Reason Magazine - Topics > Housing

An Expert-Induced Bubble

info@reason.com (David M. Levy) info@reason.com (Sandra J. Peart) — Tue, 30 Sep 2008 07:00:00 EDT

How is it that assets built out of mortgages which just yesterday were worth so much are worth so little today? Investors have only recently come to realize that the ratings for these assets were terribly biased. The question now is why we ever came to believe mortgage-backed securities were worth our investing dollars in the first place. There is of course much blame to go around. But insufficient attention has been paid to how ordinary investors—not greedy capitalists but instead those of us who are trying to save for our retirement, our kids' college education, or, indeed, the down payment for a house!—trusted the experts and got burned.

Experts are constantly telling investors what to buy. Sometimes they give us good advice and sometimes not. So surely the fact that there are experts who give investment advice can't explain the trillion-dollar bubble and subsequent meltdown we're now witnessing. The key additional fact is that experts were selling advice about mortgage-backed assets as if those assets were independent when, in reality, they weren't at all independent assets. Only once investors realized that the housing market is a national market—not a local one—did it become clear that these securities were extraordinarily risky. Hence the collapse.

Until very recently it was widely believed that all housing markets were local. If this were so, then assets constructed by pooling mortgages across different localities would consist of pooled independent assets. And these new assets would be dramatically less risky to hold than a single mortgage of similar worth: Combine a bunch of diverse mortgages and sell shares of the new security and those shares represent much less risk than holding a single mortgage of the same value as the share. Or so the story went.

All of this, however, depended critically on housing markets being local, so that the assets in the pooled security didn't move together. Not so long ago, this was the conventional wisdom. Federal Reserve Chairman Alan Greenspan testified to this effect before Congress in 2005, when the housing bubble was well under way: "The housing market in the United States is quite heterogeneous, and it does not have the capacity to move excesses easily from one area to another. Instead, we have a collection of only loosely connected local markets."

So, following Greenspan's advice, a firm could build highly rated investment portfolios of purportedly uncorrelated assets out of nothing but mortgages from different parts of the country. Once these portfolios were built, it would become easier to finance houses even for buyers of dubious credit. The problem was that these new securities, and the money which flowed into all housing markets, were sufficient to generate correlation in housing values across the country. As everyone followed the experts' advice—and invested in these new mortgage-backed assets—we began to observe correlated behavior in the housing market, nationwide.

So how did the securities maintain their high investment grades? Once correlations were evident, once the interconnectedness of housing markets nationwide was evident, why didn't another set of experts, the rating agencies, step in and downgrade the securities?

Because of incentives, the cornerstone of economists' advice about how to get good economic outcomes. In this case, the incentives weren't there to obtaining unbiased estimates of security values. Instead, incentives favored "rating shopping" and so, unsurprisingly, rating shopping became the norm. The Securities and Exchange Commission's 1994 report, Concept Release: The Nationally Recognized Statistical Ratings Organization (NRSRO), contained the following sentences:"A mortgage related security must, among other things, be rated in one of the two highest rating categories by at least one NRSRO." The phrase "one of the two highest rating categories" authorized the firm holding a mortgage backed security to shop for ratings. If one rating agency failed to produce a desirable rating, the firm could look for another, more favorable rating.

Those who made the ratings became like expert witnesses in court, seeing things the way their clients, the firms holding the securities and offering them for sale to you and me, wanted things to be seen. The problem was that shoppers, like a jury, did not have the ability to average out different pieces of testimony to help remove the bias. As long as experts were trusted and the market didn't know the difference between unbiased and biased estimates, the trick worked marvelously. The collapse followed suddenly as we have all come to understand that the ratings were miserably biased.

All of this is a telling lesson about how much and when to trust the experts. This is especially so now that a new set of experts is attempting to get us all out of the mess we're in.

David M. Levy is an economist at George Mason University and Sandra J. Peart is an economist at University of Richmond. They are the authors of The Vanity of the Philosopher: From Equality to Hierarchy in Post-Classical Economics.

The Most Promising Lede of the Week

matt.welch@reason.com (Matt Welch) — Mon, 15 Sep 2008 10:07:00 EDT

From funnyman economist/TV personality Ben Stein:

Earlier this month I was flying home to Los Angeles from the Republican National Convention in St. Paul, which I attended as a pundit, not a politician. Sitting next to me on the flight was a charming young man named Tom Morello. Ruthless questioning elicited the fact that he is the lead guitar for a fabulously successful band called Rage Against the Machine.

But instead of spinning this material into an Odd Couple-style comedy of manners, the former Nixon speechwriter (website here) uses it as an opportunity to probe the perennial, bipartisan, and futile crusade against Washington "waste, fraud and abuse," and then pivots in favor of federal regulation:

Then there is that aspect of the war against Washington in which candidates -- very often, my fellow Republicans -- rage against the machine of regulation. Indeed, this is a constant refrain of the conservatives I call my pals. Regulation is stifling growth and entrepreneurship, they say.
With respect, I don't see it. Look at the major debacles in the economy in the past quarter-century. The junk-bond scandal of the 1980s was largely a result of a failure of regulation. The tech boom of the 1990s and the subsequent bust were greatly facilitated by a lack of regulation over fiduciary behavior by underwriters and investment banks. The problem was not too much regulation, but far too little.
Or look at the current financial madness caused by wildly imprudent lending by major banks and investment banks. Basically, a major piece of deregulation, the Gramm-Leach-Bliley Act, overturned most of the laws that had kept commercial banks and investment banks separate. This made it much easier for monster-size banks to lay down enormous bets on the direction of housing prices.

I don't agree with Stein–for one thing, I'm not sure what special "regulation" was required for the dot-com bust of 2000, and the tech boom that both proceeded and succeeded it continues to be a wonderful thing indeed. Also, most entrepreneur-stifling regulations occur at the local, not federal, level, and they can stifle to the point of sending perfectly good people to jail.

