We Turned Good Renters Into Bad Homeowners
For decades, starting with Jimmy Carter's Community Reinvestment Act of 1977, there has been bipartisan agreement to use government power to expand homeownership to people who had been shut out for economic reasons or, sometimes, because of racial and ethnic discrimination. What could be a more worthy cause? But it led to tremendous pressure on Fannie Mae and Freddie Mac -- who in turn pressured banks and other lenders -- to extend mortgages to people who were borrowing over their heads. That's called subprime lending. It lies at the root of our current calamity.
~Charles Krauthammer
26 Comments:
Stephen Schwarzman sums up the problem very well. You need to have a subscription to read this article.
Before 1995, borrowers were required to put down a 20% deposit, no more than 80% of the home could be mortgaged and payments could be no more that 30% of the borrower's income. Subprime went from about 2% of total loans in 2002 to about 30% in 2006.
The more one looks at this problem, the more one begins to wonder if the government should be buying highly leveraged assets of dubious quality for which there is presently very little market. Are we putting good money after bad or has the invisible hand revealed a fundamental lack of value. How does the bailout correct the problem with excessive leveraging and mortgage defaults?
qt asks: “How does the bailout correct the problem with excessive leveraging and mortgage defaults?”
The quick answer: It doesn’t. Solving the current problem and keeping it from happening again are in fact two separate issues, or at least a different step of the same problem.
I’ve spent a lot of time in formal problem-solving, quality, and project management classes over the years: Deming, Crosby, Toyoda (5 Whys), Sigma-Six, Red-X, critical path analysis. . . . Most problems can be solved using a process instead of shooting from the hip once the emotional issues are dealt with. Most of the processes follow this order: 1) Recognize if you in fact have a problem or not, and then define the problem 2) Make sure you are addressing the problem that you defined, 3) Determine all the solutions and costs (doing nothing is a possible solution), 4) Implement the best solution given all the information you have at hand, 5) Determine the best course of action so that the problem does not happen again.
Sometime the steps can be approached simultaneously, but not usually in a different order. Additionally, different people who are experts in their fields might be necessary for each step in the process.
It’s easy to get wrapped up in blame, and beliefs and values have to be considered even though they are not easily quantified because many people are not rational beings: Especially voters.
Walt g,
I agree that blame and the emotion of anger seem to impair one's ability to sort through the issues.
Greg Mankiw's blog reviews some of the possible options.
Was wondering what your opinion is on the Treasury making loans to banks or injecting capital in exchange for a portion of ownership rather than buying assets no one wants. Buying assets increases liquidity but transfers risk to the government.
These instruments are often very complex even the credit rating agencies did a very poor job of evaluating their risk with disasterous consequences.
Walt,
The idea of returning to the discipline of problem solving is fundamental to regaining some objectivity on this question. We do have to understand what factors continue to drive the problem.
My husband is an architect and he often refers to starting from first principles for each design project rather than trying to save steps by using bits & pieces of other designs which is often done with Autocad. This discipline helps to focus your thinking. The result is that the concept develops holistically. (we generally don't use archispeak so I hope you will overlook this momentary lapse).
qt,
This is not my field, so I would have to defer my judgment to the SMEs (subject matter experts) on this complicated problem. Personally and pragmatically, here’s what I would want to know: What will the quality of my life be, and the value of my 401(k) plan and pension be in 5, 10, 20, and 30 years using three alternative solutions to the current problem: 1) Do nothing, 2) The full $700 billion bailout (that amount might end up being more), and 3) Other identified alternatives.
As you well know, we all have our notions about solving or ignoring the problem that runs the gamut of “the hell with ‘em’” to “spend as much as it takes.” I’m afraid, in the end, we just have to trust our leaders, or elect new ones.
And to think it was just two years ago that you were using the high home ownership data to demonstrate that the American people were better off than the other data showed.
>This is not my field, so I would have to defer my judgment to the SMEs (subject matter experts) on this complicated problem.<
Yeah, the SMEs have such a good handle on the problem.
Price determination is dependent on the amount of money that is in the market. The more money in the market, the higher the price will be. This is a cash supply problem plain and simple. That so many people, and even the entire system, have gotten caught off guard by the price deterioration of so many markets does not address the base of the problem.
When the Fed turned the interest tap in September 07, they turned it the wrong way, and instead of increasing cash flow into the economy, the lower interest made funds flee the country, and made the money creating banks more scrupulous in their lending. The same problem occurred a decade ago, and Greenspan was vilified for not adhering to the Keynesian solution, and put interest rates back up when the SMEs of the world were telling him to put it lower.
Money comes from the local bank; not the government, and not the Fed. The Fed declared rate is the moderator of the money supply, but it is NOT as Keynes declared, an inverse relationship of interest to supply, but a direct relationship. The higher the interest, the higher the inflation. The lower the interest, the tighter the cash crunch will be to the system.
