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From happy homeownership to the end of our economy

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Thursday, Oct 9, 2008

Promoting homeownership remains a bad idea, as Felix Salmon reminds us here.


The last thing we need right now is a resurgence in homeownership. Too many people own their homes already, including a lot of families who really shouldn’t. Let’s start thinking in terms of affordable housing, and not in terms of home equity.


Houses are not investment vehicles, treating them as such is pretty foolish and potentially destructive. And the economy as a whole is far less flexible when too many workers are tied down in one spot with a home. And when fringe exurbs are developed to allow for more lower-income families to own, it leads to enormous inefficiencies and a massive amount of energy wasted on extreme commuting. Etc.


Conservatives seem to want to blame Fannie Mae and Freddie Mac for the crisis, but though they went broke in part by facilitating the mistaken ideal of the “ownership society,” they did not cause the current economic turmoil. Along with a choice quote from President Bush from 2004 in which he promotes “agggressive lending” to first-time borrowers—how surprising that this hasn’t worked out well—Barry Ritholtz has a good concise explanation of what did cause the crisis:


To repeat my prior arguments, the proximate cause of the Housing crisis were (1) Ultra-low rates; and (2) Abdication of traditional lending standards, thanks to (3) originators ability to resell mortgages for securitization purposes, and hence, (4) not have to worry about loan defaults.
The credit crisis was caused by (1) the above securitized mortgage paper, that was (2) rated triple AAA by Moody’s and Standard & Poors, which then (3) Which was then “insured” by credit default swaps (CDS)—the unreserved for, shadow insurance products (4) whose exemption was made possible by the Commodities Futures Modernization Act. That legislation exempted these derivatives from any supervision or regulation. The lack of reserve requirements is why there is now $62 trillion in CDS, many of which will never pay their counter parties the promised insurance.


Encouraged by the society-wide celebration of home ownership, mortgage lenders believed that their business was exempt from ethics or rational due diligence about the way funds were being distributed. So they lent to people without verifying whether they had any chance to pay off the loan, because that repayment was basically someone else’s problem. (In some instances, Fannie Mae and Freddie Mac, which would repurchase mortgages from the negligent bankers who originally made them as long as they “conformed”, i.e. were not “jumbo” loans for McMansions and the like, or subprime loans. These restrictions were supposed to protect Fannie and Freddie, only many borrowers turned out to be subprime, in effect, once house prices began to drop and they couldn’t refinance. When these people began to default in high numbers, Fannie and Freddie were on the hook, having resold the mortgages as high-rated securities to other, mainly institutional investors who expected them to be guaranteed by the U.S. government—hence bailout.) All these loans were made into securities, and they were rated highly because the rate of default was presumed to be low, and defaults were supposedly protected by the default-swaps, which provided for some other company to basically pay the mortgages if the lenders didn’t. But defaults were much higher than expected, and no funds were reserved to cover the losses by those who provided the insurance—instead, those insurers were leveraged to the gills. Hence A.I.G. gets nationalized, and banks stop lending to one another (aka Libor jumps astronomically), because they don’t know which ones will go broke next. Lots of consumer rates, unfortunately, are pegged to Libor, which ordinarily tracks the Fed Funds rate closely. Right now, though, it’s off the chart. So consumers can’t afford to borrow anymore, which means the rest of the economy scales down for a recession. Welcome to Great Depression redux, according to economist Nicolas Bloom:


So why is this banking collapse and rise in uncertainty likely to be so damaging for the economy? First, the lack of credit is strangling firm’s abilities to make investments, hire workers and start R&D projects. Since these typically take several months to initiate the full force of this will only be fully felt by the beginning of 2009. Second, for the lucky few firms with access to credit the heightened uncertainty will lead them to postpone making investment and hiring decisions. It is expensive to make a hiring or investment mistake, so if conditions are unpredictable the best course of action is often to wait. Of course if every firm in the economy waits then economic activity slows down. This directly cuts back on investment and employment, two of the main drivers of economic growth. But this also has knock-on effects in depressing productivity growth. Most productivity growth comes from creative destruction – productive firms expanding and unproductive firms shrinking. Of course if every firm in the economy pauses this creative destruction temporarily freezes – productive firms do not grow and unproductive firms do not contract. This leads to a stalling productivity growth.


But at least people got to live in their “own” homes for a few years. It really gave us such a sense of pride while it lasted.

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