But it's interesting to see the re-regulatory mindset at work. Somewhere, somehow, people were making money in new-sounding ways. When enough of them started to lose money, it's time to Do Something. That is a powerful urge in any season, and it sure seems to be gathering steam in 2008.

reason on Ben Stein here; on Tom Morello here.

Look, Ma, Free Money!

matt.welch@reason.com (Matt Welch) — Thu, 11 Sep 2008 09:32:00 EDT

Forbes has a depressing little article about how the Fannie/Freddie bailout has some in Washington licking their chops for more:

A normal taxpayer might think that since the Treasury Department has just committed the government to spending an unknown (but possibly very large) amount taking over Fannie Mae and Freddie Mac, Congress would be in a tightfisted mood.
But that's not the way some Washington lobbyists and politicians think. Instead, they're viewing the bailout as an invitation to push through other taxpayer-financed bailouts and aid in the few weeks that Congress will work before members break to campaign full time for the November elections.

"We're talking about the next New Deal," enthuses William McNary, president of USAction, a national coalition of grass-roots community organizers. He wants more money from Congress for everything from food stamps to inspecting and fixing bridges and roads.

And he's not alone. The article goes on to report that the Big Three auto companies are pushing for another $25 billion in low-cost federal loans on top of their current $25 billion in low-cost federal loans, "so they can build more fuel-efficient vehicles." The Dept. of Transportation wants another $8 billion. The latest round of "emergency" supplementals for the war will cost $70-100 billion (and no doubt be filled with all kinds of unnecessary goodies). And Democrats are itching for second stimulus, of maybe $50 billion, that would be spent on "infrastructure projects, Medicaid costs and local law enforcement, as well as relief for Gulf Coast residents struggling with flood costs and those in the Northeast and upper Midwest straining to pay winter heating bills."

"I got a four-letter word: j-o-b-s," said U.S. Rep. Rahm Emanuel, D-Ill. "That's the focus of the second stimulus. We want to own the issue that we are the party of a jobs agenda. We will take it up as soon as we are done with the energy bill."

Whole thing here.

McPalin on Fannie/Freddie

matt.welch@reason.com (Matt Welch) — Tue, 09 Sep 2008 09:12:00 EDT

Writing in today's Wall Street Journal:

Along with the commitment of taxpayers' dollars, we should make market reforms to help ensure that we do not face this problem again. We will make sure the marketplace understands its obligations. Homeowners must be able to understand the terms and obligations of their mortgages. In return, they have an obligation to provide truthful financial information, and should be subject to penalty if they do not. Policies must be in place to ensure that homeowners provide a responsible down payment of equity in the initial purchase of a loan. In the future, Fannie, Freddie or any government organization should never insure a loan when the homeowner doesn't have enough of his or her own capital in the investment.
Lenders who initiate loans will be held accountable for the quality and performance of those loans, and strict standards must be required in the lending process. Every lender must be required to meet the highest standards of ethical behavior, with recourse if they do not perform.
Reforms are necessary now to make mortgage lending and banking organizations more transparent. We will require greater disclosure, so that complex derivative instruments and excessive leverage can't put the marketplace, and the financial security of your home, at risk.
We will push the nation's top mortgage lenders to provide maximum support to help cash-strapped, but credit-worthy customers. Lenders should do everything possible to keep families in their homes and business growing.

Whole thing here. Thoughts?

I Say Re-Regulation, You Say Deprivatization

matt.welch@reason.com (Matt Welch) — Mon, 08 Sep 2008 10:48:00 EDT

New York Times economics-and-politics columnist Paul Krugman gets all post-modern on the re-regulation of the U.S. housing market.

Private ownership of Fannie and Freddie never made any real sense, and was always a crisis waiting to happen.
So what we're really seeing now is deprivatization. It's not something like the UK government seizing the steel mills; it's more like firing Blackwater and giving responsibility for diplomatic security back to the Marines.

This is, I think, a neat encapsulation of the mindset that may just be on the verge of re-taking Washington. Some things, alas, are just too important to be left to the market. Like, um, bank lending.

Barack Obama approves the Bush Administration's message here, though at least he adds this to-be-sure:

In our market system, investors must not be allowed to believe that they can invest in a 'heads they win, tails they don't lose' situation.

Poor Charlie

info@reason.com (Damon W. Root) — Fri, 05 Sep 2008 16:59:00 EDT

Has Rep. Charlie Rangel (D-N.Y.) cancelled his subscription to The New York Times yet or what? First, the eminent domain-loving daily breaks the news that Rangel is a self-righteous rent control scofflaw. Now the Gray Lady reports that the dapper Harlem congressman has failed to report some $75,000 in rental fees from a villa he owns in the Dominican Republic. Seriously, this guy has four rent-stabilized New York apartments and a villa that rents out for $500 a night? Now we know how he can afford all those great suits. From the Times:

New York State law classifies filing a false city or state tax return a felony punishable by up to four years in prison, but Kathleen M. Pakenham, a tax lawyer at the law firm of White & Case, said criminal prosecutions are rare and in most cases, the taxpayer is simply fined 20 percent of the back taxes owed.

[...]

Whatever his legal exposure, the tax problems present a political embarrassment for Mr. Rangel, a Harlem Democrat who has sat on the Ways and Means Committee since 1975. As chairman, Mr. Rangel has pushed for higher taxes on the wealthy, unveiling a $1.3 trillion proposal last year that businesses denounced as a threat to the economy.

Whole thing here.

Banking on Big Changes

info@reason.com (Jeff Taylor) — Thu, 28 Aug 2008 13:00:00 EDT

Democrats in Denver are droning on about the harm done to the middle class by the current financial system pullback. The Federal Deposit Insurance Corporation (FDIC) is adding banks to its "watch list"—now at 117—and warning that it may not have enough money to insure all depositors. The FDIC seized another bank last week, the ninth such action this year.

Given all this attention, not to mention hourly stock market gyrations based on home sale and price data, you might think the American banking system must be fairly well understood, especially what brought us to the present meltdown. But this doesn't seem to be the case.

