Mortgage Crisis Shows that Government Regulation Doesn't Work

[Kevin_Kennedy]

Headlines like this drive me nuts: Mortgage Crisis Shows Why Financial Regulation is Needed. Yes, regulation is needed. Market regulation, that is. At every turn, the government and its accomplices in the financial industry--the politically-connected players--have undermined the free market's ability to self-regulate. But, of course, this is not the sort of regulation to which the author is referring. No, the market is to blame and our benevolent protectors in government must come to our aid through enlightened regulation.

The one question that no one seems to ask about this whole debacle is: where did the money come from? Where did the banks get the money to create exotic derivatives and engage in shady lending practices? What fuels economic bubbles? The answer, of course, is the government printing press.

Campaign For Liberty — Mortgage Crisis Shows that Government Regulation Doesn't Work   | by Glenn Jacobs

 

[Toro]

Since the mortgage meltdown was a result of both regulatory and market failure, drawing conclusions from the meltdown that government regulation "doesn't work" is akin to saying the free market "doesn't work."

 

[PLYMCO_PILGRIM]

Since the mortgage meltdown was a result of both regulatory and market failure, drawing conclusions from the meltdown that government regulation "doesn't work" is akin to saying the free market "doesn't work."

I think the proper conclusion to draw is that Government Regulations combined with Greed and political corruption will fail every time .

 

[Kevin_Kennedy]

Since the mortgage meltdown was a result of both regulatory and market failure, drawing conclusions from the meltdown that government regulation "doesn't work" is akin to saying the free market "doesn't work."

The Fed manipulating interest rates is a market failure?

 

[dilloduck]

Since the mortgage meltdown was a result of both regulatory and market failure, drawing conclusions from the meltdown that government regulation "doesn't work" is akin to saying the free market "doesn't work."

The Fed manipulating interest rates is a market failure?

It may be to horrifying to peek behind the cash curtain. You know it ain't pretty.

 

[Toro]

Since the mortgage meltdown was a result of both regulatory and market failure, drawing conclusions from the meltdown that government regulation "doesn't work" is akin to saying the free market "doesn't work."

The Fed manipulating interest rates is a market failure?

No. That is an example of regulatory failure.

Packaging thousands of subprime mortgages for purchase as AAA securities when they clearly weren't, giving loans to unemployed homeless people to buy houses, telling people to lie on their mortgage applications, keeping inadequate collateral on structures guaranteeing derivatives that exceed the GDP of the global economy, and excessive debt within structures under the premise that markets are efficient are all examples of market failure.

 

[PLYMCO_PILGRIM]

Since the mortgage meltdown was a result of both regulatory and market failure, drawing conclusions from the meltdown that government regulation "doesn't work" is akin to saying the free market "doesn't work."

The Fed manipulating interest rates is a market failure?

No. That is an example of regulatory failure.

Packaging thousands of subprime mortgages for purchase as AAA securities when they clearly weren't, giving loans to unemployed homeless people to buy houses, telling people to lie on their mortgage applications, and excessive debt within structures under the premise that markets are efficient are all examples of market failure.

There were regulations requiring the banks to give high risk home loans to people whom the banks would have denied if not threatened with penalties and fines by the federal government (equal opportunity lenders). However those regulations did not encourage the banks to have their customers lie on applications.

So We have regulatory failure due to corrupt politicians and oversight official looking the other way as a result of their greed for political contributions and kickbacks. Plus we have the greed of the banks combined with the greed of the borrowers.

Perfect storm .

 

[Kevin_Kennedy]

Since the mortgage meltdown was a result of both regulatory and market failure, drawing conclusions from the meltdown that government regulation "doesn't work" is akin to saying the free market "doesn't work."

The Fed manipulating interest rates is a market failure?

No. That is an example of regulatory failure.

Packaging thousands of subprime mortgages for purchase as AAA securities when they clearly weren't, giving loans to unemployed homeless people to buy houses, telling people to lie on their mortgage applications, keeping inadequate collateral on structures guaranteeing derivatives that exceed the GDP of the global economy, and excessive debt within structures under the premise that markets are efficient are all examples of market failure.

