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Jewish World Review Sept. 23, 2008 / 23 Elul 5768 Blame Need, Not Greed, for the Mortgage Crisis By Robert Tracinski
http://www.JewishWorldReview.com |
The mainstream media and Democratic politicians-is there a difference between the two any more?-have been trying to exploit the mortgage crisis to convince the public that free markets have been discredited. A particularly obnoxious writer with the Atlanta Journal-Constitution even goes to far as to demand to know, "What happened to…[those] who denounced government regulation and read from the holy scriptures as recorded by Ayn Rand?"
Well, here we are-or at least, here I am-and I am not impressed by the bluster of the anti-capitalists, because they are the ones who are getting this story completely wrong.
Both Barack Obama and John McCain agree that, in McCain's words, the basic cause of the financial crisis is "self-interest, greed, irresponsibility, and corruption" on Wall Street-as if it is in a Wall Street firm's greedy self-interest to go bankrupt.
It reminds me of the old joke from the 1939 film Ninotchka, in which a Soviet official misunderstands a basic business transaction and explains it to his comrades: "Capitalistic methods-they accumulate millions by taking loss after loss." Sadly, most politicians are just as helpless in trying to understand the workings of the private economy.
In reality, the real culprit behind this financial crisis is not the morality of greed, but the morality of need. And speaking of Ayn Rand, what came to my mind in surveying this crisis is a passage from her masterwork, Atlas Shrugged. When the South American copper magnate Francisco D'Anconia is asked about the spectacular failure of a giant mining venture, he explains that he ran it according to the moral principles everyone kept telling him to follow: he worried only about providing employment to his workers, not about producing an actual product, and he hired his employees only the basis of their "need." For example, when he hired a mining specialist to run the operation, D'Anconia explains that "He wasn't a very good specialist, but he needed the job very badly."
The same pattern applies to the current mortgage crisis. Mortgage lenders made a lot of loans to people who weren't very good credit risks, but who needed the loans very badly. And like D'Anconia, these lenders were merely acting according to the moral principles that everyone kept telling them to follow-as well as the policies that were required of them by government regulators and congressional leaders.
For more than a decade, the explicit purpose of legislation and regulation coming out of Washington has been to force lenders into extending more loans to financially unstable borrowers. All of this was done for the purpose of providing "affordable housing"-to borrowers who we now know couldn't really afford it.
The assault on lending standards began in the early 1990s, when the Community Reinvestment Act was invoked to fight alleged discrimination by lenders against minorities and residents of inner-city neighborhoods. It turns out the claims of bias were based on a faulty study, but the damage was done. To redress the supposed discrimination, lenders were encouraged to use "flexible underwriting standards."
A Federal Reserve "guide to equal opportunity lending" for example, offered banks the following advice on how to adjust their lending standards to avoid being punished. Banks should throw out the usual formula for the maximum ratio between the mortgage payment and the borrower's income, because "Many lower-income households are accustomed to allocating a large percentage of their income toward rent." Smaller down payments and closing costs should be accepted because "Accumulating enough savings to cover the various costs associated with a mortgage loan is often a significant barrier to homeownership by lower-income applicants." No comment is necessary for this next one: "Policies regarding applicants with no credit history or problem credit history should be reviewed." And the document urges a more flexible approach to verifying the borrower's income, including giving credit for "welfare payments and unemployment benefits"-which actually count as proof of the borrower's lack of income.
All of this was meant to increase the number of loans to impoverished blacks in inner-city neighborhoods. But banks were warned that "If an institution permits flexibility in applying underwriting standards"-as they were being required to do by the government-then "it must do so consistently." Which means that the same debased lending standards were encouraged and required for everyone.
Commentators are now complaining that lenders failed to inquire about the risks of the loans they were making-but in fact they were vigorously discouraged from making such inquiries, or from acting on that knowledge if they discovered it.
The charge of racial discrimination was the stick the government used to drive down lending standards. But we didn't hear much complaint from the lenders after a while, because the government was also busy doling out carrots.
Lenders became accustomed to originating loans, then selling them to third-party buyers who packaged the income from these loans into "mortgage-backed securities." This meant that the original lender could make a riskier loan without the fear that he would still be holding the mortgage when the borrower defaulted. But why weren't the buyers of these mortgage-backed securities stricter in their standards regarding what they would buy?
