There’s a housing crisis in the United States. Even though it’s been almost 10 years since the housing meltdown that happened in 2008,, there is still massive distortion in the market as a consequence of that crisis. Economics at its core is about causes and effects. Millions of people lost their homes and now rent because their credit was destroyed and can no longer qualify for a mortgage loan. Hedge funds bought up 100’s of thousands of houses and now rent out those houses at a nice profit to the very same people that lost their homes. The misery is concentrated most in the people that are the least protected.
There are people who will read that last paragraph and want to discount the message it sends. To eliminate the influence it might have so that they can alleviate their guilt and responsibility over that outcome. No one wants to take the blame for the benefits they receive by the system. Everyone thinks they have earned their wealth and position and that there is no guilt allowed in a capitalist system. Sure, in a real capitalist situation I would agree with them. But the mortgage market hasn’t been operating under true principles of capitalism for a very long time.
There are so many distortions in the housing market that it is unlikely to operate as a real capitalist system ever in the United States. But it isn’t capitalism that is the problem. It isn’t the borrowers that don’t pay their mortgages on time either. It’s the laziness and lack of talent of the leaders in the markets today. They want sure things while taking no risks. They don’t want to think of ways to make risks manageable because it’s easier to game the system for short term profits and to blackmail like-minded government officials into playing along.
But every time a bailout happens, or the perception perpetuates that capitalist systems can’t operate in a sophisticated enough way to be able to handle catastrophic risks when they occur, the government claims more irreversible power for itself. Taxes and fees become higher and higher. Fueling out of control deficits and spending on programs that seek to smooth over the pain in every conceivable scenario.
What “real capitalism” is depends on the market and the context. Recently there was a hearing at the House Financial Services Committee where various individuals that claim to be representing themselves gave testimony on ways to “fix” the housing finance system. It was interesting to hear the views of the American Enterprise Institute especially. They are supposed to represent what “real” capitalists should want. They advocate that they support no government involvement in the housing market. Of course it’s easy for them to pretend to advocate for such a position when they have certainty that the political reality of that scenario will never happen.
If the government were to remove its support of the housing market thousands of businesses would go bankrupt including many of their members. That’s just economic reality. For better or worse, the government isn’t going to remove itself from its substantial presence in housing finance because it CAN’T remove itself from having a substantial presence in housing finance. The past is baked into the system and so is the future.
The mortgage business and mortgage underwriting are pretty simple. It turns out that if you make loans to people that have jobs with verifiable income and good credit scores that you can predict accurately when they will pay their mortgage payments. During the subprime mortgage crisis, the most likely loans to fail were made to people whose incomes were not verified and who had poor credit scores.
Even though Private Label Securities failed at over twice the rate of “agency” securities that does not mean that PLS are inherently bad. When markets get out of control it is almost always when the incentives of participants become misaligned to the point where they cause the risk of a market to increase due to the incentives in place. When originators had the ability to sell almost any mortgage they could originate, no matter how terrible, they had no incentive to make better loans because they made more profit by making bad loans. And up the chain those bad incentives existed. Everyone knowing that the system was out of line but no participant having the individual incentive to get it back into line.
The last group of market participants to become involved in non-prime lending were the government sponsored enterprises. The main thing that kept them from being involved earlier was that they were subject to heavy oversight and regulation about the types of loans they could purchase from originators. It is because they were watched so closely by their enemies and regulators that they didn’t get themselves into more serious trouble. That is probably the best argument for why in this particular market, the housing market, that entities like the GSEs need to exist to keep inbalances in a fully private system from spiraling out of control. If loan availability were completely unsubsidized with no implied or explicit government guarantees or lenders like FHA, then I too would agree with eliminating the GSES. Yes they were bailed out, but the bail-outs of Fannie Mae and Freddie Mac were politically motivated efforts to destroy the companies. The irony is that the GSEs had enough cash on hand to weather YEARS of maximum possible losses.
Yet once the Treasury Department got ahold of them they made them over-reserve in cash at a rate that turned out to be 5x the losses that they actually incurred. So the government during a conservatorship whose purpose was to supposedly rehabilitate the companies made them borrow billions in dollars in cash to lend out at 3-4 percent interest while paying 10 percent interest to the government to borrow the funds. The crime of the bail-out is that accounting adjustments are not cash losses until cash is actually lost. Simply put, the bail-out was designed to intentionally destroy the companies under the guise of saving them.
Without stupid political games, fraud, over-leverage, CDOs, and predatory lending targeting minorities, it turns out that mortgage lending is a boring business. That’s because it SHOULD be a boring business. Like children, bankers and Wall Street always need a new “toy” to trick the government and masses into thinking that what they do is somehow so mysterious that they will look like they are earning their money, or that people will be intimidated and impressed by their intelligence. You know what’s impressive and intelligent? Earning money providing a product that people want at a price that provides a good value. Fannie and Freddie have been doing that for over 100 years combined and have done it better than anyone else has been able to do it. It really is that simple. It’s time to get these companies out of conservatorship.
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