Sunday, October 12, 2008

The mortgage mess: a few thoughts

Before you hear from me here’s part of an op-ed by Bill Anderson, an economics professor, who does a nice job of explaining clearly and concisely a great deal about Fannie and Freddie. I add some thoughts below the star line

Bill explains - - -

… First, what are "Fannie Mae" and "Freddie Mac"? They are entities created by the federal government to make mortgage loans and to guarantee those loans.

"Fannie Mae" is an acronym for the Federal National Mortgage Association, which was created by the Franklin Roosevelt administration in 1938 to help further home ownership.

"Freddie Mac" is the Federal Home Loan Mortgage Corporation, created by the Nixon administration in 1970 as a "competitor" for the FNMA.

Both entities ultimately were "privatized," but nonetheless have operated with the obviously implicit guarantee from the federal government that it would protect them against losses.

In a free market, there would be nothing like these entities, or if something like them existed, there would be no guarantee that losses would be covered by taxpayers, which has created an obvious moral hazard. They exist because the government decided to follow a policy during the Great Depression to encourage home ownership beyond free market levels, which also meant that the entities that would have to finance such endeavors would have to come from the government. …

Here’s Bill’s entire op-ed, “Fannie, Freddie, and a Primer in Finance.”



First, if you’re asking if this Bill Anderson is the same one who very early in the Duke case called “frame-up” on Nifong and has since written extensively and passionately demanding justice and public disclosure in the case, the answer is “Yes.”

Hats off to Bill for all he’s done on the case.

If you read Bill’s op-ed you’ll see he’s a free-market advocate who believes our government’s encouragement of home ownership by guaranteeing mortgages has been an ill-informed intrusion in the market that’s predictably led to the problems we face today.

At least that’s how I read Bill.

If I’m reading him correctly, I don’t agree with Bill if you use 1930 as a start line and today as the end line.

Over those years, we’ve had the greatest housing boom in history.

Government-backed mortgages have been a very important reason for that boom.

So has a federal tax policy that allows homeowners in almost all cases to deduct from the calculation of their taxable income the interest cost on their home mortgages. Renters can’t deduct their rent costs.

Until recently more than 98% of federally insured home mortgages were satisfactorily serviced.

Even today, more than 95% of home mortgages are being paid on time.

Sen. McCain says he wants to help the 5% or so who can’t (don’t/won’t?) pay their mortgages.

I wouldn’t object to that at all if McCain would use his own money.

But he wants to use ours.

One of the worst things the government can do to make the current mortgage market worse is to bail out mortgage-delinquent homeowners.

That will tell the markets there’s no discipline for Americans when they become mortgagors.

There are other much better ways to help homeowners in trouble as well as the rest of us.

McCain should be pushing hard for government actions that will bring down the cost of energy.

Bring the cost of a gallon of gas down $1.00 and you’ve put $60.00 a month in the pocket of a mortgagor who fills a 15-gallon tank 4 times a month.

The mortgagor’s energy bill will come down as well.

Most banks and other mortgagees are reluctant to foreclose and evict for many reasons, including not wanting to be left with a house vacant and therefore at greater risk of vandalism, etc.

So they’re willing to try to work things out with good-faith mortgagors having temporary financial problems.

There’s more I want to say but I’m out of time now.

I’ll be back on this theme tomorrow.

Hint: I’ll be talking about what “charities” can do and somethings we used to call “credit unions.”

What are your thoughts?


Anonymous said...

The basic problem is that there were Americans who were purchasing homes either to live in or for investment purposes that they could not afford. This was coupled with a change in the rules that enabled people to put little or nothing down. Thus, they have little if any equity in said homes.
Home ownership is not a right, it is a privilege - one that entails responsibilities - making one's payments on time, maintaining the property on the outside, and keeping things in working order on the inside. That all takes money. When one has bought more than one can afford, then it is next to impossible to keep up the outside let alone the interior. As any homeowner knows, a home is a sinkhole for money as there is always something that needs to be done and then there are always a hundred things that one would like to do.
I am opposed to a bailout of those who eyes were bigger than their stomachs. And while there will be a fallout in the short term for those homeowners who have paid their mortgages on time who live in neighborhoods where there are abandoned homes and foreclosures, in the long run I think that there will be a more realistic housing market that is valued to the true extent of the worth of homes rather than the inflated prices that were the result of unlimited loans and broker pricing.

bill anderson said...

I think this about says it. The problem has been that the government demands that banks give easy credit to people who really don't qualify, and that if the borrowers default, the government will cover the losses.

Then we are told that if the government is able to float the biggest bond issue in world history ($700+ billion) and buy worthless securities with the proceeds, then the economy would be saved, which is ridiculous on its face. It is like my telling you if you have financial problems to get maxed out on credit cards and buy thousands of dollars worth of dead batteries.

Americans have been told for too long that government-based finance is different than regular business or personal finance, and that debt is good and "we owe it to ourselves." That is nonsense, and it is part of the Keynesian legacy of faux economics that has dominated my profession for too long.

By the way, the Evil Paul Krugman and others are calling for another rendition of the New Deal. Don't forget that FDR's "New Deal" BLOCKED the economic recovery by holding down output and productivity, forcing wages and prices higher than they should have been, stifling real growth, and keeping the rate of unemployment in the double digits until the end of 1941.

Anonymous said...

John -

There is much to agree with Bill Anderson, and some to disagree (and Bill and I have had our differences in private because I'm not an Austrian economist). He is right that government intervention has distorted the market and that there is probably more private homeownership than there would be in the absence of that intervention. Is that a good thing? He thinks not and you think so, but that becomes a matter of whether you think the market is working right or not. If it is, then having "too much" homeownership is too much of a good thing, and thus is not a good thing.