Allan Manchester
arman,
I'm not so sure the same people who got us into this mess are the ones who will have to clean it up or change the future system so that it does not happen again.
Do you have an idea for a solution to the problem?
"And to think it was just two years ago that you were using the high home ownership data to demonstrate that the American people were better off than the other data showed"...
Hmmm, and to think that spencer's fellow travelers are totally responsible for the debacle in the first place...
Media Mum on Barney Frank's Fannie Mae Love Connection
Democratic House Financial Services Committee Chair promoted GSEs while former 'spouse' was Fannie Mae executive
I have been ranting and ranting for a few years about people getting mortgages that they could not afford to pay back.
Did anybody listen? NO... As a matter of fact they called me paranoid, ignorant, old fashioned, and stupid.
Saying I told you so doesn't help anything. However, I just want to say it anyway...
I TOLD YOU SO!!
When somebody making 30k a year is able to buy a house that cost 400k with no money down....there is a loud warning sound. But if the blind profit motive insists..then nobody will hear the warning.
By the way, I think the number one culprit in this mess are the idiot people who signed their names to mortgages when they full well knew they could not afford them.
Juandos,
More Fannie Mae hyjinx
Countrywide made preferencial home loans to Fannie Mae execs
More Fannie friends in Washington
We keep coming back to a smell of mendacity from Fannie & Freddie. Let us hope that part of the plan for seeing that we never go through this again includes the abolition of Freddie and Fannie and the culture of influence peddling that surrounds them.
Chances are that would be the triumph of hope over experience.
The masked millionaire says: "By the way, I think the number one culprit in this mess are the idiot people who signed their names to mortgages when they full well knew they could not afford them"...
Ever so true MM...
One caveat in these politically correct times, can illegal aliens read English?
Hey qt, yeah I read that Gigot piece last week due to a link I got from this excellent site: Sweetness & Light...
My favorite line in that piece was this one: Paul Krugman of the New York Times recently wrote, "What you need to know here is that the right -- the WSJ editorial page, Heritage, etc. -- hates, hates, hates Fannie and Freddie. Why? Because they don't want quasi-public entities competing with Angelo Mozilo."...
I fell out of my chair laughing...
I guess Krugman if he ever had any shame at all has since had it surgically removed so he can prattle on like he does...
BTW I found the following on InstaPundit: UPDATE: Reader John Marcoux writes:
Congressman Paul Kanjorski (D-PA) was just on CNBC and said that his mail and calls on the bailout plan are running 50-50: 50% no and 50% hell no.
This is what Barney Frank is up against. Even if the Democrats ram through the plan without Republicans signing on, they will be left holding the bag if the plan fails, as it very well could, and have to face the wrath of their constituents....
I hate to say it but in the middle of this incredible mess there sure are some humerous moments to savor...
Reduce the excessive regulations which artificially restrict the supply of housing. Let the free market operate.
More housing will be created and it will also be more affordable.
The turmoil is a direct result of the fed tightening interest rates and so tightening bank revenues as well as chasing funds out of the country (in search of better rates). Obviously the Fed does not know what it is doing, and so should not be allowed to monkey with the overnight rates... should not be allowed to bypass the local banks to lend to other institutions... should not be allowed to do anything but to print the exchange vouchers that the the local bank issues on account... and should be muzzled on what interest they are charging to the local bank. It is horrendous that a wholesaler will advertise to the retailer's customers what price the retailer is paying for product.
Simply stop cutting the interest rates, and put them back where they were before this mess back in September, and everything will stabilize immediately.
Allan Manchester
"More housing will be created and it will also be more affordable."
Your faith in the free market should be shaken, not stirred. This problem is due to price erosion (ie more affordable). The free market is begging for help from the government. The free market is only free when it is fully collapsed.
Free market policy introduced us to the dirty thirties, and kept us falling until the government totally abandoned the stupid free market ideas and enacted the FLSA in 38.
Reduce the excessive regulations which artificially restrict the supply of housing. Let the free market operate.
More housing will be created and it will also be more affordable.
Now, that really is funny. We have falling housing prices, 10.4 months worth of houses for sale...and you want to increase supply!
Juandos,
There's some great humor here. Love the Krugman...with Countrywide & Fannie cutting the deals that put us in this mess in the first place. Fannie & Fred are the dominant players in the mortgage industry buying up sub-prime loans from Countrywide, relaxing borrowing standards, encouraging zero down mortgages for folks who couldn't possibly afford a house when interest rates inevitably rose.
The market is doing exactly what it is supposed to. ie. correcting a bubble in pricing, exposing excessive leveraging and insane lending policies, and creating a price signal to stop building excess capacity.
The market determines where value lies and where it does not.
