Misdiagnosis: Housing is not the Problem

Posted by: Michael Mandel on October 01

Paulson and Bernanke misdiagnosised the root of the current crisis. They identified the problem as the housing market, and nationalized Fannie and Freddie. But all they accomplished was establishing housing as the preferred, government-guaranteed choice for investment. So now homebuyers can still get mortgages, but businesses are having trouble getting credit.

I would rather it be the other way around.

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Reader Comments

bob

October 1, 2008 11:59 AM

I presume credit comes from banking institutions. They decide who to give money to. Business relies on consumers, and consumers are broke. Broke folks can't get credit going forward, and they won't be purchasing on credit anymore.

Seems like a zero sum game, and it seems like we're buying time. What we do with that time is our own business. If the average Joe understood the inevitable, he'd panic. So, Joe Sixpack needs to be kept in the dark.

KAR

October 1, 2008 12:15 PM

It is not correct to say that Paulson and Bernanke have established housing as the government's preferred investment choice. Housing has long been endorsed by the government as its preferred investment. It is enshrined as such in the tax code: interest deduction, capital gains preservation, etc., and institutions such as the FHA, along with the VA loan program. As such it creates a foundation of stability that much of the rest of our economy is built upon.

mark

October 1, 2008 03:00 PM

Mike,
that's an interesting summary. hmm requires some thought. but hey, housing is the stability force in any society. it's the biggest asset after a lifetime of work. as such i believe housing needs to be stable, however i am thinking whether credit should be stabilized first or housing should be. You must also be aware that if housing doesn't stabilize then all those outstanding mortgage related instruments would continue to decline causing credit to be more scarce.
it simply seems to me that we are in a no win situation now. years of excess must be unwind, in whatever form.

Chris W.

October 1, 2008 06:36 PM

The fact of the matter is that the USA is quickly becoming the USSA: the North American equivalent of the now defunct Soviet Union. Or at the very least a corrupt, deceitful, third world country. A waning superpower, to be sure.

We have seen short-selling bans enacted, considered vesting the Treasury Secretary with absolute power over the economy, considered further still a transfer/theft of over $700 billion from taxpayers to irresponsible bankers (with absolutely no plan, accountability, or responsibility for doing so), transparent mark-to-market accounting rules may be thrown out the window to allow the bankers to cover up their mistakes, and the FHA's $300 billion Hope for Homeownership program went into effect just today- which robs home"owners" from actually participating in the price appreciation of their homes. The government gets it all, instead.

Make no mistake about it: the next financial crisis will require a bailout in the trillions of dollars. And there will be no solution for that.

We've been warned about this time and again for more than 200 years now, starting with Thomas Jefferson. But we never learn. Maybe disaster and collapse is the only way we can learn. For shame...

Christopher

October 1, 2008 07:56 PM

It would seem that the REAL problem is a shortage of money in the hands of renters and homeowners -- the minions, the citizenry -- who cannot make their monthly notes: Imagine having $425k suddenly to solve one's debt problems!

Wouldn't dividing the $700bn amongst every adult solve the housing crisis AND stabilize the government's finances?

With debt eliminated, many non-viable businesses will simply vanish, ones that profit from interest-based usury.

Ned

October 1, 2008 09:39 PM

What have you been smoking?

Taking over Fannie and Freddie had nothing to do with the priority of housing. It had everything to do with the need to maintain confidence in and therefore the value of paper issued by them in light of it breadth of holding in both domestic and international financial institutions.

LAO

October 2, 2008 12:05 AM

I'm having trouble making the leap from frozen mortgage instruments to Main Street economic disaster. I've been feverishly looking for solid evidence that business lending is contracting significantly, and I'm not yet convinced. It is not the case that every bank in the nation got themselves entangled in this mess. Of course, those banks that have been managed well won't get a bailout, so they'll become increasingly uncompetitive.

I do interpret current events as desperate shoring up of home ownership. Aside from trying to vindicate past policy, there is a very good reason -- home equity loans that have grown at about $500 billion per year. Without home appreciation, too many people are on the hook to work off loans that don't go away with foreclosure, so they certainly are not going to be buying consumer goods that we pretend are part of GDP. That is my understanding -- you can legally walk away from a mortgage, but not a home equity loan. The thing is, all that unearned consumption wasn't really truly helping the domestic economy anyway, except for state and local sales tax.

It is downright wierd that the nation was pushed into a service economy, yet taxing of services remains verbotten.

