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A house is seen for sale Thursday, July 23, 2009, in Blue Island,
Ill. The U.S. housing market has started to recover from the most
far-reaching crisis since the Great Depression, data released
Thursday shows.(AP Photo/M. Spencer Green)
As we all know, the downfall of the housing market precipitated the recession from which we are just now beginning to slowly recover.
Less clear, however, is the cause of this mess. Commentators generally point the finger at "free market capitalism" and the lack of regulatory oversight. Republicans, ever the tepid defenders of freedom and capitalism, have failed to truly rebut the claims of the socialists and statists harping this claim.
The truth is denied by the left and abandoned by the right. Sound familiar?
One must realize, first, that there is no free market in the United States. There never has been, although at times we’ve gotten close. But since FDR’s New Deal – an era which came and went long before most of us were around – the federal government has been involved in virtually every aspect of economic life.
Including housing. Consider Freddie Mac and Fannie Mae. In an October 2008 letter to Congress, John Allison, former CEO of BB&T, placed primary blame on the government-backed mortgage giants. “These government supported enterprises distorted normal market risk mechanisms,” Allison wrote. “While individual private financial institutions have made serious mistakes, the problems in the financial system have been caused by government policies ….”
In a Wall Street Journal opinion piece, Russell Roberts goes on to explain the root of the Freddie/Fannie debacle. “Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate income borrowers,” he writes. “For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target – 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.”
Freddie and Fannie are in no way, shape, or form creatures of the free market. It is certainly true that loose lending standards allowed mortgages for people who really had no business getting them in the first place. Those on the left are quick to blame these lowered standards on greedy lenders who were preying on people who just wanted to get a home.
Not so fast. In a commentary piece for Forbes.com, Yaron Brook points out that this is not evidence of a failed free market. Brook blames government policies which forced lowered mortgage practices on the industry. His primary culprit: the Community Reinvestment Act. “[F]or years irrational lending standards have been forced on lenders by the federal Community Reinvestment Act (CRA) and rewarded (at taxpayers’ expense) by multiple government bodies,” says Brook. “The CRA forces banks to make loans in poor communities, loans that banks may otherwise reject as financially unsound.”
In other words, normal market conditions – the kind that would exist if we lived in a free market – would never have allowed the sort of risky loans that exploded in the subprime crisis. As Roberts points out, the CRA is mixed up in the Freddie/Fannie mess as well. “Between 2000 and 2002 Fannie Mae securitized $394 billion in CRA loans with $20 billion going to securitized mortgages.”
As if Freddie/Fannie and the CRA weren’t enough, enter the third member of this unholy alliance between government and the market: the Federal Reserve. The Fed exists to tinker with and manipulate interest rates and the money supply. It is a form of command economy planning, the sort that one would not associate with a free market.
Fed-created low interest rates fueled the housing boom and, eventually, bust, by making it easier to borrow more money. Brook notes, “In a free market, lending large amounts of money to low-income, low-credit borrowers with no down payment would quickly prove disastrous. But the Federal Reserve Board's inflationary policy of artificially low interest rates made investing in subprime loans extraordinarily profitable.”
The problem with the free market turns out to instead be a problem with corporatist policies and their consequential mixed economies. It is a constant source of amusement that America’s economic system is labeled “free” in the first place, merely because we Americans enjoy relative liberty over other, more centralized nations.
None of this is to say that investors and lenders weren’t greedy. Of course they were. However, in a free market, this sort of greed could never have gone unchecked the way it did. Markets provide wonderful mechanisms to correct poor decision-making, if such mechanisms are allowed to actually work. And the stupid decisions of some would never have had the economy-wide impact they did in a free market. The sobering fact is that government policies encouraged and magnified problems which, simply, would never have been this catastrophic if the market were truly free.
For those of you eager to blame “greed,” it’s worth noting that the above-quoted John Allison is an ardent fan of Ayn Rand, one of history’s fiercest advocates for laissez-faire capitalism. It’s also worth noting that the bank Allison runs, BB&T, is doing quite well (I can attest as a satisfied customer). Evidently, free market principles and prosperity go together quite well.
But, as usual, government won’t take the blame for the disaster it caused. It never does. Similar policies created and exacerbated the Great Depression, but most people mistakenly blame capitalism. The story always plays out the same way: government meddling creates the problem, and the only solution politicians can ever come up with is more meddling. It’s the political equivalent of digging yourself into a hole and trying to get out by digging even more.
