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Like many of you, I am trying to wrap my head around the “crisis” that we are in (I hate that word…thus the scare quotes). I’m going to try to piece together a few good articles and tidbits from bloggers to help us all understand this better.The first piece is A Mortgage Fable by the Wall Street Journal Editorial Board (h/t Ramesh Ponnuru)
But Washington is as deeply implicated in this meltdown as anyone on Wall Street or at Countrywide Financial. Going back decades, but especially in the past 15 or so years, our politicians have promoted housing and easy credit with a variety of subsidies and policies that helped to create and feed the mania.
The piece then goes on to cite five different government actions and the ratings agencies as the causes of the problems we are in:
The Federal Reserve
Fannie Mae and Freddie Mac
A credit-rating oligopoly
The Bear Sterns Rescue
The Community Reinvestment Act
Our point here isn’t to absolve Wall Street or pretend there weren’t private excesses. But the investment mistakes would surely have been less extreme, and ultimately their damage more containable, if not for the enormous political support and subsidy for mortgage credit. Beware politicians who peddle fables that cast themselves as the heroes.
[Kevin Hassett on Bloomberg.com reminds us that the Democrats created the mess with Fannie and Freddie. “Fannie Mae and Freddie Mac exploded, and many bystanders were injured in the blast, some fatally.” It was the Democrats that protected Fannie and Freddie back in 2005.]
The editorial does make a passing reference to the “mark-to-market” accounting rules that are certainly a contributor to the problem. For a little bit more on that, we turn to a piece by Brian S. Wesbury and Robert Stein in First Trust Portfolios(pdf)(page 1)(h/t to Iain Murray)
Imagine if you had a $200,000 mortgage on a $300,000 house that you planned on living in for 20 years. But a neighbor, because of very special circumstances had to sell his house for $150,000. Then, imagine if your banker said you had to mark to this “new market” and give the bank $80,000 in cash immediately (so that you would have 20% down), or lose your home. Would this reflect reality? Not at all. Would this create chaos? Absolutely.
And that in a nutshell is what happened to the securitized mortgages. A domino effect kicked off causing everyone to lower their numbers on the security backed mortgages. This hit their credit ratings making it more difficult for them to get money in the credit markets. When financial companies can’t get money, they tend to go broke (i.e. Bear Stearns).
Randal O’Toole of Cato-at-Liberty would also like to remind us that land use regulation had a part in the problem:
The housing bubble was not universal. It almost exclusively struck states and regions that were heavily regulating land and housing. In fast-growing places with no such regulation, such as Dallas, Houston, and Raleigh, housing prices did not bubble and they are not declining today.
They say that the addition of Fannie Mae and Freddie Mac merely excacerbated the problem created by overly zealous urban planners. The scarry part about this being a factor is that if left unchecked, we will assuredly see another housing bubble.
The Editors at National Review Online take up the defense of the Gramm-Leach-Bliley Act of 1999.
Gramm-Leach-Bliley did not create securitization and collateralized debt obligations. It did not change the rules for banks’ leverage ratios. If anything, Gramm-Leach-Bliley mitigated some risks by allowing financial companies to diversify their businesses, and it is the most diversified firms that are best weathering the storm. Which makes sense: An investment portfolio is more stable the more diversified it is. The firms that have spectacularly imploded have mostly been non-diversified commercial banks, like Countrywide, or pure investment banks, like Lehman Brothers. But the broadly diversified megabanks are enduring — taking a hit from housing, sure, but they have other lines of business to sustain them. And we should not forget: Without the Gramm-Leach-Bliley reforms, Bank of America would have been legally forbidden to take over Merrill Lynch — very possibly leaving taxpayers on the hook for that one, too. Morgan would not have been able to buy Bear Stearns without Gramm’s reforms.
So, in short, don’t knock G-L-B. It helped save us when the stuff hit the fan this year. [They also attack Fannie and Freddi and the Community Reinvestment Act as causes of the “crisis”.]
Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.
Funny how that sounds exactly like what we are going through right now.
To try to wrap a nice little bow on this whole thing: The government created this damn problem. Let’s see if they act properly to fix it (That is going to take another post when I can digest the mountains of material that is coming out on the various plans and suggestions.)