Housing Policy

Bernanke's "Market Failure"

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Federal Reserve Chair Ben Bernanke gave a big speech on the financial crisis today, in which he identified the roots of the problem as carefree home lending by bubble-fattened financial institutions to owners who couldn't really afford their own houses:

[T]he current housing crisis is the culmination of a large boom and bust in house prices and residential construction that began earlier in this decade.  Home sales and single-family housing starts held unusually steady through the 2001 recession and then rose dramatically over the subsequent four years.  National indexes of home prices accelerated significantly over that period, with prices in some metropolitan areas more than doubling over the first half of the decade.  One unfortunate consequence of the rapid increases in house prices was that providers of mortgage credit came to view their loans as well-secured by the rising values of their collateral and thus paid less attention to borrowers' ability to repay. However, no real or financial asset can provide an above-normal market return indefinitely, and houses are no exception.  When home-price appreciation began to slow in many areas, the consequences of weak underwriting, such as little or no documentation and low required down payments, became apparent.  Delinquency rates for subprime mortgages–especially those with adjustable interest rates–began to climb steeply around the middle of 2006.  When house prices were rising, higher-risk borrowers who were struggling to make their payments could refinance into more-affordable mortgages.  But refinancing became increasingly difficult as many of these households found that they had accumulated little, if any, housing equity.  Moreover, lenders tightened standards on higher-risk mortgages as secondary markets for those loans ceased to function.

So, how to deal with this mess? Provide more home lending by bubble-chastened financial institutions to owners who really can't afford their own houses!

At the macro level, the Federal Reserve has taken a number of steps, beginning with the easing of monetary policy.  To the extent that more accommodative monetary policies make credit conditions easier and incomes higher than they otherwise would have been, they support the housing market. […]

The Federal Reserve supported the actions by the Federal Housing Finance Agency (FHFA) and the Treasury to put the housing-related government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, into conservatorship, thereby stabilizing a critical source of mortgage credit.  The Federal Reserve has also recently announced that it will purchase up to $100 billion of the debt issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks and up to $500 billion in mortgage-backed securities issued by the GSEs. […]

Yet another promising proposal for foreclosure prevention would have the government purchase delinquent or at-risk mortgages in bulk and then refinance them into the H4H or another FHA program.

Bernanke's logic is that housing prices just affect the economy too damned much, and so need to be artificially propped up for the economy to rebound. I don't agree with that, partly because I think the long-term consquences will create new destructive bubbles, but I did find Bernanke's description of "market failure" more interesting than most:

[A]necdotal evidence suggests that some foreclosures are continuing to occur even in cases in which the narrow economic interests of the lender would appear to be better served through modification of the mortgage.  This apparent market failure owes in part to the widespread practice of securitizing mortgages, which typically results in their being put into the hands of third-party servicers rather than those of a single owner or lender.  The rules under which servicers operate do not always provide them with clear guidance or the appropriate incentives to undertake economically sensible modifications.  The problem is exacerbated because some modifications may benefit some tranches of the securities more than others, raising the risk of investor lawsuits.  More generally, the sheer volume of delinquent loans has overwhelmed the capacity of many servicers, including portfolio lenders, to undertake effective modifications.

Whole Bernanke speech here. Tim Cavanaugh on Henry Paulson's definition of "market failure" here.

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  1. I’m lookin’ to sell, so I’m all for proping up the market…for 6 months or so. 🙂

  2. Un fucking believable. Bernanke can’t possibly be that ignorant. He’s got to be lying. But to what purpose?

    Pardon me, but could you help a fellow American who’s down on his luck?

  3. This whole thing is about insuring that banks and home owners get to keep their gains from the boom. They are going to prop up housing prices at everyone else’s expense.

  4. WOW, I can’t wait til he’s replaced with one of his senior advisors.

  5. At least he has a handle on the problem aspect of it.

  6. Bernanke’s logic is that housing prices just affect the economy too damned much

    That seems to be the underlying assumption of the whole bailout mania. That there’s some extreme externality of failure that’s going to infect everyone else, like a virus that needs quarantining, and that also like said disease, the effect will go away if we just limit its immediate spread. One notion based on fear, the other on the good feelings of the big band-aid. Both seem seem dubious.

  7. Poverty levels are greatly exaggerated, the great depression is not making a comeback, and the sky is not falling. Our very mixed economy is working just fine really. Let’s not fuck it up with some hairbrained right-wing or left-wing “solution.”