The present situation is portrayed overwhelmingly as an economic story when, in fact, it is primarily about regulation and public policy—the past 30 years of bipartisan, nearly universally-praised policy to be specific. And it is probably that universality of opinion that keeps misconstruing what is really happening.

The history of the FDIC illustrates what has transpired. Born out of Great Depression economic turmoil, the FDIC was created to ensure the safety and soundness of bank deposits, hence the deposit insurance bit. In the face of bank runs, the feds stepped in to say, "Not to fear, your money is not going anywhere. Uncle Sam has you covered."

Yet that is not what the FDIC is now doing. Its mission has changed. As it tries to clean up California's Indy Mac Bank, for example, its first order of business is avoiding foreclosure on bad loans the bank made to homeowners. An analyst with Barclays Capital called this approach "dangerous" because it gives investors in mortgage-backed securities a reason to run for the exits if the FDIC does not care about recovering their money. In effect, the policy shorthand has changed to read, "Not to fear, you are not going anywhere. Uncle Sam will pay your mortgage." This is very different from its original mission but perfectly consistent with the public policy trend which began in the 1970s and accelerated with the Community Reinvestment Act (CRA). The goal was to make banks agents of social change.

The federal government, Democratic and Republican, wanted trillions of dollars of credit extended to private borrowers. This was primarily done via the active secondary mortgage market participation of government-backed Fannie Mae and Freddie Mac, but also through leverage the CRA provided by requiring expanding banks to explicitly promise to lend money to higher risk borrowers. And incidentally, the overwhelming beneficiaries of that flow of credit was America's supposedly beatdown middle class, which took the money and ran to buy not just homes, but cars, boats, college educations, diamonds, furs, boobs, computers, widescreens, flatscreens, and then second homes.

So then, the policy worked? Yep, private investors created ever more complex ways of leveraging capital into ever more lendable money. They took the federal directive to spread the wealth around (quite literally) to the point where risk was no longer a negative aspect of the credit calculus. In fact, by the dawn of the 21st century, risk was courted by banks because it was more profitable in the short-term. Federal regulators, who in decades before might have been aghast at such practices, applauded because the larger goal of extending credit to every corner of the American landscape was advanced.

But with risk out of the picture it was only a matter of time before the entire enterprise became over-extended. The oil shock of $4 gas, Fed missteps, wild speculation in condo markets, or maybe the moon cycle provided nudges over the past few quarters. No matter the short-term cause, the foundation was rotten and a great de-leveraging is underway. Capital is scarce and lending nonexistent in some sectors. Now what?

How about a little honesty? Fannie and Freddie are in the process of being de facto nationalized by the Treasury. The implicit federal guarantee of their solvency is being made explicit and may hit $50 billion over time. But this may be just the start.

In a memo to clients and the president-elect, Chris Whalen of Institutional Risk Analytics suggested that the bailout of the government-sponsored enterprises (GSEs) Fannie and Freddie is part of a larger picture. Whalen explains:

Since last summer, the various parts of the securitization market have been slowly imploding, right on up the food chain from subprime [collateralized debt obligations] to the AAA-rated GSEs. The only way to staunch the bleeding and begin the process of restoring confidence in all manner of securitizations is to take the GSEs off the table as a concern for investors. When and only when the GSEs are affirmed as affiliates of the U.S. Treasury will yield spreads on GSE debt start to fall, ending the immediate crisis.

Once the GSEs are safely under a conservatorship, with a program in place to slowly run-off the retained portfolios as the debt supporting them matures, then we can start focusing on the next task, namely fixing the securitization markets and recapitalizing the commercial banks.

Whalen also adds the important insight that banks are government-sponsored enterprises too, just more competitive and charged with providing capital to the private economy in ways federal regulators and politicians desire. If that is the case, and the past 30 years certainly suggests it is, then recapitalizing the banks is going to take money from the Treasury. Lots of it.

The alternative is to permit market forces to allocate capital from private sources without direction from officials Washington or New York. Not very likely, especially in an election year.

Jeff Taylor writes from North Carolina.

Americans Should Be Outraged by the Bill I'm Voting For!

matt.welch@reason.com (Matt Welch) — Thu, 24 Jul 2008 12:02:00 EDT

John McCain has issued a curious response to the housing bailout bill. Here's how it begins:

Americans should be outraged at the latest sweetheart deal in Washington. Congress will put U.S. taxpayers on the hook for potentially hundreds of billions of dollars to bail out Fannie Mae and Freddie Mac.

With combined obligations of roughly $5-trillion, the rapid failure of Fannie and Freddie would be a threat to mortgage markets and financial markets as a whole. Because of that threat, I support taking the unfortunate but necessary steps needed to keep the financial troubles at these two companies from further squeezing American families.

This strikes me as a classic example of intervention's inescapable logic: We broke it, so we bought it, and now it's too big to fail, even though it all sucks in the first place.

On that latter point, McCain has some interesting things to say:

[I]f a dime of taxpayer money ends up being directly invested [in Fannie/Freddie], the management and the board should immediately be replaced, multimillion dollar salaries should be cut, and bonuses and other compensation should be eliminated. They should cease all lobbying activities and drop all payments to outside lobbyists. And taxpayers should be first in line for any repayments.
Even with those terms, sticking Main Street Americans with Wall Street's bill is a shame on Washington. If elected, I'll continue my crusade for the right reform of the institutions: making them go away. I will get real regulation that limits their ability to borrow, shrinks their size until they are no longer a threat to our economy, and privatizes and eliminates their links to the government.

What about Obama?

I'm heartened that the President has decided to support this bipartisan bill that will help ensure that mortgages remain affordable for American families and to prevent hundreds of thousands home foreclosures. In the months since this housing package was announced, nearly a million additional families have faced foreclosure, and our economy has continued to deteriorate. We cannot wait for a million more foreclosures before taking additional action to help struggling families and strengthen our economy. That's why I've also proposed a second stimulus of at least $50 billion with energy rebates for families struggling with high gas prices, relief for states facing budget cuts, and additional measures to protect homeowners from foreclosure.

