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Thursday, January 22, 2015

Government Created the Housing Bubble and Financial Crisis — and Could Be Doing so Again

What caused the financial crisis? How can we prevent another one from happening again? The answers you most often hear to those questions are (1) greed and deregulation and (2) the Dodd-Frank law.

But they’re patently inadequate. Greed — or the desire for monetary gain — has always been with us and always will be. And no one has convincingly linked financial deregulation to the crisis. Dodd-Frank, enacted to increase regulation, confers too-big-to-fail status on very large financial institutions, which incentivizes unduly risky behavior and penalizes smaller competitors.

The real problem was housing finance, argues my American Enterprise Institute colleague Peter Wallison in his new book “Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again.” Without changes in housing finance policy, he says, there would have been no financial crisis in 2008.

Government policies encouraged the granting of mortgages to non-creditworthy homebuyers, and government-sponsored enterprises Fannie Mae and Freddie Mac funneled securities laced with high-risk mortgages into major financial institutions. When house prices suddenly and unexpectedly dropped in 2007, these mortgage-backed securities became unsellable and the financial crisis quickly followed.

Wallison traces the policy mistake back to 1992, when Congress passed a law requiring the GSE’s to purchase a certain percentage of its mortgages granted to low- and moderate-income homebuyers–30 percent originally, later adjusted up to 56 percent by the Department of Housing and Urban Development.

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