Last night National Government Radio promoted a documentary on National Government TV about the financial crisis of 2008, which concludes that the problem was . . . not enough government.

If the “Frontline” episode mentioned any of the ways that government created the crisis — cheap money from the central bank, tax laws that encourage debt over equity, government regulation that pressured lenders to issue mortgages to borrowers who wouldn’t be able to pay them back — NPR didn’t mention it.

For information on those causes, take a look at this paper by Lawrence H. White or get the new book Financial Fiasco by Johan Norberg, which Amity Shlaes called “a masterwork in miniature.” Available in hardcover or immediately as an e-book. Or on Kindle!

And for a warning about the dangers lurking in Fannie Mae and Freddie Mac, see this 2004 paper by Lawrence J. White.

What Caused the Crisis? is a post from Cato @ Liberty - Cato Institute Blog

With the House Financial Services Committee moving forward with a bill to increase the regulation of our consumer credit markets, particularly our mortgage market, it is worth asking the question:  what’s the best protection for consumers, regulation or competition?

Let’s take the example of mortgage brokers.  They’ve often been targeted as one  of the causes of the crisis.  The story goes that they just made the loans and passed it along to the lenders and/or Wall Street and so, didn’t care about the quality of the loan.

The response of government, first at the state then the federal level, has been to subject mortgage brokers to increased oversight and licensing, with the intent to keep the “bad actors” out of the marketplace.  How well did this all work out?

According to Professor Morris Kleiner and Minn Fed Economist Richard Todd, not exactly the way you’d want.  What the economists found was that tighter regulation on who can become a mortgage broker is actually associated ”with higher broker earnings, fewer brokers, fewer subprime mortgages, higher foreclosure rates, and a greater percentage of high-interest-rate mortgages.”

It seems the barrier to entry created by these licensing requirements reduced competition in a manner that caused far more harm to consumer than any protections provided by increasing the “quality” of mortgage brokers.

Regulation and Competition among Mortgage Brokers is a post from Cato @ Liberty - Cato Institute Blog

With the Student Aid and Fiscal Responsibility Act (SAFRA) likely to be voted on by the full House or Representatives today, the media is finally giving some space to debate over the bill. Unfortunately, the New York Times only pays attention to the parts it likes, writing in an editorial today that:

The private lenders and those who do their bidding in Congress have recently taken issue with a Congressional Budget Office analysis that showed that the bill would save about $87 billion over the next 10 years.

They argue, absurdly, for example, that the savings would be smaller if the system were analyzed under accounting rules other than the ones that the federal government is required to use. The aim is to mislead taxpayers and members of Congress into believing that the C.B.O. estimate is dishonest.

Um, excuse me New York Times, but the CBO has never said the bill — not just going from subsidized to direct lending, but the whole bill — would save $87 billion over ten years. Moreover, it has been a series of analyses from the CBO — albeit driven by requests from members of Congress – that have continually increased the cost estimates for SAFRA. (I have linked to all the CBO analyses here.) CBO’s very first estimate of the bill’s likely net cost put it at around $6 billion over ten years, and it only went up from there after incorporating such things as lending risk and potentially higher Pell grant costs.

Of course, the Times isn’t alone in its refusal to talk honestly about SAFRA. Despite all of the CBO estimates, yesterday U.S. Secretary of Education Arne Duncan said SAFRA would give college students and numerous other interests the world without costing taxpayers a dime.  “We’re not asking the taxpayers for one single dollar,” he said. And SAFRA’s sponsor, Rep. George Miller (D-CA), has been touting his bill as a revolutionary money saver since day one.

The truth on this thing is out there, but it’s definitely not in the New York Times.

NYT Nonsense on SAFRA is a post from Cato @ Liberty - Cato Institute Blog

The housing boom and bust that occurred earlier in this decade resulted from efforts by Fannie Mae and Freddie Mac — the government sponsored enterprises with implicit backing from taxpayers — to extend mortgage credit to high-risk borrowers. This lending did not impose appropriate conditions on borrower income and assets, and it included loans with minimal down payments. We know how that turned out.

Did U.S. policymakers learn their lessons from this debacle and stop subsidizing mortgage lending to risky borrowers? NO. Instead, the Federal Housing Authority lept into the breach:

The FHA insures private lenders against defaults on certain home mortgages, an inducement to make such loans. Insurance from the New Deal-era agency has enabled lending to buyers who can’t make a big down payment or who want to refinance but have little equity. Most private lenders have sharply curtailed credit to those borrowers.