Bob Barr? A bit like McCain (interview is 10 days old):

I think right now, doing nothing would not be advisable. As much as a Libertarian, we don't like to see − and I don't like to see − the government get further involved with yet another sector of the economy.
I think, because the government has caused this problem, similar to the savings and loan problem that the government caused a generation ago, it has to do something. [...]
Yet, as long as it is done with the thought in mind that there has to be long-term congressional action here to restructure and reformulate the very way Freddie Mac and Fannie Mae operate, I think that would be an advisable solution, but not doing nothing. [...]
But the ultimate goal, I think, has to be a very firm commitment to restructure Fannie Mae and Freddie Mac.

Business Is Booming for the Repo Man

mriggs@reason.com (Mike Riggs) — Fri, 18 Jul 2008 11:16:00 EDT

The Miami Herald reports that not everyone is taking the credit crunch as hard as kids in Britain:

While the recession means hard times for most people, it's a godsend for the repo man, the person who shows up—often unexpectedly—to snatch your property when you're behind on payments.
At [Repo man Charlie Clarke's] employer, Fort Lauderdale boat repossessor and auctioneer National Liquidators, business has tripled in the last 18 months as higher maintenance fees, fuel and docking costs—as well as the real-estate crisis—have put boat owners behind on payments.
"Before the house, everything else goes,'' says Clarke, a former navy engineer who's never seen more boats in five years on the job. He has taken small motorboats, sailboats and multimillion-dollar yachts. For the 63-footer he takes on this day, its loan hasn't been paid for months, with $200,000 overdue.

I grew up in a Florida neighborhood where repos were a daily occurrence long before the housing bubble burst, and as such, I view folks like Clark with a mixture of disgust and awe: they make their money off saps who can't pay the bills, but they do so with incredible efficiency. As Bryan Burrough points out in his Vanity Fair story about the collapse of Bear Stearns, one person's (or company's) bad news, is another person's cause for celebration.

Katherine Mangu-Ward blogged here about the repo man's alleged credit crunch cohort: payday lenders.

It's Bailout Time

jwalker@reason.com (Jesse Walker) — Mon, 14 Jul 2008 09:40:00 EDT

The L.A. Times reports:

The Bush administration said it would ask Congress to authorize the Treasury Department to lend Fannie and Freddie more money than current limits permit and buy stock in the two companies.

Also Sunday, the Federal Reserve agreed to permit the companies to borrow directly from the central bank, as investment firms were allowed to do after the near-collapse of Bear Stearns Cos. in March. The money would tide Fannie and Freddie over while the administration and Congress rush the emergency measures through....

The plan is certain to be highly controversial, with critics saying it bails out shareholders of companies that took excessive risks during the housing boom in recent years.

Critics of government intervention say such rescues encourage irresponsible investing -- thus bringing about financial-market bubbles -- because investors believe the government will bail them out at taxpayer expense.

Well, yes. Meanwhile, Karen De Coster makes a pertinent point:

In listening to the constant chatter about the Fannie-Freddie crisis, one thing struck me as funny -- Bloomberg analysts appeared to be perplexed that both companies are ranked Aaa by the credit-rating oligopoly, yet derivatives traders were trading both at levels that implied a credit rating at least five levels lower.

Credit ratings by the government-granted oligopolists are not the market; trading actions based on actual knowledge and/or informed interpretations of known events are the market. The act of trading credit-default swaps (tied to debt sold by Fannie and Freddie) does not hinge on implied promises on the part of the government. Sure, implied government backing has caused the security prices to be skewed for Fannie and Freddie. But what's happening here is that the market participants, in spite of an implicit government guarantee, are coming to their senses and realizing the insolvency...of both Fannie and Freddie.

In My Uncle's House

jwalker@reason.com (Jesse Walker) — Sat, 12 Jul 2008 17:05:00 EDT

With Fannie Mae and Freddie Mac in a shaky state, The New York Times reports that the Bush administration is mulling "a plan to have the government take over one or both of the companies and place them in a conservatorship if their problems worsen," or possibly "an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies." Philip Klein comments:

When [Freddie Mac was] created in 1970, Fannie and Freddie were granted a relatively modest $2.25 billion line of credit from the government. Though they have never dipped into it, the implicit government backing has allowed them to finance bond purchases at cheap rates. The whole idea was to boost home ownership by spreading risk around so that mortgage lenders were more comfortable issuing loans knowing they would be backed by Fannie and Freddie. Of course, what this translated into was companies issuing loans to people who weren't credit worthy enough, and instead of risk getting spread out, it actually became heavily concentrated into these two companies.

While neither of these mortgage financiers loan money directly to consumers, they hold the bundled mortgages from the companies that do, and as a result own or back more than half of the nation's $12 trillion in mortgage debt. Nationalizing their debt, on top of the tremendous potential costs involved, would mean the federal government ultimately owning a massive portion of American homes.

John McCain, sadly, has already come out in favor of some kind of bailout for Fannie and Freddie.

Obama, meanwhile, is staying vague. Fannie and Freddie insist that there's no crisis. And -- oh, yeah -- the feds just took over a teetering Pasadena-based bank.

I Love Livin' in the City

info@reason.com (Damon W. Root) — Fri, 11 Jul 2008 07:40:00 EDT

The New York Times reveals that my old Congressman, Rep. Charles Rangel (D-N.Y.), is one of the many wealthy New Yorkers hoarding a rent-stabilized apartment. Four of them, in fact, all located in Harlem's coveted Lenox Terrace building on 135th Street between Fifth and Lenox Avenues. From the Times's report:

State officials and city housing experts said in interviews that while the law does not bar tenants from having more than one rent-stabilized apartment, they knew of no one else with four of them. Others suggested that the arrangement undermines the purpose of rent regulation.

