Topic: Finance, Banking & Monetary Policy

What Caused the Crisis?

Last night National Government Radio promoted a documentary on National Government TV about the financial crisis of 2008, which concludes that the problem was … not enough government.

If the “Frontline” episode mentioned any of the ways that government created the crisis – cheap money from the central bank, tax laws that encourage debt over equity, government regulation that pressured lenders to issue mortgages to borrowers who wouldn’t be able to pay them back – NPR didn’t mention it.

For information on those causes, take a look at this paper by Lawrence H. White or get the new book Financial Fiasco by Johan Norberg, which Amity Shlaes called “a masterwork in miniature.” Available in hardcover or immediately as an e-book. Or on Kindle!

And for a warning about the dangers lurking in Fannie Mae and Freddie Mac, see this 2004 paper by Lawrence J. White.

Regulation and Competition among Mortgage Brokers

With the House Financial Services Committee moving forward with a bill to increase the regulation of our consumer credit markets, particularly our mortgage market, it is worth asking the question:  what’s the best protection for consumers, regulation or competition?

Let’s take the example of mortgage brokers.  They’ve often been targeted as one  of the causes of the crisis.  The story goes that they just made the loans and passed it along to the lenders and/or Wall Street and so, didn’t care about the quality of the loan.

The response of government, first at the state then the federal level, has been to subject mortgage brokers to increased oversight and licensing, with the intent to keep the “bad actors” out of the marketplace.  How well did this all work out?

According to Professor Morris Kleiner and Minn Fed Economist Richard Todd, not exactly the way you’d want.  What the economists found was that tighter regulation on who can become a mortgage broker is actually associated ”with higher broker earnings, fewer brokers, fewer subprime mortgages, higher foreclosure rates, and a greater percentage of high-interest-rate mortgages.”

It seems the barrier to entry created by these licensing requirements reduced competition in a manner that caused far more harm to consumer than any protections provided by increasing the “quality” of mortgage brokers.

Sound Money Essay Contest

Our friends at the Atlas Economic Research Foundation are offering prizes for the best essays on sound money by students and young faculty and policy analysts:

The Atlas Economic Research Foundation invites you to participate in its Sound Money Essay Contest, which has a deadline of November 24th, 2009.

The contest is open to students, young faculty, and policy writers who are interested in the cause of sound money.  It aims to engage you in thinking about sound money principles with relevance to today’s economic challenges.

The overall winner will receive a cash prize of $5000.  Two additional prizes of $1000 each will be given to outstanding essays written by junior faculty, graduate students, or policy writers.   And three additional prizes of $500 each will be given to outstanding essays written by undergraduate students.

Essay topics include:

·      “Money and the Free Society: Can Money Exist Outside of the State?”

·      “The Ethical Implications of Monetary Manipulation”

·      “Monetary Policy and the Rule of Law in the United States”

To be eligible, you must be a legal resident of the U.S. or engaged as a full-time student or faculty in the U.S.  You must also be no more than 35 years old on the date of the contest deadline (November 24, 2009).   Atlas welcomes involvement of older and non-U.S. scholars in its discussions and ongoing work on sound money, but this essay contest is targeted to the audience described above.

For a list of reference materials and writing guidelines, please visit the Atlas website.

And for Cato research on sound money, check here.

Federal Reserve as Cash Cow

Scheduled for consideration before the House Financial Services Committee this week is a draft bill creating a Consumer Financial Protection Agency. 

While there is a lot wrong with the bill – after all it is based on the premise that somehow consumers were tricked into not making a downpayment or re-financing thousands out of their homes, and then walking away – perhaps the most important provision, and the least discussed, is funding the agency by a transfer of cash from the Federal Reserve.  Section 119 of the bill requires the Federal Reserve to transfer an amount equal to 10 percent of its expenses to the new agency’s Director. 

This I believe is the first time in history that Congress is using the Federal Reserve to simply fund another agency.  Why stop there, how about have the Fed just prints trillions of dollars to pay for the rest of the government?  If Congress believes this agency will benefit the public, then the agency should be funded by the public, by a direct appropriations raised by taxes. 

