Paul Krugman writing in the New York Times today says conservative ideology destroyed proper lending regulation, and says that it was conservative thinking that led directly to the “unmitagated disaster” the nation is experiencing in the mortgage and housing industry. Excerpts from the article:
- Apologists for the mortgage industry claim, as Mr. Greenspan does in his new book, that “the benefits of broadened home ownership” justified the risks of unregulated lending. But homeownership didn’t broaden. The great bulk of dubious subprime lending took place from 2004 to 2006 — yet homeownership rates are already back down to mid-2003 levels. With millions more foreclosures likely, it’s a good bet that homeownership will be lower at the Bush administration’s end than it was at the start.
- Meanwhile, during the bubble years, the mortgage industry lured millions of people into borrowing more than they could afford, and simultaneously duped investors into investing vast sums in risky assets wrongly labeled AAA. Reasonable estimates suggest that more than 10 million American families will end up owing more than their homes are worth, and investors will suffer $400 billion or more in losses.
- So where were the regulators as one of the greatest financial disasters since the Great Depression unfolded? They were blinded by ideology. “Fed shrugged as subprime crisis spread,” was the headline on a New York Times report on the failure of regulators to regulate. This may have been a discreet dig at Mr. Greenspan’s history as a disciple of Ayn Rand, the high priestess of unfettered capitalism known for her novel “Atlas Shrugged.”
- In a 1963 essay for Ms. Rand’s newsletter, Mr. Greenspan dismissed as a “collectivist” myth the idea that businessmen, left to their own devices, “would attempt to sell unsafe food and drugs, fraudulent securities, and shoddy buildings.” It’s no wonder, then, that he brushed off warnings about deceptive lending practices, including those of Edward M. Gramlich, a member of the Federal Reserve board. In Mr. Greenspan’s world, predatory lending — like attempts to sell consumers poison toys and tainted seafood — just doesn’t happen.
- Mr. Greenspan wasn’t the only top official who put ideology above public protection. Consider the press conference held on June 3, 2003 — just about the time subprime lending was starting to go wild — to announce a new initiative aimed at reducing the regulatory burden on banks. Representatives of four of the five government agencies responsible for financial supervision used tree shears to attack a stack of paper representing bank regulations. The fifth representative, James Gilleran of the Office of Thrift Supervision, wielded a chainsaw.
- Also in attendance were representatives of financial industry trade associations, which had been lobbying for deregulation. As far as I can tell from press reports, there were no representatives of consumer interests on the scene.
- Two months after that event the Office of the Comptroller of the Currency, one of the tree-shears-wielding agencies, moved to exempt national banks from state regulations that protect consumers against predatory lending. If, say, New York State wanted to protect its own residents — well, sorry, that wasn’t allowed. Of course, now that it has all gone bad, people with ties to the financial industry are rethinking their belief in the perfection of free markets. Mr. Greenspan has come out in favor of, yes, a government bailout. “Cash is available,” he says — meaning taxpayer money — “and we should use that in larger amounts, as is necessary, to solve the problems of the stress of this.”
- Given the role of conservative ideology in the mortgage disaster, it’s puzzling that Democrats haven’t been more aggressive about making the disaster an issue for the 2008 election. They should be: It’s hard to imagine a more graphic demonstration of what’s wrong with their opponents’ economic beliefs
From the New York Times, “Blindly Into the Bubble,” written by Paul Krugman
Who ever got the idea that debt was a substitute for actual wealth?
Montgomery County is now one of the leading places in the country for mortgage foreclosures. Homeownership is the key to the American dream for most people of modest means, and is the only real asset of value for most people. In addition to the borrowers who lose their homes, and all that means to their families, foreclosures leave vacant, often gutted properties which destroy those who live around them and eventually entire communities.
The subprime mortgage market ran amok in an environment of legal deregulation. Loan originators could make huge profits immediately whether the loan is good or bad. Furthermore developments like securitization (the immediate sale of loans, bundling them into securities, and selling shares in the securities to investors, and taking a large sahre of the profits for doing so) diffused the responsibility for making bad loans. There were no consequences in the marketplace for making bad loans. Local lenders who know and depend on the health of their communities were replaced by national and multinational lenders. These lenders relied on local mortgage brokers who work on commissions. Lenders compete for the business of the mortgage brokers rather than the business of borrowers. Thus lenders have an incentive to look the other way if brokers inflate appraisals or invent imaginary income, and to reward brokers for selling their customers a more expensive loan.