Would any of that have been possible to the degree that it was without the Fed manipulating interest rates?

 

[Toro]

Would any of that have been possible to the degree that it was without the Fed manipulating interest rates?

Probably, but the effects would have been far less.

The Fed is the primary cause of the crisis, IMHO, but there is a lot of blame to go around, including those who acted freely in a private market.

 

[Toro]

There were regulations requiring the banks to give high risk home loans to people whom the banks would have denied if not threatened with penalties and fines by the federal government (equal opportunity lenders). However those regulations did not encourage the banks to have their customers lie on applications.

So We have regulatory failure due to corrupt politicians and oversight official looking the other way as a result of their greed for political contributions and kickbacks. Plus we have the greed of the banks combined with the greed of the borrowers.

Perfect storm .

The regulations requiring lending had a marginal, if any effect.

If you believe in markets, then what would have happened if programs like the CRA and the GSEs were the cause of the crisis is that both the homes funded by those loans would have risen faster than average and the loans themselves would have gone bad at a faster rate than the rest of the market. But that did not happen. In fact, the opposite happened. The biggest bubbles occurred primarily in middle class to wealthy neighborhoods funded by non GSE-qualifying loans, in the states where one would generally expect bubbles to occur - CA, AZ, FL, NV. Home prices in poorer areas did not rise as fast, nor did loans default as fast as the biggest bubble areas.

Therefore, this bubble was driven primarily in the private markets.

 

[PoliticalChic]

Since the mortgage meltdown was a result of both regulatory and market failure, drawing conclusions from the meltdown that government regulation "doesn't work" is akin to saying the free market "doesn't work."

The goal of expanding home ownership led to the creation of new mortgage subsidies across the board. The loosening of standards became the policy of Fannie Mae and Freddie Mac, the pseudo-private "government-sponsored enterprises" that bought mortgages from originating lenders. A particular change in the tax law in 1997 encouraged many households to make buying and improving a home the primary vehicle by which they enhanced net worth. By eliminating any capital-gains tax on the first $500,000 of profits from the sale of an owner-occupied residence once every two years, Washington encouraged enterprising American families to purchase homes, fix them up, re-sell them, and then repeat the process. Flipping became a financial pastime for millions because this special advantage created a new incentive—which didn't exactly fit the model of encouraging people to remain in a stable home for many years and thereby help to stabilize the neighborhood around them.

The housing bubble was thus a fully rational response to a set of distortions in the free market—distortions created primarily by the public sector. The heads of large financial institutions, as Prince's remark suggested, recognized the risk-taking subsidy inherent in public policy, but felt they had no choice but to play along or fall behind the other institutions that were also responding rationally to the incentives created by government intervention.

The long-term solution is for government to stop playing favorites, as it has for decades with housing. Home ownership should neither be penalized nor favored under government policy.
A Government Failure, Not a Market Failure - WSJ.com

 

[JakeStarkey]

No one has offered any convincing argument that federal regulation caused the meltdown. Plymco_Pilgrim seems to be the most sensible: greedy politicans of both parties AND the commerical and investment banking interests colluded in greed.

Because the concept of a "free market" is only a philosophical concept, a government must corruption/greed in business while encouraging competititon.

 

[PoliticalChic]

The Fed manipulating interest rates is a market failure?

No. That is an example of regulatory failure.

Packaging thousands of subprime mortgages for purchase as AAA securities when they clearly weren't, giving loans to unemployed homeless people to buy houses, telling people to lie on their mortgage applications, keeping inadequate collateral on structures guaranteeing derivatives that exceed the GDP of the global economy, and excessive debt within structures under the premise that markets are efficient are all examples of market failure.

Would any of that have been possible to the degree that it was without the Fed manipulating interest rates?

The current economic crisis can be traced to the collapse of the US housing market. Is that collapse due to a failure of capitalism, or government? Under free market capitalism, the government should have no involvement in home ownership. This means government wouldn’t encourage it via artificially low interest rates, Fannie and Freddie, tax breaks, “Community Reinvestment Act,” pressure on banks to lend, etc. Bank loans would be set based on risk, reward, and an understanding of the results of bad loans.