Of course after watching Ben Bernanke turn the Fed’s balance sheet into a slush fund for Wall Street, it was only going to be a matter of time before someone in Congress decided to use that slush fund for their own purposes.  So much for transparency in government.

What’s Wrong With Being A Renter?

A recent New York Times piece focusing on the financial health of the Federal Housing Administration (FHA), offered a couple of examples of borrowers who would not have gotten mortgages, but for FHA’s low downpayment and underwriting requirements.

Take for instance a Ms. Shimon, mentioned in the piece.  If she had to come up with a larger than 3.5 percent downpayment, she “would still be a renter,” in the words of the New York Times.  Yes, my reaction was probably the same as yours; no, not that, not a renter, anything but being a renter.  I am trying to remember at what point in our history did being a renter become a social stigma, or some sort of disease to be cured?  Of course, the article does not explain why it would be bad if Ms. Shimon had stayed a renter, because apparently the New York Times assumes all decent, upstanding people own their own homes.

Now yes, there are dozens of academic studies that show owning your own home is associated with being a better citizen, better educational and health outcomes for your children, and greater savings on the part of owners.  But it is important to remember that none of these studies show that homeownership causes these outcomes, just that on average, homeownership is associated with these outcomes.  More importantly, the marginal homeowner, who would not have bought a home without some sort of subsidy, is likely to be quite different than the average homeowner.

Some, like my home-building friends, might justify ever-expanding homeownership because it creates construction jobs.  But so does building apartments.  If we had a shortage of apartments, then maybe encouraging people to buy homes would relieve pressure on the rental market.  But the glut of apartments is almost as big as the glut in homes.  Rental vacancy rates are near historic highs in much of the country.  Even with declining home prices, in many places it still makes more financial sense to rent.

The federal government’s obsession with homeownership was one of the contributing factors to the financial crisis.  It is time we recognized renting as a viable option for many households, and starting treating renters as if they were as equal citizens as anyone else.

Perpetuating Bad Housing Policy

Perhaps the worst feature of the bailouts and the stimulus has been that, whatever their merits as short terms fixes, they have done nothing to improve economic policy over the long haul; indeed, they compound past mistakes.

Here is a good example:

For months, troubled homeowners seeking to lower their mortgage payments under a federal plan have complained about bureaucratic bungling, ceaseless frustration and confusion. On Thursday, the Obama administration declared that the $75 billion program is finally providing broad relief after it pressured mortgage companies to move faster to modify more loans.

Five hundred thousand troubled homeowners have had their loan payments lowered on a trial basis under the Making Home Affordable Program.

The crucial words in the story are “$75 billion” and “pressured.”

No one should object if a lender, without subsidy and without pressure, renegotiates a mortgage loan. That can make sense for both lender and borrower because the foreclosure process is costly.

But Treasury’s attempt to subsidize and coerce loan modifications is fundamentally misguided. It means many homeowners will stay in homes, for now, that they cannot really afford, merely postponing the day of reckoning.

Treasury’s policy is also misguided because it presumes that everyone who owned a house before the meltdown should remain a homeowner. Likewise, Treasury’s view assumes that all the housing construction over the past decade made good economic sense.

Both presumptions are wrong. U.S. policy exerted enormous pressure for increased mortgage lending in the years leading up to the crisis, thereby generating too much housing construction, too much home ownership and inflated housing prices.

The right policy for the U.S. economy is to stop preventing foreclosures, to stop subsidizing mortgages, and to let the housing market adjust on its own. Otherwise, we will soon see a repeat of the fall of 2008.

New Paper: Would a Stricter Fed Policy and Financial Regulation Have Averted the Financial Crisis?

Many commentators have argued that if the Federal Reserve had followed a stricter monetary policy earlier this decade when the housing bubble was forming, and if Congress had not deregulated banking but had imposed tighter financial standards, the housing boom and bust—and the subsequent financial crisis and recession—would have been averted.

In a new study, Cato scholars Jagadeesh Gokhale and Peter Van Doren investigate those claims and dispute them.