In a time of a mortgage crisis, temptations abound to create new rules to “fix” the market and prevent future catastrophe.
The subprime crisis has spawned numerous calls for tightening the credit market and banking regulations, in a market that is already highly regulated. Politicians and the public have placed the blame largely on the mortgage and lending industries. As the real estate bubble burst, many predatory lenders suffered the consequences of their own ill-conceived loans.
The irony is that the subprime crisis emerged largely from manipulation and regulation of the credit system by various government institutions, including the Federal Reserve.
Over the past few years, the U.S. economy relied heavily on the housing market as an economic engine, and the Fed labored, through its fiscal policy, to sustain the housing boom.
This may prove to be a critical error in the long run. In order for an economy to grow and evolve, investment and capital must move naturally to where they are most efficiently used. Those who made bad investments during the heady times should learn from their mistakes. Those who were not fatally wounded will be more cautious–and hence better–investors in the future.
But that lesson will be learned only if the government doesn’t bail them out.
The recent expansion in federal power over the housing market began with the expanded use of the discount window, continued in the bailout of Bear Stearns, and will accelerate with the proposed regulatory overhaul. These new policies are at their core an extension of existing interventionist policies. A sound recovery will come only through the establishment of a long-term policy that practices government restraint and a return to sound market fundamentals.
The government should not be in the business of subsidizing the risk of borrowers and lenders at the expense of current and future taxpayers.
A good example of a program gone awry is the Community Reinvestment Act, designed to ensure that all homeowners were treated equally by avoiding “redlining,” the deliberate shifting of financing away from low-income or high-risk areas. While the CRA was designed to serve a positive goal, the economic implications of the new regulation were far more complicated. The CRA required mortgage lenders to provide loans to riskier clients, often in stark contrast to what market forces may have dictated.
Those new loans spawned a new subprime mortgage market–a financial sector now embroiled in controversy, whose collapse triggered the current downward economic trend. The CRA is in many ways socialized financing, forcing banks to lend counter to market trends and thus increasing the risk of failure. We are now caught in a financial downturn that has emerged as a result of these risky loans.
The Senate’s plan to address the mortgage crisis takes a few steps forward and a giant leap backwards. The goal of the new plan is to create a more active role for the government in private lending agreements, spending billions of dollars to prop up a market that is currently highly unstable and risky.
Using taxpayer money to support an ailing system is both fiscally and morally irresponsible. The new law’s supporters have tried to portray these bailouts as a rescue for homeowners, but they are in fact more harmful than helpful, ignoring the root causes of the crisis.
In times of crisis the government often needs to make tough decisions that may lead to difficulties in the short term. The best course of action for the government today is to cease manipulating interest rates and allow the markets to run their course. Let individual lenders and borrowers work out loan arrangements. Where fraud and mismanagement exist, the market will purge the rot in the lending system if left alone.
With the expansion of the Federal Housing Authority, the government is taking on additional risk. Instead of allowing the private market to correct itself and fix the root causes of the crisis, the government is assuming the risk of individual buyers at taxpayer expense. This new risk pool places the FHA at increased risk of failure due to the volatile nature of lower-priced mortgage loans. The result of the expansion is all risk and no reward for American taxpayers.
Far too many solutions from the government today simply involve throwing taxpayers’ money at a problem. This wrongheaded macroeconomic “leadership” is bad public policy and harmful to the economy. Moving government tax revenue into an already-bloated housing market will prolong the housing bubble that emerged as a result of previous government mismanagement of interest rates.
Matthew Glans ([email protected]) is a legislative specialist in financial services for The Heartland Institute.