Government Intervention=Bad

Here are a couple of posts that I thought were interesting. This one comes from Larry Kudlow, and this one is actually a report from the US House of Representatives and how the role of government in creating more affordable housing spurred the global financial crisis.

First, some excerpts from Kudlow:

There’s no question that current government policies for taxes, spending, and regulation are causing the U.S. to lose competitiveness in the global race for capital, prosperity, and growth.

Of course, China has been moving in the direction of free-market capitalism for years. To some extent, this shows the positive benefits of America’s free-trade policies and its open-mindedness in helping nurture not only China growth, but also middle-class prosperity worldwide.

But what’s particularly galling about Obamanomics is that we may well be losing our competitive edge with Europe. While Europe is ever so slightly moving toward Reagan and Thatcher, the U.S. is shifting toward an overtaxed and overregulated model that smacks of François Mitterrand. That’s something no one should want to tolerate.

Heavy government controls at home, along with an income-leveling social policy couched in economic-recovery terms, is no way to run a railroad. At the simple stroke of a computer key, world investment flows to its most hospitable destination. That includes a reliable currency. But in President Bush’s last year and President Obama’s first, the U.S. has become a less-hospitable destination for global capital. That should worry everybody.

And then from the HOR report:

The housing bubble that burst in 2007 and led to a financial crisis can be traced back tofederal government intervention in the U.S. housing market intended to help provide homeownership opportunities for more Americans. This intervention began with two government-backed corporations, Fannie Mae and Freddie Mac, which privatized their profits but socialized their risks, creating powerful incentives for them to act recklessly and exposing taxpayers to tremendous losses. Government intervention also created “affordable” but dangerous lending policies which encouraged lower down payments, looser underwriting standards and higher leverage. Finally, government intervention created a nexus of vested interests – politicians, lenders and lobbyists – who
profited from the “affordable” housing market and acted to kill reforms. In the short run, thisgovernment intervention was successful in its stated goal – raising the national homeownership rate. However, the ultimate effect was to create a mortgage tsunami that wrought devastation on the American people and economy. While government intervention was not the sole cause of the financial crisis, its role was significant and hasreceived too little attention.

Risky mortgage lending, particularly loans with very low down payments, contributed directly to the rise of a housing bubble. Had this risky lending been contained within thelow-income segment of the market targeted by politicians advocating more “innovation” in “affordable lending,” the damage to the wider economy might have been minimal. However, these “innovations” in “flexible” loans products spread beyond just affordable lending into the entire U.S. mortgage market. The lure of reduced underwriting standards held true not just for borrowers of modest income but for those at all income levels. Although the erosion of mortgage underwriting standards began in Washington within itiatives like the CRA as a way to reduce “barriers to homeownership,” this trend inevitably spread to the wider mortgage market. One observer noted:

Bank regulators, who were in charge of enforcing CRA standards, could hardly disapprove of similar loans made to better qualified borrowers. This is exactly what occurred.

Borrowers – regardless of income level – took advantage of the erosion of underwriting standards that started with government affordable housing policy. As one study observed,“[o]ver the past decade, most, if not all, the products offered to subprime borrowers have also been offered to prime borrowers.”24 For example, Alt-A and adjustable-rate mortgages became incredibly popular with borrowers – who were generally not low-income – engaging in housing speculation. As home prices continued their dizzying rise, many people decided to cash in by buying a house with an adjustable rate mortgage featuring a low introductory teaser rate set to increase after a few years.These borrowers, confident in the oft-cited assertion that U.S. home values had never before fallen in the aggregate, planned to sell or refinance their investment before the mortgage rate adjusted upward, pocketing the difference between the initial purchase price and the subsequent appreciation in value. However, buyers failed to grasp the effect of a government policy that had quietly eroded the prudential limits on mortgage leverage, creating a dangerous speculative bubble.

As the size of down payments for mortgages fell, so too did borrowers’ equity stake inthe homes they purchased. This had two important effects. First, it eliminated the borrower’s “skin in the game,” increasing the likelihood that he or she would walk away from the mortgage if times got tough. It also increased the borrower’s leverage (debt) as measured by the Loan-to-Value ratio.25 This leverage allows borrowers to purchase more expensive houses than they would otherwise be able to afford at a given level of income. It was this process of steadily increasing leverage that drove the complete decoupling of home prices from Americans’ income and fed the growth of the housing bubble. As the average down payment shrank and leverage correspondingly increased, the amount of mortgage debt relative to borrowers’ income increased. This increasing leverage in turn eroded the power of supply and demand to restrain irrational price increases. In a normal housing market, free of government intervention, an increase in home prices would havebeen restrained when the marginal, or next, home seller tried to charge a price too highfor prospective borrowers to afford. This home seller would have been forced to cut his or her unreasonable price.

Once government-sponsored efforts to decrease down payments spread to the wider market, home prices became increasingly untethered from any kind of demand limited by borrowers’ ability to pay. Instead, borrowers could just make smaller down payments and take on higher debt, allowing home prices to continue their unrestrained rise.

Government actions distorted the housing market, yet advocates of affordable housing policies, such as Congressman Barney Frank (D-MA), have asserted that those who criticize these policies seek to place blame for the financial crisis solely on borrowers of modest means.27 This misses the mark entirely. In fact, responsibility for the erosion of mortgage lending standards, which began with government affordable housing policy, rests squarely on the policy makers who advocated these ill-conceived policies in the first place. Borrowers quite naturally responded to the incentives they were given, irrespective of their socioeconomic status, and risky lending spread to the wider mortgage market.

I think those last several paragraphs give a really good explanation of how the housing bubble was created. If you are looking for the name of a politician to really dislike, Barney Frank should be at the top of your list. Unless you really follow politics, you probably have never heard of him, but I can't think of any American politician who I fundemantally disagree with more than that man. He could very well be despicable. And this is coming from someone who has Boxer and Feinstein as my state senators.

Government does has its place in the economy, but these two articles highlight the inherent problems it creates for its citizens when it begins to overstep its boundaries.