Neither political party has shown any interest in sound economics and policy. Before you buy into the talking points prattling about “lender greed,” look behind the curtain. Check out the links above and read the facts which most politicians, media outlets, and professors won’t mention. Then, perhaps, we can throw away the shovel.
Comments
Why is no one able to see that the bomb would be sitting quietly unexploded had the very same lending insitutions and oil companies not been able to participate in a completely unregulated derivatives market that drove gas prices to $4 a gallon? People living paycheck to paycheck cannot sustain a quadruple price increase on a major recurring bill. It is also a unique situation in that when one is pressed against the wall to decide between buying gas and paying their mortgage. If they stop buying gas, they cannot get to work, and cannot pay their mortgage. I agree that poor economic and lending policies are the bomb planted by past administrations, but $4 gallon gas lit the fuse!
Good article bro.
In 1999 when the Glass-Stealgal act was repealed I made a bet with my office workers how long it would take for the Wall Streeters to blow the planets economy up. I thank you for making me richer! Mechanical Governors are placed on engines for good reasons. Bank robbers don’t like police and adding more police won’t keep bank robberies from occurring. And dreaming about an absolute free market is like asking for Utopia, it’s not going to happen for obvious reasons. And as for government meddling in the mortgage market, before the 1930’s and the GSE’s, all mortgage backed securities where 5 year bonds and when the Depression hit nobody could get refinanced after the 1929 crash. That’s why the government created 30 year fixed rate mortgages! Listening to this rant is like a bank robber trying to blame society for his criminal activity. We need traffic cops for a reason!
The same lunacy from Congress that mandates policy onto banks like the CRA is the same mindset behind Wall Street protectionism. Congress lives to reward and incentivize unproductive, hazardous behavior like loaning to unqualified borrowers and risk-free speculative trading. The problem is Capitol Hill's command/control central planning mindset.
I'll be the first one to argue that Wall Street's a buggy whip, that the practice of US taxpayers subsidizing crony capitalism has exceeded its useful life. But the solution is not more misguided regulation from Washington, DC. I don't know the solution but a good start is to allow risks to be realized by the risk-takers, i.e. allow Goldman Sachs to fail instead of giving them $13 BILLION via AIG pass-through.
The same lunacy from Congress that mandates policy onto banks like the CRA is the same mindset behind Wall Street protectionism. Congress lives to reward and incentivize unproductive, hazardous behavior like loaning to unqualified borrowers and risk-free speculative trading. The problem is Capitol Hill's command/control central planning mindset.
I'll be the first one to argue that Wall Street's a buggy whip, that the practice of US taxpayers subsidizing crony capitalism has exceeded its useful life. But the solution is not more misguided regulation from Washington, DC. I don't know the solution but a good start is to allow risks to be realized by the risk-takers, i.e. allow Goldman Sachs to fail instead of giving them $13 BILLION via AIG pass-through.
We need to vote every member of congress out in 2010. Republicans and Dems alike. You want real change in the U.S.? VOTE THEM ALL OUT IN 2010. Find a group and join them so we can clean up the mess in Washington and break the relationships they have with lobbyists.
The same lunacy from Congress that mandates policy onto banks like the CRA is the same mindset behind Wall Street protectionism. Congress lives to reward and incentivize unproductive, hazardous behavior like loaning to unqualified borrowers and risk-free speculative trading. The problem is Capitol Hill's command/control central planning mindset.
I'll be the first one to argue that Wall Street's a buggy whip, that the practice of US taxpayers subsidizing crony capitalism has exceeded its useful life. But the solution is not more misguided regulation from Washington, DC. I don't know the solution but a good start is to allow risks to be realized by the risk-takers, i.e. allow Goldman Sachs to fail instead of giving them $13 BILLION via AIG pass-through.
If government regulation means anything, it means doing what the government wants you to do instead of doing what you want to do. Those who allegedly caused the bubble (mortgage brokers, real estate agents, financiers, etc,) were, in fact, doing exactly as the government wanted. (Almost) Nobody wanted to stop the gravy train. Nor did any of them see what was coming. Instead, the Fed made even more gravy. It was only after the gravy train crashed that those who demand regulation asked why didn't they stop it? Hindsight is easier than foresight.
Old GOP talking points never die, they are just recycled by blogers who have no facts, no new ideas and no clue. Wow, the Wall Street Journal tries to shift blame for the crisis away from Wall Street, that convinces me.
SAD
Do some research and you will see the Community Reinvestment Act had little or nothing to do with this mess. That is assuming that you have the intellectual integrity to look outside of the right wing media bubble.