Fannie Mae was started in 1938 by FDR, with a billion dollars, to buy up mortgages from private lenders so that those banks would have more capital to lend. By 1968 the huge loan portfolio weighed on the federal budget, so that President Johnson converted it into a publically traded quasi-governmental corporation. Get it? It was designed to appear to be a free market entity. But everyone knew that the government wouldn’t allow them to fail, giving it an unfair advantage over its competition, and access to guaranteed lines of credit and exemption from state and local taxes. Then they used the same track for Freddie Mac. Then, in September ’08, the government took back control of the two, along with $5 trillion in mortgage liabilities.

From "Arguing With Idiots," by Glenn Beck

 

[PoliticalChic]

No one has offered any convincing argument that federal regulation caused the meltdown. Plymco_Pilgrim seems to be the most sensible: greedy politicans of both parties AND the commerical and investment banking interests colluded in greed.

Because the concept of a "free market" is only a philosophical concept, a government must corruption/greed in business while encouraging competititon.

a. Congress passed a bill in 1975 requiring banks to provide the government with information on their lending activities in poor urban areas. Two years later, it passed the Community Reinvestment Act (CRA), which gave regulators the power to deny banks the right to expand if they didn’t lend sufficiently in those neighborhoods. In 1979 the FDIC used the CRA to block a move by the Greater NY Savings Bank for not enough lending.

b. In 1986, when the Association of Community Organizations for Reform Now (Acorn) threatened to oppose an acquisition by a southern bank, Louisiana Bancshares, until it agreed to new “flexible credit and underwriting standards” for minority borrowers—for example, counting public assistance and food stamps as income.

c. In 1987, Acorn led a coalition of advocacy groups calling for industry-wide changes in lending standards. Among the demanded reforms were the easing of minimum down-payment requirements and of the requirement that borrowers have enough cash at a closing to cover two to three months of mortgage payments (research had shown that lack of money in hand was a big reason some mortgages failed quickly).

d. ACORN then attacked Fannie Mae, the giant quasi-government agency that bought loans from banks in order to allow them to make new loans. Its underwriters were “strictly by-the-book interpreters” of lending standards and turned down purchases of unconventional loans, charged Acorn. The pressure eventually paid off. In 1992, Congress passed legislation requiring Fannie Mae and the similar Freddie Mac to devote 30 percent of their loan purchases to mortgages for low- and moderate-income borrowers.

e. Clinton Administration housing secretary, Henry Cisneros, declared that he would expand homeownership among lower- and lower-middle-income renters. His strategy: pushing for no-down-payment loans; expanding the size of mortgages that the government would insure against losses; and using the CRA and other lending laws to direct more private money into low-income programs.

f. Shortly after Cisneros announced his plan, Fannie Mae and Freddie Mac agreed to begin buying loans under new, looser guidelines. Freddie Mac, for instance, started approving low-income buyers with bad credit histories or none at all, so long as they were current on rent and utilities payments. Freddie Mac also said that it would begin counting income from seasonal jobs and public assistance toward its income minimum, despite the FHA disaster of the sixties.

g. Freddie Mac began an “alternative qualifying” program with the Sears Mortgage Corporation that let a borrower qualify for a loan with a monthly payment as high as 50 percent of his income, at a time when most private mortgage companies wouldn’t exceed 33 percent. The program also allowed borrowers with bad credit to get mortgages if they took credit-counseling classes administered by Acorn and other nonprofits. Subsequent research would show that such classes have little impact on default rates.

h. Pressuring nonbank lenders to make more loans to poor minorities didn’t stop with Sears. If it didn’t happen, Clinton officials warned, they’d seek to extend CRA regulations to all mortgage makers. In Congress, Representative Maxine Waters called financial firms not covered by the CRA “among the most egregious redliners.”

i. Mortgage Bankers Association (MBA) shocked the financial world by signing a 1994 agreement with the Department of Housing and Urban Development (HUD), pledging to increase lending to minorities and join in new efforts to rewrite lending standards. The first MBA member to sign up: Countrywide Financial, the mortgage firm that would be at the core of the subprime meltdown.