In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance. FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year.

And what is the result of this surge in FHA insurance?

The Federal Housing Administration, hit by increasing mortgage-related losses, is in danger of seeing its reserves fall below the level demanded by Congress, according to government officials, in a development that could raise concerns about whether the agency needs a taxpayer bailout.

This is madness. Repeat after me: TANSTAAFL (There ain’t no such thing as a free lunch).

C/P Libertarianism, from A to Z

Housing Bailouts: Lessons Not Learned is a post from Cato @ Liberty - Cato Institute Blog

The recent focus in Washington on mortgage modifications once again illustrates one of the most fundamental flaws in current political debate:  the notion of using government to threaten or force the “voluntary” transfer of wealth from one group of citizens to another.

Just this week Rep. Barney Frank warned the banking industry if they don’t “voluntarily” do more to reduce foreclosures, Congress will step in and make them do so, by allowing bankruptcy judges to re-write mortgage contracts.  This proposal is really nothing more an ex poste transfer of wealth from investors in mortgage backed assets to borrowers.

Of course, Rep. Frank and others respond that they are only trying to “bring lenders to the table” in order to keep negotiations going.  In the words of many “consumer” advocates, this is just a “stick” to the motivate the lenders.  I could think of few things more offensive to a free society.  In a government truly constituted on the notion of the common good or general welfare, it would be no more appropriate to use the stick of the state on lenders than it would be on borrowers.  Government quite simply should not take sides in purely private disputes. 

One would think that if anyone could understand the principle that government should not interfere in the private, voluntarily entered relationships of consenting adults, it should be Mr. Frank.

Mortgage Mods: Congressman Prefers Coercion over Cooperation is a post from Cato @ Liberty - Cato Institute Blog

As covered in both today’s Wall Street Journal and Washington Post, the Obama administration has called 25 of the largest mortgage servicing companies to Washington to try to figure out why the Obama efforts to stem foreclosures has been a failure.

The reason such efforts, as well as those of the Bush Administration and the FDIC, have been a failure is that such efforts have grossly misdiagnosed the causes of mortgage defaults.  An implicit assumption behind former Treasury Secretary Paulson’s HOPE NOW, FDIC Chair Sheila Bair’s IndyMac model, and the Obama Administration’s current foreclosure efforts is that the current wave of foreclosures is almost exclusively the result of predatory lending practices and “exploding” adjustable rate mortgages, where large payment shocks upon the rate re-set cause mortgage payment to become “unaffordable.”

The simple truth is that the vast majority of mortgage defaults are being driven by the same factors that have always driven mortgage defaults:  generally a negative equity position on the part of the homeowner coupled with a life event that results in a substantial shock to their income, most often a job loss or reduction in earnings. Until both of these components, negative equity and a negative income shock are addressed, foreclosures will remain at highly elevated levels.

Sadly the Obama Administration is likely to use today’s meeting as simply an excuse to deflect blame from themselves onto “greedy” lenders.  Instead the Administration should be focusing on avenues for increasing employment and getting our economy growing again.  Then of course, this Administration has from the start been more focused on re-distributing wealth rather than creating it, which explains why it views mortgage modifications as simply a game of taking from lenders (in reality investors – like pension funds) and giving to delinquent homeowners.

Why Mortgage Modifications Aren’t Working is a post from Cato @ Liberty - Cato Institute Blog

With the Obama administration preferring to rely on politics rather than the law to “fix” the auto industry, bondholders have discovered that the new politics of this administration is quite a bit more brutal than the old politics practiced by the Bush administration.

Henry Payne and Richard Burr write of “gangster government” using not just demagogic public attacks on greedy bondholders but apparent threats of regulatory sanction to get its way in bankruptcy court.  They explain:

The holdout debtholders sought the refuge of the courts, where decades of bankruptcy law promised that secured lenders would receive just compensation for their investment. But then Obama called in his fixers.

In his April 30 news conference, Obama singled out Chrysler’s self-described “non TARP lenders” as “speculators” who sought to imperil Chrysler’s future for their own benefit. “I do not stand with them,” Obama thundered. “I stand with Chrysler’s employees and their families and communities. . . . (not) those who held out when everybody else is making sacrifices.” Michigan Democratic allies like Sen. Debbie Stabenow and Rep. John Dingell piled on, calling the lenders “vultures.”

Then, on Detroit radio host Frank Beckmann’s show May 1, a lawyer for the lenders, Tom Lauria, chillingly revealed how “one of my clients was directly threatened by the White House and in essence compelled to withdraw its opposition to the deal under threat that the full force of the White House press corps would destroy its reputation if it continued to fight.”

