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Foreclosure Misery: Government’s Intervention in Housing

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October 15, 2010 – Comments (7)

DavidKretzmann.com

Today it was announced that banks foreclosed on 288,345 houses in the past three months, the highest amount of foreclosures in any three-month period since 2006. It’s estimated that 1.2 million homes overall will be foreclosed in 2010. Well, gee, looks like government bailouts of the financial industry have paid off! Despite hundreds of billions of dollars in bailouts, piles of regulatory codes, and vastly expanded government power, the pinch on Main Street is tightening and more people are losing their homes. It makes you wonder, how did all this happen in the first place and why hasn’t increased government intervention solved the problem?

Since the early 20th century it has been the initiative and policy of the federal government to lower the price of housing so every single family could own a home. Other arrangements that would commonly arise in a free market (such as renting) just don’t fit into the government’s version of the “American dream.” One of the first to lobby for governmental support of individual home ownership was President Herbert Hoover. On July 22, 1932 Hoover signed the Federal Home Loan Bank Act, and he explained the purpose of the bill “is to establish a series of discount banks for home mortgages.” In other words, the federal government would help organize the mortgage loan industry and provide cheaper loans for people to obtain, thus increasing home ownership. Hoover went on to explain:

“In the long view we need at all times to encourage homeownership and for such encouragement it must be possible for homeowners to obtain long-term loans payable in installments. These institutions should provide the method for bringing into continuous and steady action the great home loaning associations which is so greatly restricted due to present pressures.” — Herbert Hoover (Emphasis added.)

The “present pressures” of course being the Great Depression, an eensy-weensy economic slump that resulted in banks giving out fewer loans. Still, Hoover thought this was an appropriate time for government to encourage people to buy a house even if the economy was in dire circumstances. So began the history of the federal government’s intervention in the mortgage market, often subsidizing or forcing banks to lower their lending standards and give loans to people regardless of their ability to pay them back.

Taking Hoover’s actions a step further, President Franklin Roosevelt signed a bill that led to the formulation of Fannie Mae and Freddie Mac in 1938. Interestingly, these government-sponsored enterprises (GSEs) were created to help bail out banks who were faced with (wait for it…) a growing number of mortgage defaults.

Essentially the scenario looks like this: First the government organized banks to lower the price of mortgages in 1932; once people bought the loans, however, many were unable to pay them back and forced to default; upon seeing this flow of events, Roosevelt attempted to bail out the industry by creating Fannie Mae and Freddie Mac in 1938. This was the beginning of the secondary mortgage market, the practice where the GSEs (using taxpayer dollars) purchase mortgages from banks, thereby freeing up money for the banks to provide more mortgages.

“The GSEs are companies created by Congress to bring liquidity, stability, and affordability to the nation’s residential mortgage markets. Traditionally, we’ve fulfilled this role by purchasing mortgages in the secondary market and bundling them into mortgage-related securities that can be sold to investors or held in our portfolio.” — Ed Haldeman, Freddie Mac CEO

This new setup encouraged banks to offer loans to riskier clients who in an actual market scenario would not be eligible to purchase a mortgage. Because of government’s creation of the secondary mortgage market banks found themselves with extra liquidity, which was used to offer loans to financially-insecure individuals. It’s not tough to do the math: riskier customers lead to a higher likelihood of default. These policies have the least desirable impact on the poor people they are intended to help. In reality,  it is much more economically feasible and sensible for a poor person/family to rent a house or apartment than to buy a house. However, artificially low mortgage rates lure poor people into an investment they won’t possibly be able to pay back. Government’s intervention creates a market imbalance that pushes the poor into buying a house when it is almost certainly not in their long-term interest to do so.

The painful effects of foreclosure we see today are the inevitable consequence of ongoing government meddling in the mortgage market. Government either subsidized or forced banks to offer risky loans to risky customers, but when the entire scheme begins to collapse we’re told it is a failure of the free market. (As if Fannie Mae, Freddie Mac, the Federal Housing Administration, and other such entities were created through free, voluntary exchange and not by politicians and bureaucrats.)

Before someone blames the current economic mess on “deregulation” and injustices of the free market, consider this action undertaken by the Clinton Administration, as explained by the New York Times:

“In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.”

“In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980′s.” — New York Times; September 30, 1999

Historical evidence clearly shows that government has led the endorsement of subprime mortgages and lower lending standards, with complete disregard for the economic misery that erupts out of such policies and programs. Increasing bailouts will merely delay and worsen the inevitable collapse of the modern mortgage industry that government has played a major role in creating and sustaining.

Even so, you might say, on September 24, 2008, John McCain suspended his presidential campaign with the selfless objective to pass emergency legislation to “protect taxpayers and homeowners,” so the government must know what it’s doing, right? What America got in September 2008 were the TARP bailouts which, given the situation of the mortgage market today, haven’t done squat to “protect homeowners.” Given the government’s miserable record of attempting to provide affordable housing, who in the world expects more government intervention to save homeowners this time around? You can’t save a drowning person by throwing more water on him, nor can you save a government-manipulated economy with more government intervention.

The free market is the best tool to save the housing market and actually provide affordable housing for those who need it. Allowing liquidation of the housing market is necessary and would bring a short-term correction, but it would end the ongoing misery homeowners are experiencing due to government manipulation in the first place. Housing prices would drop to levels most potential homeowners could actually afford, and it wouldn’t require one dollar of government intervention.