j. A 1998 sales pitch by a Bear Stearns managing director advised banks to begin packaging their loans to low-income borrowers into securities that the firm could sell. Forget traditional underwriting standards when considering these loans, the director advised. For a low-income borrower, he continued in all-too-familiar terms, owning a home was “a near-sacred obligation. A family will do almost anything to meet that monthly mortgage payment.” Bunk, says Stan Liebowitz, a professor of economics at the University of Texas: “The claim that lower-income homeowners are somehow different in their devotion to their home is a purely emotional claim with no evidence to support it.”

k. Any concern was quickly dismissed. When in early 2000 the FDIC proposed increasing capital requirements for lenders making “subprime” loans—loans to people with questionable credit, that is—Democratic representative Carolyn Maloney of New York told a congressional hearing that she feared that the step would dry up CRA loans. Her fellow New York Democrat John J. LaFalce urged regulators “not to be premature” in imposing new regulations.
l. In July 1999, HUD proposed new levels for Fannie Mae’s and Freddie Mac’s low-income lending; in September, Fannie Mae agreed to begin purchasing loans made to “borrowers with slightly impaired credit”—that is, with credit standards even lower than the government had been pushing for a generation.

m. In 2004 Congress pressed new affordable-housing goals on the two mortgage giants, which through 2007 purchased some $1 trillion in loans to lower- and moderate-income buyers. The buying spree helped spark a massive increase in securitization of mortgages to people with dubious credit.

n. In October 1994, Fannie Mae head James Johnson had reminded a banking convention that mortgages with small down payments had a much higher risk of defaulting. (A Duff & Phelps study found that they were nearly three times more likely to default than conventional mortgages.) Yet the very next month, Fannie Mae said that it expected to back loans to low-income home buyers with a 97 percent loan-to-value ratio—that is, loans in which the buyer puts down just 3 percent—as part of a commitment, made earlier that year to Congress, to purchase $1 trillion in affordable-housing mortgages by the end of the nineties. According to Edward Pinto, who served as the company’s chief credit officer, the program was the result of political pressure on Fannie Mae trumping lending standards.

o. In 1992, the Boston Fed produced an extraordinary 29-page document that codified the new lending wisdom. Conventional mortgage criteria, the report argued, might be “unintentionally biased” because they didn’t take into account “the economic culture of urban, lower-income and nontraditional customers.” Lenders should thus consider junking the industry’s traditional income-to-payments ratio and stop viewing an applicant’s “lack of credit history” as a “negative factor.” Further, if applicants had bad credit, banks should “consider extenuating circumstances”—even though a study by mortgage insurance companies would soon show, not surprisingly, that borrowers with no credit rating or a bad one were far more likely to default. If applicants didn’t have enough savings for a down payment, the Boston Fed urged, banks should allow loans from nonprofits or government assistance agencies to count toward one. A later study of Freddie Mac mortgages would find that a borrower who made a down payment with third-party funds was four times more likely to default, a reminder that traditional underwriting standards weren’t arbitrary but based on historical lending patterns.

p. The Congressional Hispanic Caucus launched Hogar in 2003, an initiative that pushed for easing lending standards for immigrants, including touting so-called seller-financed mortgages in which a builder provided down-payment aid to buyers via contributions to nonprofit groups. As a result, mortgage lending to Hispanics soared. And today, in districts where Hispanics make up at least 25 percent of the population, foreclosure rates are now nearly 50 percent higher than the national average, according to a Wall Street Journal analysis.

q. Republicans and Democrats, meanwhile, have scrambled to reignite the housing market through ill-conceived tax credits and renewed federal subsidies for mortgages, including the Obama administration’s mortgage bailout plan, which recalls the New Deal’s HOLC. Behind these efforts is a fundamental misconception among politicians that housing drives the American economy and therefore demands subsidy at virtually any cost.
Obsessive Housing Disorder by Steven Malanga, City Journal Spring 2009

 

[Toro]

For those who think that the GSEs caused the financial crisis, it should be noted that the empirical research has concluded that the GSEs lowered interest rates on mortgages by 0.25%-0.5%.

