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On the Conservative Mortgage Crisis Meme


The standard conservative response to the mortgage crisis is about the same as Herbert Hoover's initial response to the Great Depression: do nothing. As George F. Will more or less said on "This Week" last Sunday and wrote in his regular column, the government should not reward people who bet on the upward housing price spiral and lost. In short, they took a risk and they should face the consequences. We're only encouraging more defaults if we do anything to help the dolts who got themselves into trouble.

If only it were so simple.

The housing price rise was stimulated by strong demand for new housing. While a number of factors undoubtedly drove housing prices upward, easier access to credit was surely one of the more important ones. More people had easy access to money so more people had money to spend on buying houses and prices rose.

Credit was made much cheaper--artificially stimulating demand and jacking up housing prices--through several factors, including:

(1) Loans requiring no down payment. People who "buy" homes with these loans start with no equity in their home. If prices decline, it becomes hard to refinance since they already owe more money than the value of their home. Moreover, portions of these loans usually have extra-high rates because of the extra risk.

(2) Lending too much. When I bought a home, I was amazed at how much money lenders were willing give me. Indeed, brokers offered around twice as much debt as I could reasonably expect to service without radical life changes. Since many loans are sold within days of closing, brokers generate income by lending money but feel no long-term responsibility for the ability of the borrowers to service the loan.

(3) Interest-only mortgages. The hot lending instrument of the decades, interest-only loans are tempting because the payments are lower. However, the buyer doesn't acquire an asset as with more traditional mortgages.

(4) Adjustable-rate mortgages (ARMs). Once upon a time, Americans used to almost always buy homes with fixed-rate mortgages. While not as new as interest-only loans, higher prices led a lot more borrowers to turn toward these mortgages because the lower interest rates are more affordable--in the short term. The payments can become much more expensive if interest rates rise, even as modestly as they have recently by historic standards.

(5) The combo platter. Of course, many of the above options were often wrapped into a single loan. As housing prices soared, more Americans sought more complex loans which have turned out to be unaffordable just to get into the game.

I am not sure how government should respond to this crisis in terms of either how to help people in danger of losing their homes or to prevent it in the future. The one measure which strikes me as immediately sensible is eliminating the mortgage-home-interest tax break for new interest-only loans taken out to buy properties of greater value than currently owned by the homeowner since the point of the tax credit is to help people acquire a home.

As we do figure out how to handle this problem, however, we should recall that most people borrowed money to have a place to live--not as a means of cashing in on the country's housing price boom. And the boom made the American dream of owning your home that much riskier. While this doesn't mean that the federal government, or the Federal Reserve, should necessarily rush to bail out borrowers or lenders with bad loans, it does mean that the question deserves a far closer look than suggested by conservative pundits.


David Lublin August 17, 2007 - 2:57pm
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( categories: Analysis | USA: Domestic Issues )

Paul Krugman addressed this very topic

It's behind the NYT Select (subscriber only) firewall, but available at Truthout

Here's his conclusion:

This looks to me like a clear case for government intervention: there's a serious market failure, and fixing that failure could greatly help thousands, maybe hundreds of thousands, of Americans. The federal government shouldn't be providing bailouts, but it should be helping to arrange workouts.

And we've done this sort of thing before — for third-world countries, not for U.S. citizens. The Latin American debt crisis of the 1980s was brought to an end by so-called Brady deals, in which creditors were corralled into reducing the countries' debt burdens to manageable levels. Both the debtors, who escaped the shadow of default, and the creditors, who got most of their money, benefited.

The mechanics of a domestic version would need a lot of work, from lawyers as well as financial experts. My guess is that it would involve federal agencies buying mortgages — not the securities conjured up from these mortgages, but the original loans — at a steep discount, then renegotiating the terms. But I'm happy to listen to better ideas.

The point, however, is that doing nothing isn't the only alternative to letting the parties who got us into this mess off the hook. Say no to bailouts — but let's help borrowers work things out.

tjfxh August 17, 2007 - 8:38pm
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Statement of the question:

How to provide housing without endangering credit markets but not rewarding the vultures that prey upon the needs of others. That’s an unfortunate combination of need and greed.

