Wednesday, October 15, 2008

Too true to dismiss as lies

Local blogger and teacher Jay Bullock is concerned that the media has allowed Congressman Jim Sensenbrenner to "lie" about the cause of the financial crisis. The "lie," according to Jay, was that the government acted, through th Community Revinvestment Act and GSEs like Freddy and Fanny, to weaken underwriting standards.

As you can read here and here and here here(subscription required), this is not a lie. It's true. Freddie and Fannie as Jay points out, did not make these loans but they made a market for them. If Freddie and Fannie would buy the loans, then lenders would make them. Moreover, Freddie and Fannie, by virtue of their size and influence, could go along way in making the market, influencing what other players in the secondary market would do and what type of loans are deemed acceptable.

It is undeniable that the federal government, during both the Clinton and Bush administrations, pressed Freddie and Fannie to support a market for "affordable" loans.

While its true that HUD lost subprime market share in 2006, it bought an awful lot of bad paper in the preceding years. Nor is it clear that the "tougher standards" that it was subject to helped. It certainly did not prevent the two from owning so much of this stuff that they failed.

There are other ways in which the government facilitated this mess. In 1993, the Boston Fed issued new - and looser - underwriting guidelines. The CRA, in this story, was not so much a cause in and of itself as it reflected a larger movement toward encouraging homeownership by "rethinking" underwriting standards. These looser standards then came to be accepted outside the context of minority and low income loans.

The CRA, in this story, is part of a well intentioned, but wrong-headed, direction in policy which occurred over a number of years in a number or ways.

Of course, that's not the whole story. The influx of foreign cash and Fed policy resulted in ridiculously low interest rates. This, in turn, encouraged more aggressive pursuit of returns and the ability to offer incredibly low ARMs. All of this took place in the context of typically American expectations about ongoing increases in the value of housing. In some areas, this was exacerbated by strict zoning and environmental regulations that artificially restricted the supply of housing.

I don't think that this issue can be reduced to an argument of unregulated markets v. central planning. The markets in question were highly regulated but they weren't regulated well. Government tried to move the markets but, to the extent it succeeded, moved them in the wrong direction.

But all the mistakes that the government made would not have been enough had buyers and lenders not misjudged the housing market. It took a village to make this crisis.

1 comment:

Publius said...

There seems to be a lack of strategic thinking is to the full impact of the myriad of regulations and how they are enforced.

When the "mark to market" accounting principles were put into effect to simplify corporate balance sheets, the effect on those corporate balance sheets under conditions such as we see today was not foreseen and should have been.

We count on the central government to safeguard us, and to think ahead were the normal person can't.

I would like to see governments actions to be slow and logical; but now they seem to feel that is their place to rush in and bail out the entire mess.

I like to think of free markets would take care of themselves without intervention. I seem to be in the minority.