CNBC's Mark Faber did a documentary on the crisis called "House of Cards" and you will find out how little the CRA and GSE had to do with this thing. And yes this thing was predictable, I profitted from the collapse, So did many others. The CRA didn't cause these people to commit Mortgage Fraud on a massive scale. Again, what idiot decided to repeal the "Glass-Stealgal Act"? It was put there for a reason!
Does anyone who disagrees with me here have any facts to refute what I've said? I understand many of you insult my intelligence (classy move, when you can't argue), but what facts justify whatever you're saying?
Oh wait, you have none.
"Old GOP talking points never die"
Actually, what I'm saying is not being said by Republicans. And I'm not a Republican anyway so I could care less what they think.
"Wow, the Wall Street Journal tries to shift blame for the crisis away from Wall Street, that convinces me. "
I'm sorry, I assumed most of my readers would be persuaded by facts (like the ones I cited), not ignorant denial such as yours. Truly you are blissful.
"Do some research and you will see the Community Reinvestment Act had little or nothing to do with this mess. "
I did some research and included it in my article. Looks like you missed that. Perhaps you should try, you know, reading.
"That is assuming that you have the intellectual integrity to look outside of the right wing media bubble. "
Again, I'm a libertarian, which is neither right nor left wing. Ironic for you to call ME stupid.
Secondly, rather than insult me, back up what you say with facts (which you cannot, very clearly).
“For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target – 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.”
This tells me only that they decided to go down market. The question is, how far down market? On a historical basis, what had been the income level most lenders used (as you have implied, THE key metric) in determining factor to minimize the risk of default? Given how fast an organization reacts, let's say it was 38% in 1995, give or take. Also left out is how HUD went about accomplishing thier mandate. One would assume they stopped making loans to the better customers, i.e. those in the above 52% median income mark, so they could leave their profits to the commerical lenders (who so graciously fund Congressional campaigns) as was originally intended. Did HUD stop making those loans to more affluent customers? (NEXT)
K.R., first of all thank you for posting a decent response to my article without the insults and profanity I've become accustomed to.
In response to your question, what we do know from these facts is that the government put pressure on the GSEs to increase lending to shaky borrowers. These are the market distortions to which Mr. Allison referred, and really the only facts we need to know. It's obvious this means lending to people with LESS money, hence these were riskier borrowers.
But the overarching fact is that the government, not the market, pressured this "downward" lending. The HUD and congressional involvement you referred to make my point that these were non-market forces at work. Let's not forget the pressure put on the GSEs by Barney Frank and the Clinton Administration in the late 90s to make these loans.
Had lenders not loaned to some of these folks, there would likely have been charges of red-lining, prejudice, and so forth. Damned if you do, damned if you do
This was a fine effort, and do keep it up.
But the above is a swing and a miss factually. The key facts have been the center of attention lately. See, e.g., http://www.cjr.org/the_audit/the_big_lie_of_the_crisis_call.php?page=a
*As for banks, and their deeper history of targeting poor neighborhoods and providing them with a crappy set of services (the benefits of which tend to inure to wealthier patrons "worthy" of competitive services, if anyone does see returns) check out the Community Reinvestment Act.
The CRA was largely a response to "redlining" -- something like, "we'll hold onto our local patrons' money but we won't give anyone in the area a loan." But since then, banks and other lenders have fallen in love with "reverse redlining," and all kinds of predatory stuff like negative amortization, absurdly high penalties for paying too late -- or early, for that matter, -- etc. I forgot the whole crazy playbook. I used to know it better...
Honestly, I'm ashamed to be slightly enthusiastic about exposing the truth in all of this. This is a tragedy of human imperfection and injustice that reaches epic proportions.
*Finally, I disagree with you to the extent that you presume that markets are "free" as long as there is no government. Society needs laws, and they're often the only way to capture massive externalities that the private sector otherwise pushes off on society, causing a net loss. You're a lawyer; you should know this!
BTW do you read the libertarian-esque law and economics folks (e.g., the ones over at Univ. of Chicago like Posner, Epstein, Skykes, etc.)? I'm fascinated by the ideas re: "optimal regulation" that they've contributed to. I'm still learning, of course, as most interested people are. Happy to chat anytime.
Cheers,
-Bill
Wow -- I'm really punching shadows at this point. I've just realized that nobody's added to this for 2 years. I might be right (pats self on back) but I'm still a raging idiot!
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