Public policy and housing – the root of the credit problem

“But let me just tell you that Countrywide for 40 years has been on a mission to lower the barriers of entry for the American people to have the opportunity of home ownership.” - CEO Angelo Mozilo answers critics in Business Week interview with Maria Bartiromo

One of the major government middle class policies since the Depression has been the promotion of home ownership. A rally cry from any presidential candidate has been that we have to help the “little guy” own a home. Renting is not good for America. When home ownership increases, policy makers state that we are doing something right. When ownership falls, or the affordability index declines, there is something going wrong in America.

Public policy has set up programs to help funnel capital to the housing market. The boom in securitization started with the mortgage markets. With the big mortgage organization, Fannie Mae and Freddie Mac controlling the confirming market, private firms developed innovative lending programs. The growth was in non-conforming lending and one of the key ways to access financing was through structuring deals. You had to find those willing to take systematic housing risk.

So we got what we wanted, more ownership across the board, even for those that could not afford the normal terms of ownership. No one was arguing that banks should tighten lending standards. In fact, they did not have to if they were selling off the loans in packages. Policy-makers liked and wanted affordability and securitization was going to make this happen. The boom was in adjustable rate mortgages under the assumption that price would rise faster than interest rates. If the yield curve inverted, borrowers would move to fixed mortgages. Even Alan Greenspan extolled the virtues of adjustable rate mortgages.

Now the call is for investigation of the people who pushed up affordability and ownership with sub-prime lending. The solution is that we bail-out the borrower. They could not read the documents. They could not comprehend the risks of rising rates. They could not say no when their disposable income after mortgages payments was not enough to feed their families. They could not anticipate a decline in housing prices. Of course, the lenders were no better. The profit margins were fat. They pushed loans knowing that a portion of any pool of mortgages will default. We had "liar" loans and NINJA (no income, no job, no assets) loans.They took no responsibility for impending problems. Their job was to ride the housing wave as long as possible regardless of the consequences for the borrower

I am not arguing against the housing policy of home ownership. It has been good for America, but with many policies the law of unintended consequences takes over. Let's get affordability for everyone. But what is the measure of success for housing in America? From the concept of housing affordability came the root of the current problem. The issue is what to do to get out of this mess.

The measured response from Ben Bernanke’s speech at Jackson Hole seems to hit the right tone for now. (Chairman Bernanke also provides a nice history of mortgage markets over the last 100 years. It is a good introduction to the market developments. http://www.ft.com/cms/s/0/1a84f22a-57cd-11dc-8c65-0000779fd2ac.html

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.

While the stock market ended on a high note, we are far from over with the problem of housing.