  8. Who is spoofing Lefiti by writing reasonable stuff?

  9. No, it’s me. I’m back. The ban has been lifted. Notice that I wrote “mixed economy.” The mixed part is a little fact you libertarian zombies like to ingonre.

  10. No, it’s me. I’m back. The ban has been lifted. Notice that I wrote “mixed economy.” The mixed part is a little fact you libertarian zombies like to ingonre.

    I can’t speak for other libertarians, but I am well aware that we have a mixed economy.

    Straw men are easy to slay.

  11. I don’t see this as a “market failure”.

    Fannie Mae, Freddie Mac, the Federal Home Loan Banks and other programs were created by politicians specifically to encourage the making of loans that lenders would otherwise consider to risky. Virtually, every piece of legislation in the last 70 years that touched upon the mortgage industry sought to encourage lenders to make more and more risky loans in order to “encourage home ownership.”

    I hate to break it to Lefiti but if we had worked under some ideal free market system we would not have seen such a massive bubble form. No purely private actor would have bought up hundreds of billions of shaky loans the way the Freddie Mae et al did. Instead, we might have smaller more localized problems occurring relatively frequently but I doubt we would have seen such a massive collapse without the government in effect buying up marginal loans.

  12. It’s not a fucking straw man. Libertarians tout unfettered free markets and never that I’ve ever seen give credit to the role government has played in creating our own very stable prosperity. Have libertarians ever admitted a flaw in the theory? No, it’s always some straw man that’s being attacked. the theory is flawles. Fuck!

  13. “I hate to break it to Lefiti but if we had worked under some ideal free market system we would not have seen such a massive bubble form.”

    How the fuck do you know how your ideal free- market system will work?

  14. Helping to blow up the housing price bubble was a major part of the problem. Pushing homeownership beyond all reason was a major part of the problem. Therefore, we need to do both more.

  15. Indeed, Shannon. What we’re seeing isn’t the market “failing” — It’s the market trying to reassert itself.

    And as for keeping the real estate bubble inflated until the economy rebounds — The list of precedents where artificial economic props have been withdrawn because they’re “no longer needed” isn’t exactly a long one.

  16. the Federal Reserve has taken a number of steps, beginning with the easing of monetary policy.

    What a crock. The asshole doesn’t admit that the lenders couldn’t have done what they did without the Fed providing an unlimited pool of credit to draw from, so he offers more inflation to postpone the reckoning.

    Bernanke should be doing time in a cell with Greenspan.

    -jcr

  17. It’s not a fucking straw man. Libertarians tout unfettered free markets and never that I’ve ever seen give credit to the role government has played in creating our own very stable prosperity.

    It’s so stable that we had to spend more than our entire GDP to rescue it.

  18. Where’s joe? Isn’t he supposed to show up and assert that subprime mortgages have nothing to do with the financial crisis?

  19. I have four pet squirrels and they are NUTS!

  20. Actually the thing that would help the economy rebound that fastest would be to accelerate forclosures, let housing prices plummet, and then allow reponsible renters to buy them up on the cheap.

    The responsible former renters will then have more money available to spend on things like appliances, and the irresponsible former homeowners will be freed from burdensome debt and can blow their money on retail instead of interest payments.

    Keeping current homeowners in their mortgages primarily benefits banks, since their money will continue to go to pay interest on loans. It’s bad for consumers in the general economy who aren’t well served by being debt-slaves.

    The Bernanke policy basically is about directing the economy’s wealth into the coffers of financial services companies who do nothing useful, but push paper instead.

    Personally, I think the economy would be better off if people spend less money on debt and more money buying useful things.

  21. At the macro level, the Federal Reserve has taken a number of steps, beginning with the easing of monetary policy. To the extent that more accommodative monetary policies make credit conditions easier and incomes higher than they otherwise would have been, they support the housing market. […]

    Here’s the interesting thing, in a Chinese proverb way. They have no more bullets in the clip in this regard. Sure, the target rate is 1%, so in theory they could drop that further or even all the way to zero like BoJ did. But the effective rate is back down below 0.5% (although not as disconnected from the target when it was 0.22% a month ago). And the ten year is possibly as low as it’s been in the history of the republic at 2.59%, and even crazier the 13 week is at 0.005% – a nickel a year for every 1000 bucks put up.

  22. Hazel,

    Technically, joe asserts that the loans guaranteed under the Community Reinvestment Act didn’t contribute to the crisis. While the CRA is an example of the government’s obsession with getting people who can’t afford a house into a house, it’s not really the source of the “toxic” debt that is dragging the economy down.

