the government continues the mortgage mess. The Fannie/Freddie bailout bill looks set to pass, and I am scared of repercussions of this. Are we doubling the national debt? What will happen to the spread between treasury bonds and agency bonds?

 
At 7/23/2008 9:17 AM, Blogger juandos said...

anon @ 8:12 AM says: "Libertarian Texas has not, yet it is holding it's own when it comes to mortgage delinquency rates though. LOL

Once again, Sowell is blowing smoke
"...

Well for what its worth anon apparently: CNBC doesn't agree with you:

The states with the highest delinquency rates are:

Mississippi, 4.85%
Texas, 4.09%
Michigan, 4.06%
Georgia, 3.89%
West Virginia, 3.83%

 
At 7/23/2008 9:19 AM, Blogger juandos said...

"Why would you wish to continue to pay more for something worth less?"...

Hmmm, because one signed a contract originally to pay for the house maybe?

 
At 7/23/2008 9:53 AM, Anonymous QT said...

Juandos,

If you put down $100k, you have something to lose so you are stuck waiting on average for about 10 years for prices to return or selling your home at a loss if you are in financial difficulties. Been there. Done that.

If you have paid no deposit and almost nothing in principle, what are you losing by defaulting. People are pretty good at rationalizing. They also see that they can either be a slave to a large mortgage or stick the bank with the problem (hey, banks are the robber barrons, aren't they?).

I agree a contract has been signed and one should honor one's commitments. However, I doubt that either of us will ever be sub-prime borrowers.

 
At 7/23/2008 10:31 AM, Anonymous Anonymous said...

Between 2005 and 2008 default rates in Texas have remained basically unchanged. Rates in California and other supply restricted communities have skyrocketed

And what's your position Brian. Are you stating that when the oil market collapsed in the 1980's, Texas/Colorado mortgage delinquency rates were lower than the California/Florida rates today. Or are you just stating that Texas sucks all the time? Do you have a citation in support of your position? Probably not and just like Sowell, you are blowing the libertarian smoke

_________________________________

Well for what its worth anon apparently: CNBC doesn't agree with you


As usual juandos, working in the airline industry at 35000 feet has crimped the oxygen supply to your brain. You are a year late and a bankruptcy or two shy with your data.

_________________________________

Well, qt, I believe I'm the only anon above you on this thread. Congratulations, you have isolated the problem. Maybe you should talk to Brian about the 1980's Texas walkaways.

 
At 7/23/2008 11:04 AM, Blogger juandos said...

Typical of you anon @ 10:31 AM not to do your homework...

I do know as a Texan (regardless of the year and the 14 month old CNBC article) that Texas STILL has a problem with mortgage delinquency rates...

Home foreclosures in the state increased to 0.6 percent in third quarter 2007—slightly below the U.S. rate of 0.8 percent. Mortgage delinquencies also rose. Texas delinquencies for all loans 90 days past due were 1.6 percent in the quarter—higher than the U.S. rate of 1.3 percent...

Got anymore fairy tales anon?

 
At 7/23/2008 11:46 AM, Anonymous QT said...

"Well, qt, I believe I'm the only anon above you on this thread. Congratulations, you have isolated the problem. Maybe you should talk to Brian about the 1980's Texas walkaways."

I'm really wounded here...pardon me while I break into an aria.
Is that the best you can do "go talk to Brian"? Good grief

Not every economist is unaware of the phenomenon of homeowners who choose their self-interest over morality (hey, there are even businesses trying to tap into these folks, see www.youwalkaway.com):

http://economistsview.typepad.com/economistsview/2007/12/walking-away-fr.html

http://globaleconomicanalysis.blogspot.com/2008/04/walking-away-next-mortgage-crisis.html

Most of us are also aware of the work of Ed Glaeser on housing prices:

http://www.nytimes.com/2006/03/05/magazine/305glaeser.1.html

You could try offering your own ideas on the sub-prime problem but then, the easiest job in the world is being a critic.

"Above you"...hmmm, I sincerely doubt that but if it makes you feel "special"...whatever lights your candle.

 
At 7/23/2008 12:21 PM, Anonymous Anonymous said...

Above you"...hmmm, I sincerely doubt that but if it makes you feel "special"...whatever lights your candle

You are a real special candle, qt. Can I clean my ears with your Q-Tip?

 
At 7/23/2008 1:11 PM, Anonymous QT said...

Anon.

Thank you for providing me with information regarding HTML.

Nice to know that you are not a complete git...despite the great impersonation.

 
At 7/23/2008 2:22 PM, Blogger Brian Shelley said...

"And what's your position Brian."

High prices were caused by restricted supply. Foreclosure rates were masked by high growth rates. Foreclosures exploded AFTER price drops. Restricted supply introduced volatility to the housing market.

"Are you stating that when the oil market collapsed in the 1980's, Texas/Colorado mortgage delinquency rates were lower than the California/Florida rates today. Or are you just stating that Texas sucks all the time?"

1980's? No, and I wouldn't be shocked if TX had higher foreclosure rates long term than CA.

"Do you have a citation in support of your position?"

Send me an e-mail and I will send you my numbers. I had to painstakingly pull them from pdf's at RealtyTrac.

Jan. 2006
Foreclosures
California - 9354
Texas - 14669

Mar. 2008
Foreclosures
California - 64711
Texas - 10700

The last number for Texas is deceivingly low. The slope of the 27 data points is -40/month.

 

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