The Subprime Housing Crisis -Becker
...Many economists and members of Congress have claimed that the housing crisis was greatly magnified because unqualified home buyers with limited incomes and assets were not fully aware of the terms of their mortgage loans, such as that the low initial (teaser) interest rates were only temporary. This belief in the beneficial effects of greater knowledge about mortgage terms is inconsistent with the evidence that the most sophisticated banks and investment companies, including Merrill Lynch, Citibank, and Morgan Stanley, have written down their housing investments by billions of dollars. No one can reasonably claim that these banks lacked the skills and knowledge to evaluate all the terms of, or the likelihood of repayment, on the subprime and other mortgages that they originated or held as assets. The losses to investors have been so large, and have so eroded their capital base, that some of the major investment companies have needed large infusions of capital from Middle Eastern and Asian Sovereign Funds (see our discussion of these funds on December 10th).
Although there was some fraud by mortgage lenders and by borrowers, fraud was not the main reason why so many subprime mortgages were issued. Otherwise savvy investors greatly undervalued the risks associated with many of the mortgage-backed securities that they held. They and borrowers alike did not fully appreciate that interest rates were likely to increase from their unusually low levels, and that many borrowers lacked the financial means to meet their mortgage repayment obligations at higher rates, and sometimes even at the low initial rates they had received.
Given the low interest rate lending atmosphere of the past few years, it is highly unlikely that borrowers would have turned down the mortgages they received if they had much better information about terms, or that lenders would have been more reluctant to originate or hold these mortgage assets if they had better information about the credit and other circumstances of borrowers. This is why I doubt that the rules proposed this week by the Federal Reserve to require lenders to get more information about borrowers, and to provide more information to borrowers about the terms of mortgage loans, would have been effective in warding off this crisis, or will be effective in preventing future crises.
Some have proposed that families should not be allowed to get mortgages if they do not meet minimum standards of income and assets, even if lenders would be willing to provide mortgages, and would-be borrowers still want a mortgage after being informed of the risks. This proposal is a dangerous form of paternalism that denies the rights of both borrowers and lenders to make their own decisions. Moreover, it is ironic that only a few years ago, banks were being investigated for "redlining"; that is, for avoiding lending to blacks and other residents of poor neighborhoods. The Fair Housing Act of 1968 prohibits discrimination in lending, and The Community Reinvestment Act of 1977 requires banks to use the same lending criteria in all communities, regardless of the living standards of residents. As a result of the present crisis, however, banks and other lenders are being criticized for equal opportunity lenient lending to all, including black residents of depressed neighborhoods.
The United States housing market is riddled with subsidies and regulations, including among many others, insurance by the Federal Housing authority of mortgages to first time and low income homeowners, tax deductibility of interest payments on mortgages –to families that itemize their deductions- and the quasi-governmental Fannie Mae and Fannie Mac Corporations that channel billions of dollars to the mortgage market. Nevertheless, both the White House and leading Congressional Democrats have proposed additional rules to help borrowers who may have difficulty avoiding foreclosure under present conditions. Treasury Secretary Paulson has been negotiating "voluntary" agreements with mortgage lenders to freeze the low introductory rates for five years on some subprime home loans, and to offer borrowers the right to refinance their loans into more affordable mortgages. The Democrats want to go much further than the administration, and have proposed, for example, to help homeowners renegotiate terms of their mortgages if forced into bankruptcy.
I am skeptical of additional government interventions into a housing market that already has too much. To be sure, homeowners who only temporarily have trouble meeting repayment schedules on their mortgages should not have to go into foreclosure. But lenders already have strong incentives to help these borrowers since lenders are also hurt by foreclosures, especially in the current weak housing market where it is not possible to sell repossessed homes at reasonable prices in poorer neighborhoods. Lenders also have much better evidence and experience than governments can ever have regarding which borrowers have a reasonable chance of handling their mortgages if given some temporary help, such as allowing selected borrowers to be in arrears on payments for a while, permitting some borrowers to renegotiate terms, and making other adjustments that raise the likelihood of eventual repayment. Lenders also are better informed about which borrowers are hopelessly in debt, and are better off going into bankruptcy rather than trying to sacrifice savings or consumption to meet their mortgage payments.
A counterargument to this skepticism is that the government should intervene further in the housing market because the Fed is partly responsible for the crisis by keeping interest rates artificially low. Perhaps the Fed did keep the federal funds rate too low for a couple of years preceding the onset of the crisis, but low interest rates were found worldwide. The main reason for the low rates was not the Fed, but the high savings rates in China and other rapidly developing nations that put pressure on interest rates all over the world...
becker-posner-blog.com
meganmcardle.theatlantic.com
The Subprime Mortgage Mess--Posner's Comment
...6. What Is to Be Done? In my opinion, nothing. There have always been bubbles. There will always be bubbles because of the factors that I have been discussing. The Federal Reserve Board, though ably led and staffed, missed the mortgage bubble just as it missed the tech-stock bubble that exploded in 2000. The proposals now on the table for resolving the subprime mortgage "crisis" or preventing future such fiascos include, first, requiring that more information be given to prospective borrowers and, second, that mortgage interest adjustments be frozen or other measures taken to reduce foreclosures. Information is not the problem, as I have argued; and bailing out the borrowers, which is to say truncating downside risk, will set the stage for a future housing bubble. Nor is it a good excuse for the second class of measures that we must at all costs avoid a recession. A major depression, such as we last experienced in the 1930s, imposes immense social costs in the form of lost output. A recession involving some temporary unemployment may impose lower social costs than governmental interventions designed to head it off.
becker-posner-blog.com
The reminder about the redlining hysteria of ~15-20 years ago is a crucial point. Our government is almost schizophrenic when it comes to the issue of credit for marginal borrowers. On the one hand, it wants the poor to have access to credit, and on the other hand, it rails against any business that offers them credit in a viable way. This is true not just of sub-prime mortgage lenders but of payday lenders and credit card companies.
Posted by Fred | December 27, 2007 4:11 PM
meganmcardle.theatlantic.com |
