Monday, July 21, 2008

How Government Created the Mortgage Mess

It was government intervention in the financial markets, which is now supposed to save the situation, that created the problem in the first place.

Laws and regulations pressured lending institutions to lend to people that they were not lending to, given the economic realities. The Community Reinvestment Act forced them to lend in places where they did not want to send their money, and where neither they nor the politicians wanted to walk.

Now that this whole situation has blown up in everybody's face, the government intervention that brought on this disaster in is supposed to save the day.

Politics is largely the process of taking credit and putting the blame on others— regardless of what the facts may be. Politicians get away with this to the extent that we gullibly accept their words and look to them as political messiahs.

~Thomas Sowell

13 Comments:

At 7/22/2008 2:15 AM, Blogger Sophist said...

Next thing I will hear is that LTCM failed because of government regulation, although their friend and (allegedly) investor Greenspan at that time bailed then out.

Actually, one of the originators of LTCM failed again recently. Was that due to government regulation, or de-regulation?

The driving force behind the mortgaga mess was greed. Maybe the fault of the government was not regulating greed well enough.

Can you blame your dog for eating your lunch if you let it free in your kitchen. It happened to me once and you know what I did?

I said to my dog: Good, you did the right thing. Now, I will bail you out...

 
At 7/22/2008 6:49 AM, Blogger Matt S said...

I think sophist might be on the right track. I've heard from Krugman (I think it was Krugman) that deregulation helped cause this. I mean after all, these past 8 years have been deregulation central (except for civil rights) for anyone trying to make a buck.

 
At 7/22/2008 6:56 AM, Blogger Brian Shelley said...

For once, I think that Thomas Sowell is missing the real problem. The real government role in the housing crisis is at the state and local level. In recent years there has been a massive increase in supply restricting land use regulations. This caused the skyrocketing prices.

We know this because other fast growing cities like Dallas and Atlanta experienced no significant increase in home price growth rates. Mortgage backed securities are priced on backward looking credit default rates and severities. As prices soared, foreclosure rates looked low because home equity was rising rapidly. High home equity in a liquid market means no foreclosure.

When the cash flow into mortgages slowed, prices leveled and foreclosures started to reveal themselves. Foreclosure rates in California up over 300%. Foreclosure rates in Texas - flat.

People have forgotten that there was a housing boom/bust in Southern California in the early 90s. Were sub-prime loans the cause then as well?

Restricting housing supply through regulation has increased the inelasticity of demand and introduced price volatility to the housing market.

Expect another bubble within a decade.

 
At 7/22/2008 7:16 AM, Blogger jomama said...

Underlying it all is the Fed.

Without the government-sanctioned Fed it would have been a tiny problem or non-existent as there
would be no bailouts, loose money,
or government guarantees.

Sowell's critique stands.

 
At 7/22/2008 7:53 AM, Blogger Sophist said...

Brian, good points. Same type of crisis happpend in the East Cost in the late 80's. I remember a friend of mine (we were both graduate students then) bought a one bedroom apt at 14 str and 7th ave. NY, for about 70k. previous owner had paid over 180k.

A couple of things:

(1) The whole subprime crisis was caused by greed which was reflected in the pricing of the derivative products. Those greedy investment bankers knew rates will go up and defaults will skyrocket. Yet, they wanted to make commissions and hence the result.

(2) I see the subprime crisis not as a financial crisis but as a correction mechanism that redistributed wealth. Money flew from greedy investors looking for high yields to home builders and related businesses. Then the investors started screaming from fear and convinced people through the media that this was a major problem with the economy. They started selling shares to cause panic and get the bail out.

(3) FED intervention in the subprime crisis was maybe the biggest mistake ever of US economic policy. US is loosing reputation as a free market economy. They should have left all those greedy banks to go belly up.

(4) I am very dissapointed indeed to see that US is using the same old trick to create new wealth that corrupt European states use and has to do with restricting land use so that prices of existing land and homes go up. This has many adverse side effects down the road. In Europe for example, most companies do not reinvest in R&D but in real estate and their balance sheets show profits from such transactions.

 
At 7/22/2008 10:15 AM, Anonymous Anonymous said...

There is no question that Sowell is blowing smoke and did not read the Traiger & Hinkley report:

Our study concludes that CRA Banks were substantially less likely than other lenders
to make the kinds of risky home purchase loans that helped fuel the foreclosure crisis.

 
At 7/22/2008 1:35 PM, Blogger OBloodyHell said...

> I think sophist might be on the right track. I've heard from Krugman (I think it was Krugman) that deregulation helped cause this.

OK, so you start out agreeing with both sophist AND Krugman.

What part of this argument does not strike you as highly doubtful just on those two merits?

LOL.

 
At 7/22/2008 1:47 PM, Blogger OBloodyHell said...

> Those greedy investment bankers knew rates will go up and defaults will skyrocket. Yet, they wanted to make commissions and hence the result.

Yes, it could not possibly be the result of pressure to grant housing loans to people whose credit history did not merit those loans, because of racial issues. Naw. 'S gotta be th' greed.

> FED intervention in the subprime crisis was maybe the biggest mistake ever of US economic policy.

Fed intervention in ANY crises is usually the biggest mistake in US economic policy.

Thanks for stating the obvious, a point which has been noted repeatedly around here for a long while, I'm sure.

> I am very dissapointed indeed to see that US is using the same old trick to create new wealth that corrupt European states use

1) You're assuming similar intent. Most land use restriction in the USA comes from two sources:
... a) Eco-nitwits at every level throwing their weight around
... b) Busybody politicians and bureaucrats throwing their weight around. There should be like 4, maybe 5 classes of zoning (if that -- you could make a good case for zoning as a whole being a violation of private property rights and representing an illegal taking), and that's it. Instead there are usually dozens of classes.