Prices of subprime loans are hard for borrowers to determine as they are generally made in secret and sold individually. Bait and switch tactics are common and people have little or no chance to review complex piles of paperwork, where only experts know where the traps are, before the loan closing.
Eventually lenders learned that they could lower monthly payments by selling adjustable rate mortgages that only adjust upward. Often the mortgage has an initial low “teaser” rate that is only affordable for two or three years. In times of low rates that can only go up, this gaurantees that the borrower will be back in a few years to refinance and pay another set of fees.
The subprime market developed to serve people whose credit history excluded them from the old fashioned “prime market”. While the subprime market is credited with expanding homeownership, in fact a huge majority of subprime loans were refinances. Cash strapped homeowners, often senior citizens coping with a fixed income and a tattered social safety net, tried to stay alive in the consumer economy. They far outnumber the speculators and other people trying to ride the housing bubble to undeserved wealth. The subprime market soon segregated itself from the prime, enabling it to charge the kind of exploitative premium that business seems to require if it is going to serve the poor. However, like a roach motel, anyone who blundered into the subprime market generally stayed there, even if they could have qualified for a cheaper prime loan.
Eventually the desire for high yield securitizations caused the lenders to stop looking at loans to see whether they could be repaid at all. Rating agencies did Enron type accounting and sold securities not just to high risk hedge funds but to our own 401(k)s. Like the S&L crisis of a generation ago, scammers got rich and ordinary people face huge losses.
There is little doubt that ordinary people are no match for mortgage professionals in sophistication as to the products in the mortgage market. Imagine if we financed brain surgery the way we finance mortgages, where a brain surgery broker could make thousands of dollars talking people into brain surgery, whether they needed it or not. Brain surgery appraisers would be paid a few hundred dollars for approving the need for surgery, and of course the brokers would pick the appraisers who would approve the deal. If the patient was killed or injured by inappropriate surgery, there were no consequences for the broker. How much unsuitable brain surgery do you think we would get in such a system?
Yet we continue to hear blame for borrowers, either as the primary cause or at least as an equal cause for the problem. However few borrowers had any level of sophistication to match against mortgage professionals. Few even comprehend the meaning of balloon payments or prepayment penalties or the effect of adjustable rates or teaser rates. These things are not within their experience. Yet they are asked to bet the farm on them.
Amazingly many ordinary people, as well as the business press, have little sympathy for the borrower. People see this relief for borrowers as rewarding bad behavior, and acting in bad faith to all the people who managed to avoid making a bad loan. There were also a lot of stereotypes about people who bought more house than they could afford, probably have a lot of high end consumer products like big screen tvs that the rest of us don’t, or perhaps “use their home like an atm machine” which I guess is morally suspect as well as exceptionally costly.
This is essentially the argument against welfare that reemerges often described as “personal responsibility.” Somehow one of the downsides of a consumer economy is that everyone is pitted against everyone else, the values of the stuff we buy is the only thing that matters, and that people somehow deserve whatever happens to them. If we try to do anything for the losers we are being unfair to the winners and making things worse by somehow punishing the good and rewarding the bad. These become “values issues” by which people measure the meaningfulness of life, often from a position of highly limited power. Our values are in fact very individualistic and judgmental, even though our dominant religions are generally to the contrary.
There are some free market true believers who think that markets can do no wrong. Many believe that limitations on debt and the costs of credit, once known by the ancient concept of usury, is archaic. In fact the evils of excessive debt were commented on by Thoreau and was a large part of the unrest of 19th centruy America. They are making there way back, including in some evangelical settings.
The mortgage meltdown is a case where the markets are disfunctional. This has happened as a result of imbalances of knowledge, power and sophistication as well as factors of psychology, herd behavior and other irrational and emotional behavior in the marketplace. Disfunctional markets are not uncommon. Markets work well to the extent that they produce things that people need, and badly to the extent that one side can sell or con people into doing harmful things, as is rampant in the auto and credit card industries. Let the buyer beware is a bad idea. We would not buy food or cars or fly on planes if we didn’t believe someone with some power was looking out for our safety.