Lauria later confirmed the threats came from Rattner and that the target was Perella Weinberg, which had suddenly withdrawn its opposition after the president’s April 30 press conference.

The White House denied the threats, but Business Insider subsequently reported that “sources familiar with the matter say that other firms felt they were threatened as well. None of the sources would agree to speak except on the condition of anonymity, citing fear of political repercussions.”

“The sources, who represent creditors to Chrysler,” continued the Insider story, “say they were taken aback by the hardball tactics that the Obama administration employed to cajole them into acquiescing to plans to restructure Chrysler. One person described the administration as the most shocking ‘end justifies the means’ group they have ever encountered. . . . Both were voters for Obama in the last election.”

The idea of the White House–with the IRS and SEC at its disposal–threatening investment firms should have sent off alarm bells in America’s newsrooms. Inexcusably, the media establishment largely ignored the hardball tactics. This is the same media that has doggedly reported on President Bush’s U.S. attorney firings and the post-9/11 interrogations of terrorist suspects.

I have no opinion on who should get what as part of Chrysler’s bankruptcy — other than that the taxpayers shouldn’t be paying for America’s version of lemon socialism so common around the world.  But crude political interference by the political authorities in Washington in a bankruptcy case erode the rule of law and administration of justice.  If Obama and company believe that the end justifies the end when it comes to handing the auto companies over to favored interests, who among us is safe from similar action by this or another administration in the future?

“Gangster Government” at Work is a post from Cato @ Liberty - Cato Institute Blog

In an editorial yesterday on President Obama’s proposal to end federal guaranteed student lending and turn everything into loans and grants direct from Uncle Sam, the New York Times had an interesting take on what constitutes putting ”taxpayers’ interests first”:

Private companies that reap undeserved profits from the federal student-loan program are gearing up to kill a White House plan that would get them off the dole and redirect the savings to federal scholarships for the needy. Instead of knuckling under to the powerful lending lobby, as it has so often done in the past, Congress needs to finally put the taxpayers’ interests first.

So let me get this straight: Redirecting tax dollars from lenders — who do get cushy fees and security through the guaranteed loan program — and giving it to students is somehow in the best interest of taxpayers? Maybe I’m old fashioned or something, but wouldn’t the best thing for taxpayers be to get their money back, not just see it shuffled from one special interest to another?

Obviously it would, and not just because taxpayers are best off when they decide how their ducats are used. As Andrew Gillen and I made clear in a Capitol Hill briefing last week, the best thing that could happen for taxpayers, students, and all of society would be for the federal government to provide much less aid to students, not more. The reality is that student aid drives massive, self-defeating college price inflation, creates ugly bloat and waste in our ivory towers, and ultimately cramps economic growth.

And we wonder why there are tea parties!

What “Taxpayers?” is a post from Cato @ Liberty - Cato Institute Blog

Peter Van Doren and I have been puzzling over this very interesting NYT op-ed on home foreclosures by Yale economist John Geanakoplos and Boston University law professor Susan Koniak. If G&K’s story is right, then shouldn’t there be an opportunity for some clever financiers to help struggling homeowners keep their houses, help banks and other investors repair their balance sheets — and the financiers could help themselves to piles of cash in the process?

G&K argue that all three parties to a home mortgage — the homeowner, the lender, and the loan servicer who works as a go-between — currently face grim financial prospects:

• Many homeowners are “underwater” — that is, they owe more on their mortgages than their homes are now worth. According to First American Core Logic, some 20% of mortgages were underwater as of December 2008. The percentage varies greatly from state to state, with 55% of mortgages underwater in Nevada, but only 7% in New York. The homeowners who are underwater include not just those who purchased with little down payment, but also many people who put down the traditional 20 percent when they bought in 2005 or 2006, at the peak of the real estate bubble. According to Case-Shiller index data, house prices nationwide have fallen 27% (as of December) from their May 2006 peak. Some local markets have experienced more dramatic declines, highlighted by Phoenix’s 46% slide. Rental prices are now far below many homeowners’ monthly mortgage payments, and lots of underwater homeowners will have to make payments for years before they have some equity stake in their homes. Many of those homeowners would rather default and risk foreclosure. G&K’s op-ed includes this figure showing that defaults increase dramatically as homeowners sink further and further underwater. Given their current options, default is rational.
• The mortgage lender faces heavy losses if the home enters foreclosure. According to G&K, ”the subprime bond market now trades as if it expects only 25 percent back on a loan when there is a foreclosure.”
• The servicer also is at risk. According to G&K, the servicer is obligated to continue paying the lender its monthly payment even if the borrower is in default. That obligation only lifts at foreclosure.

