Hell in a Hand-Basket: Part 4

How Government Stoked the Mania

Housing prices would never have risen so high without multiple Washington mistakes.

By RUSSELL ROBERTS

Many believe that wild greed and market failure led us into this sorry mess. According to that narrative, investors in search of higher yields bought novel securities that bundled loans made to high-risk borrowers. Banks issued these loans because they could sell them to hungry investors. It was a giant Ponzi scheme that only worked as long as housing prices were on the rise. But housing prices were the result of a speculative mania. Once the bubble burst, too many borrowers had negative equity, and the system collapsed.

David Klein

Part of this story is true. The fall in housing prices did lead to a sudden increase in defaults that reduced the value of mortgage-backed securities. What's missing is the role politicians and policy makers played in creating artificially high housing prices, and artificially reducing the danger of extremely risky assets.

Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate income borrowers. For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.

For 1996, HUD required that 12% of all mortgage purchases by Fannie and Freddie be "special affordable" loans, typically to borrowers with income less than 60% of their area's median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was to be 28%. Between 2000 and 2005, Fannie and Freddie met those goals every year, funding hundreds of billions of dollars worth of loans, many of them subprime and adjustable-rate loans, and made to borrowers who bought houses with less than 10% down.

Hear No Evil

What some Congresspeople said about Fannie and Freddie.

Fannie and Freddie also purchased hundreds of billions of subprime securities for their own portfolios to make money and to help satisfy HUD affordable housing goals. Fannie and Freddie were important contributors to the demand for subprime securities.

Congress designed Fannie and Freddie to serve both their investors and the political class. Demanding that Fannie and Freddie do more to increase home ownership among poor people allowed Congress and the White House to subsidize low-income housing outside of the budget, at least in the short run. It was a political free lunch.

The Community Reinvestment Act (CRA) did the same thing with traditional banks. It encouraged banks to serve two masters -- their bottom line and the so-called common good. First passed in 1977, the CRA was "strengthened" in 1995, causing an increase of 80% in the number of bank loans going to low- and moderate-income families.

Fannie and Freddie were part of the CRA story, too. In 1997, Bear Stearns did the first securitization of CRA loans, a $384 million offering guaranteed by Freddie Mac. Over the next 10 months, Bear Stearns issued $1.9 billion of CRA mortgages backed by Fannie or Freddie. Between 2000 and 2002 Fannie Mae securitized $394 billion in CRA loans with $20 billion going to securitized mortgages.

By pressuring banks to serve poor borrowers and poor regions of the country, politicians could push for increases in home ownership and urban development without having to commit budgetary dollars. Another political free lunch.

Fannie and Freddie and the banks opposed these policy changes at first through both lobbying and intransigence. But when they found out that following these policies could be profitable -- which they were as long as rising housing prices kept default rates unusually low -- their complaints disappeared. Maybe they could serve two masters. They turned out to be wrong. And when Fannie and Freddie went into conservatorship, politicians found out that budgetary dollars were on the line after all.

While Fannie and Freddie and the CRA were pushing up the demand for relatively low-priced property, the Taxpayer Relief Act of 1997 increased the demand for higher valued property by expanding the availability and size of the capital-gains exclusion to $500,000 from $125,000. It also made it easier to exclude capital gains from rental property, further pushing up the demand for housing.

The Fed did its part, too. In 2003, the federal-funds rate hit 40-year lows of 1.25%. That pushed the rates on adjustable loans to historic lows as well, helping to fuel the housing boom.

The Taxpayer Relief Act of 1997 and low interest rates -- along with the regulatory push for more low-income homeowners -- dramatically increased the demand for housing. Between 1997 and 2005, the average price of a house in the U.S. more than doubled. It wasn't simply a speculative bubble. Much of the rise in housing prices was the result of public policies that increased the demand for housing. Without the surge in housing prices, the subprime market would have never taken off.

Fannie and Freddie played a significant role in the explosion of subprime mortgages and subprime mortgage-backed securities. Without Fannie and Freddie's implicit guarantee of government support (which turned out to be all too real), would the mortgage-backed securities market and the subprime part of it have expanded the way they did?

