Foreclosure Misery: Government’s Intervention in Housing
Today it was announced that banks foreclosed on 288,345 houses in the past three months, the highest amount of foreclosures in any three-month period since 2006. It’s estimated that 1.2 million homes overall will be foreclosed in 2010. Well, gee, looks like government bailouts of the financial industry have paid off! Despite hundreds of billions of dollars in bailouts, piles of regulatory codes, and vastly expanded government power, the pinch on Main Street is tightening and more people are losing their homes. It makes you wonder, how did all this happen in the first place and why hasn’t increased government intervention solved the problem?
Since the early 20th century it has been the initiative and policy of the federal government to lower the price of housing so every single family could own a home. Other arrangements that would commonly arise in a free market (such as renting) just don’t fit into the government’s version of the “American dream.” One of the first to lobby for governmental support of individual home ownership was President Herbert Hoover. On July 22, 1932 Hoover signed the Federal Home Loan Bank Act, and he explained the purpose of the bill “is to establish a series of discount banks for home mortgages.” In other words, the federal government would help organize the mortgage loan industry and provide cheaper loans for people to obtain, thus increasing home ownership. Hoover went on to explain:
“In the long view we need at all times to encourage homeownership and for such encouragement it must be possible for homeowners to obtain long-term loans payable in installments. These institutions should provide the method for bringing into continuous and steady action the great home loaning associations which is so greatly restricted due to present pressures.” — Herbert Hoover (Emphasis added.)
The “present pressures” of course being the Great Depression, an eensy-weensy economic slump that resulted in banks giving out fewer loans. Still, Hoover thought this was an appropriate time for government to encourage people to buy a house even if the economy was in dire circumstances. So began the history of the federal government’s intervention in the mortgage market, often subsidizing or forcing banks to lower their lending standards and give loans to people regardless of their ability to pay them back.
Taking Hoover’s actions a step further, President Franklin Roosevelt signed a bill that led to the formulation of Fannie Mae 1938. (Fannie Mae was split up into Freddie Mac and Ginnie Mae as well under the Johnson Administration.) Interestingly, these government-sponsored enterprises (GSEs) were created to help bail out banks who were faced with (wait for it…) a growing number of mortgage defaults.
Essentially the scenario looks like this: First the government organized banks to lower the price of mortgages in 1932; once people bought the loans, however, many were unable to pay them back and forced to default; upon seeing this flow of events, Roosevelt attempted to bail out the industry by creating Fannie Mae in 1938. This was the beginning of the secondary mortgage market, the practice where the GSEs (using taxpayer dollars) purchase mortgages from banks, thereby freeing up money for the banks to provide more mortgages.
“The GSEs are companies created by Congress to bring liquidity, stability, and affordability to the nation’s residential mortgage markets. Traditionally, we’ve fulfilled this role by purchasing mortgages in the secondary market and bundling them into mortgage-related securities that can be sold to investors or held in our portfolio.” — Ed Haldeman, Freddie Mac CEO
This new setup encouraged banks to offer loans to riskier clients who in an actual market scenario would not be eligible to purchase a mortgage. Because of government’s creation of the secondary mortgage market banks found themselves with extra liquidity, which was used to offer loans to financially-insecure individuals. It’s not tough to do the math: riskier customers lead to a higher likelihood of default. These policies have the least desirable impact on the poor people they are intended to help. In reality, it is much more economically feasible and sensible for a poor person/family to rent a house or apartment than to buy a house. However, artificially low mortgage rates lure poor people into an investment they won’t possibly be able to pay back. Government’s intervention creates a market imbalance that pushes the poor into buying a house when it is almost certainly not in their long-term interest to do so.
The painful effects of foreclosure we see today are the inevitable consequence of ongoing government meddling in the mortgage market. Government either subsidized or forced banks to offer risky loans to risky customers, but when the entire scheme begins to collapse we’re told it is a failure of the free market. (As if Fannie Mae, Freddie Mac, the Federal Housing Administration, and other such entities were created through free, voluntary exchange and not by politicians and bureaucrats.)
Before someone blames the current economic mess on “deregulation” and injustices of the free market, consider this action undertaken by the Clinton Administration, as explained by the New York Times:
“In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.”