    As for Bernanke… what do the people who bought a house within their means get out of all of this? Oh, that’s right… assrape.

  23. Bernanke’s logic is that housing prices just affect the economy too damned much…

    Yeah, well this was all brought about by the central banks who lowered rates during a recession (2001)… and then CONTINUED TO LOWER RATES after the economy rebounded.

    The central bank LOWERED interest rates when demand for credit INCREASED. How stupid can you get?

  24. How the fuck do you know how your ideal free- market system will work?

    A valid point. I counter with this: It won’t work like this system, that’s for sure.

  25. I actually agree with Lefiti that a mixed economy works well enough, in a utilitarian sense, to produce prosperity. That’s assuming government doesn’t do anything hair-brained to screw it up. Of course, they usually do. Witness the current situation.

  26. [A]necdotal evidence suggests that some foreclosures are continuing to occur even in cases in which the narrow economic interests of the lender would appear to be better served through modification of the mortgage.

    Umm, color me unimpressed. That’s not a market failure, but Tony Soprano merely calling in his debts. Yes, there are some cases where a simple restructure of the mortgage might help the lender. Except the lender leveraged himself 30:1, 40:1, and now his creditors are calling in their debts. That causes everyone down the chain to demand something now. Not in 20 years at below-market interest rates.

    Unfortunate for some buyers? Sure. But also the way this stuff works… and the way it’s supposed to work.

    For instance, when you get a variable rate loan, as the borrower, you’re making a bet. A bet that either 1: interest rates will fall, 2: interest rates won’t go up high enough to upset your own cash stream or ability to pay. In exchange for that variable rate, you got better upfront terms for the loan.

    When you demand your lender ‘restructure’ the loan when 1: interest rates do go up, or 2: go up high enough to upset your cash stream, it’s the very definition of changing the terms of a bet when you realize you lost.

    The same goes for the financial institutions themselves. All of this commercial paper is worth something, just not what you want it to be worth. Enter Uncle Sam.

    This whole thing makes me ill.

  27. A mixed economy with a minimally interventionist government with limited powers is one thing. . .what we have today is something else altogether.

  28. Actually the thing that would help the economy rebound that fastest would be to accelerate forclosures, let housing prices plummet, and then allow reponsible renters to buy them up on the cheap.

    Hazel, hats off to you. That sums it up in a nutshell. It’s completely counterintuitive to the political caste which makes it such an elegant solution.

  29. How the fuck do you know how your ideal free- market system will work?

    What we have now is an ideal-free market system. That’s why it’s such a mess.

  30. Technically, joe asserts that the loans guaranteed under the Community Reinvestment Act didn’t contribute to the crisis. While the CRA is an example of the government’s obsession with getting people who can’t afford a house into a house, it’s not really the source of the “toxic” debt that is dragging the economy down.

    Sugarfree, you missed yesterday’s thread. He claims that subprime in general, not CRA specifically, wasn’t the source of the crisis, and spent several posts attempting to defend the statement. Including by manipulating statistics on forclosure rates of prime vs. subprime mortgages.

  31. Actually the thing that would help the economy rebound that fastest would be to accelerate forclosures, let housing prices plummet, and then allow reponsible renters to buy them up on the cheap.

    Not coincidentally, exactly the same should happen to the financial institutions. Those that are insolvent should be shoved through speedy bankruptcies, forcing the prices of their toxic assets to be determined at their floor as soon as possible and allowing responsible institutions to take their places in the financial system.

    Marginally insolvent financial firms are a harder call. Helping them limp through the crisis by, say, reducing their capitalization requirements might be better for all. But starting bailouts with the lamest institutions is exactly where one should not start. That just extends the pain and increases uncertainty in the market.

  32. I actually agree with Lefiti that a mixed economy works well enough, in a utilitarian sense, to produce prosperity. That’s assuming government doesn’t do anything hair-brained to screw it up. Of course, they usually do. Witness the current situation.

    A mixed economy is, by definition, the government doing something hare-brained to screw it up.

  33. exactly the same should happen to the financial institutions.

    When this whole thing started, that was really the wise advice: Our system has a process to figure out what all these assets are worth: Chapter 11. The counter argument to this (at the time) was that Chapter 11 would have taken too long with all the court proceedings and as such, the economy would meltdown before then.

    I wouldn’t have been completely against the government stepping in at that point with some very carefully laid out plan as to how to either accelerate the proceedings, or even put some stop-gap cash into the system, with first rights to compensation when the institutional worth was figured out and subsequently liquidated.

