In The New York Times earlier this week, David Leonhardt wrote one of the more amazing sentences I have seen about the financial crisis and the efforts to reform our financial system:
"Why didn’t any government agency prevent banks from issuing mortgages that homebuyers obviously could not repay?"
It would take more time than I have to point out all of the mistakes and misconceptions contained in this one sentence, but let me point out a few. This is important because, if somebody really thinks this sentence makes sense, then they will also probably think the financial reforms that Congress is working on will actually work like those proposing them say they will. And it is important to disabuse everybody of that idea.
Here I go. First, it wasn’t obvious that certain mortgages couldn’t be repaid. If housing prices had continued to go up and with a lucky break on refinancing, maybe nobody would have gone bust. Everything is clear after that fact. Before hand, it’s a different story.
Second, why would a homebuyer sign up for a mortgage that he or she obviously could not repay? We shouldn’t assume buyers are stupid. Maybe they really thought they could pay it off. Or maybe they were just taking a chance. After all, if they didn’t put much down, it wasn't that big of a risk for them.
If you say that, given all that happened, we don't want people taking that kind of risk, then the answer is a lot simpler than setting up a new government agency: Just have Fannie, Freddie and the FHA stop insuring loans with only 3.5% down. The market won't support that kind of loan anymore without a federal guarantee. If people have to put 10% or 20% down, they won't be taking this kind of chance.
Third, why do we think some government regulator is going to know what people can afford any better than they know? If the government was that smart, we wouldn’t have had the housing bubble and the near-panic in the financial market in the first place. Why is this next set of regulators going to be all that much smarter than the last ones?
Fourth, somebody, either a lender or a rating agency or a broker, said the loan was okay. If it was so obvious that the buyer couldn’t pay it, why didn’t they catch it? If they didn’t care or if they lied, why do we think the government will care enough to stop them or be smart enough to catch the lie? Fraud and waste are endemic in many government programs. If the government can’t stop that, how are they going to get this right?
Fifth, how are you going to like having to prove to some government bureaucrat that you have enough money to pay off the mortgage you want – or at least have to show that you meet some government standard to be allowed to buy the house you want to buy (when you're not even getting a FHA loan)?
That’s enough.
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