Friday, March 25, 2011

The Real Estate Market: The Government Gets It Wrong

The housing market is still in a slump slowing the recovery of our economy.  What is the solution to revitalizing the housing market?

First, we need to analyze why we are in this situation.  In the 1970’s, the Community Reinvestment Act went into effect, largely because many banks were avoiding lending in poor neighborhoods in big cities.  Rather than considering individual credit, they were “redlining” entire areas in large cities as off limits to lending.  It was a simple way to avoid risk, but a shortsighted policy.  Lazy lenders were not bothering to determine individual risk but were disqualifying entire communities.

The government’s solution was to require banks to invest in low income communities.  The government enforced that requirement by mandating a certain level of lending in the affected areas. However, the government set unrealistic requirements. There were certainly credit worthy customers that banks had ignored in the affected areas, but the level of lending the government sought would have resulted in banks lowering credit standards. Because banks were regulated by the government which required certain credit standards, banks were put in an untenable position—they could not lower their credit standards, or they would run into trouble with regulators; but those same regulators required investment in the affected communities at an unrealistic level.

Government attempted to fix the problem it created by allowed Fannie Mae and Freddie Mac to lower their credit standards while providing mortgage guarantees for most mortgages issued by banks.  Banks, seeing a way to meet their CRA goals, lent money to low income households in the affected CRA areas, knowing the loans would be guaranteed.
The government’s good intentions had major unintended consequences. Not only did lower income households qualify for loans that under past higher credit standards would not qualify, but higher income families began to purchase homes beyond their means.  Because of the increase in demand for homes, home prices shot up creating a classic bubble which finally burst in the summer of 2007.

The government is now trying to solve the housing problem by forcing tax payers to subsidize home mortgages that are under water.  This policy is contributing to our stalled economic recovery:  Government is interfering with the normal market cycle in real estate; and, the increased tax burden hinders economic growth.     

The housing crisis can be solved by reducing government involvement in the market.  Here’s how: 

  • Stop the mortgage buyout program.  Let the market do its job.
  • Maintain mortgage guarantee programs that help low income households through Fannie Mae and Freddie Mac but reduce the percentage of the mortgage guaranteed from the present 95% to a more realistic 85%, so that buyers have to put a realistic down payment on a home, and reduce the maximum guarantee amount from $750,000 mortgage to $300,000. There is no need to continue subsidizing people purchasing high priced homes.
  • Continue low income housing tax credits.

As we reduce the government involvement in the housing market, the free market will adjust and reinvigorate the housing market.  As long as government continues to artificially try to prop up markets, the uncertainty created and costs to taxpayers will be a drag on our economy.      

1 comment:

  1. I did not understand before how Freddie and Fannie Mac worked, nor did I understand the impact of the programs on the housing market. That makes sense. What is the difference between Freddie and Fannie Mac, and how is the government forcing taxpayers to subsidize home mortgages that are under water?