Drew

October 2, 2008 10:57 AM

Christopher-

$700,000,000,000 / 300,000,000 people = $2333.33 per person...

But $425,000 was a pretty good guess.

-Drew

LAO

October 2, 2008 12:19 PM

Having just read Peter Coy's article on the spread of the credit crisis to business and listened to your discussion with John Byrne, I'm beginning to be convinced. What a revelation this was: pre-emptive borrowing! Perhaps that term could be used to describe the nation's elusive economic policy.

You and Editor Byrne used a phrase that I feel hits upon something very central -- shared sacrifice. I understand the extreme distaste for the concept of redistribution of wealth, even if it could be proved essential to a staggering economy, and have been coming around to a different, more palatable idea that you've inadvertantly crystalized for me -- redistribution of sacrifice. I think the public by and large cannot bring themselves to accept that the structure of the system plays a major role in individuals' financial success or failure, but their broad rage articulates certainty that sacrifice needs to be distributed in a way that they perceive as fair. Stating the case in those terms could well bestow the political legitimacy that you have noted is lacking.

Lawmakers were indeed called upon to address this with the $700B plan, though they barely seem to recognize it and certainly have squirmed to avoid facing it. How the current version of the plan distributes sacrifice is not all that clear, but I have a feeling there will be more opportunities to deal with it again in the future.

GP

October 2, 2008 02:20 PM

I always thought that "owning" a house was a liability, not an asset. So I find it funny, that bankers find it so important to prop up house prices?

Brandon W

October 2, 2008 03:31 PM

Your mortgage IS an asset... on the bank's balance sheet.

Doug

October 2, 2008 04:56 PM

Having been a "credit" based economy has allowed the US to grow at a much greater rate than had we been a cash based economy. But, easy credit has become our heroin. Our savings rate has been the lowest in the industrial world. It was a negative number the last time I looked. We, as a nation, use the equity in our homes as our savings accounts. Now that our home equity has evaporated, our 401k's are appreciably smaller, and the banks have little to lend, we'll see what effect this has on our society. My guess? The $770 billion won't be near enough.

Michael949

October 7, 2008 02:24 AM

The root cause of the meltdown is billions in bad mortgages. This was the result of the Democrats in Congress setting increasingly higher goals for CRA loans as well as Freddie and Fannie to "low income" borrowers. As more investors sought securitized mortgages with their percieved high returns and low risk this fed the mortgage explosion (which Congress permitted in 1995, despite the fact that six times in history American has tried securitized mortgages and each time it ended in a market collaspe). Fannie Mae subprime purchases exploded from $600M in 1995 to over $17Billion in 1999 and up to $158 Billion in 2006. At a hearing in 2003, Barney Frank explicitly stated that Fannie and Freddie’s government privileges were conditional on their willingness “to make housing more affordable.” The only way to achieve the low income loan targets while dramatically increasing lending was to erode underwriting standards. Fannie Mae aggressively bought Alt-A loans, where these loans may require little or no documentation of a borrower’s finances.

For a great video on the causes

http://www.youtube.com/watch?v=1RZVw3no2A4&feature=iv&annotation_id=even

Mike Reardon

October 7, 2008 01:23 PM

Michael949

Back before 1987 I read an article by a German Banker critical of Alan Greenspan in either the SF Chronicle or the Examiner. It said then Greenspan believed that housing was a asset class that a home owner could use as leverage like any other asset.
That was a criticism of Greenspan being considered before he was made Fed Chairman in 1987. Can’t find a supporting link so its only my recollection.

But, it was never a surprise to me that after 2001 when it was needed after both the dot-com bust and 9/11, he open this as a solution and it was use to prop-up the economy. Everyone business, government, and the Fed signed on to generating the extra refinance of housing to create purchasing power in the economy. I say this was done by agreement of all concerned, its not a vehicle that can be pinned onto one party.

Mike Mandel

October 7, 2008 06:26 PM

To Michael949,

Yes, we ended up with bad mortgages. But the root cause is that we tried to spend more than we could afford.

dbarber970

October 8, 2008 08:39 AM

I am reading an interesting independent public policy report citing the cause(s) of the mortgage meltdown. It is available at www.independent.org. Not a bad read...about 30 pages. The author - an economist out of UT-Dallas - attributes a great deal of the problem to CRA.

Thank you for your interest. This blog is no longer active.

 

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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