Human Nature and D.C.-backed Loans

Posted: Feb 20, 2011 12:01 AM
Human Nature and D.C.-backed Loans

In 2009, when CNBC's David Faber asked former Federal Reserve Chairman Alan Greenspan what lessons could be learned to prevent another great financial meltdown in the wake of the mortgage-financing collapse, Greenspan did not have a happy-face answer.

"Somewhere in the future we're going to have this conversation again," Greenspan replied. "It will not be for quite a period of time, but it will occur because the flaws in human nature are such that we cannot change that. It doesn't work."

Lawmakers like to talk about passing laws to ensure that -- the following should be said with a timbre of indignation -- "this will never happen again." Of course, Washington should pass and enforce regulations to prevent and minimize economic damage. But the smartest course for Washington may well be to assume that, eventually, the worst will happen and to focus on:

(a) How Washington can minimize the damages to taxpayers and

(b) What regulatory changes can be made quickly that will not unduly shock the housing market.

The experts don't always know the answer. As the Obama administration's report "Reforming America's Housing Finance Market" noted, when housing prices began to turn in 2006, "Almost no one in the housing finance market was prepared."

The good news now: Obamaland is clear on the concept that the best way to minimize taxpayer losses is to minimize taxpayer exposure.

The report, written by the departments of Treasury and Housing and Urban Development, smartly pledged to cut back and ultimately "wind down" Fannie Mae and Freddie Mac, the giant government-sponsored enterprises that now back about 90 percent of new mortgages. The Wall Street Journal editorial page wrote of the Obama report, "It's enough to make you believe in miracles."

The document does not blame the meltdown on Fannie Mae and Freddie Mac. Private institutions, it observes, were the trailblazers in subprime mortgages, while delinquency rates on private-label securities "were far higher than ... loans held by Fannie Mae and Freddie Mac."

Even still, it notes, the Treasury -- this means the taxpayers -- has had to put up more than $130 billion to cover Fannie's and Freddie's losses.

It's time to return private mortgages to private banking. And it's time for lending to return to standards that limit risk. Hence the Obama administration's call to raise minimum down payments for Fannie and Freddie loans to at least 10 percent and to increase the price of Federal Housing Administration mortgage insurance.

The report offers "three possible courses for long-term reform."

The first would privatize housing finance and leave a narrow role for government. Its downside: It will be harder and costlier for Americans to secure 30-year fixed-rate mortgages.

The middle option would add "a backstop mechanism to ensure access to credit during a housing crisis." Same downside as the first option, with a larger government role.

The third option would provide government reinsurance for certain mortgages, which, as the Wall Street Journal warns, "looks like Fannie in a new suit."

The boldest element of the report can be seen in the Obama administration's flinty look at the vaunted goal of homeownership for all. President George W. Bush certainly had no problem pointing to high home ownership rates as proof of his administration's success.

The report recommends policies that, instead of pushing mortgages for all, demonstrate "a commitment to affordable rental housing."

Here is an area where left and right can meet. On the left, Politico columnist Michael Kinsley has questioned the wisdom of policies that drive up housing prices -- and make homes harder for young families to afford: "There is no physical reason why a house should become more valuable at all. It is not like growing a crop. It is not producing anything that you can turn around and sell, like a factory. It just sits there. It becomes more valuable because people believe that it will become more valuable."

For their part, conservatives question the wisdom of using taxpayer-backed loans to push people who are chasing the American dream into homes they ultimately cannot afford. And by the way, those loans fueled the housing market bubble.

As the Treasury/HUD report noted, trillions of dollars were bet nationally and globally on "the faulty expectation that national house prices would only rise. Twenty years of economic stability had desensitized every player in the housing market to the possibility that home prices could fall."

That's a strong argument for policies that keep U.S. taxpayers from being left holding the bag.