    Instead, they just asked for boatloads of money, started throwing it at the companies and hoped for the best while assuring the public that this was easy profit.

    I live by a simple rule for these situations:

    If someone is asking you to fork over money to invest in a scheme that’s sure to make big profits, but they won’t invest their own money in this “guaranteed” cash cow? It’s a losing investment.

  34. And you!

  35. “How the fuck do you know how your ideal free- market system will work?”
    Honestly, we don’t. Human behavior is ultimately unpredictable. Economics really only gives a good idea of general trends over long periods of time. What happens in the short term is anyone’s guess. However, our knowledge is that in the long term on large scale, if you mask the effects of bad decisions, you will encourage more bad decisions of that type. That’s the basis of our utilitarian argument.
    From a normative or rights-based perspective, a free market is better because it is noncoercive. When the government enforces certain loan structures or bails out people who make bad decisions, it restricts either freedom of contract or the right to property, respectively (with the taxes used for the bailout being considered the rightful property of the taxpayer).

  36. Sensible thing is to let prices drop so people can afford to buy somewhere to live without having to take out ridiculous mortgages. But no the government has to prop up people who took out mortgages they could never really afford in the first place.

  37. A mixed economy is, by definition, the government doing something hare-brained to screw it up.

    This is an example of libertarians overstating their case, which I think happens a lot. I don’t believe you can say definitively that every government action in a mixed economy is nothing but a hare-brained scheme or has nothing but ill effects.

    For example, if the government builds or does maintenance on a bridge that gives people work for a time and produces something of value. As libertarians, we may say the act is immoral because they stole the money they used to pay the workers, and they may have seized the land they used to build the bridge. But these are moral and not utilitarian arguments.

    The fact is, the bridge might be extremely useful, improve many people’s lives, and make everyone more wealthy. So by utilitarian standards, a mixed economy might work really well if the government made mostly wise, responsible decisions. The trouble is, 1) they rarely do, and 2) the ends don’t justify the means.

    That’s why I consider moral arguments to be just as important as utilitarian ones.

  38. The housing bubble happened because people are prone to mass hysteria. It was caused by the stupid belief that housing always goes up.

    The fact that govt tried to get poor people into houses they couldn’t afford, may have helped but they have been doing that shit for a long time, so I think it’s impact is small.

    Was it a market failure? I don’t think so. There is an upside to bubbles. The bubble caused us to invest heavily in housing, causing prices to drop and attempting to make life easier for a future generations (like me). Sure some dumb fucks went overboard, and the market is now teaching them a lesson about too much debt also(if the govt would let it).

  39. “That’s why I consider moral arguments to be just as important as utilitarian ones.”

    Same here. Unfortunately, the handle “moralist” just doesn’t go over so well. I’m not sure why.

  40. fortyouncer,
    While there are such things as “market failures” in the case of externalities, most so-called “market failures” could be described simply as human errors en masse.

  41. The “herd mentality” is a big one. I think it can play havoc with the markets. But it can be infinitely more damaging in the context of politics.

  42. Damn it, I shouldn’t have bought the Navigator a year ago, now I owe more on it than it’s worth. Besides, now I could get one a lot cheaper. Someone, somewhere owes me. Either the car dealer ripped me, the finance company hosed me or
    the money guy stuck it to me. I need a bailout and I need it now!!

  43. I propose that concerned observer and LoneWacko (OLS) should have a troll war.

  44. The “herd mentality” is a big one. I think it can play havoc with the markets. But it can be infinitely more damaging in the context of politics.

    I am in complete agreement on that one. Bubbles will happen in free markets, because people are sheep. But the idea that elected officials are going to behave more rationally when there a bubble is laughable. Politicians are more likely to try to inflate bubbles than deflate them. At least the market has short sellers. Everyone hates them precisely *because* they don’t buy the hype. Short sellers are the killjoys who tell you when the bandwagon has a broken axle. Politcians are the band leaders handing out the booze.

  45. Capitalism is doomed. Once workers own the means of prodcution, the state will whither away. Oops, wrong utopian dream…. Sorry!

  46. I propose that concerned observer and LoneWacko (OLS) should have a troll war.

    Two trolls enter, one troll leaves.

  47. I wouldn’t have been completely against the government stepping in at that point with some very carefully laid out plan

    *outright, prolonged, laughter*

  48. “Short sellers are the killjoys who tell you when the bandwagon has a broken axle.”
    Nothing a little duct tape can’t fix!

  49. And I’m serious about the troll war.

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