…
“In moving, even tentatively, into this new area of lending, 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.” — New York Times; September 30, 1999
Historical evidence clearly shows that government has led the endorsement of subprime mortgages and lower lending standards, with complete disregard for the economic misery that erupts out of such policies and programs. Increasing bailouts will merely delay and worsen the inevitable collapse of the modern mortgage industry that government has played a major role in creating and sustaining.
Even so, you might say, on September 24, 2008, John McCain suspended his presidential campaign with the selfless objective to pass emergency legislation to “protect taxpayers and homeowners,” so the government must know what it’s doing, right? What America got in September 2008 were the TARP bailouts which, given the situation of the mortgage market today, haven’t done squat to “protect homeowners.” Given the government’s miserable record of attempting to provide affordable housing, who in the world expects more government intervention to save homeowners this time around? You can’t save a drowning person by throwing more water on him, nor can you save a government-manipulated economy with more government intervention.
The free market is the best tool to save the housing market and actually provide affordable housing for those who need it. Allowing liquidation of the housing market is necessary and would bring a short-term correction, but it would end the ongoing misery homeowners are experiencing due to government manipulation in the first place. Housing prices would drop to levels most potential homeowners could actually afford, and it wouldn’t require one dollar of government intervention.
For a true recovery to take place you don’t need increased government spending, intervention, or control; all that’s needed is a return to the free market, where individuals will manage their lives and economic decisions far better than any politician or bureaucrat in Washington D.C. The free market is the only option for a sustainable, lasting, and prosperous recovery.
I disagree with most of the points except that it has been the government’s policy to encourage home ownership. Happy you brought up the Federal Home Loan Bank System. If you or anyone else is interested in the history of the FHLBank System you might find the book, “Mission Expansion and the Federal Home Loan Bank System” of interest. It was just published by SUNY University Press and it details the history and development of the System including the current crisis. You can find it on Amazon.
Hi Mark,
Do you think government intervention and lowering of lending standards didn’t play any part in the current mortgage mess? I think it’s clear that government involvement played a large role in creating the housing bubble and collapse. I didn’t mention the Federal Reserve in this article but artificially low interest rates had a major role in expanding banks liquidity, which they subsequently lent out in higher risk mortgages.
I appreciate the book tip, I’ll take a look! Thanks for your comment.
Good article so far David, however I think you’re primarily talking about the early history of the housing problem. You’re leaving out several (IMHO) important parts. For instance the Bush administration knew there were problems and tried to “stop” the bad loans and it was Rep. Barney Frank who shut down any attempts to “fix” the situation.
Rep. Barney Frank, a well known homosexual, had a partner who was the number two guy in (Freddie/Fannie?) at the time this was going on. Doesn’t this pose any ethical problems? Can you imagine a Republican whose wife was the number two person in charge of Freddie/Fannie and this happening?? Not to mention the fact that one of his friends/partners (I’m not sure which) was running a male prostitution ring out of one Barney’s homes. (He was cleared of any wrongdoing… I’m sure he’s totally innocent).
IMHO Barney Frank is one of the primary, if not the main reason we are in this housing debacle. He has stymied every attempt at correcting the housing problem and to this day the problem hasn’t been solved. It is only a matter of time before this comes back and hits us again.
Furthermore, Mr. Frank is the chairman of the House Financial Services Committee. Using his position he is personally blocking the audit of the Fed. Even thought 300+ Representatives and Senators want to audit the Fed, Mr. Frank can, as chairman, block this audit (or rather not bring a bill before congress).
On top of all this housing crap, they give the leadership (Franklin Raines and others) of Freddie/Fannie almost 100 million in bonuses. Of course it was proven they (Raines) were fraudulently doctoring the books and had to give a lot of the money back… BUT criminal charges were never filed AND Franklin Raines was “promoted” to another organization.
There is so much corruption at Freddie/Fannie it’s unbelievable.
http://en.wikipedia.org/wiki/Freddie_Mac
“Much of the illegal fund raising benefited members of the House Financial Services Committee, a panel whose decisions can affect Freddie Mac.” (can you say Barney Frank and others?)
One more interesting tidbit, the government now owns approximately 96% of all mortgages in the USA. Does that concern anyone besides me?
I know your time is limited, but keep digging on this housing “bubble” caused by government interference. There is a lot more to it than many people realize.
As you say, the government needs to get out of the housing market and let the Free Market do what it does best!