Perhaps. But before we conclude that markets failed, we need a careful analysis of public policy's role in creating this mess. Greedy investors obviously played a part, but investors have always been greedy, and some inevitably overreach and destroy themselves. Why did they take so many down with them this time?

Part of the answer is a political class greedy to push home-ownership rates to historic highs -- from 64% in 1994 to 69% in 2004. This was mostly the result of loans to low-income, higher-risk borrowers. Both Bill Clinton and George W. Bush, abetted by Congress, trumpeted that rise as it occurred. The consequence? On top of putting the entire financial system at risk, the hidden cost has been hundreds of billions of dollars funneled into the housing market instead of more productive assets.

Beware of trying to do good with other people's money. Unfortunately, that strategy remains at the heart of the political process, and of proposed solutions to this crisis.

Mr. Roberts is a professor of economics at George Mason University and a scholar at the Mercatus Center. His latest book is a novel on how markets work, "The Price of Everything: A Parable of Possibility and Prosperity" (Princeton University Press, 2008).

The Insane World of Barack Obama!

This guy is the most radical and the most liberal of the hard-left in the U.S. Senate. Do you really want him running the government --- and your life?

If Bailout Plan Is Too Socialistic, Just Wait For Obama Leviathan

By INVESTOR'S BUSINESS DAILY | Posted Tuesday, September 30, 2008 4:20 PM PT

Election '08: Have Americans been so lulled by Barack Obama's smooth talk that they don't realize his plans would expand government into a massive socialist behemoth? His is a soft-spoken, hard-left agenda.

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IBD Series: The Audacity Of Socialism

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During Friday night's debate in Mississippi, Obama disparaged what he called "this notion that the market can always solve everything and that the less regulation we have, the better off we're going to be."

But the subprime crisis Washington is dealing with is the result of three decades of the federal government pressuring banks — via the regulatory demands of the Democrats' 1977 Community Reinvestment Act, which was expanded by Bill Clinton — to make tens of billions of dollars in bad loans to poor people with lousy credit ratings.

It was Democrats' regulatory and litigious assaults upon the mortgage market in pursuit of "social justice" that left our economy in its precarious position of today; indeed as an attorney, Obama himself in 1994 represented a client suing Citibank, accusing it of systematically denying mortgages to blacks.

But if the taxpayer rescue of Wall Street and Uncle Sam's taking over the banking system scares you, the broader socialism planned by the Democratic presidential nominee should leave you petrified.

Here are a few examples, with price tags provided by the National Taxpayers Union Foundation:

• Politicized financial regulation: Obama would establish a Financial Market Regulation and Oversight Commission to "end our balkanized framework of overlapping and competing regulatory agencies" and "which would meet regularly and report to the president, the president's financial working group and Congress on the state of our financial markets and the systemic risks that face them."

Translation: more centralized and heavy-handed regulatory power over businesses for Washington.

• Government-managed medicine: Even left-leaning health care experts concede that Obama's expanded coverage plan will cost $100 billion; with no real cost containment, that will mean a second wave of reform that could impose full socialized medicine on our country.

Obama declares that "governments at all levels should lead the effort to develop a national and regional strategy for public health, and align funding mechanisms to support its implementation."

His plan also presumes racial discrimination, "requiring hospitals and health plans to collect, analyze and report health care quality for disparity populations and holding them accountable for any differences found."

• Community health centers: Your local doctor may become obsolete in Obama's brave new world in which $6.7 billion will be spent over five years building "community health centers" featuring "preventive, diagnostic and other primary care services."

• Antitrust enforcement: Promising this "is how we ensure that capitalism works for consumers," a President Obama would "stop or restructure those mergers that are likely to harm consumer welfare, while quickly clearing those that do not" and "working with foreign governments to change unsound competition laws."

Behind this harmless-sounding rhetoric is the misguided belief that the government must shield companies of its choosing from their competitors' lower prices and innovative practices. Courts and government bureaucrats under Obama could be expected to use antitrust to claim the existence of imaginary monopolies and squash mergers and other business transactions.

• Required IRAs: Under Obama, "employers who do not currently offer a retirement plan will be required to automatically enroll their employees in a direct deposit IRA account."