The fourth apartment, by the way, a 10th floor one-bedroom for which Rangel is paying just $630 a month (he also has a two-bedroom, a one-bedroom, and a studio on the 16th floor), is serving as his campaign office, a pretty clear violation of state and city laws mandating that rent-stabilized apartments serve as a tenant's primary residence. Then there's this:

Some Congressional ethics experts, while saying it appears legitimate for Mr. Rangel to have one rent-stabilized apartment, question whether his acceptance of the additional units may violate the House of Representatives' ban on members' accepting gifts of more than $100. They suggest that the difference between what Mr. Rangel pays for the second, third and fourth apartments and what a new market-rate tenant would pay—some $30,000 annually—could be considered a gift because it is given at the discretion of the landlord and it is not generally available to the public.

Whole sordid story here. Nick Gillespie on Califorinia's rent control laws here. The Cato Institute's William Tucker on how rent control drives out affordable housing here.

Congress Tackles the Risky Loan Shortage

jsullum@reason.com (Jacob Sullum) — Wed, 25 Jun 2008 10:12:00 EDT

Here's the New York Times summary of the housing legislation Congress is on the verge of approving:

The centerpiece of the Senate package is a rescue-refinancing plan aimed at stemming the tide of more than 8,000 new foreclosures a day that lenders are filing across the country. The plan would allow distressed borrowers and their lenders to stem losses by allowing qualified owners to refinance into more affordable, 30-year fixed-rate loans with a federal guarantee.
The legislation would also provide benefits for first-time buyers, who would receive a refundable tax credit of up to $8,000, or 10 percent of the value of a home, on purchases of unoccupied housing.
As part of a regulatory overhaul of Fannie Mae and Freddie Mac, the mortgage finance giants, the bill would permanently increase to $625,000, from $417,000, the limit on loans they can purchase from lenders in expensive housing markets, making it easier for borrowers to obtain mortgages at discounted rates.

Problem: Lots of people took out loans they could not afford to buy houses that subsequently declined in value.

Solution: Bail out borrowers and lenders, putting taxpayers on the hook for the bad loans; increase subsidies for home purchases; and make it easier to take out big mortgages.

What could possibly go wrong?

Your Fingerprints Are Literally All Over This Housing Bill

gillespie@reason.com (Nick Gillespie) — Fri, 23 May 2008 11:39:00 EDT

reason contributor John Berlau looks at the fine print of a Senate housing bill and finds a mess of whorls that might just play havoc with your right to anonymity:

...a measure creating a federal fingerprint registry totally unrelated to national security passed a U.S. Senate committee almost without notice. The legislation would require thousands of individuals working even tangentially in the mortgage and real estate industries - and not suspected of anything - to send their prints to the feds. The database and fingerprint mandates were tucked into housing and foreclosure assistance bills that on Tuesday passed the Senate Banking Committee by a vote of 19-2.
The measure the committee passed states that "an indvidual may not engage in the business of a loan originator without first ... obtaining a unique identifier." To obtain this "identifier," an individual is requiredto "furnish" to the newly created Nationwide Mortgage Licensing System and Registry "information concerning the applicant's identity, including fingerprints for submission" to the FBI and other government agencies.

More here.

True confession: The first merit badge I ever earned in the Boy Scouts on the long path to the rank of Eagle, was Fingerprinting.

Insert Cock Joke Here

matt.welch@reason.com (Matt Welch) — Fri, 09 May 2008 20:09:00 EDT

In the same week that the city of Los Angeles criminalized home remodeling over a certain size, dreary Councilwoman Janice Hahn is trying to see to it that homeowners only get one cock per walk:

Under her proposal, residents would need a permit to keep one rooster, and people who wanted to keep up to three would need to seek special permission from the city.

Speaking of "affordable housing" illiteracy, this L.A. Times story on Washington's latest subprime bailout bill contains a gem of a quote from Republican Congressperson Ginny Brown-Waite of Florida:

No one wins when a house in the neighborhood is foreclosed. Absolutely no one, because it brings down the value of those properties.

Now Playing at Reason.tv: What We Saw at the Mortgage Bailout Demonstration

gillespie@reason.com (Nick Gillespie) — Tue, 22 Apr 2008 16:30:00 EDT

On April 16 in Washington, D.C., the Ad Hoc National Network to Stop Evictions & Foreclosures organized a demonstration outside a meeting of the Mortgage Bankers Associaton at the Washington Court Hotel.

reason.tv's Dan Hayes and Michael C. Moynihan checked out the demonstration and talked with some of the activists, who quickly changed the subject from home loans to Castro's Cuban paradise, the need to free Mumia Abu Jamal, forgiving student loans, the Rothschilds (!), Haitians eating a mixture of dirt and oil (!?!?), and much, much more. Approximately six minutes.

To view the video, click on the image below.

For the full song used in the intro and outro, go here.

McCain on Mortgage Bailouts

gillespie@reason.com (Nick Gillespie) — Fri, 11 Apr 2008 07:34:00 EDT

Sen. John McCain (R-Ariz.) has gone from knowing nothing about the economy to becoming a free-enterprise guy to sounding like an interventionist. Reports the LA Times:

McCain, in a campaign stop at a windows business in Brooklyn, said, "There is nothing more important than keeping alive the American dream to own your home, and priority No. 1 is to keep well-meaning, deserving homeowners who are facing foreclosure in their homes."

Well, you know what's coming next: McCain has announced a mostly detail-free plan to unburden deserving folks (of course!) of "a burdensome mortgage for a manageable loan that reflects the market value of their home." His plan, details to come sometime next week, will cost less than Hillary Clinton's or Barack Obama's, won't be a bailout for speculators or banks, blah blah blah.

That sort of turn is totally predictable. What's truly strange in the Times piece is this bit from New York City Mayor Mike Bloomberg, who was campaigning for McCain:

Bloomberg...recalled a visit several years ago to McCain's retreat outside Sedona, Ariz. He joked that the home and surrounding property were "relatively small" to be called a ranch and recalled that McCain's trademark ribs, which he grills himself, "were slightly on the well-done side." But Bloomberg said he "loved them anyways."

