Monday, July 28, 2008

Another boring economics post on . . . housing!

Paul Krugman has an interesting op-ed in today's NYT on the housing bill that's likely to be signed into law this week. Like many economists, Krugman seems to think that it offers a lot piecemeal remedies to the current housing crisis, but very little in the way of comprehensive reform of the mortgage industry.

Krugman's solution is, of course, to strong-arm mortgage originators into more vigorously screening applicants--compelling them to deny mortgages to the riskiest borrowers in order to protect the rest of us. And I must say, I don't necessarily disagree with this:

If the government is going to stand behind financial institutions, those institutions had better be carefully regulated — because otherwise the game of heads I win, tails you lose will be played more furiously than ever, at taxpayers’ expense.

If the government is going to be taking on billions of dollars in mortgage liability, of course it should force financial institutions to limit the amount of risk that they're exposed to. The issue is why the federal government is bailing out large investment banks like Bear Stearns with tax payer dollars in the first place. Aren't we setting an awfully scary precedent by doing this?

I can understand ensuring the liquidity of large government-sponsored enterprises like Fanny Mae and Freddy Mac (which are already intensely regulated by the Office of Federal Housing Enterprise Oversight), but why is the Federal Reserve now letting private investment firms off the hook for bad decisions?

I'm certainly not an expert on the mortgage industry, and I can't imagine how hard it must be for all of those families facing foreclosure, but it seems to me that if our goal is a little more humility from large financial institutions, it's probably a bad idea to tell them that they're basically too important to fail--no matter how badly they screw things up.


petpluto said...

I agree with Paul Krugman; the problem with the mortgage industry is the reason behind they approve of the riskiest of mortgages and loans -and that is because banking is a business with stocks and share holders who want to see the company making money and growing incredibly fast -at times exponentially- instead of rewarding a slow and steady pace.

Those whose houses are being foreclosed aren't being benefited from the bank bailout the government is performing right now. They're pretty much sunk in the mire and will probably stay that way for quite a while. The worst thing about this whole crisis are the people who were staying afloat until the bank limited their lines of credit -because LOCs are based on the value of the house, and the housing market has all but collapsed- without telling those customers they were doing so. These people may have had enough money coming in to cover the expense of their LOC but needed the LOC in order to write checks for expenses coming in the middle of the month. Now these customers are pretty far in debt as well, and with no real help coming from on high.

The banks being saved are being saved to protect people's savings and checking accounts, so that there are not runs on the banks like there was in the beginning of the Depression and so that faith in the financial institutions remain and then -theoretically- the recession will never fully come to be a recession and we'll all be saved. Of course, this is all the information coming from the banking end of the deal, so something completely different may have be the reasoning on the government side. I doubt it though.

And yeah, I very much doubt that we should be bailing out these banks without some repercussions/stipulations.

mikhailbakunin said...

Yo, Pet. Two things: 1) Hopefully, some of those borrowers who are at risk of foreclosure will be able to refinance (I don't know too much about FHA-Secure, but it seems like it may help out those people who now owe more than their homes are worth), and 2) I wonder how much of the current mortgage crisis was the result of predatory lending and how much of it was just borrowers taking on more debt than they could afford, lying on their mortgage applications, etc.

It seems like progressives are blaming the banks and conservatives are blaming the borrowers. I suspect the truth is probably somewhere in the middle. So, how do we mete out justice when both parties are responsible?

petpluto said...

Working on the mortgage side of things leaves me more apt to blame the bank. I saw some of those applications that came rolling through, and I heard about the pressure to approve loans that were high risk. Has very little to do with me being of a liberal bent and very much to do with how I saw the system working. Were there people who forged their income levels, etc. in order to secure a loan? Sure. But the overall state of banking practices were balanced to give high risk borrowers the benefit of the doubt in order to make the money necessary to avoid being taken over by another bank. It wasn't based on any evil intentions but good old fashioned fear. For that reason I wouldn't call it "predatory lending"; for the most part, these banks weren't going after people who couldn't pay. They were just betting on the housing market and economy staying on the sunny side of the street.

As for those people in danger of foreclosure, hopefully some of them WILL be able to refinance, but I know that a lot of people at our particular bank were being turned down for refinancing because the bank had already been burned. Plus, it does cost money, and that is something many people are woefully lacking these days. And that doesn't exactly help the people who have already lost their homes.

As for justice, I don't think it can be achieved. No laws were broken; it was just bad business decisions. The most we can hope for is that the banks suffer some kind of repercussion for their hand in the fall; the government's bail outs may be good for the short term economy, but I don't think they do much to suggest to the banks that a change in business practices is necessary. Most of the people who potentially worked the system are already in the rut, so its less of a worry about whether or not they will escape unscathed.