I doubt if all that many of those restrictions are done so as to drive up prices. There may be exceptions in specific areas, but not in general.

2) Most of the additional wealth in this nation in the last 20+ years is entirely in the form of new IP and Service Organizations, not increased property values.

As a matter of fact, a large part of the so-called "trade deficit" would not exist at all if a reasonable estimate of the true value of pirated media were taken into account, which it currently is not. Yet another reason for the complete overhaul of IP laws and regulations.

 
At 7/22/2008 2:32 PM, Blogger spencer said...

Right, the Community investment act of 1977 caused the crises of 2008.

You must of been studying the long and variable lags Larry Kudlow uses to demonstrate that the Reagan tax cuts of 1981 caused the investment boom of the late 1999s.

This must be as good as your using regressions with an R squared of 15.

 
At 7/22/2008 3:13 PM, Blogger juandos said...

Again we see that clear thinking by some folks is apparently a physical impossibility...

Fannie, Freddie Crisis Reflects Failure Of Gov't, Not Capitalism

"Fannie Mae and Freddie Mac aren't capitalist enterprises; they're in fact government businesses that happen to have private shareholders"...

(skip)

"The truth is, in effect, Fannie and Freddie have been socialized.

How did we come to this?

You have to go all the way back to 1938. That's when President Roosevelt created Fannie Mae to give a boost to the residential mortgage market and to increase home ownership in America — both, on their own, laudable goals.

For a while, it seemed to work well. But in 1968, a Democrat-led Congress stepped in and turned Fannie Mae into a "government sponsored enterprise," or GSE.

Then, worried about Fannie Mae dominating the market, Congress in 1970 created Freddie Mac.

This had unintended consequences. In effect, it let two government-backed companies compete unfairly with private companies for capital, instead of one.
"...

(skip)

"Like so many of this nation's current economic ills, it had its genesis in the turbulent 1960s.

It was then that LBJ and his Democrat-controlled Congress used the New Frontier to push expanded welfare benefits for the nation's inner cities, which decimated African-American families and led to trillions in welfare spending.

He also expanded Social Security and, in 1965, created Medicare, which together led to a long-term decline in private saving that can be seen today.

Each of these moves extended government's reach into the lives of average Americans as never before.

We have not only wasted trillions of dollars, but the key role of innovators and entrepreneurs as problem solvers and wealth builders has been diminished.
"...

Freddie, Fannie Funded Jesse Jackson’s Pet Projects

"After Freddie Mac signed a $1 million contract for Rainbow/PUSH to run an “Economic Literacy” program, Jackson’s nonprofit coalition turned around and charged churches $1,000 to enroll in the program, the NCLP said.

Freddie Mac also pledged to earmark $1 billion in mortgage loans specifically for minorities
"...

Yep! Gotta hand it to socialists...

They screw it up every thing they touch... Sort of the reverse Midas touch or could I call it the, "fecal touch"?

 
At 7/22/2008 4:30 PM, Anonymous QT said...

What most people miss is changes to the international banking rules, Basel II which led to the proliferation of securitization. Under the new rules, increased capital was required for mortgages but this rule did not apply to mortgages bundled as securities.

The intent was to strengthen the world financial system and unfortunately, the onerous new capital requirements created an incentive to securitize resulting in increased leveraging.

Over the last several years, many economists have wondered at the amount of cash moving around the global markets by one estimate, the total global transfers amounted to the sum of the annual GDP of China. For better or worse, the global economic growth has been stimulated by this injection even if the piper must eventually be paid.

While the collapse in the market for securitized products was triggered by the sub-prime problems by calling into question the quality of the underlying securities, the credit crunch would appear to be a separate issue from the slump in U.S. housing prices and problems with excess leveraging of those assets.

That is part of the problem is that we are really looking at 2 complex problems and trying to come up with a magic bullet to fix both.

On sub-prime lending, it would appear that there have been many factors that have played a part including

1. interest rates at a 50 year low leading to a bubble in housing prices
2. borrowers who signed variable rate mortgages on the assumption that rates would stay low or that they could re-mortgage in a year
3. availability of products that required little if any downpayment
4. lack of legal restrictions on the % of one's home that could be mortgaged
5. tax policy allowing deduction of mortgage payments encouraging taxpayers to increase their mortgages
6. investment experts who were advising their clients to take out a mortgage and invest the money in the market.
7. availability of credit from a multitude of sources; many of these sub-prime loan mortgages were initiated by mortgage brokers who subsequently sold the mortgage to a lender
8. homes that now have mortgages that are worth less than the principle of the mortgage meaning that the borrower has nothing to lose by walking and the lender is not willing to re-negotiate

Keeping interest rates too low for too long is arguably a key ingredient. Blaming government, lenders, borrowers, or the FED is tempting but it doesn't really tell us where we go from here nor how we prevent a similar problem in the future.

 
At 7/22/2008 6:52 PM, Anonymous Dr. T said...

The Community Reinvestment Act, though a bad idea, played only a minor role in the subprime mortgage problem. The bigger role was played by two government-created entities: Fannie Mae and Freddie Mac. These mortgage brokers bought iffy loans from banks, which gave the banks more money to loan to more unqualified home buyers. The two FMs held 44% of all subprime mortgages. Now they need taxpayer bailout (hardly a surprise). So, we bail out Bear Stearns, bail out Fannie Mae and Freddie Mac, and bail out individual home buyers who put no money down and could barely meet the low early payments on their subprime adjustable rate mortgages! I'm so happy to support these worthy businesses and people, who helped cause the current economic calamity that lowered the value of my stock portfolio by 20%.

 
At 5/19/2009 3:09 AM, Anonymous RM_Apply said...

I was searching for some reference regarding this matter. Good thing I've found your article. Great insight.

 

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