Question: How would McCain know if Boomer was campaigning against him?

Whole LAT piece here.

Reason Foundation's Mike Flynn on mortgage and big-bank bailouts here.

reason Editor in Chief Matt Welch wrote the book on McCain. Buy Myth of a Maverick now!

No Judgment? No Problem!

schapman@tribune.com (Steve Chapman) — Thu, 03 Apr 2008 07:00:00 EDT

Democracy does not cultivate a taste for deferred gratification: Politicians eyeing the next election want to give people what they want sooner rather than later. And in a time of economic turmoil, the impulse to do something immediately is even stronger. But the haste is misplaced. In the current climate of panic, policymakers need to learn patience, and they need to learn it right now.

A couple of alleged crises are getting all the attention at the moment. The first is the risk of a recession. The second, not unrelated, is the mortgage meltdown and the credit crunch it has helped to bring about. Just about everyone in Washington agrees that swift action is needed on both.

The scenario brings to mind what the late Ohio State football coach Woody Hayes said about throwing the football: Three things can happen, and two of them are bad. Efforts to micromanage the macroeconomy may be useless, or they may be destructive. In either case, they can impede a painful process that is needed to correct mistakes like the housing bubble.

For all the alarms about a repeat of the Great Depression, it's not a sure thing we'll even have a recession, much less a serious one. A recession is technically defined as two consecutive quarters of negative economic growth—meaning total output actually declines. A recent Wall Street Journal survey of 51 economists, however, found that, on average, they expect not shrinkage but very slow growth in the first and second quarters.

One economist interviewed by the Journal suggested that "there might not be even one negative quarter in this recession"—which is the equivalent of a damp drought. Herbert Hoover should have had such problems.

But let's suppose we face a real downturn. If the federal government can do anything to goose growth, it's already doing it. The Federal Reserve has slashed interest rates since last summer, and the Treasury is about to start sending tax rebates to 130 million families, who are supposed to rush out and spend it in a flurry of economic stimulus.

It may not work, but we may never know—since even if it doesn't, the economy will do what it normally does in a recession, which is to ultimately right itself. But the economic stimulus is no longer such an appealing option for Congress and the president, because it has already been done and therefore can't be done now, which is when they want to be doing something.

Fortunately, the mortgage mess is an excuse for additional intervention, which they can justify in the name of helping homeowners as well as the economy. As it happens, though, an effort to rescue people who can't pay their mortgages will probably make a bad thing worse.

In the first place, it will slow down what has to happen to bring back the housing sector—which is for prices to drop to a level that will clear out the existing oversupply. In the second, it will shift the burden of bad lending and borrowing decisions from the people who benefited from them to the people who didn't.

Rep. Barney Frank, D-Mass., is pushing a bill to let the Federal Housing Administration guarantee "at risk" mortgages if lenders agree to reduce the total debt. It might be callous of me to say this approach amounts to rescuing "people who were imprudent and bought more house than they should have." But I didn't say it. Barney Frank did.

If the FHA guarantees all these mortgages—up to $300 billion worth, if Frank has his way—it will be putting its trust in people who have already shown themselves to be a bad bet. So taxpayers could end up eating a lot of delinquent loans.

The mortgage problem has had the useful effect of forcing financial institutions to exercise greater care in scrutinizing their customers. A lot of the credit crunch is not a bad thing but a good thing, reflecting a tightening of standards that got way too loose. A bailout, by contrast, can only weaken the lesson we should all learn from this episode.

Acting in a hurry without considering the long-term consequences, you may recall, is how we got into this predicament. Fixing major mistakes is not an overnight task. But in time, foreclosures will subside, the housing sector will return to normal and the economy will regain its usual vigor. Here's what Washington should do to help: Let them.

COPYRIGHT 2008 CREATORS SYNDICATE, INC.

Don't Just Do Something; Stand There

jsullum@reason.com (Jacob Sullum) — Fri, 28 Mar 2008 12:59:00 EDT

I don't know if he really means it (not long ago he was confessing that economics is not his strong suit), but John McCain is making the right noises about the mortgage mess, braving derision as a do-nothing, head-in-the-sand market worshiper from Democrats who are eager to intervene:

Drawing a sharp distinction between himself and the two Democratic presidential candidates, Senator John McCain of Arizona warned Tuesday against vigorous government action to solve the deepening mortgage crisis and the market turmoil it has caused, saying that "it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers."...
"Rampant speculation" on both sides is the root cause of the crisis, Mr. McCain said. He placed part of the responsibility for the mortgage mess on lenders, who he said had grown "complacent" in a rising market and as a result acquired a "false sense of security" that caused them to "lower their lending standards."
But in a departure from Democrats, who have focused on the lending industry's role in the crisis, Mr. McCain suggested that some homeowners had also engaged in dangerous practices, including borrowing too much in hopes that a rising market would cover their mortgages....
"Some Americans bought homes they couldn't afford, betting that rising prices would make it easier to refinance later at more affordable rates," he said. Later he added that "any assistance must be temporary and must not reward people who were irresponsible at the expense of those who weren't."

That last part does leave the door open a bit to some sort of bailout. But on this issue McCain sounds more sensible than Barack Obama, who in turn sounds more cautious than Hillary Clinton.

Hillary Mortgages the Future

schapman@tribune.com (Steve Chapman) — Mon, 18 Feb 2008 07:00:00 EST

You will count speed as a virtue if you're going through a home remodeling, clicking on an Internet link or drafting a cornerback. But presented with looming calamity, most of us would much prefer one that moves slowly. Which is why there is no comfort in hearing that if Hillary Clinton is elected president, she will be "ready on Day One."

In her campaign, she presents herself as an experienced hand with a penchant for practical solutions, suggesting that her opponent, Barack Obama, dispenses nothing but vaporous oratory detached from the real world. When it comes to the mortgage meltdown, though, her policy rests on the assumption that upon arriving in the Oval Office, she'll open the closet and find a magic wand.