Foreclosure should be an easy one in that it does great harm to borrowers, their communities and even the lenders and ultimately the world economy. Still the financial services industry resists change as if it were pulling teeth,. It remains to be seen whether they make any changes because of the Bush/Paulson negotiations or if Congress can resist industry campaign contributions and put some legal obligations, and perhaps some improved bankruptcy remedies, out there to save the hundreds of thousands of homes that are in danger.
and the next day the NYT suggests the home mortgage deduction should be discontinued all together, Maybe that’s not a bad idea.
http://query.nytimes.com/gst/fullpage.html?res=9503E6DC1039F931A25752C0A960958260&sec=&spon=&pagewanted=all
Free Market ideologues and financial professionals complained that rescuing homeowners from losing their homes would present a “moral hazard,” encouraging bad economic behavior among the masses. The right wing Cato Institute even said “Capital markets without losses is like religion without hell.” In fact lenders see foreclosure as encouraging payment the way hell encourages virtue. Accordingly the financial services industry has been resisting efforts to seriously help homeowners, as opposed to PR media events like the highly limited “Project Hope” announced by the Bush Administration.
However on Friday the Federal Reserve rode to the rescue of the Bear Stearns investment banking firm. These are among the folks had helped invent the securitization of mortgages, which brought additional capital to fund the subprime loan market but which also, in a deregulated environment, encouraged loan originators working on commission to sell unsuitable loans to people. They could then unload them on investors with the help of rating agencies with a financial interest in saying they were great investments, a reprise of the Enron experience. Bear Stearns had the misfortune that some of their hedge funds which had invested in subprime loans went bust, which did for the subprime mortgage meltdown what the fall of the Bastille did for the French Revolution.
“Bailout” is not a word that voters, and people lucky enough to have avoided the bad mortgages themselves, wanted to hear. So instead we are told that Bear Stearns was having a “liquidity crisis.”
A homeowner who can’t pay his mortgage because the teaser interest rate and resulting payment have “adjusted” to unaffordable levels also is having a “liquidity crisis.”
Industry says that if Bear Stearns or another major financial institution fails, a “crisis in confidence” or major financial panic would ensue.
Individual homeowners are not so important on Wall Street or inside the beltway. However when thousands of foreclosures happen each year in Montgomery County alone, devastating families and communities alike, that is pretty major too. And this scenario is happening all over the country, with millions of foreclosures taking place .
America needs to stop blaming the victims, most of whom relied on the experts concerning incomprehensible and complex legal documents which define products that only the experts knew how to manipulate and make millions.
We need legislation that will save homes. The industry, despite their media events, is neither set up nor “incentivized” to do this (meaning no one will pay them to hire the needed staff, let alone make a profit from doing so.)
Government needs to buy the bad mortgages, particularly those with either excessively high balances due to bogus appraisals arranged by loan originators, or with various rate adjustment gimmicks that soon render the loans unaffordable, and fix them to get rid of these bad features. After the loans are fixed, the secondary market can invest in them with reasonable confidence that they won’t go into foreclosure.
Also the bankruptcy laws need to be changed to allow bankruptcy judges to impose repayment plans reflecting both the borrower’s ability to pay and the actual value of the home. If the Judge can make them the industry is more likely to go along with modifications rather than resist. This is already the law except for a loophole for home mortgages that was procured by the industry a while back. Industry recently got the Republicans to filibuster this provision and President Bush says he will veto it. However it will be back and the foreclosure situation keeps getting worse.
Reagrding the home mortgage deduction–I would favor elimination of ALL deductions and tax credits.
Taxes should exist to provide a revenue stream, period. Unfortunately, our addled legislators think that taxes may be used equally well for criminal law enforcement, social programs, and economic development. Essentially, they think “rather than dedicating expenditures to promote housing, health, employment, investment, charity–instead we’ll put incentives on our revenue side in the tax codes.” The system then has no firm budget–there’s no way to get a handle on what home ownership, for example, is costing us since there’s no way to limit the amount of home mortgage deductions.
If there are no deductions, credits, etc., then the IRS could operate on much smaller budget–we’d save millions and millions. Filing tax returns would become simpler (currently the IRS estimates that the average taxpayer devotes more than one full workday to filing its tax returns). Government then could then target economic growth or social welfare through directly funded programs or grants–in both methods, gaining the ability to limit expenditures. The only losers would be the tax preparation services–and let’s face it, they don’t exactly provide a service that enhances the quality of our lives.
Of course, you can’t pull the plug on all deductions precipitously–people need to be able to make long-term plans without fear of sudden changes. But a slow phase-out of the more widely-used deductions would be fair to all.
It is ridiculous to lay the blame for this debacle solely at the feet of conservatives. Krugman does state that during the bubble years, the mortgage industry lured millions of people into borrowing more than they could afford, and simultaneously duped investors into investing vast sums in risky assets wrongly labeled AAA. That’s where the greatest blame lies, banks that made loans that were very risky. I disagree with Stan that we really can’t blame the borrowers because they were unsophisticated. A person of average intelligence can understand a balloon payment and that an adjustable mortgage can be adjusted upward.
