One Bad Law Usually Leads To Others: The Housing Bubble and Dodd-Frank
Let’s start with a pop quiz. Here’s the question.
The housing bubble was caused by:
a) The boundless greed of Wall Street fat cats
b) The natural instability of markets under capitalism
c) Deregulation
d) Foolish laws passed as long ago as the 1930s
Putting the possible answers that way is almost cruel to those who have been schooled in “progressive” thinking because the first three answers all seem equally correct. How can one choose?
The correct answer is d). We would never have suffered through the housing bubble if the federal government had not blundered into the housing market, which used to function efficiently on its own. Politicians of both parties, however, imbued with what Hayek called the “fatal conceit” that government regulation is superior to the spontaneous order of civil society, thought they could improve upon that market.
Instead, they made things far worse, creating a destructive bubble and then reacting by passing another disaster-laden law – Dodd-Frank.
Right now, America is transfixed on the unfolding cataclysm of Obamacare, but it’s worthwhile to look back on Washington’s last policy blunder to see if it holds any lessons for us. It does.
For a clear, concise explanation of the genesis of the housing bubble, I recommend the November, 2013 Hillsdale College Imprimis, “The Case for Repealing Dodd-Frank” (available here), by Peter J. Wallison of the American Enterprise Institute. Wallison shows how the government’s serial meddling in the housing market brought about the housing boom and bust, which in turn led to yet another damaging law.
The story begins in 1934, with the creation of the Federal Housing Administration. Before then, the housing industry had functioned without any trouble, settling on various standards for safe lending, especially the 20 percent down-payment rule. The market’s standards efficiently allocated credit to those who had shown themselves to be credit-worthy. Even though the FHA could have issued mortgages on weaker standards, for a long time it didn’t.
Between 1957 and 1961 however, Congress decided that the housing market needed stimulation and decreed that the FHA would go to a 3 percent down standard. “Predictably,” Wallison writes, “this resulted in a boom in FHA insured mortgages and a bust in the late ‘60s. The pattern keeps recurring and no one seems to remember the earlier mistakes.”
Precisely – no one remembers the earlier mistakes.
The feds left the housing market pretty much alone until 1992, when Congress thought it would be politically advantageous to posture as champions of “affordable housing.” The politicians decreed that the two mortgage giants it had created, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) would have to meet quotas for mortgages from lower-income people. Creatures of politics, the two government-sponsored enterprises had no choice but to comply.
Initially, 30 percent of the mortgages Fannie and Freddie purchased had to be lower income mortgages but as the housing mania kept growing, the quota was raised repeatedly, reaching 56 percent in 2008.
None of that had anything to do with Wall Street or capitalist greed. It was a case of politics overriding the free market to help politicians win re-election.
Of course, most of those mortgages written and purchased to meet arbitrary quotas were high risk ones that would never have been made by capitalists who have to balance the possibility of profit against the risk of loss. The resulting gusher of bad mortgages was not due to any inherent instability in the natural workings of the market. It was due to instability caused by meddling politicians who stood to lose nothing if their decisions turned out badly.
Because Fannie and Freddie were regarded as having the government’s backing, financial institutions that would otherwise have carefully looked into the riskiness of the paper they were buying from them were lulled to sleep. Why worry about Fannie or Freddie paper when it has the U.S. Treasury behind it? Bad investments spread through the financial system like a metastasizing cancer.
Then, in 2007, the house of cards fell. Home prices that had been bid up too high began collapsing. The bubble popped, taking down huge numbers of jobs in the housing industry, erasing billions in paper wealth, and costing many individuals homes that they should never have borrowed to purchase.
Have we learned a lesson?
Obviously not, because the response from Congress was to pass a new law (Dodd-Frank) that was supposed to deal with the problems caused by the previous laws. Wallison details the ways in which Dodd-Frank both fails to cure the underlying problems and creates new ones in his book Bad History, Worse Policy.