Obama, by contrast, acknowledges the bitter truth that when government regulators clamber into a carriage, it can easily turn into a pumpkin.

Their approaches to the problem are not an aberration but a symptom of a larger difference. Obama is not a staunch free marketeer, but he grasps the value of markets and shows some deference to economic laws. Clinton, however, tends to treat both as piddly obstacles to her grand ambitions.

You don't have to take that from me. Some on the left see the Illinois senator as suspiciously unenchanted by their goals and methods. Robert Kuttner, an economics writer and co-editor of The American Prospect, scorns Obama's advisers as "free-market guys who want to use markets to somehow solve social problems, which is like squaring a circle." New York Times columnist Paul Krugman denounced Obama because his health care and fiscal stimulus plans "tilted to the right" and concludes he is "less progressive" than Clinton.

If progressive means issuing dictates that prevent informed people from entering into mutually agreeable and economically valuable transactions, that is undoubtedly true. Many liberals prefer to rely more on command and control. Nowhere is the contrast between the Democratic contenders more vivid than on how to deal with the fallout from the epidemic of mortgages gone bad.

Clinton has a stunningly simple solution, as stated in one of her TV ads: "freeze foreclosures" for 90 days and "freeze rates on adjustable mortgages." Those are a perfect answer, assuming this is the question: How can the government reward irresponsibility, discourage mortgage lending and raise the cost of financing a home?

After all, it's easy to pass a law prohibiting lenders from foreclosing. But the first result of that would be a lot more borrowers deciding that paying the mortgage is no longer the highest priority. Those who have practiced strenuous frugality in order to meet their monthly obligations would get nothing, and those who behaved recklessly would prosper.

The second result would be to choke off the flow of credit. When a bank makes a loan, it needs some assurance of being repaid. When it isn't, foreclosure offers a way to minimize its loss. If Clinton blocks that option for a time, banks will be markedly less eager to offer loans—particularly for anyone with a less than perfect credit history.

Then there is the matter of the interest rates future borrowers will have to shoulder. Lenders offer adjustable-rate mortgages, which carry low rates in the early years, in the hope of reaping higher rates later on. If a President Clinton were to void the second part of these deals, many mortgage companies would stop offering the first part, in effect saying: Freeze this.

Obama is not willing to let this turbulent market sort itself out without the intervention of government, but he offers nothing remotely as alarming as Clinton's dual freeze. Among his main proposals are tougher enforcement of laws against fraud and deception and mandates for "easy-to-understand information" for borrowers -- ideas few advocates of economic freedom would find objectionable.

More important than what he advocates is what he doesn't. His chief economic adviser, Austan Goolsbee of the University of Chicago, told me that Obama thinks "we shouldn't have a blanket policy of bailing out everyone." In formulating remedies, Goolsbee says, "you have to think how not to reward bad behavior."

In Clinton's world, that is not a concern: The government can take from the lenders and give to the borrowers without any unwanted consequences. Now who's telling the fairy tale?

COPYRIGHT 2008 CREATORS SYNDICATE, INC.

Straw Bale Construction Camo

jwalker@reason.com (Jesse Walker) — Mon, 04 Feb 2008 09:24:00 EST

An English farmer tries to avoid planning controls by concealing a mock-Tudor castle in a 40-foot haystack:

Once it was finished, he and his family moved in and lived there for four years before finally revealing the development -- complete with battlements and cannons -- in August 2006....

Problems began last April when Mr Fidler, thinking he had beaten the planning system, applied for a certificate of lawfulness which is given if a property is erected but nobody objects to it after four years.

But Reigate and Banstead Council says the four-year period after which the building would be allowed to stay is void -- because nobody had been given a chance to see it.

The matter will now be decided in February by the council's planning inspector, who could give the Fidlers as little as six months to tear the castle down.

I hate to say it, but I think Castle Fidler is doomed. Enjoy the view while you can:

Excuse Me, Is the Hermann Goering Hot Tub on This Floor?

gillespie@reason.com (Nick Gillespie) — Wed, 23 Jan 2008 10:04:00 EST

Brent Bozell's Cybercast News Service ("The Right News. Right Now.") reminds us that the world--or at least Serbia--is an endlessly strange and horrifying place:

The Mr. President Hotel, in Belgrade, Serbia, offers hotel rooms named after past or present world leaders. Among them is the $200-a-night Hitler suite, where a portrait of the uniformed German dictator, with a swastika on his arm, hangs on the wall over the king-sized bed.

Other suites honor President George W. Bush, his father, former President George H.W. Bush, former British Prime Minister Margaret Thatcher, Cuban Leader Fidel Castro, former Russian dictator Joseph Stalin and former Yugoslavian communist dictator Josip Broz Tito.

Whole thing here. Where, one asks, is the Pierre Trudeau Whoopie Parlor?

Last June, reason's Michael C. Moynihan checked into "The Hotel Honecker," a Berlin "hotel that 'recreates the experience' of East Germany for the budget traveler."

Little Boxes

jwalker@reason.com (Jesse Walker) — Fri, 11 Jan 2008 10:53:00 EST

Friday fun link: a website "devoted to listing as many examples of people using shipping containers as architectural elements as I can find." Like this "mixed wood and container home":

Or this retractable café:

Or this enormous "makeshift mall" in Ukraine:

That last one might not look impressive -- hey, it was closed at the time -- but the story behind the mall is pretty amazing:

[T]he last Soviet city fathers of Odessa expelled the pioneers in a previously unknown free market from the city, banishing them to a 10-acre spot seven kilometers, or about four miles, from the city's limits....That was in 1989, as the Soviet Union itself was unraveling, and what has since emerged is Europe's most extraordinary and, some say, largest market.

It now sprawls over 170 acres. The largest shopping center in the United States, the Mall of America in Bloomington, Minn., covers 96 acres, though all comparisons end there.

The market is part third-world bazaar, part post-Soviet Wal-Mart, a place of unadulterated and largely unregulated capitalism where certain questions -- about salaries, rents, taxes or last names -- are generally met with suspicion.

