jungle

How Did We Get into This Financial Mess?
by Lawrence H. White


Lawrence H. White is the F.A. Hayek Professor of Economic History at the University of Missouri-St. Louis and an adjunct scholar at the Cato Institute. He is the author of Competition and Currency, Free Banking in Britain, and The Theory of Monetary Institutions.

Published on November 18, 2008


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As policymakers confront the ongoing U.S. financial crisis, it is important to take a step back and understand its origins. Those who fault "deregulation," "unfettered capitalism," or "greed" would do well to look instead at flawed institutions and misguided policies.

The expansion in risky mortgages to underqualified borrowers was encouraged by the federal government. The growth of "creative" nonprime lending followed Congress's strengthening of the Community Reinvestment Act, the Federal Housing Administration's loosening of down-payment standards, and the Department of Housing and Urban Development's pressuring lenders to extend mortgages to borrowers who previously would not have qualified.


Meanwhile, Freddie Mac and Fannie Mae grew to own or guarantee about half of the United States' $12 trillion mortgage market. Congressional leaders pointedly refused to moderate the moral hazard problem of implicit guarantees or otherwise rein in their hyperexpansion, instead pushing them to promote "affordable housing" through expanded purchases of nonprime loans to low income applicants.

The credit that fueled these risky mortgages was provided by the cheap money policy of the Federal Reserve. Following the 2001 recession, Fed chairman Alan Greenspan slashed the federal funds rate from 6.25 to 1.75 percent. It was reduced further in 2002 and 2003, reaching a record low of 1 percent in mid-2003 - where it stayed for a year. This set off what economist Steve Hanke called "the mother of all liquidity cycles and yet another massive demand bubble."

The actual causes of our financial troubles were unusual monetary policy moves and novel federal regulatory interventions. These poorly chosen policies distorted interest rates and asset prices, diverted loanable funds into the wrong investments, and twisted normally robust financial institutions into unsustainable positions.

For full text: http://cato.org/pub_display.php?pub_id=9788


"Some commentators (and both presidential
candidates) have blamed the current
financial mess on greed. But if an unusually
high number of airplanes were to crash this
year, would it make sense to blame gravity?
No. Greed, like gravity, is a constant. It can’t
explain why the number of financial crashes
is higher than usual. There has been no
unusual epidemic of blackheartedness."
L.H. White

Pilotpip

I think a lot of people on all sides just turned a blind eye.

The lenders kept lending to people that couldn't afford the payments.
The buyers kept buying more than they could, knowing they had no room for error.
The fed kept lowering intrest rates to keep the markets artificially high.

Gas broke the camels back. All of a sudden the $7 cup of coffee and any other discretionary spending went away. People suddenly had to shift money away from their mortgages to buy gas to get to work. Investors had nowhere to turn so they jumped into oil futures, which only compounded the issue. At some point, it broke and it broke big.

I have no formal training on the subject of the economy but amid the tripe from the media, industry and our government (this all just hit us without warning! the sky is falling!)I wonder if things would be this bad right now if the powers that be would have just let things take their natural course a few years ago.

js081285

I think that the statement regarding gravity and greed as laws is brilliant. I never understood why people thought all of the sudden America got greedy. Capitalism has always been based on greed and what is best for oneself. Thats how a producer and consumer meet at the best price. Producer would love to make as much money as they can, consumer would love to spend the least money they can. The fair price is somewhere in between.

Kilgore Trout

So we're in this current mess because of government encouraged loans to risky borrowers?
This brings to mind images of inner city poor folks applying for mortgages at some sort of community organized housing expo. Guaranteed housing loans suddenly started falling from the hands of the government backed lenders? Is that the case?
I minored in Economics at a cow college, so I usually get in over my head on this stuff, but I can't believe that low income delinquent borrowers really contributed all that much to this re-adjustment we are having.
Why did anyone think it was a good idea to offer these programs? I have to believe it actually appealed to some agencies or elected reps who believed in the idea of putting the responsibility for housing oneself and family into the hands of the individual. Removing people from subsidized housing (which I assume requires a vast outlaying of resources to administer) by streamlining the process?
If that's the case then are these articles saying that these loans have failed on a large scale? How many of these borrowers are still making their payments?
Was anyone not requiring government housing subsidies interested in the properties these programs were designed to get people into?

jungle

Information on Recent Default and Foreclosure Trends for Home Mortgages and Associated Economic and Market Developments
GAO-08-78R October 16, 2007
Full Report (PDF, 61 pages) Accessible Text

Summary
Substantial growth in the mortgage market in recent years has helped many Americans become homeowners. However, as of the latest quarterly data available, June 2007, more than 1 million mortgages were in default or foreclosure, an increase of 50 percent compared with June 2005. Defaults and foreclosures on home mortgages can impose significant costs on borrowers, lenders, mortgage investors, and neighborhoods. Additionally, recent increases in defaults and foreclosures have contributed to concern and increased volatility in certain U.S. and global financial markets. These developments have raised questions about the extent and causes of problems in the mortgage market. To provide some insights on these issues, Congress asked GAO to analyze (1) the scope and magnitude of recent default and foreclosure trends, and how these trends compare with historical values, and (2) developments in economic conditions and the primary and secondary mortgage markets associated with these trends.