Hi Kevin,
You’re certainly correct regarding the corruption this whole decade. Barney Frank has been a stalwart objector to transparency and accountability with government organizations, however I didn’t feel I had the space in this article to go into that.
Bush took similar positions to Bill Clinton on using government to lower lending standards, so it’s certainly not an issue of party. While Clinton pressured Fannie and Freddie, Bush primarily used the Federal Housing Administration (I believe FHA lending standards were lowered to the point that hundreds of thousands of people got loans regardless of their ability to pay them back. Nice idea, but we’re feeling the consequences of that today.)
There are many culprits responsible for growing the artificial housing bubble, the most major one I believe is the Federal Reserve which gave banks the extra liquidity to begin with. For this article I primarily wanted to focus on the agencies created in the Great Depression and the role they played in today’s collapse.
Thanks for mentioning Barney Frank and the other factors that helped get us to where we are today. If I ever get the time to write a longer piece on the housing situation I’ll be sure to mention them.
I’m just trying to give people a basic overview of the secondary mortgage market and the understanding that there hasn’t been a free market in mortgages for a long time.
Thanks again for your comment! It’s much appreciated as always.
Love the new site David! Great article as well.
Thanks for the feedback David! I’m loving this new setup.
I’ve got your CAPS blog bookmarked now, so we’ll definitely be staying in touch. Keep up the great work and if you ever want to collab on something do let me know; I’d love to help promote your work.
David,
I understand space is limited and with a subject like this it could take up a lot of pages.
You’re also right about being plenty of blame to spread around. The Bush administration is no angel in this matter, although they did realize there was a problem. I’m sure many people on both sides of the asile knew there were problems but either didn’t care, couldn’t do anything about it or even wanted it to continue.
I’ve read that much of the housing problems started under the Carter administration. I haven’t had time to research it, but maybe I will.
No doubt the Fed has it’s hands in this mess as well. All the more reason to audit their books! If the Fed didn’t have anything to hide, why not open their books…. I’m just saying.
Did you know the Fed made $76 Billion last year (or so I’ve heard) and the year before that they made $50 Billion +/-. That $50 Billion was the most money any company in the history of the world has ever made in one year. I would be willing to bet that $76 Billion is another record breaker. How come BP (i.e. Big Oil) gets slammed for obscene profits and yet people never hear a peep about the Fed??
Great article! I enjoyed the history lesson on Fannie Mae & Ginnie Mae. Thanks.
Nice article, I like this format better than the old Freedom Chatter. I think the emphasis must always be with the FED. It is the FEDS expansion of credit that causes these bubbles. In what sectors of the economy these bubbles manifest is basically incidental. In this case government programs designed to increase home ownership (although in reality home ownership didn’t increase so much as additional home sales) channeled the excess credit into a housing bubble. However even if the government had not had mercantilist corporations like Fanny or Freddy the expansion of credit would have manifested someplace else. Several people here have pointed out other layers of corruption (like Barny Frank). To be sure this corruption is real, but its rather akin to pointing out shoddy construction on an office chair on top of a 30 story building which has a faulty base. It may actually be defective, but the more serious issue by far is the shaky construction of the base. In our world the most serious problem is the FED, monetary policy, and the role of the state within society generally. Most other major social problems are ancillary to these.
Hi Austrogetorix,
Glad you like this format! It’s easier to maintain and is a cleaner look; I continue to get good feedback on it.
As I mentioned to Kevin here in the comments, I agree that the Federal Reserve is the key piece of the puzzle. I’ve written a good amount about the Fed in the past, and here I wanted to give an overview of the secondary mortgage market and the government’s obsession with “home ownership” stemming from Herbert Hoover (supposedly the laissez faire president who didn’t want to intervene in anything). Hoover had always seen home ownership as a worthy governmental endeavor since he became Secretary of Commerce, and not too many people know about this.
Anyway, I fully agree with your statements about the Fed and monetary policy. I wanted this article to focus more on the mortgage market and government’s ambitions in home ownership. I believe these policies would have been disastrous with or without the Fed, but there is no doubt the Fed played a major role in allowing this to go as far as it did.
Thanks for your comment!
Best,
David
Next time, put in the entire NYT quote.
To continue;
“…In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates — anywhere from three to four percentage points higher than conventional loans.”
Selfless John McCAin… Brother!