Costing $292 billion annually, according to the NTUF's latest analysis, Obama's plans are far more than just "change"; they would transfigure American society into full-blown socialism. With little more than a month to go before this most consequential election, voters seem not to appreciate the danger.

• Dictatorial energy policy: Obama would spend $150 billion over a decade "to advance the next generation of biofuels and fuel infrastructure, accelerate the commercialization of plug-in hybrids" and create other ways to force uneconomical forms of energy on the auto and oil industry.

A Clean Technologies Deployment Venture Capital Fund would artificially finance the environmentalist pet projects in which private investors have little faith.

Negating the global labor market, the Illinois senator also promises to "provide specific tax assistance and loan guarantees to the domestic auto industry to ensure that new fuel-efficient cars and trucks" are built within the U.S.

• Bullying utilities: The Chicago Democrat would require that 25% of electricity consumed in the U.S. be "derived from clean, sustainable energy sources, like solar, wind and geothermal by 2025." Unless those alternative sources get cheap fast, that likely means a big escalation in consumers' electric bills.

Obama also proposes "to 'flip' incentives to state and local utilities by ensuring companies get increased profits for improving energy efficiency, rather than higher energy consumption."

• Billions for teachers unions: Instead of school choice for parents, in which competition would improve public educations and give the poor access to private education, Obama proposes "an accountability system that supports schools to improve, rather than focuses on punishments."

His five-year, $90 billion education plan would dole out "a $200 million grant program for states and districts that want to provide additional learning time for students in need," double federal funding for afterschool programs, provide "professional development and coaching to school leaders, teachers and other school personnel," "develop multi-tiered credentialing systems that encourage principals to grow professionally," and cook up other ways to keep public school teachers on the clock longer.

Uncle Sam would also "collect evidence about how prospective teachers plan and teach in the classroom" in an Obama administration.

• Required public service: In return for the federal government paying the first $4,000 of college tuition through a tax credit — which would be tough for most American families to turn down — Obama would require recipients "to conduct 100 hours of public service a year."

• Required sick leave: Spending $1.5 billion over five years, Obama would "encourage" the states to adopt paid-leave systems that "guarantee workers seven days of paid sick leave per year."

• Thought police: In what sounds like the outdated and unconstitutional Fairness Doctrine on steroids, Obama would "encourage diversity in the ownership of broadcast media, promote the development of new media outlets for expression of diverse viewpoints, and clarify the public interest obligations of broadcasters who occupy the nation's spectrum."

What would the "public interest obligations" of liberal Democrats' opponents within the media end up being in an Obama administration?

• Green Corps: Barack Obama would spend $390 million over five years to fund "an energy-focused Green Jobs Corps to engage disconnected and disadvantaged youth . . . to improve the energy efficiency of homes and buildings in their communities, while also providing them with practical skills and experience in important career fields of expected high-growth employment."

It's a quasi-paramilitary organization dedicated to environmentalism that promises inductees that they would be getting practical employment training for future "green jobs."

• Teaching parents parenting: The senator would spend $300 million over five years establishing "Promise Neighborhoods in cities that have high levels of poverty and crime and low levels of student academic achievement." A key feature would be "parenting schools for parents."

• Housebuilding army: the Youthbuild program would be expanded from 8,000 to 50,000 over eight years at a cost of $257 million to "construct and rehabilitate affordable housing for low-income and homeless families."

• Patent reform: Obama's idea of "opening up the patent process to citizen review" would make it much tougher for businesses to challenge the government's judgment on the ownership rights of an invention, which will have a negative effect on the incentives to innovate.

• Private parklands regulation: Obama would "do more to encourage private citizens to protect the open spaces and forests they own and the endangered species that live there . . . and encourage communities to enhance local greenspace, wildlife and conservation areas."

The Obama campaign uses the word "encourage" over and over in numerous areas of policy. Expect it to be the form of encouragement practiced by Don Corleone — making you an offer you can't refuse.

• Autism czar: If you weren't convinced that the Democratic nominee intends to use the federal government's powers to solve every known problem, consider his promise to spend $2.5 billion over four years on appointment of an "Autism Czar" to "ensure that all federal funds are being spent in a manner that prioritizes results."

