The epicenter of the current economic crisis has been the U.S. housing market. The collapse of the subprime mortgage market and the dramatic fall in home values have sent out shock waves of economic disruption around the world.
Many have interpreted these events as another example of the inherent instability of the free market. There have been loud calls for greater and more detailed government regulation of the mortgage business and financial markets in general.
But before hasty policy decisions are made it is always useful to step back and carefully look at the facts. How, actually, did this housing market horror story come about, and what government policies may have helped to set this disaster in motion?
The story is told with great persuasive clarity in The Housing Boom and Bust (Basic Book, $25) by economist Thomas Sowell, who is a long-time senior research fellow at the Hoover Institution on the campus of Stanford University.
Sowell explains that the Federal government began a huge regulatory push to create “affordable housing” in the 1990s, under the presumption that the cost of acquiring a home was out of reach for a growing number of American families.
However, he shows that in general average American incomes were keeping up with or even exceeding the cost of buying a home in most of the U.S. The only problem areas were in places like California, where regulations on land development and home building were making land scarcer and more costly to buy.
Prominent Democratic and Republican members of Congress and both President Clinton and President Bush put pressure on lending institutions to lower their credit rating standards; reduce the minimum down payment requirements (in a growing number of cases, to zero); and introduce short-term flexible monthly payment methods that would only increase later on.
Often under the intimation of bank and mortgage market regulators, financial institutions greatly increased their lending to targeted socio-economic groups that were less credit worthy due to fears that they might otherwise be hit with anti-discrimination law suits. As Sowell points out, the tragedy of forcing banks to make home loans to people really not financially able to bear the costs of a house once times turned even moderately bad, is that foreclosure rates are highest for this segment of the population.
Two major vehicles for the growth of this unsustainable housing bubble were the semi-governmental agencies, Fannie Mae and Freddie Mac. Congress and the White House pressured both agencies to extend loan guarantees or buy up the mortgages of these credits unworthy borrowers, until finally before the housing crash last year these two agencies held or guaranteed around fifty percent of all the home loans in America.
The irresponsibility of Fannie Mae and Freddie Mac, and those in Congress who pressured them to go out on this limb has been shown by their formal take over by the government and the huge sums of taxpayer’s money that it has cost to maintain their solvency.
What also fed this housing market frenzy, Sowell explains, was the monetary policy of the Federal Reserve. In 2003 and 2004, the central bank kept interest rates artificially at historically low levels. Indeed, when adjusted for inflation, for part of the time interest rates were zero or negative. Mortgage rates were pushed down to barely two or three percent in real terms.
If there is a lesson to be learned from the facts of the housing crisis, it is that its cause has been misguided and intrusive regulations and political pressures, and not any inherent weakness or instability in a market economy.