Topic: Economic Policy
Forcing Mortgage Lenders to Give Mortgages to Poor by Jeff Peters
(conservative)
Friday, March 6, 2009
In this article Economist Thomas Sowell states that what caused the housing crisis was in fact government intervention.
His thinking goes like this: regulations by the Housing and Urban Development (HUD) Department required mortgage brokers to give mortgages to the "disadvantaged." It was advised by HUD that brokers engage in creative lending in an effort to lower standards so that the poor can receive credit.
Sowell then goes on to say sarcastically that it is then immediately "obvious" to politicians that once these creative lending efforts, aimed at increasing mortgages and credit to the disadvantaged, failed that the "market has failed."
In actuality, Sowell would reply, mortgage brokers were forced to take risks that they normally wouldn't take. Sowell does mention the quote "lending money to American homebuyers had been one of the least risky and most profitable businesses a bank could engage in for nearly a century."
This makes a ton of sense. Usually when the government involves itself in the market, it tends to neglect the potential side effects of its incentives.
I do believe that Sowell is taking a one sided point of view.
Firstly, allow me describe a very simple labor compensation scheme. Consider a worker that is being compensated for his or her output by commission. Also suppose that this worker is high ability and has exhausted the number of "legitimate" transactions.
To apply this model to the current situation: the worker paid on commission is a mortgage broker and this person is very good at what he or she does and can no longer find customers with the required level of credit.
Assuming there's no cap on pay, and assuming that this high ability mortgage broker can still and wants to get more money if he or she continues to intermediate mortgages, will this broker stop working?
The answer to that is probably not - this worker will go on to sign mortgages even for individuals that obviously show no signs of good credit history. If there are no disincentives for signing on bad mortgages they will continue to do so.
All in all, it's not necessarily true that the government had to intervene to make the market worse since incentives for bad behavior are not always purged from profit maximizing firms.
Create an email alert for new articles by Christopher Espinal by going here.
Did you like this article? If you did, Thumb It! 2 thumbs so far
The views expressed in this
article are those of Jeff Peters only and do not represent
the views of Nolan Chart, LLC or its affiliates. Jeff Peters is
solely responsible for the contents of this article and is not an
employee or otherwise affiliated with Nolan Chart, LLC in his/her role as a columnist.
Posted By: Walt Thiessen
Date: 2009-03-06 01:44:35
Sowell is more right than you are, because your analysis fails to answer a simple, basic question: why didn't the lenders engage in foolish lending practices en masse before now? Did they all take stupid pills? Did the government remove prior limitations on lenders that caused them to start behaving so stupidly?
The answer of course is no, they didn't take stupid pills, and the government didn't stop doing some regulating that it had previously been doing all along which led the out-of-control lenders to suddenly start wreaking havoc on the economy.
So what changed? Why did lenders suddenly start acting as if they were stupid, after years of intelligent and (relatively) prudent lending practices? Until you can answer that question, you haven't got this issue licked.
Posted By: Christopher Espinal
Date: 2009-03-06 09:03:02
You are probably right lenders were forced to make stupid decisions and suddenly exhibited stupid behavior.
I guess this is more of a theoretical question, but then you could ask why did many people before the Depression make a similar mistake: take excessive amounts of loans to purchase stock on the margin? This question does assume that purchases of stock in the late 20's were excessive. I think in general it's people taking too much risk, unless the same sort of regulation was present during the 20's as well.
Hi Chris, Good point. You are right in that too much blame was put on this type of loans by the fingerpointers and brokers will "tweak" the rules any time. When "qualifying" for anything is required, the rules can and will always be bent. It is just another form of risk and return.
The main rule that is in place though is still supply and demand of money. The amount of money available determines the amount of loans given out, bankers don't let money sit around and can't loan it when they don't have it.
The more money, the better every potential applicant looks coming in the bank door, the more brokers and bankers will help "adjust" applications to make them work. The lower the interest rate, the more potential purchasers.
Posted By: Jahfre Fire Eater
Date: 2009-03-06 21:08:29
Hi Christopher,
There are several assumptions underlying your article/Sowell's article that I just don't buy. Until I ask about those I can't begin to assess your take on the situation.
I don't buy that:
1. Banks began to take on mortgage risk. I say banks were given a pass on mortgage risk through the derivatives market. Why? To extract profit from a previously idle, massive resource. By whom? I don't know the detailed history of the evolution of the derivatives market. I'm more interested in the cause and effects than I am in the people involved. I'm not sure which came first, the increased risk or the safety valve of derivatives.
The risks were ultimately not incurred in the loan origination but in the banks stupidity regarding what they did with that tremendous new fee-based revenue stream. They invested in derivates. Mortgage sausage comprised of the risky loans they had made with no risk. To make this point clear I often liken it to drinking the effluent from one's own compost heap.
Are bankers stupid, or is blind greed to blame? I'm sure there was plenty of both to go around. I also think that the personal investments of the people who were driving the accelerating spiral of leveraging worthless sausage as if it had solid redeemable value were the reason the situation was so pervasive and so acceptable. It looked like a perpetual profit machine to everyone who was receiving the proceeds.
Point to ponder: If one truely believes to have become part of a perpetual profit generating machine can it really be called greed or is it simply common sense to keep it going? I vote for greed. :-)
2. The "poor" were the bulk of the increase in bank mortgages. Obviously banks started making vastly more loans and yes some of them were to lower income families. That group didn't fuel the housing bubble because they were POOR! A bubble is caused by ever increasing cash chasing a slower growing commodity. The bubble wasn't inflated by increasing the cash coming from the poor. That was just one single puff into the balloon for each borrower. The bulk of the increase came from two areas, speculators and those with increasing incomes, who far outnumbered the poor both in volume and number of transactions per family.
3. The derivatives market changed the mortgage business from a risk management / investment model to a fee-based model. Once banks were released from the risk, if they every incurred it to begin with, depending on which came first, they eagerly pursued means of increasing their transaction volumes and they weren't forced in any way. It was simply a money machine. The more transactions, the more fees. Crank it UP! Was the strategy of the day.
4. Any other government intervention aside from inflationary monetary policy can hold a candle to that juggernaut with regard to the housing bubble. The government needed to get lots of cash into circulation to keep the fraud from being discovered. Hey, lets go with a plan that requires new and accelerating amounts of cash forever! Freaking morons.
#3 that Jahfre mentioned is very important. The loan became of no importance other than to close it and pass it on at a profit. interest rate, qualifications, terms, etc. meant little, it all would someone else's responsibility and a profit would be made.
this profiting on capital itself, rather than interest, is a sure sign of "fictitious" or phony capital. capital in a sound economy is worthless unless applied back to labor and resource. if you can somehow change the rules and profit within and on only the capital [rather than production] you can direct profits and wealth anyplace you want until what is being done is brought to light. then we all have problems!
Want to comment on this
article? Leave your comment here. Your email address is
required to track your comment. However, we will neither
publish your email address nor distribute it to other
organizations or persons. The only reason we might use
it would be if we needed to contact you regarding your
comment. All comments are subject to our
terms of use policy.