It should also be noted that most subprime mortgages were neither purchased nor approved by the GSEs.

Finally, the biggest price increases and biggest price declines occurred in housing markets that were not funded by GSE loans. Again, if you believe in markets, then the biggest increases and declines should have occurred in markets where the GSEs and the CRA were the biggest players. That did not happen. In fact, the opposite happened. You can't say you believe in the efficacy of the market, then ignore how the market operates.

The CRA and the GSEs were marginal players in this debacle.

http://www.usmessageboard.com/economy/70006-cra-not-to-blame-for-housing-debacle.html
http://www.usmessageboard.com/economy/65413-cra-did-not-cause-financial-crisis-fed.html

I have yet to see any serious study suggesting otherwise. If anyone can link to something other than opinion, then I would be happy to see it.

 

[PoliticalChic]

For those who think that the GSEs caused the financial crisis, it should be noted that the empirical research has concluded that the GSEs lowered interest rates on mortgages by 0.25%-0.5%.

It should also be noted that most subprime mortgages were neither purchased nor approved by the GSEs.

Finally, the biggest price increases and biggest price declines occurred in housing markets that were not funded by GSE loans. Again, if you believe in markets, then the biggest increases and declines should have occurred in markets where the GSEs and the CRA were the biggest players. That did not happen. In fact, the opposite happened. You can't say you believe in the efficacy of the market, then ignore how the market operates.

The CRA and the GSEs were marginal players in this debacle.

http://www.usmessageboard.com/economy/70006-cra-not-to-blame-for-housing-debacle.html
http://www.usmessageboard.com/economy/65413-cra-did-not-cause-financial-crisis-fed.html

I have yet to see any serious study suggesting otherwise. If anyone can link to something other than opinion, then I would be happy to see it.

My posts clearly indicate that government and forces related to government influenced mortgages.

You regularly excuse the CRA, but are you prepared to excuse the sum influence that I have outlined above, and say it had no effect?

I know how often you refer to that data, and while it may be relevant, consider:

Would the crisis have occurred had not government, either because it garnered them votes, or they felt it was in the interests of the country, interfered or intervened?

 

[Toro]

My posts clearly indicate that government and forces related to government influenced mortgages.

Of course the government influenced mortgages. That's not the issue. The issue is whether or not it caused the financial calamity. The answer is "no."

You regularly excuse the CRA, but are you prepared to excuse the sum influence that I have outlined above, and say it had no effect?

At best, it was tangential. Otherwise, no.

I know how often you refer to that data, and while it may be relevant, consider:

Would the crisis have occurred had not government, either because it garnered them votes, or they felt it was in the interests of the country, interfered or intervened?

No.

This, again, is simple. If the CRA or GSEs were the primary cause of the housing bubble, then the houses that would have went up the most then crashed the hardest, and the loans that would have defaulted the most, would have been CRA and GSE loans. This is simply supply and demand. Loans that would have been forced into the market would have been used to increase the demand for homes, which would have lead to home prices that would have risen faster than anywhere else. If you believe in the market system, this must have happened. But it did not. The exact opposite happened.

This crisis would have occurred without the GSEs or the CRA.

Put it another way, the commercial mortgage market went bananas as well. That is the next mess to implode. The GSEs do not guarantee commercial real estate mortgages, and there is no CRA requiring banks to lend in red-lined areas. So tell me how the commercial real estate market can also go into a bubble when there are no government guarantees nor forced lending to cause the bubble?

Also, there were other countries which had even larger bubbles than the US. The UK, Ireland, Spain, Portugal, Greece and Australia, to name a few, saw home prices rise even further above long-term trends than in America. Please tell me how the GSEs caused the housing bubble in Spain, or how the CRA led to minority lending in Australia.

The only people whom I know who are promoting this line of thinking are dogmatic ideologues (and that includes the editorial page of the WSJ). If anyone has any empirical evidence to support this view, I would truly like to read it.