Arman,
The mortgage market can hardly be thought of as a "free market" given the dominant market share of GSE's Freddie & Fannie who lead the race to the bottom. We are in this snafu thanks to these two.
Fan & Fred spent 130 million over the last 10 years on lobbying congress. In return, their friends made sure that there were no reforms, little oversight and a complete free pass-go. Now, U.S. taxpayers are picking up the tab on their adventures in leveraging with foreclosures, falling housing prices, and financial contagion to the entire finance industry.
Markets expose the good, the bad & the ugly while governments merely enable such activities by invoking the "public good". So, where's the good when the sh** hits the fan?
"Markets expose the good, the bad & the ugly while governments merely enable such activities by invoking the "public good". So, where's the good when the sh** hits the fan?"
So why the panic? Let the market collapse. This bailout plan is not for public good, but to preserve businesses whose competition are salivating at the funeral plan. All business is in competition with all other business. The consumer dollar is tightly limited, and must be spread through all existing business. Less businesses equal more prosperity.
I want to protest that two of the morons most responsible for the problems (Rep Frank and Sen Dodd) are now part of the team working on negotiating the "recovery package"!
I have ZERO CONFIDENCE in Dodd and Frank. They both should have been bounced from their chairs.
this is from an article titled "Time to Reform Fannie Mae and Freddie Mac" published in 2005 by the right leaning Heritage Foundation:
"Despite its claims to the contrary, Fannie Mae’s basic operating procedures do not target any particular type of buyer/borrower. Indeed, evidence from the federal government indicates that Fannie Mae and Freddie Mac are in fact neglecting first-time homebuyers in comparison to the entire private conventional mortgage market. Between 1999 and 2003, 9.0 percent of the conventional conforming loans (the type the GSEs are authorized to buy) made by the private mortgage market were to first-time minority homebuyers. By contrast, only 4.7 percent of Fannie Mae loans and 3.5 percent of Freddie Mac loans over the same period were to first-time minority homebuyers."
http://www.heritage.org/Research/GovernmentReform/bg1861.cfm
it sure doesn't sound like fannie and freddie were up to their eyeballs in subprime lending as of 2005.
Wait, I thought this was Bill Clinton's fault. Now you're telling me it was Jimmy Carter's fault? Geez, can't you just blame all the Democratic presidents and get it over with? We all know the Republicans didn't have anything to do with this, right?
Problems of today's economy were born last week, or at most last month. No one fails to spend a raise or move on an expansion capability for a few months. The fact that the economy is always better during a democratic regime is because right wingers THINK that they have a handle on the economy. When their stupid policies produce effects that they didn't want, they blame a fictitious "stickiness" for their failures.
qt said:
Reduce the excessive regulations which artificially restrict the supply of housing. Let the free market operate.
More housing will be created and it will also be more affordable.
Now, that really is funny. We have falling housing prices, 10.4 months worth of houses for sale...and you want to increase supply!
Rents in my area have gone up 25% in the last three years. Yes, you bet I want more supply!
p.s. if housing prices are falling, why are rents soaring?
the masked millionaire said:
When somebody making 30k a year is able to buy a house that cost 400k with no money down....there is a loud warning sound. But if the blind profit motive insists..then nobody will hear the warning.
I don't want a $400K house. All I need and want is a 400 sq ft house - maybe a $75K house. Millions of people like me would love to buy a tiny home (and thereby stabilize our housing costs and build wealth), why isn't this niche being served?
> So why the panic? Let the market collapse.
Because the market isn't only the screwups in this case -- there's a ripple effect because it's gotten too interlinked. AIG insures airplane purchasing. AIG goes down, that pulls down Boeing and Airbus and the airline industry, which, while not particularly "well off", is certainly not a part of the problem.
There are certainly lessons to be learned, here, but implementing the fixes is probably better done with a middle road that finds neither extreme.
> Geez, can't you just blame all the Democratic presidents and get it over with? We all know the Republicans didn't have anything to do with this, right?
Not at all. The GOP is 25% reesponsible, give or take 10%. The rest is pretty much the Dems.
In 2003, Bush tried to increase oversight of the FMs. Barney Frank, Dem head of the Senate Finance Committee, raised hell.
In 2005, McCain attempted to implement a bill to increase oversight of the FMs. Guess who stonewalled the bill, keeping it locked up in committee?
Now, Frank actually has the outright BALLS to be making open statements that the Bush admin is all at fault for failure to introduce proper oversight measures.
EExperts have been saying this was coming to a boil for about 2-odd years, if you listened. Guess who's been in charge of Congress during that time, and hasn't done JACK S*** except try to bust G-W's chops day in and day out, obstructing literally anything he tried to do on any matter at all?
Right. They're both at fault. But the real culpability lies substantially more with the Dems.
And if they win in November -- we'll be able to count ourselves lucky if it's only as bad as the 1970s.
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