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The Real Culprit in the Housing Crisis

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The Housing Boom and Bust
by Thomas Sowell (Basic Books, 2009); 192 pages.

Throughout Thomas Sowell’s long career, he has tried to get Americans to grasp some simple but crucial truths about economics and government policy. One of those lessons is central to this book, namely that it is a mistake to judge policy enactments on the basis of their stated, hoped-for results because government policies inevitably create many other results, usually detrimental. The story of the housing boom is a perfect illustration. Government officials and activists who thought they were doing good things by promoting home ownership did not foresee the enormous damage that their meddling with the free market would do.

In The Housing Boom and Bust, Sowell clearly and patiently explains the origins of the boom, its results, and the appropriate policies for cleaning up the mess and preventing a recurrence. The book is a perfect antidote for the poisonous ideas being circulated that the boom and bust should be attributed to capitalism, deregulation, and business greed. The truth, readers discover, is that the boom was entirely due to government interference with the normal operations of the market, and if people are looking for culprits, they need to look to politicians, especially their representatives in Congress.

“Affordable housing” first became a political issue in the 1970s, when liberal Democrats saw that they could pose as champions of “the little guy” by advocating policies meant to ensure that housing was more accessible for the poor. Sowell points out that the reason housing was rapidly rising in price (in a few areas of the country) was that politicians had imposed land-use restrictions that greatly limited the amount of land upon which houses could be built. Coastal California was the poster child for this “crisis” because so much land had been declared “protected” against any sort of residential or commercial use. Those policies made environmentalists feel good, since they believed that development was harming Mother Earth. Whether you believe that or not, the inevitable consequence of limiting the supply of housing in areas of rising demand was rapidly rising housing prices.

In other parts of the country, where government interfered little or not at all with land use, there was no such escalation in prices. But in politics, the squeaky wheel gets the grease. Leftist writers began spreading the idea that the whole nation was facing a crisis of affordable housing and many politicians, always eager for new issues on which to demonstrate their deep concern over social problems, jumped on the bandwagon. Of course, they didn’t advocate changing the land-use laws that were responsible for the alleged crisis. Instead, they went about devising new laws. Anti-discrimination policies

Congress passed and Jimmy Carter signed into law the Community Reinvestment Act (CRA) in 1977. That statute provides that lending institutions are to “meet the credit needs of the local communities in which they are chartered.” Communities, however, are just abstractions and don’t have any “needs.” Individuals or firms within them may desire to borrow money, but the location of the would-be borrowers has nothing to do with their credit-worthiness. Those who entrust money to lending institutions want it lent out safely and those who run the institutions want to make profitable loans. By substituting the judgment of government officials, who stand to lose nothing if they are wrong, for the judgment of business people, who do stand to lose if they make bad loans, government interference in lending operations could only be harmful. Although the CRA did not have much immediate impact, it paved the way for a sustained attack on lending standards that began during the Clinton administration.

In 1993, Bill Clinton’s Department of Housing and Urban Development began bringing lawsuits for “discrimination” against mortgage lenders if there was even the slightest evidence that they had declined to lend to a higher percentage of minority applicants than to white applicants. Sowell points out that the justification for this legal mugging was a study by the Federal Reserve Bank of Boston (why Federal Reserve Banks should be in the business of producing policy reports is beyond me) purporting to show that lenders “discriminated” — that is, they turned minority applicants down somewhat more frequently than they did white applicants. Sowell demonstrates how feeble and misleading that and similar studies were. Most applicants were approved no matter what their race and the fact of a marginally higher rate for minority applicants reflected their poorer credit history.

Nevertheless, the finding of a higher rejection rate led to headlines such as “Blacks Three Times as Likely to Be Turned Down as Whites.” Publicity-hungry politicians pounced on that, sensing an opportunity to win votes by meddling in the housing market. In 1996, Congress (both chambers under Republican control), set quotas for Fannie Mae and Freddie Mac (the two gigantic “government-sponsored enterprises” that create the secondary market for mortgages) that at least 42 percent of the mortgages they bought had to have been made to lower-income borrowers. That allowed both Clinton and Republicans to strut around as “friends” who were helping blacks and Latinos achieve the “American dream” of home ownership.