Where I differ with Bill is on two points. The first is the nature of the rental market. He says the government's tilt of the market towards homeownership creates rental shortages. I do not think so, at least not initially. Rather the initial effects lead to a surplus of rental housing. What the government's tilt will do is to make renting relatively more expensive than owning. That induces would be renters to own instead of rent. Ultimately, that leads to fewer rental units being demanded and to a decline in rents. That in turn leads to fewer rentals being built and to some being converted to private ownership (as in buildings that go condo or, as in New York City, to go coop). Later, if something happens to the homeownership market, as has happened now, then there will be a scarcity of rental units relative to demand, and that is when rents will be driven up.

My second disagreement with Bill is his use of the term 'malinvestment.' This is a favorite Austrian expression which to me has no operationality. That is because it is not well-defined. One can speak of 'excess investment' which can be defined and can have some meaning, but not of 'malinvestment.'

To cks and others, the problem is far more complex than just a problem with the wrong people being homeowners. (That though is not to disagree here with the points cks has made.) The entire problem in the subprime market, according to a recent study, will cost no more that $180 billion. While not a small sum, it's one we can live with. Why then are things so bad? It's because that small sum is packaged with other things in something called a 'Collateralized Debt Obligation' (CDO). The entire CDO is many times larger than the bad subprime inside the package, but the bad subprime inside the package poisons the whole package, and so a relatively small problem has become a massive problem. Indeed, I'm not sure how we are going to get ourselves out of this mess, except by confidence being restored in some ways to the financial markets. This is where government intervention, contra Bill, in the form of some kind of guarantee on loans may not be such a bad thing.

Jack in Silver Spring

Anonymous said...

What "saved" FDR's New Deal was American entry into WWII. This engendered full employment. Rationing of goods and the focus on war-related goods rather than on luxury items meant that people had nothing much to do with their monies, once basic needs were met, then to invest. The monies inherited by the baby boomers are the investments that their parents made during the war and in the booming economy of the fifties and early sixties.

Anonymous said...

While not the sole cause of our melt-down, the damage wrought by the Community Reinvestment Act was phenomenal. McCain's "solution" is distasteful to economic thinkers like Bill Anderson and those who believe in the economic philosophy of Ludwig von Mises. I think McCain killed his chances for victory by his ill-advised foray into FDR-style government intervention. Our only hope is that the polls are artificially imbalanced by Democrats who can't admit they have no intention of voting for a Black candidate.
Tarheel Hawkeye

Anonymous said...

To cks via JnC -

What saved America was WWII. The New Deal was what ruined America for the nine or so years before America entered WWII. One of the first acts of whe New Deal was
the National Recovery Act (known as the NRA and which Americans of African descent called, the Negro Runaround Act). The NRA tried to prevent prices from falling, which is just the wrong to do when demand is falling. Note, in 1921, a downturn similar to 1929 occurred, but following which prices fell by about 35 percent in 18 months. After 1929, by contrast, first because of Hoover's jawboning and then because of the legislated NRA, prices fell neither as quickly nor as deeply. You can thank a couple of Jewish chicken slaughterers in Brooklyn for getting the abomination that was the NRA declared unconstitutional. Other actions taken by FDR upset the markets no end, so there was no real recovery until WWII. Moreover, it is FDR we can thank for the current segmentation of our society into special interest groups. (He figured out that by making certain groups dependent on the government, he could them to vote for the Democrats, and that's how he won the 1936 and subsequent elections.) BTW, the rationing of WWII that you mention is consequence of the opposite of the NRA: price and wage controls to prevent prices and wages from going up. Rationing had to be used because without market price to ration supply and demand, some other mechanism to ration goods and services. Ration books are one answer. When there are price and wage controls, people try to evade them because they need to get goods and services, or they need to get and retain workers. During WWII, one way employers could get and retain workers was to offer them non-wage benefits, one such benefit being free health insurance. With that, the mess that is current medical delivery system in the US was born. As Marc Anthony said, the good people do is buried with them, the evil lives on. (PS - I would recommend Amity Schlaes' book, The Forgotten Man, for a good history of FDR's misguided policies.)

To TH via JnC -

It is not the CRA itself per se that has caused the current problem, it was the CRA in the hands of Bill Boy Clinton and Obama's ACORN, and their use of it to threaten mortgage lenders with litigation if they did not lend to poor.

Jack in Silver Spring

Anonymous said...

Jack in Silver Spring -
You are quite right about the New Deal. I did not mean to imply that Roosevelt was on the right track with his program - quite the opposite. It was Hoover's programs that finally kicked in that really made the difference - that and the entry into the war. Of course, the economic policies set by one president generallly bear fruit (of what ever sort) for the next president. Just watch - should Obama be elected and the economy recovers due to the policies just put in place - Obama will be credited with the recovery - just as if the process fails and McCain is elected, he will be blamed.


AMac said...

This is a complicated issue, so it is good to see a variety of opinions. I'll offer two links (one old, one new) that might be worth exploring.

Chart of the Day: Fixed vs Variable Subprime Default Rates dates from 7/18/07. Felix Salmon offers a fascinating chart and an explanation: the popularization of subprime variable-rate mortgages with an initial period without payment of principal promoted speculation, in a way that the lenders did not anticipate or account for.

Last Friday, Steve Sailer published "The Diversity Recession;" lead-in here. His thesis: increased lending to higher-risk minority groups did not, per se, cause the housing bubble. However, the ever-more-lax standards that were designed to promote increased minority homeownership--and did--also promoted increasingly risky behavior on the part of non-minorities. Since political correctness prevented critical examination of either the foundation of these policies or their developing effects, promotion of the bubble lasted all the way until... the collapse. Sailer's summary: "Ideas have consequences."