Might a combination of low rate mortgage insurance included in repayment terms for borrowers and tighter regulation of the banks and lenders offer a solution?

Tighter credit for everyone punishes need. Bailouts alleviate need but reward predators.

Unfortunately, any steps to reign in predatory lenders does impact the segment of the market that really cannot afford a house and should not be buying one because their inclusion affects too many borrowers who with generous terms would do everything in their power to fulfill their financial obligations. Adding insurance to mortgage re-payment terms is not an option for 'all' because super high-risk borrowers would default and the loss would have to be covered by the insurance industry.

With tighter regulatory controls on the predators, the market stands a decent opportunity to correct itself. Lenders should not be able to slough off their responsibility by selling worthless paper. That part of the equation must be dealt with harshly or they'll expect to be bailed out over and over and over.

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Good discussion at this link regarding the Complexity of the problem

Sounds like Bernanke is starting to make the right noises.

“the Fed is planning on issuing new regulations at the end of the year to ensure that borrowers are better informed and better protected in today's complex mortgage market. These regulations will cover all mortgage originators, not just banks and credit unions.”

What I didn't see was Bernanke reprimand those most knowledgeable...the lenders. Shysters ignored current regulations.

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It isn't acceptable to lay the blame on the borrowers and not be empathetic about their financial condition. Many borrowers would be able to repay their current loans if terms were adjusted and the mortgages were converted to a fixed rate.

canuck August 17, 2007 - 11:11pm
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Let's find the real problem...

By and large, the crisis is the result of "creative lending". Not just NINJA loans, but failure to disclose some really predatory lending practices. "Reduce your monthly payment" (not said: "by increasing your principal"). Early payment penalties (should be illegal--why penalize someone for paying off a loan early?), no-down loans, with excessive closing costs quietly rolled into the principal. The laundry list is endless. And why not? Collect your commission and sell the thing--it's not as if you actually had to hold the mortgage yourself.

Time for some very strict regulations. While we're at it, let's bring back the Glass-Steagall act and make banks go back to making money honestly.

In the meantime, "a fool and his money are soon parted". So you bought a bundle of bad loans. Live with it.

Petronius August 18, 2007 - 1:22am
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Moral Hazard

Let's remember that it is largely derivatives, which are responsible for the moral hazard affecting the lending industry, that resulted in this widespread problem, going far beyond the mortgage market. This is much more a financial problem than a banking or even lending problem. Moreover, it has not yet even begun to play out. This is going to affect the global financial system for the foreseeable future, until greater transparency is instituted in the realm of "funny money." The problem is that the subprime meltdown may be part of a much bigger picture. No one knows owing to lack of transparency. So the whole system is spooked.

tjfxh August 18, 2007 - 9:57am
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And a bailout isn't going to help

to unspook the system. A few people will wag a finger, maybe a hand or two will get slapped, but it takes catastrophe to change things.

Bernanke essentially sent a signal that the current mood is for a quick fix and not major soul-searching. Unfortunately, that only means that the chickens will come home to roost later.

Petronius August 18, 2007 - 11:34am
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Glass-Steagall changed bad banks into bad all-in-ones

by removing the wall between investment banks and commercial banks. No lobbyists were involved in this repeal;-).

The repeal bill was signed by Clinton, but the safety [provisions of the bill were already being eroded in 1986. PBS Frontline has a good piece on this called "Mr Weill goes to Washington"


"George Washington did not cross the Delaware for Capitalism," Shmuley Boteach

nymole August 18, 2007 - 10:41am
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the government should not

the government should not reward people who bet on the upward housing price spiral and lost.

Which government? uh, that wouldn't be the same government that DID bail out all the bankers back in the S&L crisis? ...bankers that included some Bush buddies and made some equally bad bets.

A conservative's idea of fair is one of the most sickening things at work in this country these days.

greensmile August 18, 2007 - 9:06pm
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