how the government aggravated the mortgage crisis

Topics: Housing
03 Sep 2008

From: Ervan Darnell

The government didn't wholly cause the mortgage melt down, but it aggravated it. Here are three ways it did so:

1) The riskiest loans are those with little or no down payment, exactly because those are the people who have nothing at risk and because those are the people least able to get their financial house in order, as evidenced by their inability to save a down payment. These are the people the government is subsidizing with down payment assistance (e.g. ADDI [1]).

Mix in with that political correctness (since African Americans are poorer on average) and you have one government folly defending another (I like this piece on African American congressman defending money laundering as housing subsidy[2]).

2) Why would profit seeking investment groups invest in risky mortgages at low rates? A lack of good information on risk seems to be part of it, but another part of it is because someone else is carrying the mortgage insurance, especially Freddie and Fannie. But why would you trust them in a broad down market? Because there is an implicit government backing. We've seen that in action now, so the expectation was not misplaced. That very expectation created the crisis it was intended to prevent.

3) Similar to backing Freddie and Fannie, the government is going through various subsidies of the riskiest borrowers. While these are not complete bailouts, and lenders are still taking a loss, the loss they would have faced is diminished by the various bailouts. How much did lenders bet on that when making risky loans?

The irony in this is that liberals created the problem (Freddie and Fannie were FDR's creations [3]) and now they are going to politically profit from their own failure this election cycle (as the house of cards fell while Bush was in office).

[1], it passed unanimously

Ervan Darnell

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