Because of the servicer’s obligation, the servicer has strong incentive to push for quick foreclosure. However, the homeowner and the mortgage lender would likely benefit from a loan modification — even a significant write-down of principal — because that would keep the homeowner in his house and it would deliver a better return to the lender than the 75% loss from foreclosure. G&K thus argue that government, instead of continuing to bail out the banking industry and struggling homeowners (and putting taxpayers on the hook for hundreds of billions of dollars), should simply require that the lenders write down the mortgage principal.

But is government action needed? Couldn’t some private actors accomplish the same thing — and make some serious scratch in the process?

A financial wizard with sufficient backing could approach a troubled lender and offer, say, 50% of the original loan amount in order to take some of the toxic mortgages off the lender’s hands. Now, the lender won’t be happy with selling at a 50% loss, but that certainly beats a 75% loss, so the lender would grudgingly agree. The financial wizard would then approach the homeowner and offer to write down the mortgage principal to, say, 60% on condition that the homeowner purchase mortgage insurance. The homeowner should jump at the offer because it would put him back above water, purchasing a home that’s worth more than its debt. Finally, the financial wizard would get the servicer to release its control over the loan, because the servicer would want to be freed from the risk of having to cover the payments to the lender. The financial wizard would then pocket a cool 10% of the original mortgage’s value.

That is not chump change. G&K estimate some 8 million homes could be foreclosed upon in the coming years. Assume the original mortgage on each of those houses is $199,025 (95% of the median sale price of new U.S. homes in January 2004, about halfway up the bubble); that 10% would represent almost $160 billion.

Of course, if the bank proves recalcitrant and demands more than 50%, or the homeowner demands a write-down of more than 40% or he’ll walk away, that would cut into the profits. And the financial wizard would have to cover his costs and possible risk premiums. Still, at least in theory, there would seem to be a significant pile of money on the table.

So why isn’t this happening? Are there no money-loving financial wizards out there?

To some extent, they are. Last week, the NYT reported that some former Countrywide executives have formed a firm called PennyMac that, with financial backing from hedge funds and other investors, purchases toxic mortgages from insolvent banks at low prices, modifies the loans to increase homeowners’ likelihood of making payments, and profits from the rekindled mortgage revenue stream. In the particular case reported in the NYT, PennyMac paid 38 cents on the dollar. But PennyMac seems like very small potatoes compared to the $160 billion that may be on the table. And the banks were forced to sell the loans because they had been taken over by the FDIC.

So why aren’t there more firms doing what PennyMac is doing, or following the strategy that Peter and I have laid out above? And why aren’t banks lining up to offload their toxic mortgages (or to do the write-downs themselves and pocket the 10%)? Peter and I can think of three possible reasons:

1. As G&K note in their op-ed, banks and other investors who’re currently saddled with toxic assets may be waiting for some form of government rescue that would enable them to recoup far more than the 50% or so that would be offered by our financial wizards.
2. Banks are keeping bad mortgages on their books at values much higher than the 25 to 40 cents on the dollar observed in the rare sales of troubled assets, and so the banks are unwilling to sell the assets for 50 cents on the dollar. (Remember that PennyMac is purchasing assets from banks that have been taken over by the FDIC — in other words, these are forced sales.) The banks (and their managers) may strongly prefer to keep the assets on their books rather than sell them at a 50% loss.
3. The transaction costs involved in this scheme (e.g., analyzing the toxic assets to determine which ones to buy, negotiating with the delinquent and at-risk homeowners) are prohibitively large.

Government can address (1) by committing not to bail out the investors. Unfortunately, it’s unclear how reliable that commitment would be, especially given government actions so far in this financial crisis.

Fixing (2) is difficult. Accounting rules could be changed to force the banks to lower their book values for bad mortgages, but it would be difficult to get that accounting change passed quickly. Besides, some accounting experts argue that, in stressful times, accounting rules should have more wiggle room rather than less.

As for (3), the PennyMac guys claim that the work is difficult. But c’mon, there could be a $160 billion payday for the guys who can figure it out.

So, come on you money-loving financial wizards: your country needs you!

Solve the Financial Crisis (and Make Some Serious Money) is a post from Cato @ Liberty - Cato Institute Blog