Parallel Universes

Civil discourse over fundamental issues is hard to find in our increasingly polarized politics. So it is with a bit of a leap of faith that this week a Cato Institute free market, flat tax booster and I attempt to have a sensible dialogue about the housing market, economic turmoil, and the proper role of government. Today's installment follows, and the full week of point/counterpoint can be found at the LA Times. You be the judges....let me know what you think.

October 14, 2008

Today's question: Who've been the real heroes and villains in Congress when it comes to housing policy? Previously, Abromowitz and Mitchell discussed whether Washington should give tax breaks to homeowners.

De-regulators brought us the meltdown
Point: David M. Abromowitz

Dan,

You invoked on Monday the widely circulated myth that our national foreclosure crisis and "Wall Street meltdown" stem from "government intervention" that promotes affordable home ownership. Like most urban legends, this one falls apart under close examination. The real story is just the opposite -- deregulation and non-intervention pulled us into the abyss.

Throughout the 1990s, federally regulated banks slowly expanded lending to low- and moderate-income families, partly due to more serious enforcement of the Community Reinvestment Act of 1977. That law simply requires that banks taking deposits from low- to moderate-income communities actually try to meet the credit needs of residents in those areas. Fannie Mae and Freddie Mac backed more loans to low- to moderate-income borrowers who could be responsible homeowners if allowed somewhat more flexible credit scoring and terms. The result? A strong increase in home ownership rates by the late 1990s, especially among low- to moderate-income and minority borrowers.

But these were still "prime" loans, conforming to national underwriting guidelines and income verification. Banks reserved capital for losses and were accountable for safe and sound underwriting. Not surprisingly, a careful staff review of 500 large banks in 2000 by the Federal Reserve showed that lending under the Community Reinvestment Act was neither riskier nor less profitable than other home mortgage lending.

Then came the explosion after 2000 in subprime loans by unregulated mortgage companies. These were high-cost loans with inadequate underwriting to borrowers with poorer credit histories. By 2005-06, subprime mortgages were nearly half of all loans made to home buyers. The vast majority of these loans were to higher income -- not low- to moderate-income -- borrowers.

Did government mandate this subprime surge to aid less-than-wealthy borrowers? No. And it would seem bizarre to think that the government forced Bear Stearns and other Wall Street investment banks to pocket billions in historically high profits by bundling millions of these "innovative products" into pools laxly given the highest credit ratings for sale to investors worldwide -- yet many conservative commentators would have you believe this.

Instead, the Bush administration and its free-market orientation, assisted by a Republican-controlled Congress advocating the same principles, systematically dismantled or under-enforced a range of rules the could have prevented the situation spiraling out of control. The referees who were supposed to be on the field calling fouls and keeping the mortgage game fair were told to go sit on the sidelines.

As my colleagues and I have described in greater detail, this happened in many ways. Take the Federal Reserve's failure in 2001, despite many warnings by consumer and other watchdog groups, to ban mortgage company practices such as charging high origination fees, providing little disclosure of the risks of adjustable interest-rate resets and retaining no risk after selling loans. This past July -- seven years too late and after millions of loans had gone to foreclosure -- the Fed finally invoked the Home Ownership and Equity Protection Act of 1994 and barred those "unfair, abusive or deceptive home mortgage lending practices."

Similarly, the Office of the Comptroller of the Currency in 2003 overrode efforts by states to protect their consumers from predatory mortgage lending. The Securities and Exchange Commission in 2004 permitted Wall Street investment banks -- the primary creators of the loan pools now dubbed "toxic mortgage assets" -- to vastly increase their "leverage ratio," borrow more money and lend more to mortgage brokers generating more subprime loans.

Yes, our government aided and abetted the housing market meltdown. But it did so by promoting its view of the best of what the free market could do. In many ways, the era of 2001-06 was intended to be the dress rehearsal for a pageant demonstrating that we no longer needed government involvements like Fannie Mae, Freddie Mac, the Federal Housing Administration or a regulated bank mortgage market system; the unregulated mortgage broker-Wall Street axis would do just fine, thank you. Unfortunately, we are all stuck with watching the pageant having turned into a colossal flop.

David M. Abromowitz is a lawyer and a senior fellow at the Center for American Progress Action Fund.

Republicans and Democrats both deserve blame
Counterpoint: Daniel J. Mitchell

We have both been asked to identify the heroes and villains in Congress. David, you 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.

You also argue that fraud has occurred, and this certainly is true, but because we both agree that criminal behavior should be punished, it's not clear what this has to do with either regulation or the topic we are supposed to discuss. Last but not least, you 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).

Now to the issue at hand. 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 at the Cato Institute, where he is an expert on tax reform and supply-side tax policy.

Comments

[bittertooth]

Quick Vote
Are women at work judged more by their appearance than men are?
Yes 88% 132420
No 12% 18841
Total Votes: 151261

That's a small city with the same number as Al Pacino's latest movie. I did the work, so sir, I get the credit.

