Saturday, September 20, 2008

Why isn't the government taking its share of the blame for the foreclosure mess?

Who's to blame for the foreclosure mess that's tanking the U.S. economy and bearing down hard on markets around the world?

Why, those nasty, greedy bankers, of course!

Honestly, that's about half the story. Yes, some banks took on far too much risk and are partially to blame. We've watched the likes of Countryside fall into financial ruin and let's not forget that the pinheads running Fannie Mae and Freddie Mac contributed to the mess we're in, too.

Amazingly, however, the media and the government have almost entirely overlooked how Congress contributed to the whole mess. One of the best and most concise articles you'll find on the government's roll in the death of the subprime lending market can be found right here. Read it and Digg it, or at least consider what the author has to say about the government's role in subprime lending. Sadly, that analysis was written a year ago and has largely been ignored.

In a nutshell, the subprime lending market has its roots in the 1977 Community Reinvestment Act, which was pushed for by that walking disaster known as Jimmy Carter. That act, in essence, encouraged making mortgages available to people with bad credit. The idea was that it was somehow discriminatory and/or downright unfair for banks to look solely at economic criteria and seek to minimize risk when granting mortgages.

The act has been refined over the years and, eventually, led to the authorization of subprime mortgages (via an revision to the act signed by the perpetually addled George Bush -- he also signed that hideous bankruptcy reform junk into law, so an argument can be made he'll approve damn near anything stuck in front of him).

So, banks were encouraged and, at times, compelled to extend those wretched subprime things in an attempt to make it easier for more Americans to own homes. Thank God for banks like Bentonville, Ark.-based Arvest which refused to have any part of that nonsense.

I point at Arvest as an example because that bank is still doing well. It's the largest bank in Arkansas and is rapidly spreading to other states, as well. An Arvest official told me a few months ago that shareholders and customers put the bank under a lot of pressure to give out subprime loans, but cooler heads prevailed. Thank goodness for those cooler heads.

At any rate, there was another disastrous trend that emerged years before the birth of the subprime market -- the elimination of usury laws. Those laws, of course, put a cap on interest rates and mostly impacted short-term rates.

There is a significant distinction between the traditional, 30-year, fixed-interest rate mortgage and the more variable packages put together for the subprime market. Forget about the notion that long-term rates will be impacted when the Fed cuts the federal funds rate. That long-term mortgage rate moves along with the bond market and tends to behave independently on what the feds are doing.

Contrast that with, say, an adjustable rate mortgage that's part of a subprime package. That rate will typically be low for an initial period and then float along with a short-term index.

In other words, you had usury caps removed and a national policy that encouraged (and, in some cases, bullied) lenders into assuming risky loans. Banks, when they assume risk, pump up that interest rate and were allowed a lot more leeway without usury laws standing in their way.

So, everything looked great when the subprime market was booming as loans were getting written, people who thought they'd be renting forever were able to purchase homes and a lot of money was flowing through the economy. The problem of that entire system was masked -- all those subprime mortgages came with outstanding initial terms and rates.

Reality set in, however, when that initial term expired and higher rates and more unfavorable terms kicked in. All of the sudden, a lot of people couldn't afford their mortgage payments and were forced into foreclosure.

It's worth pointing out that the people who saw disaster looming when everything appeared to be great on the surface were told to shut the hell up and quit being so "negative."

At any rate, here's the point -- the government had a significant role in creating this mess. How much do we believe the people stupid enough to put us in this position will fix it? Yes, Congress may come up with a solution but we should be wary and really should pay more attention to what's happening.

Too much government involvement will often lead to disaster. Want to keep this kind of thing from happening again? Leave the lenders alone and let them go back to the "bad old days" when fixed interest rate mortgages were one of the few things available and you'd better have a down payment of some sort and a decent credit history if you want to borrow money from a bank.

If that too restrictive? Maybe, but setting up a system in which high risk loans are encouraged and the feds will be there to bail out banks when the very foreseeable mortgage defaults take place just ruins the economy, hurts tax payers and invites a future rash of foreclosures.


Anonymous said...

Great information, Hawg! I have one teeny disagreement with you, though. I think the government is 100% responsible for the mess. Before this disgusting law was passed, banks were not about to lend to people they knew couldn't pay it back - socialists in our government stuck their noses under the tent, compelled banks to make horrid loans, and here we are today. I blame LEFTIST LEGISLATORS FIRST AND FOREMOST. Yes, I love President Bush because of his honesty and tenaciousness, but he should have vetoed every socialist bill that crossed his desk. He obviously did not. To his credit however, he did attempt to get more oversight on the financial world and Congress laughed at him, or rather, sneered at him. Nevertheless, I put blame on government first, customers who knew they couldn't repay the loan second, and the banks only third.

The Natural State Hawg said...

Good points, but I tend to put banks and the government on the same plane when we're assigning blame. Why? The banks rallied hard to get rid of usury laws in this state and other ones. And banks advertised hard in an attempt to sell subprime loans to anyone who would buy them.

Of course, the lefties in Congress got the ball rolling and then that idiot Bush went and authorized the subprime loans that got us here. And, yes, idiot Bush -- I'm a Reaganite and know full well how the Gipper would hare reacted to such a horrid proposal.

But, I don't think trying to figure out who shares most of the blame matters that much right now. There's a lesson here -- when the government steps in and meddles with the free market too much, bad things happen.

I know you and I agree on that point, and that is the important one!

Da Old Man said...

I'm with the government is mostly at fault also crowd. Banking is highly regulated, they can't do much without approval. They get this by bribery--I mean PACs and various contributions to political parties.

The Natural State Hawg said...

Da Old Man:

Exactly! You'd better believe that lobbyists for mortgage lenders were paying fat cash to get rid of usury laws, make riskier mortgage packages available and etc. And let's not forget that shareholders will go ga-ga over virtually anything new that promises a lot of short-term profits.

Again, banks were a major component in all of this. But certainly not the only one (heck, maybe not even the biggest one) that led us to where we are right now.

Roger DJ said...

Good info/post. I've been wondering how to write about this but I guess there's no sense in re-inventing the wheel. I'll just point folks this way.
Sadly, it seems both candidates have some of these same guys giving them advice on economics. I've also heard from some that another factor in the mess was allowing insurance companies to get into the banking business and visa-versa. There used to be a clear division.

The Natural State Hawg said...


I'm not sure how the insurance angle really works in here at all. I'd have to take a look at that.

One thing that is very true is that private mortgage insurance is a big deal -- if you put less than 20 percent down, you often to buy an insurance policy guaranteeing payments on the loan. Obviously, those are ony good for so much...

Of course, thanks for the kind words! Send 'em right on over...

Sara said...

Congrats on the Broncos win. As a Saints fan, it was painful.

The Natural State Hawg said...

Thanks, Sara. Here's the problem with the Saints -- it's really hard to root against them.

That team's home city -- as you well know -- was nearly wiped off the map three years ago and was in danger again this year. One can't help but pull for the Saints at least a little bit. Hey, I'm a Broncos fan to the core, but I just can't work up much enthusiasm against the Saints.

Here is something to encourage you, however. The team looked awfully good on Sunday and got very close to winning after being down by 18 points. The offense for the Saints is certainly there and the defense looked great against the highest-scoring team in the NFL today.

Karen said...

What a great post. I think everyone played a part in this fiasco. Humans are greedy by nature. I gave you an award. You can check it out over on my sewing blog! You do read my sewing blog don't you? LOL

The Natural State Hawg said...


Well, I'm going to read at least one sewing blog from here on out ;)

Thanks for the award!