Open every day but Friday, the market now has 16,000 traders or so and a central staff of 1,200, mostly security guards and janitors, making it the region's largest employer. An estimated 150,000 shoppers come each day, traveling in hundreds of buses from as far as Russia, more than 300 miles away, in search of the bargains that the evident avoidance of customs and taxes makes possible.

"Over the 15 years of its operation it has been called different things," the Ukrainian newsweekly Zerkalo Nedeli wrote in 2004, "but in fact it is a state within a state, with its own laws and rules. It has become a sinecure for the rich and a trade haven for the poor."

Teresa Nielsen Hayden has more on shipping container architecture here, and CNN tackles the topic here. Virginia Postrel praises shipping containers in general here. "As generic as the 1's and 0's of computer code, a container can hold just about anything, from coffee beans to cellphone components," Postrel writes. That ain't half of it.

The Real Mortgage Fraud

schapman@tribune.com (Steve Chapman) — Mon, 17 Dec 2007 06:48:00 EST

Nothing is more fun than doing noble deeds with someone else's money, and right now, Democrats are getting ready for a rollicking good time. Contemplating the subprime mortgage problem, with numerous borrowers unable to pay their debts, the party's presidential candidates and congressional leaders have a simple solution: Fleece the lenders.

The troubles arose because banks and finance companies offered mortgages to millions of people who, despite their imperfect credit histories, yearned to buy homes. The loans generally start out with a low interest rate that, after a couple of years, rises substantially. Some homebuyers now discover that the reset payments are more than they can handle. On top of that, falling real estate prices mean some can't recoup by selling, because the home is now worth less than the mortgage.

This spectacle has brought forth recriminations from politicians who picture the lenders as James Bond villains, cackling at the chance to toss hard-working families out on the street. In fact, this course is almost as bad a deal for lenders as it is for borrowers. They typically lose up to half the value of the mortgage on foreclosures.

From listening to the critics, you'd never guess that. Barack Obama denounces "predatory lenders" for "driving low-income families into financial ruin." Barney Frank (D-Mass.), who chairs the House Financial Services Committee, blames everything on an epidemic of "abusive lending."

But lenders who made bad decisions are already paying the price. Many mortgage companies have gone bankrupt. And if these loans are so unconscionable, the question is not why the foreclosure rate is so high but why it's so low.

According to the Mortgage Bankers Association, less than 5 percent of subprime adjustable-rate mortgages are in the process of foreclosure. The vast majority of borrowers are making their payments, keeping their homes and asking no one for a bailout.

Nor is it clear that soaring payments are the chief culprit. Foreclosures are most common in places where home prices are falling-such as California, Florida, Michigan and Ohio, which account for half of all foreclosures this year. Apparently many borrowers, seeing no point in paying off a $200,000 debt for the privilege of owning a $170,000 home, have elected to walk away from their obligations.

The remedies urged by Hillary Clinton, John Edwards and the like include placing a moratorium on foreclosures, freezing teaser rates for five years or more, and forcing lenders to reduce loan amounts to reflect deflated home values. These options are conspicuous for a couple major defects.

The first is that they punish lenders for the failings of borrowers. Why should someone who has kept the terms of a contract be penalized for the benefit of the party that didn't? A lot of people took a calculated gamble on interest rates and home prices. Had they bet right, they'd be reaping the rewards. Since they bet wrong, they are entitled to bear the consequences.

It's true that if lenders have committed fraud with phony information about their loans, they deserve to be separated from their ill-gotten gains. At the same time, honest ones shouldn't be punished for offering creative terms just because the loans sometimes go bad.

When we're talking about faceless institutions, it may sound reasonable to confiscate a share of their assets. But there's no reason to stop with these greedy usurers.

Say I sell my home at a handsome premium to someone who, we now learn, has been victimized by a "predatory" loan. Why should I benefit from the lending abuse? If the mortgage company has to sacrifice some of its profit so the buyer can avert eviction, why shouldn't I have to turn over a portion of mine? Most of us would fail to see the justice in this humane act of redistribution.

If the government imposes the punitive option, another problem will arise down the road: Lenders will be far less willing to offer credit to people with flawed credit records. Even the Bush administration's plan for mortgage companies to freeze rates on a small number of loans effectively warns lenders to steer clear of all but the soundest borrowers. As Yogi Berra might put it, if mortgage companies don't want to do business with certain customers, nobody is going to stop them.

The consequence of this approach is clear. We'd be robbing tomorrow's subprime borrowers for the benefit of today's. Of course, when it comes to proposed solutions, robbery seems to be the order of the day.

COPYRIGHT 2007 CREATORS SYNDICATE, INC.

22 Floors of Freedom

jwalker@reason.com (Jesse Walker) — Fri, 07 Dec 2007 11:09:00 EST

An interesting story from São Paulo, Brazil, where hundreds of homeless families took over an abandoned building and made something out of it:

The Prestes Maia building in downtown São Paulo, abandoned for 12 years, had become a haven for drugs and prostitution. Then, in 2002, more than 400 homeless families, in cooperation with a local group called the Downtown Homeless Movement, occupied the 22-story building. Conditions were crowded and difficult--the building lacks electricity and running water--but residents established a free library, cinema, and educational and social activities....

The Downtown Homeless Movement, which has reclaimed more than 30 buildings in São Paulo, is just one of many groups reclaiming abandoned buildings across Brazil. At Prestes Maia, residents have fought eviction with protests, road blockades, and legal battles. After years of struggle, they have won either new housing or assistance from the government.

I'd rather they won the building itself. But after a two-decade absence, the original owners apparently wanted it back. I'm sure there's more to this story than I now know, but based on what I've read so far, I'd say cases like this are why adverse possession laws are a good idea, despite their occasional abuses.

Elsewhere in Reason: Robert Nelson reviews a book about squatters, in Brazil and in other countries.

Elsewhere not in Reason: Photos from Prestes Maia.