For a true recovery to take place you don’t need increased government spending, intervention, or control; all that’s needed is a return to the free market, where individuals will manage their lives and economic decisions far better than any politician or bureaucrat in Washington D.C. The free market is the only option for a sustainable, lasting, and prosperous recovery.

7 Comments – Post Your Own

#1) On October 15, 2010 at 10:55 AM, JaysRage (88.41) wrote:

Yep, I agree that this bubble was clearly created by government intervention in housing.   

I'm in favor of foreclosures for multiple reasons.   Foreclosure is the natural end to a bad business deal that BOTH sides had no business entering into.   People are not entitled to a house that they cannot afford.    What I don't think people understand is that in many of these cases, under no circumstances should these buyers have been allowed to own the home they own.   After this realization has come to fruition, forcing the banks to hold their side of the bargain when the other side is not participating is just bad economics.   Letting the banks foreclose, letting these houses on the market at real valuations, letting them take the losses, letting people get into financial situations that are sustainable is the right solution.   The fact that banks are actually following through on foreclosures and taking these losses on their balance sheets is very encouraging to me economically.   When they keep the bad loans on their books at full value and people are living in their houses without paying for it, the system is broken.  

The system is finally healing itself.   Let it finish. 

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#2) On October 15, 2010 at 10:56 AM, awallejr (76.63) wrote:

This current mess was BECAUSE of letting the free market run rampant when shadow banks were allowed into the business.  I've said this a ton of times, and it still bears repeating.  Changing Glass-Steagall Act in 1999 set the stage.  You then had Wall Street and a ton of mortgage broker companies getting into the fray. 

When banks required PMI (private mortgage insurance) if people were borrowing more than 80%, these shadow banks found a gimmick and offered 80% along with 20% home equity loan, thus circumventing the need for PMI, which was designed to protect the lenders.  On top of that they gave 6% closing cost credits. And what they did with that was to bump up the purchase price by 6% (so the borrower could borrow even more money) and then offset it at closing with a 6% credit. 

What these shadow banks then did was bundle the mortgages off to Fannie or Freddie or bondholders.  Mortgage brokers didn't care about any serious underwriting standards, they just wanted to churn and dump the mortgages off. 

If they never allowed these shadow banks into the business, Lehman would still exist, Bear Stearns would still exist, and the financial system would never have gone to the brink like it did.

THIS was your free market at work.

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#3) On October 15, 2010 at 11:45 AM, dbjella (< 20) wrote:

awallejr

these shadow banks found a gimmick and offered 80% along with 20% home equity loan, thus circumventing the need for PMI, which was designed to protect the lenders. 

You think that was the free market at work?  The banks didn't find the gimmick.  Fannie Mae had Desktop Underwriter (black box mortgage decision engine that EVERYONE used to qualify a loan.  Fannie previously to 99 had started to venture outside of traditional A paper.  Nobody could prove it, because nobody knew the underwriting rules except for Fannie, but we all saw more people approved from different credit scores.

Combo loans (1st and 2nd) were nothing new either.

I worked for a company that securitized alt A and subprime loans and we found more money than we knew what to do with :)

Where did all that money come from?

When banks found it cheaper to use the discount window rather than the open market to borrow what do think that did to arm loans? 

I think you are treating a symptom.  IMHO. 

 

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#4) On October 15, 2010 at 11:48 AM, davejh23 (< 20) wrote:

awallejr - This wasn't the free market at work.  This wouldn't have been possible without stupid buyers.  It wouldn't have been possible without risky lending practices by the banks.  AND, probably most importantly, it wouldn't have been possible without direct government involvement.  It wasn't just repealing Glass-Steagall and stepping aside...not regulating...the government was actively encouraging this.  Fannie/Freddie were key enablers and it was government intervention, not the free market, that drove these GSE's practices.

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#5) On October 15, 2010 at 11:57 AM, starbucks4ever (97.98) wrote:

You should only change the following sentence

"Since the early 20th century it has been the initiative and policy of the federal government to lower the price of housing so every single family could own a home." 

to

"Since the early 20th century it has been the initiative and policy of the federal government to increase the price of housing so not every single family could own a home."

And then everything in your post will make sense and it will show how artificially low mortgage rates made housing unaffordable for most households that did not jump on the bandwagon when the rates were above 10%.

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#6) On October 15, 2010 at 2:30 PM, TMFPencils (99.81) wrote:

Hi zloj,

I suppose if I were describing the effects and not intentions of the government that sentence would be best. :D 

People blaming the market on problems caused by government intervention tend to have a very short sighted view of history. The current mess isn't a result of one law, regulation, or program changed in the past couple decades. It's a result of nearly a century of central banking, government planning and manipulation of banks and lenders, and policies that are in direction contradiction with free markets.

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#7) On October 16, 2010 at 1:46 AM, awallejr (76.63) wrote:

I won't challenge the argument that free flowing money and excessively low interest rates for too long a period were also contributing factors, but the fact that the sharks of Wall Street were let into the business was the worse thing that ever happened.

Having survived the crash of the late 1980s, the 1990s was actually a very healthy time period for real estate.  You had steady but subdued annual growth, with PMI and reasonably responsible lending by the banks.  But come 1999 the candy store was opened to the greedy sharks.  And while I blame Clinton and congress for opening those floodgates, the fact remains that it was unenforced regulation of greedy, manipulative, and flat outlying brokers and Wall Streeters running amok that brought this Country to the brink of disaster.

Wall Street NEVER should have been allowed into the mortgage business. Period.

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