Friday, March 4, 2011

The Housing Bust

Despite fierce propaganda to the contrary, including the recently released final report of the Financial Crisis Inquiry Commission (which covers up the role of CRA, government agencies and GSEs in the crisis), government regulation and oversight caused lax lending standards in the financial industry.  That was the foundation of the house of cards that collapsed in Septermber 2008.  As Sowell puts it, "The spread of financial disaster from local housing markets to national and international financial markets was much like a heavy rainfall in the mountains, filling a thousand little creeks and streams that empty into a big river, ultimately flooding people living far downstream from the source of the water.  Perhaps better levees might have saved the people downstream.  But that does not change the fact that the flood originated in heavy rainfalls in the mountains.  In the case of the housing market collapse, much has been made of the claim that there was inadequate regulatory agency oversight of the financial markets that turned home mortgages into esoteric Wall Street securities which added to the risk.  But these securities would have remained secure if people had continued to make their monthly mortgage payments.  It was ultimately the skyrocketing rates of mortgage delinquencies and defaults that were like the heavy rain the mountains that caused the flooding downstream... 'From the current handwringing, you'd think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job.'"

The collapse was triggered by Fed Chairman Bernanke's decision to raise rates from 1% in 2004 to 5.25% in 2006.  Too many creative mortgages with rate resets, taken out by too many sub-prime borrowers, resulted in too many defaults with resulting harm to financial securities built from the faulty mortgages.  The markets hardest hit were those with stringent land use restrictions, where prices had run up the highest, and borrowers stretched the furthest in order to get into homes.  Holman Jenkins of the Wall Street Journal drew attention to the fact that much of the subprime crisis originated in particular counties of just four states.  CRA mortgages were especially hard hit.  For instance, only 7% of Bank of America's loans had been made under Community Reinvestment criteria, while 29% of its mortgage losses came from that group.   In sum, as home prices fell, incentives to sub-prime and prime borrowers alike increased to default on mortgages; financial institutions' assets fell correspondingly; securities built on defaulting mortgages plummeted in value; rates of delinquency and default skyrocketed feeding the vicious cycle anew; panic set in.

Ironically, given the blame that the free market took for the debacle, the market was quick to learn from its mistakes, and adjust.  Buyers learned to stay within their means; down payments once again rose; the percentage of innovative mortgages taken out plummeted; the use of second mortgages to enter homes dropped significantly.  Yet, the political response was to look for scapegoats especially on Wall Street, to hunker down, and to brazen out mistakes without admitting to them.  In other words, politicians learned nothing, and they've given us more of the same.  Chris Dodd blamed George Bush and Alan Greenspan, and dug in to defend Fannie Mae and Freddie Mac for continuing to flow credit into markets keeping housing "affordable."  Sowell observes, "That private financial institutions, which were risking their own money, were reluctant to continue [lending], while government-sponsored enterprises that could pass their risks on to the taxpayers were still going full steam ahead was not ... a reason for congratulating them for getting in deeper... Yet Senator Dodd acted as if those who had issued the warnings he had consistently rejected were now discredited by the continued risky lending of Fannie Mae and Freddie Mac."  As late as July of 2008, he protested that Fannie and Freddie were fundamentally strong, and that it was not a good time to panick about their leverage and massive holdings of bankrupt mortgages.  Barney Frank blamed "a conservative philosophy that says markets know best," and proclaimed that "the subprime crisis demonstrates the serious negative economic and social consequences that result from too little regulation."  Both joined forces to bailout home purchasers and to prevent housing prices from falling, which would have had the effect of making housing affordable, their alleged aim.  Neither asked the question of why it was morally superior, or economically more sensible, to spare decision-makers the consequences of their risky or simply poor decisions, and to foist the cost of those decisions onto the backs of others who didn't make the same mistakes.

Sowell puts the trillions of dollars expended in order to bailout and stimulate sectors of the economy in perspective.  "A trillion seconds ago, no one on this planet coud read or write.  The ancient Chinese dynasties and the Roman Empire had not yet come into being.  None of the founders of christianity, Judaism or Islam had yet been born." He is critical of President Obama's stimulus plan which was passed with great urgency in two days, though its release of a funds was not to occur for nearly two years.  The government's ad hoc responses to the crisis served merely to create uncertainty, and thereby stunt the economy's natural responses.

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