Fannie and Freddie, two crony capitalist companies whose officials knew that they had to dance to the congressional tune, pressured the many mortgage originators to lower their lending standards so that the quotas could be met. The result was a profusion of mortgages where the borrowers put little or nothing down, had negligible assets, and often had a poor employment record. But with home prices rising rapidly, many such people thought that buying a house was a “sure thing.” Buyers and lenders threw caution to the wind, as did investors worldwide, who bought up Fannie’s and Freddie’s securities, assuming that they were almost as safe as U.S. bonds. After all, Fannie and Freddie were government-sponsored enterprises and powerful politicians had often said that fears about their solvency were groundless.

The bust

Like all artificial booms, however, the housing boom was unsustainable. Housing prices started to level off in 2006, then plunged. Interest rates, which the Federal Reserve had depressed to absurdly low levels for several years after the “dot-com” bubble burst in 2000, rose back to normal. Millions of people who had been lured into a big real-estate gamble couldn’t continue to make their payments and with the market gone cold, they couldn’t sell their property either. Default rates skyrocketed and many financial institutions suddenly found that they had huge holdings of bad paper.

Would any of that have happened in a truly free market? No. Government policy undermined traditional lending standards; government policy drove interest rates below their natural levels; government policy created the moral hazard that made investors assume they were buying solid value when they were actually buying high-risk securities. The housing boom was not capitalism at work. Rather, it was due to massive interference with capitalism.

Once the bubble burst, the politicians who had been basking in the glow of the boom — especially the idea that they were the ones to thank for the increase in minority home ownership — suddenly had to wiggle out of a potentially damaging situation. What if people blamed them?! In a frantic effort to save face, many politicians, Democrats and Republicans, latched on to the excuse that “deregulation” was the culprit. Sowell seems to take special joy in explaining that the one government agency that was supposed to regulate Fannie and Freddie (the Office of Federal Housing Enterprise Oversight) had in fact tried to blow the whistle and draw attention to the dangerous loans they were buying and peddling. When it did so, powerful members of Congress threatened its budget if it didn’t shut up. Sowell drives the point home: the politicians wanted the housing boom, engineered it, and were not going to let any sort of regulation get in their way. They were to blame.

What about the efforts of the Bush and Obama administrations to revive the economy after the market crash? Sowell is scornful of the entire program of bailouts and “stimulus” spending. He sees no rational basis for this spending deluge, some of it to succor people and firms that made bad housing and investment decisions (why should everyone else cover their losses?) and most of it an orgy of political waste on projects that weren’t important enough to have merited funding previously. Furthermore, since the federal budget is already deep in the red, the money for all of this has to be borrowed, leading Sowell to observe, “This means that future generations of Americans will have to ship trillions of dollars’ worth of their output to China and other countries to whom that debt is owed.”

Have Americans learned anything from this episode? Sowell is skeptical, writing,

The housing market collapse dealt a blow to some of the devices that fed the crusade — ‘creative’ financing and lax lending standards, for example — but even the ensuing national crisis did nothing to end the political attractiveness of the goal of making housing affordable by government fiat, rather than by individuals buying or renting housing that was within their own income range.

There is the real villain — the idea that politics can and should be used to make things better for people, not just in housing, but in health care, education, nutrition, transportation, and so on. That idea is disastrous. When individual people make decisions, they have to consider the trade-offs involved, but when politicians make decisions, they often ignore those trade-offs because they have supposedly lofty, transcendent goals in mind. Individual people are compelled to face the consequences of their foolishness and therefore are rarely foolish. When politicians are foolish, the consequences are almost always visited upon hapless people in society.

So, if Americans would like to avoid future repeats of this boom-and-bust cycle, all they have to do is find a way to prevent politicians from meddling with interest rates, lending standards, and perceptions of risk. The Constitution failed to restrain such behavior. Will something else work?

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    George C. Leef is the research director of the John W. Pope Center for Higher Education Policy in Raleigh, North Carolina. He was previously the president of Patrick Henry Associates, East Lansing, Michigan, an adjunct professor of law and economics, Northwood University, and a scholar with the Mackinac Center for Public Policy.