Paris in London is not right. We need a national campaign to keep her in the US.

[Novista]

I love polarization! It's ideology when 'the other side' uses it but 'A great Shining Truth' when ~we~ say so.

Any faction that does not admit to owning *some* of the fault isn't worth following.

[Erdgeist]

Daniel J. Mitchell arguments are too ideological if not entirely abstract. I would bring to his attention something Team Bush did which launched predatory lending. In 2003, Team Bush using the OCC (Office of the Comptroller of the Currency) invoked a clause from the 1863 National Bank Act***. By doing this, the federal government effectively preempted all state predatory lending laws making them inoperative. So the cat was locked up in a cage so the rats could play. And play they did!

***http://query.nytimes.com/gst/fullpage.html?res=9904E2DA153EF932A3575BC0A9659C8B63
***http://www.washingtonpost.com/wp-dyn/content/article/2008/02/13/AR2008021302783.html

[Pdubya]

"Yes, our government aided and abetted the housing market meltdown. But it did so by promoting its view of the best of what the free market could do".

You can't manage a free market! Thats called corporatism - aka, fascism.

"Allow me to issue and control a nation's money and I care not who writes its laws!" Amshell Rothschild.

Free market tenets include allowing bad businesses to fail, freeing up illiquid assets for reinvestment.

Regulation vs. deregulation is a moot debate when it is structured within a Keynesian, centralized monetary system. It is akin to arguing over whether the gaping chest wound was caused by the mortar or its shrapnel.

Is there a call for regulation? Yes. Much more effective is your advesary's suggestion. Scrap what is on the table and simplify. Encourage whistleblowing and existing fraud and anti-trust laws. Regulate (cough) - abolish - the Federal Reserve, the REAL culprit of issuing funny money that dilutes the purchasing power of those enticed into risky loans. After a few years, their purchase power declines because of the devaluation of the dolar. It also affects those that could qualify for less risky home purchases.­..everyone is affected by their policy of inflation. Regulate the Presidential Working Group and the currency reserves.

You lost this round Mr. Abromowitz.

[MajorKong]

To someone from the Cato Institute conservative policies can never fail, they can only be failed. That's why they think the solution is even more deregulation. It's like a religion with these people. They just KNOW it has to work.

[Pdubya]

You are not a student of history, are you?

We've had managed markets for 95 years, fully put into gear in 1971 with the Bretton Woods breakdown.

You've accepted the paradigm that we're suffereing from the cancer of free-markets. We haven't had free markets..we've had managed markets all this time.

Free markets can not even exist within Keynesian, centralized bank economics - especially when the money is not issued by the market (thats you and me and our Congress). It is profoundly limiting when the currency is fiat.

It never ceases to amaze me the regurgitation of propoganda. Seriously, with few exceptions, no plutocrat on the Hill hasn't pushed the string of regulation vs. deregulation in our economy to benefit themselves and their cronies. When a certain regulation is rebuttled, another version is put in its place. Corporate lobby WRITES the regulation via whoring Congress.

www.mises.org

[MajorKong]

Wonderful. Let's go back to those fun-filled days before Keynesian economics when the boom/bust cycles were so severe that we had a Depression ever 20 years or so.

Hard to find a good analogy here, but if you took the rev limiter off your car it would indeed self regulate. When the motor got to spinning too fast it would naturally slow down when the connecting rods came flying through the block. It would also be one ugly, expensive mess to clean up afterward.

[LeftRight]

"Problem No. 3 -- the Community Reinvestment Act"

This one could theoretically be an issue, except for the minor little fact that of the top 20 mortgage lenders providing sub prime loans (which account for more than half of these loans.....) only ONE was subject to the CRA. The others were all on their own and almost COMPLETELY unregulated!!

[flanardiente]

A rule among Republicans is, if you can't blame it on Clinton, blame it on Carter. People who took out mortgages under the CRA when it was first enacted have likely paid off their houses by now. There is one thing I'd like to hear addressed by any champion of the so-called free market: if government intervention in the marketplace is so toxic, why are you people so frothing-a­t-the-mout­h eager for a taxpayer-funded government bailout?

[BillZBubb]

The right wing is really hilarious. Who knew the 1978 CRA was a stealth ticking time bomb that totally bypassed the 1980's and then the 1990's only to blow up in the late 2000's! That really was some trick by that Jimmy Carter. Sometimes I fear that they even believe their own nonsense.

[Snowball]

It's fascinating how Mitchel merely ignores that you just blew to pieces his argument that the CRA was responsible for this mess and simply restates it as if it were a given fact. There is no arguing with the free market fundamentalists, like the predictably rigid dogmatic ideologues they are, they simply regurgitate their predetermined talking points, facts and evidence be damned.