What To Do? Oh, What To Do?

Now that we are in this hand-basket, what should we do that makes the most sense? Here's one sensible view:

How The Plan Turns A Profit For Taxpayers

By LAWRENCE KUDLOW | Posted Monday, September 29, 2008 4:30 PM PT

The single biggest mistake in the Paulson bank-rescue-plan marketing effort has been the failure to explain clearly how taxpayers are going to recoup $700 billion used to buy toxic assets at auction to unfreeze the banking system.

In other words, folks don't understand how taxpayers will be paid back, and may actually make profits, which will enable the new government debt to be erased after the Treasury bank-rescue is completed.

Here's the key point: Any loan package bought by the Treasury will be 100% taxpayer owned. Period.

Let's walk through this hypothetical for a moment. Through a market-driven auction, the Treasury will purchase some dollar amount — say $100 billion — of loans that banks will sell.

The Treasury will then buy those loans at the prices that fill the auction, starting with the lowest prices and working up. Now, the Treasury will hold those bonds either to maturity or for a sale in the open market if rising prices in the market make that sale attractive.

In other words, suppose the Treasury buys a bond package at 20 cents on the dollar. They hold it for a while, and if market conditions improve, they sell it for 50 cents on the dollar to some buyer (for example, an investment fund, a private-equity fund, a hedgie). The Treasury will make the sale at the higher price in order to gain a profit for taxpayers.

In the meantime, as the Treasury holds the loans, the government will get monthly cash flows coming in on the mortgages, or on any other loans that it owns. So it is a win-win for taxpayers:

First, taxpayers get the cash flow generated by the assets (something like a 10% interest rate.)

Second, if the loan is sold for profit, the taxpayers will own that profit. And the new law must of course stipulate that all the cash flows and/or profits go for debt-reduction to protect taxpayers.

I don't think a lot of folks understand this win-win scenario. Let me repeat:

The taxpayers own the bonds the Treasury buys; the taxpayers own the cash flows generated by the bonds; the taxpayers own the profits when the bonds are sold; and the taxpayers benefit when the profits and cash flows are used to pay-down government debt.

Actually, for taxpayers, it's a win-win-win-win.

Rallying Confidence

Think about this. The troubled assets purchased by the Treasury right now are likely to be very underpriced because of the chaotic and frozen market conditions. But over time, through monthly cash-flow payments or through loan sales, taxpayers will get all their money back and in great likelihood a handsome profit.

I have been in conversation with leading House Republicans. And they understand these key points. Unfortunately, this understanding did not materialize in their original meeting with Mr. Paulson. But now the actual reality is sinking in.

Another point: Republican leader Eric Cantor has an excellent idea for a federal bond insurance guarantee for straight mortgage-backed paper, financed by private-sector insurance premiums. That will improve investor confidence in mortgage bonds and will make those bonds highly marketable.

Importantly, senior Treasury officials have told me that Mr. Paulson will accept the insurance idea as an option in the final bill, alongside the ability of the Treasury to purchase distressed assets.

Clean Plan

Sources also tell me that other conditions will be necessary to bring the House GOP along. First, the ACORN slush fund must be removed. Second, the so-called union proxy to run a slate of corporate directors is a big problem. Third, all profits from the Treasury rescue mission must be used to reduce the national debt — 100%.

Fourth, Republican members are opposed to bankruptcy judges setting mortgage terms and interest rates (Sen. Obama also is opposed). Fifth, the so-called government equity ownership of banks is distasteful because it effectively creates a corporate tax increase on banks at a time when they are struggling. And last, the Treasury secretary's request for $700 billion is regarded as way too high.

Essentially, House Republican leaders want a slimmer, cleaner Paulson plan supplemented by Mr. Cantor's mortgage-bond insurance program. I think it's a good package that would be great news for stock and bond markets that are now ailing badly.

It would set the stage for a gradual return to normalcy on the part of bank lenders, including loans to small businesses, consumers and homeowners. It would be a pro-growth package at a time when the economy desperately needs a prosperity tonic.

Copyright 2008 Creators Syndicate, Inc