Having said that, I do believe the regulators were lax. They allowed, but did not require banks to make bad loans. Laws should be passed to prevent this from happening again so the regulators will not allow this.
Don’t those companies that provided these official AAA ratings have much of the liability? If the loans could not be easily traded many fewer would have been written.
There were of course some speculators wanting to get rich in real estate, as well as individuals who wanted some of the bigger and more expensive houses America has been building lately. But those are a minority. The foreclosure crisis is doing the most damage to ordinary people whose homes are getting foreclosed on. This happened because of the combination of high up front profits made by loan originators regardless of whether the loan was good or bad, and the securitization device which effectively eliminated consequences for eliiminating a bad loan. We also saw the development of “exotic” mortgage products which gave an enormous advantages to insiders who devised and priced them. Ordinary people were used to the old fashioned mortgage, you pay for an agreed time and then it’s gone. The most important thing to them was the lower monthly payment. Industry devised various ways to make this happen such as longer long terms which greatly increased the interest paid and the time needed to make substantial reductions in principal, balloon payments that do not pay off when the term is over, adjustable rate mortgages with temporary “teaser rates” that are lower than the formula used during the rest of the loan, “interest only gimmicks”, low minimum payment gimmicks, bait and switch tactics and promises to refinance later when your credit is improved. In the subprime market, borrowers did not have access to the underlying rate decisions making each deal different and comparison shopping impossible. An adjustable rate mortgage had a slightly lower monthly payment, but both ordinary experience and the sales pitch did not indicate that rate and payment changes would be extreme. People were perhaps familiar with miniscule changes in their interest earnings on bank accounts, but ill equipped to understand that small changes in interest rate numbers can turn into enormous changes in mortgage payments. Most people don’t speculate in currencies and know nothing about the LIBOR (London Interbank Offering Rate, essentially the English money market in dollars) that is used in most subprime mortgages. Borrowers’ expectations was that there might be a small change, even though the contracts provided for huge ones. The Truth in Lending disclosures for mortgages assume there will be no change in interest rates, and explanations are both unduly benign and incomprehensible. The LIBOR bottomed out in 2004 setting people up for drastic rate and payment increases, which have been temporarily alleviated by the federal reserve.
As to whether conservatives should be blamed; 1. conservatives of the Reagan era came up with deregulation and the idea that markets if left alone make the right decisions, while governments make the worng decisions. In practice this works best when you have people with equal knowledge and bargaining power but poorly when you have a high degree of imbalance in knowledge and power, as happens in the mortage market and many other parts of the economy. In addition, the deregulation approach is based on an assumption that participants in markets are rational, when in fact ordinary people often behave irrationally and are encouraged to do so by advertising and marketing; 2. “conservatives” are actually a spectrum of people who work in coalition to take and hold power. At least two groups within the conservative coalition are heavily involved in a symbiotic way. One is free market ideologues who have turned the mortgage market into the wild west. However the most powerful group in the colation is the owners and managers of business combined with those who share their culture and world view. These are people who are interested in getting rich, and many did, not because of better ideas and better products, but by deception, corruption, tricks and traps, leaving investors and homeowners holding the main bag. However so many are holding the bag that it threatens the economy in general. In addition a major danger is to ordinary people, particularly the poor and working people and minority communities where the family home is the main asset and source of wealth, but also any community in which foreclosures are occuring and reducing property values due to vacant and often vandalized properties..
Stan, I don’t fully understand your statement “and the securitization device which effectively eliminated consequences for eliiminating a bad loan. We also saw the development of “exotic” mortgage products which gave an enormous advantages to insiders who devised and priced them. ” However, based on my little knowledge, this would seem to be a very ripe area for corrective action. Even a free trader ideologue should understand that businesses should not be able to isolate themselves from bad decisions.
As to whether conservatives should be blamed, as a conservative I agree that they bear some blame. Deregulation simply went too far. Banks that made bad loans and other facilitators of these schemes bear an enormous amount of brains. Those consumers who understood the risk and took out the loans anyway bear blame as well. A whole lot of repair of this area needs to be done and quickly and I will support reasonable reform.
Here’s a concise overview on who is to blame for the subprime mess:
http://www.investopedia.com/articles/07/subprime-blame.asp
Correction: Banks that made bad loans and other facilitators of these schemes bear an enormous amount of Blame, not brains. Heck, it was their lack of brains that got us into this mess!
Lack of brains equals uncontrolled greed.