Overall, the number and percentage of mortgages in default or foreclosure rose sharply from the second quarter of 2005 through the second quarter of 2007 to levels at or near historical highs, but there was significant variation among market segments, loan types, and states. The overall default rate grew by 29 percent, reaching a point at which just over 1 in every 100 mortgages was in default, almost a 28-year high. The foreclosure start rate did reach a 28-year high, rising by 55 percent. The subprime market experienced substantially steeper increases in default and foreclosure start rates than the prime or government-insured markets, accounting for two-thirds or more of the overall increase in the number of loans in default or foreclosure during this time frame. Among types of loans, ARMs experienced relatively steeper growth in default and foreclosure rates, compared with FRMs which experienced no or modest increases. According to mortgage industry researchers and participants, the number and percentage of loans in default and foreclosure are likely to worsen through the end of 2007 and into 2008, due partly to scheduled payment increases for many ARMs. A number of studies and industry data indicate that a combination of economic and market developments contributed to recent increases in default and foreclosure rates. First, the rapid decline in the rate of home price appreciation throughout much of the nation beginning in 2005 may have reduced incentives for borrowers to keep current on their mortgages and made it more difficult for borrowers to refinance or sell their homes to avoid default or foreclosure. Second, in some states with foreclosure rates that were already relatively high in 2005, weak labor market conditions likely contributed to mortgage problems. Third, more aggressive lending practices--an easing of underwriting standards and wider use of certain loan features associated with poorer loan performance--reduced the likelihood that some borrowers would be able to meet their mortgage obligations, particularly in times of economic hardship or limited house price appreciation. Fourth, growth in the market for private label RMBS beginning in 2003 provided liquidity to some brokers and lenders to support these more aggressive lending practices. Investors were attracted to these securities because of their seemingly high risk-adjusted returns. A number of other factors--including incentives that potentially emphasized loan volume over loan quality and growth in the incidence of mortgage fraud--may have contributed to recent default and foreclosure trends, but additional information would be needed to fully assess their impact.



It has gotten much worse since last year, latest numbers aren't out yet.

RXS676

In part, because these programs allowed politicians to boast about the growth in homeownership rates. More significantly, they also (artificially) inflated the economy through a rapidly expanding real estate and construction sector, and through profligate consumer spending from home equity lending.

It is likely these properties would not have existed but for these programs. The increased number of "qualified" homebuyers resulted in a massive contruction boom that resulted in more homes than would have been necessary for buyers who qualified under more traditional lending standards.

Kilgore Trout

Thank you for the clarification RXS676 and Dr. H.S.T., err, Jungle. I've gotta go mull this over a bit.
Perhaps you've seen it already but there's some interesting stuff going down at the APCF thread on "GM Killing on demand freight Ops".
Cheers,

AL E NEWMAN

It's no coincidence that most of the areas hardest hit by the foreclosure wave -- Loudoun County, Va., California's Inland Empire, Stockton and San Joaquin Valley, and Las Vegas and Phoenix, for starters -- also happen to be some of the nation's largest illegal alien sanctuaries. Half of the mortgages to Hispanics are subprime (the accursed species of loan to borrowers with the shadiest credit histories). A quarter of all those subprime loans are in default and foreclosure.
The amnesty-promoting National Council of La Raza and its Development Fund have received millions in federal funds to "counsel" their constituents on obtaining mortgages with little to no money down; the group almost succeeded in attaching a $10-million earmark for itself in one of the housing bills past this spring.

The top banks clamoring for their handouts as their profits plummet, led by Wachovia and Bank of America, launched aggressive campaigns to woo illegal alien homebuyers. The quasi-governmental Wisconsin Housing and Economic Development Authority jumped in to guarantee home loans to illegal immigrants. The Washington Post noted, almost as an afterthought in a 2005 report: "Hispanics, the nation's fastest-growing major ethnic or racial group, have been courted aggressively by real estate agents, mortgage brokers and programs for first-time buyers that offer help with closing costs. Ads proclaim: "Sin verificacion de ingresos! Sin verificacion de documento!" -- which loosely translates as, 'Income tax forms are not required, nor are immigration papers.'"In addition, fraudsters have engaged in massive house-flipping rings using illegal aliens as straw buyers. Among many examples cited by the FBI: a conspiracy in Las Vegas involving a former Nevada First Residential Mortgage Company branch manager who directed loan officers and processors in the origination of 233 fraudulent Federal Housing Authority loans valued at over $25 million. The defrauders manufactured and submitted false employment and income documentation for borrowers; most were illegal immigrants from Mexico. To date, the FBI reported, "Fifty-eight loans with a total value of $6.2 million have gone into default, with a loss to the Housing and Urban Development Department of over $1.9 million."

It's the tip of the iceberg. Thanks to lax Bush administration-approved policies allowing illegal aliens to use "matricula consular cards" and taxpayer identification numbers to open bank accounts, more forms of mortgage fraud have burgeoned. Moneylenders still have no access to a verification system to check Social Security numbers before approving loans. I don't think the federal government is willing to expose this problem for financial reasons as well as for fear of political repercussions."

The chickens are coming home to roost. And law-abiding, responsible taxpayers are going to pay for it.

jungle

The trick to thinking about this clearly is to get the victim out of the hands of the ghouls and their assorted versions of lies, half-truths and outright fabrication. Once the victim is on the autopsy table under good lighting, a proper investigation may begin.

Once you begin to examine an economic policy without the shade of political infighting and denial you can make progress. Our country can't generate the revenue to continue along it's current path with regard to completely unbridled spending. Practical solutions are required.

AL E NEWMAN

Send Congress home for 9 months out of the year for starters