Thursday, April 2, 2015

The Housing Bubble 2.0

Combine economic illiteracy of the public with Democrat racial politics and you have a sure recipe for disaster. So it was it 2007 with the financial meltdown. And so it now seems that, because of the same illiteracy and racial politics, we will be repeating that meltdown sometime in the foreseeable future.

Let's review the origins of the subprime crisis that brought our economy to its knees in 2007. In the early 90's, a charge was leveled that banks were being discriminatory in their lending practices. It turned out upon review to be a mistaken charge, but by then the facts no longer mattered. The left went on a jihad to force banks to lower their colorblind lending standards that had been developed based on over a century of experience showing that, if a borrower had sufficient capital of their own invested in a house (10% to 20% at time of purchase), than the loan was far more likely to be repaid. The left empowered community groups such as ACORN to bring suits against banks without the slightest evidence of discriminatory intent in lending standards beyond mere statistical disparities in the number of loans issued to minorities. Bill Clinton coupled this with a massive program to increase mortgage loans through the quasi government agencies, Fannie Mae and Freddie Mac, who began underwriting mountains of loans with little or no money down.

The subsequent explosion in subprime and alternative home mortgages gave the illusion of wealth. In reality, it was a cancer, but one made exponentially worse by the biggest scandal of the whole bubble, that credit rating agencies were giving triple-A ratings to bonds backed by subprime mortgages. The Credit Rating Agencies did so, one, knowing that these were highly risky investments, they did so with the connivance of Fannie Mae and Freddie Mac, and they did so with the full knowledge of our legislators. Barney Frank led the left's charge to beat back any attempt at stopping this insanity by repeatedly playing the race card, right up until the whole system collapsed. With the bonds AAA rated, they could lawfully be purchased by any financial institution in the world -- and thus did the contagion spread. Added to this were Credit Default Swaps, a rather brilliant form of private insurance between institutions that became regularly used in regards to these AAA rated, subprime mortgage backed bonds. They would have worked fine if the market dipped, but when the housing market tanked completely, the Credit Default Swaps failed also, adding a huge layer of complexity to the problems faced by our financial institutions. Thus the 2007 meltdown that threatened the viability of most banking institutions in the U.S. and many in Europe.

With Obama's win in 2008, any chance that we had of addressing the actual causes of the financial crisis that ruined our economy was lost. Obama blamed the meltdown on some vague allegations of "Wall Street greed" and Credit Default Swaps. The prime architects of our financial meltdown, Barney Frank and Chris Dodd, drafted legislation that severely burdened our financial institutions, and did worse than nothing about any of the actual causes of the meltdown. The deeply misguided social engineering of our lending standards were not simply ignored in the legislation, but actually significantly strengthened -- to the point that Eric Holder, in his time as Attorney General, has claimed as one of his stellar achievements to be strong arming banks into lowering lending standards even further. Zero down loans were allowed to continue. Fannie Mae and Freddie Mac were left intact to continue to underwrite risky mortgages. No changes have been made to the Credit Rating Agencies. And worse, the legislation, by providing de facto government backing of large banks, has seen smaller banks across the nation, the ones that fully knew and supported their communities, forced to shutter their doors, making our nation as a whole ever more dependent on a few colossal institutions that really are "too big to fail." Plus there is the fact that a whole swatch of people who should have been jailed over the fraud that drove this system have not, and will likely never, pay any price.

So, on that happy note, there is this the other day from John Stossel:

They're doing it again! . . .

Then the politicians said, "We'll fix this so it doesn't happen again." Congress passed Dodd-Frank and a thousand new regulations. The complex rules slowed lending, all right. It's one reason this post-recession recovery has been abnormally slow.

But -- April Fools'! -- the new rules didn't solve the problem of reckless lending, and it's happening again.

Because our government subsidizes home purchases, recklessness is invited. Somehow, Americans buy cars, clothing, computers, etc. without government guarantees, but politicians think housing is different. . . .

At the time of the housing crash, most high-risk loans were guaranteed by the government. Those banks wouldn't have been as reckless if they had their own money on the line.

But they knew they could grant a mortgage to most anyone and the FHA would back it or government-sponsored companies Fannie Mae and Freddie Mac would buy it. That fueled the frenzy of lending.

After the bubble popped, I assumed the political class would learn a lesson, but they haven't. Today, even more American mortgages are guaranteed by government. More than 90 percent of new loans are backed by taxpayers. After the crash, Fannie and Freddie did raise their minimum down payment -- to a measly 5 percent -- but a few months ago, they lowered it again to 3 percent!

Are they crazy? A sensible congressman, Rep. Jeb Hensarling (R-TX), tried to get an answer from the administration's new mortgage regulator, asking in a hearing, "All things being equal, is a 3 percent down riskier to the taxpayer than a 10 percent down loan?"

A pretty basic question -- but one that director Mel Watt still dodged, responding, "Mr. Chairman, that is generally true. But when you pair the down payment with compensating factors ... look at other considerations ... you can ensure that a 3 percent loan is just as safe."

What? That's nonsense. This is what happens when pandering politicians get to dispense your money. Watt is among the worst. When he was a congressman, he pushed for mortgage subsidies for welfare recipients who made down payments as low as $1,000.

Edward Pinto, who studies housing risk for the American Enterprise Institute, says policies like this put us on the way to another bubble: "The government is once again ... saying, let's loosen credit, give loans to people that potentially can't afford them, and everything will be fine because house prices will go up."

On my show, former FHA commissioner David Stevens, who did improve lending standards a bit after the crash (before Watt and his cronies weakened them), responded that this time the government has new regulations that will prevent things falling apart: "I think in the effort, post-recession, to make sure we never go down this path again, we have created more rules than ever existed in the history of this country."

But more rules aren't a solution. Government's regulators didn't foresee the problems last time. Fannie and Freddie got a clean bill of health right up until the collapse.

The solution is less government involvement. Canada doesn't have a Fannie, Freddie or FHA. Canada didn't have the trauma of a housing bubble. In Canada, lenders and homeowners risk their own money.

Does that mean Canadians cannot afford homes? No! Without all that government help, Canada's homeownership rate is higher than ours.

Back to the future, eh.

1 comment:

Gary said...

Mr. Wolf,

Love your blog.

But I put 100% of the blame at the feet of the big government-Wall Street loving Republican Party.

The GOP controlled Congress from 1995 to 2007 and the White House from 2001 on. They were in charge of writing the laws, and regulating the crooked Wall Street bankers (none of whom went to jail for loan fraud).

The GOP under the village idiot Bush inflated the bubble to keep and keep the "party" going and win elections.

Both parties are corrupt and in the back pockets of Wall Street, but the GOP wins the prize for the financial bubble.