When Reform Isn’t Reform

In the months leading up to the passage of the financial reform legislation, Congress decided to segregate the issues of financial regulation and the government sponsored enterprises (GSEs) that were central to the collapse. Now that Dodd-Frank is in the bank, Congress and the White House are turning to Freddie and Fannie, the two GSEs that have already  sopped up $150 billion in taxpayer money. Will this process lead to meaningful reforms?  An article by Binyamin Appelbaum in yesterday’s NYT does not give me much hope.

The financial crisis came in the aftermath of the collapse in the real estate bubble. The bubble was created, in part, by government efforts to promote high levels of home ownership, particularly among low income citizens. This was justified in the 1990s through evidence suggesting racial discrimination in credit markets; during the Bush presidency it was promoted as part of the effort to create the so-called “ownership society.”

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 mandated that the Department of Housing and Urban Development set quantitative targets for GSE purchases of mortgages serving a low and moderate-income clientele.  Between 1993 and 2007, the target increased from 30 percent to 55 percent.  Even if we stipulate arguendo that the goal of extending home ownership to low income borrowers was laudable, it was nonetheless the case that this population—and the speculators that moved in to take advantage of liberalized underwriting standards—were highly vulnerable to economic fluctuations.

Let me be clear: I am not claiming that the housing policy of the Clinton and Bush administrations and Congress was the sole source of the financial crisis. But without the bubble it created (facilitated by a number of other factors, including the Taxpayer Relief Act of 1997, the Fed’s policies, and private sector chicanery), the crisis would not have occurred.  Clinton, Bush, and congressional majorities of both parties embraced a set of social goals and decided to use the GSEs as the instruments of choice in realizing these goals.

The NYT article contains some quotes that should disturb anyone hoping for genuine reform.  Appelbaum reports:

Mr. Geithner said continued government support was important “to make sure that Americans can borrow at reasonable interest rates to buy a house even in a downturn.”

While a range of options are on the table, Appelbaum notes:

The choice will reflect in large part a judgment about how hard the government should try to increase homeownership. Broader guarantees create greater risks for taxpayers, but also lower interest rates, bringing ownership within reach for more families. Shaun Donovan, the housing secretary and a host of the conference with Mr. Geithner, said that the administration remained committed to “broad access to homeownership, including options for those families who have historically been shut out of these markets.”

The conclusion: clear evidence that efforts to use the GSEs to engineer a predefined level of home ownership has had no discernable impact on policymakers’ desire to continue using the GSEs for this purpose.

I can imagine a principled argument from the Right that the level of home ownership is an emergent property of incomes and preferences. Rather than trying to achieve some politically-defined level of ownership, we should create the preconditions for growth and make certain that lenders bear the risk for the loans they make, even if this results in more stringent underwriting standards.

I can imagine a principled argument from the Left that the real problem has been the nation’s failure to invest in public housing for low-income households. Under the sway of neoliberalism, Democrats and Republicans alike gravitated toward “third way” solutions that effectively allowed them to move their responsibility to the poor off budget.

What I cannot imagine is a principled argument for a continuation of the status quo.

3 thoughts on “When Reform Isn’t Reform

  1. I was also appalled at the Secretaries’ comments. There you have Pimco saying they would not buy MBS unless the owner had 30% or more equity. Why should the taxpayer be guaranteeing more leverage than the private sector will accept? Surely it is not because government evaluates credit better.

    And this phrase: “families who have historically been shut out of these markets.” – This is just a rephrasing of “low credit worthiness”. Why should the taxpayer be lending them money? There is a difference between having a home and owning it. It is sufficient that people have a place to dwell even if rented. There is no argument that any housed citizen citizen should get a subsidy to switch from renter to owner at the taxpayer’s risk.

  2. There is a new NBER working paper (No. 15968) by Li, White, and Zhu, claiming that the 2005 bankruptcy reform led to an additional 200,000 mortgage defaults annually.

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