Dodd-Frank imposes huge new regulatory costs, while sending this message to the financial industry: don’t take risks. Banks have had to substitute compliance officers for lending officers. As a result of this counter-productive mountain of a law (over 360,000 words), there is today much less investment capital available for entrepreneurial activities and small business growth, both of which are crucial to our economic vitality. Dodd-Frank is a considerable part of the federal drag that has kept the economy’s recovery from the bubble so sluggish.
Wallison has plenty of company in arguing that Dodd-Frank was a terrible move in the wrong direction. Independent Institute scholar Vern McKinley and Hester Peirce of the Mercatus Center recently wrote on Forbes that Dodd-Frank is “a bigger ticking time bomb than Obamacare itself.” Peirce is one of the co-authors of Dodd-Frank: What It Does and Why It’s Flawed, another in-depth analysis of the severe, unintended consequences of a law passed just so Obama and the Democrats in Congress could say, “See, we’ve done something about the bubble problem!”
And as we read in this FHA Watch report from December, the FHA is still buying almost exclusively high-risk mortgages – 87 percent. As the old saying goes, “When you’re in a hole, stop digging.” But government officials just keep digging deeper by encouraging risky lending. The losses, after all, won’t hurt them; they’ll fall on the taxpayers.
Whether we’re talking about housing or medical care or education or unemployment or any other socio-economic problem we face, the roots are nearly always to be found in prior government tampering with the spontaneous order of free markets and civil society.
Ludwig von Mises pointed this out in his book A Critique of Interventionism, writing, “Authors of economics books, essays, articles, and political platforms demand interventionistic measures before they are taken, but once they have been imposed no one likes them. Then everyone—usually even the authorities responsible for them—call them insufficient and unsatisfactory. Generally the demand then arises for the replacement of unsatisfactory interventions by other, more suitable measures. And once the new demands have been met, the same scenario begins all over again.”
Obamacare, Dodd-Frank, and many more statutes and regulations owe their existence to that scenario. Instead of repealing a harmful law, we enact new ones that just make things worse. I’m afraid that’s an inherent problem in a democracy where the government has grown far beyond its proper functions.
Representative Barney Frank, co-architect of the Act (Photo credit: Wikipedia)
RECOMMENDED BY FORBES
Let’s start with a pop quiz. Here’s the question.
The housing bubble was caused by:
a) The boundless greed of Wall Street fat cats
b) The natural instability of markets under capitalism
c) Deregulation
d) Foolish laws passed as long ago as the 1930s
Putting the possible answers that way is almost cruel to those who have been schooled in “progressive” thinking because the first three answers all seem equally correct. How can one choose?
The correct answer is d). We would never have suffered through the housing bubble if the federal government had not blundered into the housing market, which used to function efficiently on its own. Politicians of both parties, however, imbued with what Hayek called the “fatal conceit” that government regulation is superior to the spontaneous order of civil society, thought they could improve upon that market.
Instead, they made things far worse, creating a destructive bubble and then reacting by passing another disaster-laden law – Dodd-Frank.
Right now, America is transfixed on the unfolding cataclysm of Obamacare, but it’s worthwhile to look back on Washington’s last policy blunder to see if it holds any lessons for us. It does.
For a clear, concise explanation of the genesis of the housing bubble, I recommend the November, 2013 Hillsdale College Imprimis, “The Case for Repealing Dodd-Frank” (available here), by Peter J. Wallison of the American Enterprise Institute. Wallison shows how the government’s serial meddling in the housing market brought about the housing boom and bust, which in turn led to yet another damaging law.
The story begins in 1934, with the creation of the Federal Housing Administration. Before then, the housing industry had functioned without any trouble, settling on various standards for safe lending, especially the 20 percent down-payment rule. The market’s standards efficiently allocated credit to those who had shown themselves to be credit-worthy. Even though the FHA could have issued mortgages on weaker standards, for a long time it didn’t.
Between 1957 and 1961 however, Congress decided that the housing market needed stimulation and decreed that the FHA would go to a 3 percent down standard. “Predictably,” Wallison writes, “this resulted in a boom in FHA insured mortgages and a bust in the late ‘60s. The pattern keeps recurring and no one seems to remember the earlier mistakes.”
