Commentary

Who Are the Villains of the Mortgage Mess?

In this current mess, one problem is identifying the heroes and villains in Congress. Many analysts conveniently dodge this question and instead make the rather novel claim that the turmoil in financial markets somehow is the result of deregulation. Yet the financial services industry is probably the most heavily regulated sector of the American economy, saddled with hundreds of laws, thousands of regulations and a plethora of government agencies. If red tape were the answer, this problem never would have happened.

Many lawmakers want more rules and regulation governing disclosure, ostensibly to protect consumers. But the existing policies already have created a jumble of legalese that even highly sophisticated borrowers have trouble grasping, so it is far from apparent how this would help. A far better approach would be sweeping deregulation, replacing all the current clutter with a simple, easy-to-understand disclosure form, such as the one proposed by Alex Pollock of the American Enterprise Institute (PDF).

Back to identifying the heroes and villains. To assign blame, it is first necessary to understand what caused the problem. At the risk of oversimplification, let’s touch on three main causes of the financial turmoil and identify the culprits in the political world:

Problem No. 1— easy-money policy from the Federal Reserve: In an ideal world, the Federal Reserve provides the liquidity needed to enable commerce but avoids excess liquidity to avoid either rising prices (which happens when excess money bids up consumer prices) or bubbles (which happens when excess money bids up asset prices). The Fed clearly failed in this regard, as evidenced by unsustainably low interest rates earlier this decade.

Culprits: Almost every single politician deserves a share of the blame. The political class likes easy money. In the early stages, inflation feels good. Voters feel like they have more money in their pockets and borrowers (who always outnumber lenders) like the artificially low interest rates. And that is why very few voices were raised against the Federal Reserve’s policy.

Problem No. 2 — corrupt subsidies from Fannie Mae and Freddie Mac: These government-sponsored enterprises were created explicitly to distort the flow of capital and encourage over-investment in residential real estate. Responding in part to campaign contributions (a clear conflict of interest), politicians dramatically expanded the power of Fannie and Freddie in recent years, thus creating widespread systemic risk because of the implicit (now explicit) government guarantee.

Culprits: Many politicians from both parties were recipients of campaign contributions from the Fannie and Freddie slush funds, though Democrats had their hands much deeper in the cookie jar. The Bush administration has a very dismal economic record, but the White House does deserve some credit for having tried to rein in Fannie and Freddie earlier this decade. Opponents, led by Democrats Barney Frank in the House and Chris Dodd in the Senate, blocked reforms that would have saved huge amounts of money for taxpayers.

Problem No. 3 — the Community Reinvestment Act: Politicians imposed numerous regulatory burdens on financial institutions, but “affordable lending” requirements such as those imposed as a result of the Community Reinvestment Act were among the most perverse. In effect, banks were extorted into making loans to people who were not credit worthy. This added to the bubble and expanded systemic risk. It’s also worth noting that poor people were victimized by this government policy, because many of them were lured into houses they could not afford.

Culprits: President Carter presumably deserves some of the blame because many of these policies were first imposed during his dismal reign, primarily with support from Democrats. But the so-called affordable-lending requirements were expanded during the Clinton and the current Bush administrations, so the GOP is not without blame.

Daniel J. Mitchell is a senior fellow specializing in tax issues and author of The Flat Tax: Freedom, Fairness, Jobs, and Growth.