Thursday, September 25, 2008

Guess again: whose greed is to blame?

Lax mortgage standards. Where did they come from?
"Home mortgages have been a political piñata for many decades," writes Stan J. Liebowitz, economics professor at the University of Texas at Dallas, in a chapter of his forthcoming book, Housing America: Building out of a Crisis.

Liebowitz puts forward an explanation that he admits is "not consistent with the nasty-subprime-lender hypothesis currently considered to be the cause of the mortgage meltdown."

In a nutshell, Liebowitz contends that the federal government over the last 20 years pushed the mortgage industry so hard to get minority homeownership up, that it undermined the country's financial foundation to achieve its goal.

"In an attempt to increase homeownership, particularly by minorities and the less affluent, an attack on underwriting standards was undertaken by virtually every branch of the government since the early 1990s," Liebowitz writes. "The decline in mortgage underwriting standards was universally praised as 'innovation' in mortgage lending by regulators, academic specialists, (government-sponsored enterprises) and housing activists."

He continues, "Although a seemingly noble goal, the tool chosen to achieve this goal was one that endangered the entire mortgage enterprise."
The Wall Street Journal quoted Congressman Barney Frank, D-Mass., in 2003 as criticizing Greg Mankiw "because he is worried about the tiny little matter of safety and soundness rather than 'concern about housing.'"

Frank, chairman of the House Financial Services Committee, rejected a Bush administration and Congressional Republican plan for regulating the mortgage industry in 2003, saying, "These two entities – Fannie Mae and Freddie Mac – are not facing any kind of financial crisis." According to a New York Times article, Frank added, "The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing."
For the pointer thanks goes to Carpe Diem, always worth a daily visit and today is no exception -- go and scroll.

Addendum. Villainous Company has much more, including Senator Schumer's complicity and this nugget: "consider that the Bush administration called for reform of GSEs [Fannie and Freddie]no fewer than 17 times in 2008 alone." Thanks to John Palmer for the pointer.

Addendum 2. If you find video more convincing than words on a page check this out.

Addendum 3. In this vein, Greg Mankiw points out that the seeds of the mess cannot merely be laid at the feet of an "economic philosophy that deregulation is always bad" (quoting Obama). But there's also this statement by the SEC Chairman Christopher Cox from late Friday:
The last six months have made it abundantly clear that voluntary regulation does not work. When Congress passed the Gramm-Leach-Bliley Act, it created a significant regulatory gap by failing to give to the SEC or any agency the authority to regulate large investment bank holding companies, like Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns.

Because of the lack of explicit statutory authority for the Commission to require these investment bank holding companies to report their capital, maintain liquidity, or submit to leverage requirements, the Commission in 2004 created a voluntary program, the Consolidated Supervised Entities program, in an effort to fill this regulatory gap.

As I have reported to the Congress multiple times in recent months, the CSE program was fundamentally flawed from the beginning, because investment banks could opt in or out of supervision voluntarily. The fact that investment bank holding companies could withdraw from this voluntary supervision at their discretion diminished the perceived mandate of the CSE program, and weakened its effectiveness.
Some say, though, the Cox was a strong proponent of voluntary supervision before he was an opponent.

Speaking of supervision, where were the private rating agencies?
``I view the ratings agencies as one of the key culprits,'' says Joseph Stiglitz, 65, the Nobel laureate economist at Columbia University in New York. ``They were the party that performed that alchemy that converted the securities from F- rated to A-rated. The banks could not have done what they did without the complicity of the ratings agencies.''

Addendum 4. More reports on this angle from June and February.


Anonymous Anonymous said...

There was an article about two years ago stating that due to state laws banks HAD TO provide a certain percentage of its loans to the under-privileged. This was a percentage of about 23% if I remember the article correctly.

This was considered as the start of the sub-prime phenomenon where the banks were forced to overlook the financial soundness of a couple of loans in order to comply with the banking regulations.

This law also gave certain minority groups the right to place banks under investigation for not complying with this requirement, sometimes without just cause. This would then in effect cause the bank to close during the period of the investigation.

2:18 PM  

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