Precisely – no one remembers the earlier mistakes.
The feds left the housing market pretty much alone until 1992, when Congress thought it would be politically advantageous to posture as champions of “affordable housing.” The politicians decreed that the two mortgage giants it had created, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) would have to meet quotas for mortgages from lower-income people. Creatures of politics, the two government-sponsored enterprises had no choice but to comply.
Initially, 30 percent of the mortgages Fannie and Freddie purchased had to be lower income mortgages but as the housing mania kept growing, the quota was raised repeatedly, reaching 56 percent in 2008.
None of that had anything to do with Wall Street or capitalist greed. It was a case of politics overriding the free market to help politicians win re-election.
Of course, most of those mortgages written and purchased to meet arbitrary quotas were high risk ones that would never have been made by capitalists who have to balance the possibility of profit against the risk of loss. The resulting gusher of bad mortgages was not due to any inherent instability in the natural workings of the market. It was due to instability caused by meddling politicians who stood to lose nothing if their decisions turned out badly.
Because Fannie and Freddie were regarded as having the government’s backing, financial institutions that would otherwise have carefully looked into the riskiness of the paper they were buying from them were lulled to sleep. Why worry about Fannie or Freddie paper when it has the U.S. Treasury behind it? Bad investments spread through the financial system like a metastasizing cancer.
Then, in 2007, the house of cards fell. Home prices that had been bid up too high began collapsing. The bubble popped, taking down huge numbers of jobs in the housing industry, erasing billions in paper wealth, and costing many individuals homes that they should never have borrowed to purchase.
Have we learned a lesson?
Obviously not, because the response from Congress was to pass a new law (Dodd-Frank) that was supposed to deal with the problems caused by the previous laws. Wallison details the ways in which Dodd-Frank both fails to cure the underlying problems and creates new ones in his book Bad History, Worse Policy.
Dodd-Frank imposes huge new regulatory costs, while sending this message to the financial industry: don’t take risks. Banks have had to substitute compliance officers for lending officers. As a result of this counter-productive mountain of a law (over 360,000 words), there is today much less investment capital available for entrepreneurial activities and small business growth, both of which are crucial to our economic vitality. Dodd-Frank is a considerable part of the federal drag that has kept the economy’s recovery from the bubble so sluggish.
Wallison has plenty of company in arguing that Dodd-Frank was a terrible move in the wrong direction. Independent Institute scholar Vern McKinley and Hester Peirce of the Mercatus Center recently wrote on Forbes that Dodd-Frank is “a bigger ticking time bomb than Obamacare itself.” Peirce is one of the co-authors of Dodd-Frank: What It Does and Why It’s Flawed, another in-depth analysis of the severe, unintended consequences of a law passed just so Obama and the Democrats in Congress could say, “See, we’ve done something about the bubble problem!”
And as we read in this FHA Watch report from December, the FHA is still buying almost exclusively high-risk mortgages – 87 percent. As the old saying goes, “When you’re in a hole, stop digging.” But government officials just keep digging deeper by encouraging risky lending. The losses, after all, won’t hurt them; they’ll fall on the taxpayers.
Whether we’re talking about housing or medical care or education or unemployment or any other socio-economic problem we face, the roots are nearly always to be found in prior government tampering with the spontaneous order of free markets and civil society.
Ludwig von Mises pointed this out in his book A Critique of Interventionism, writing, “Authors of economics books, essays, articles, and political platforms demand interventionistic measures before they are taken, but once they have been imposed no one likes them. Then everyone—usually even the authorities responsible for them—call them insufficient and unsatisfactory. Generally the demand then arises for the replacement of unsatisfactory interventions by other, more suitable measures. And once the new demands have been met, the same scenario begins all over again.”
Obamacare, Dodd-Frank, and many more statutes and regulations owe their existence to that scenario. Instead of repealing a harmful law, we enact new ones that just make things worse. I’m afraid that’s an inherent problem in a democracy where the government has grown far beyond its proper functions.
Representative Barney Frank, co-architect of the Act (Photo credit: Wikipedia)
RECOMMENDED BY FORBES