Here is the next piece of the puzzle. As part of the same "affordable housing" crusade, Congress has systematically encouraged the expansion of Fannie Mae and Freddie Mac, two "government sponsored enterprises" that were formed precisely for the purpose of buying mortgages from the original lenders, guaranteeing the income from these mortgages, and then re-selling them to other investors. Fannie Mae and Freddie Mac could keep on guaranteeing these mortgages without trashing their own credit rating because they were backed by the federal government, which put taxpayers on the hook for all of the risks involved.
This turned out to be a honey pot for Fannie Mae and Freddie Mac. Their government backing allowed them to raise money at lower interest rates than other lenders. This meant they could buy a mortgage originated at a higher interest rate with funds they raised at a lower interest rate-and pocket the difference between the two interest rates.
Financial analyst Bill Burnham, who consulted for Fannie Mae in the 1990s, describes the consequences of this scam:
Fannie Mae began a campaign to increase "home ownership" and "affordability." It created a home ownership "foundation" which opened offices in almost every congressional district and promptly set about mobilizing all the local advocates for "affordable" housing to put pressure on their elected representatives to let Fannie Mae offer "affordable housing programs."…
This proved to be a highly effective political coalition for Fannie Mae. Not only did they build a huge network of grass roots political supporters through their "foundation," but politicians saw political advantages in supporting the programs because it cast them in the role of trying to help families buy a new home (as opposed to lowering underwriting standards to help a giant corporation keep up its earnings growth by taking a free ride on the US government's guarantee).
But not all of this pressure for lower standards was originated by Fannie Mae or Freddie Mac. Some of it came back down from Congress. A recent New York Times article describes how "executives of both companies maintain that one of the reasons the firms hold so many bad loans is that Congress has leaned on them for years to buy mortgages from low-income borrowers to encourage affordable housing." In fact, "Once, a high-ranking Democrat telephoned executives and screamed at them to purchase more loans from low-income borrowers, according to a congressional source."
Similarly, one my readers e-mailed me a link to a 2006 press release from the federal Department of Housing and Urban Development, which boasts of its role in encouraging Fannie Mae and Freddie Mac to meet their government-mandated targets for generating millions of loans to lower- and moderate-income borrowers and those in the inner city and other "underserved"-i.e., undesirable-neighborhoods.
Behind all of this, there was one other form of government interference that kept the bad loans flowing. The Federal Reserve has consistently kept interest rates low, even at the risk of increasing inflation, precisely in order to keep low-interest capital flowing into the financial markets, in an attempt to artificially stimulate the economy. You can't say the Fed didn't succeed, because lending has been stimulated-artificially, which is why the bills are now coming due.
I don't mean to imply that the past decade's housing boom was entirely a "bubble." Housing prices have dropped, but they are still well above pre-boom levels. A genuine increase in housing values is supported by a rising population and rising wealth that allows most Americans to build bigger and nicer homes than they did thirty years ago.
This housing boom was real, and the government didn't create it. All government did was to make the boom unstable by encouraging the widespread issuance of riskier loans-and then masking this risk with the promise of government guarantees.
This debacle bears the fingerprints of the US Congress, the US Treasury, the Federal Reserve, the Department of Housing and Urban Development, and the "government sponsored enterprises": the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.
Put all of that alphabet soup together and two words jump out: "federal" and "government."
So tell me again how all of this is being caused by private greed and the free market?
And now the federal government is taking on an even bigger role, with plans to bail out everyone from homeowners (a misnomer in this case, because many troubled borrowers own little or no equity in their homes) to investment banks. The New York Times recently noted the irony:
When the government bails out failing firms, economists call this "moral hazard," because of the risk that the promise of a government bailout will encourage irresponsible behavior. But the real moral hazard involved here is much, much bigger.
The driving moral standard behind the "affordable housing" debacle was need, not greed. Mortgages had to be extended to lower-income, less-financially-stable borrowers because their need allegedly gave them a claim to the benefits of homeownership. This explains the seemingly crazy rush to debase mortgage lending standards. Higher-risk borrowers had to be given loans precisely because they were higher-risk and therefore needed the loans more-and it was the job of lenders, investors, and ultimately taxpayers to carry the burden of that increased risk.
The mortgage crisis is not the product of self-interest. It is the product of an anti-self-interest morality in which responsible individuals are required to sacrifice to the needs of those who are not responsible. And once that moral hazard is introduced, there is no limit to what can be claimed on the basis of need-and, as the billions of dollars in federal bailouts add up, no limit to what the rest of us will be made to sacrifice.
Come to think of it, that's precisely what Ayn Rand warned about. Discredited? I would say she has been vindicated.
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© 2008, Robert Tracinski |
Arnold Ahlert | |||||||||||
