How Big Government caused the housing crash

Government Caused the Meltdown
(LewRockwell.com) -- by George C. Leef --

Thomas Woods’s Meltdown is a truly radical book.

That is to say, it probes to the root of America’s persistent boom-and-bust economic cycles. Not only has the most recent episode, beginning in 2007 with the rapid collapse of inflated housing prices, brought about widespread economic pain as unemployment rises, foreclosures increase, and bankruptcies mount, but it has also brought us to the brink of a sea change in the United States. For decades, the United States has been sliding into the quicksand pit of federal domination of the economy (and also most other facets of life). Now the politicians responsible for the current economic debacle are determined to use it as the leverage they need to force changes that will greatly increase Washington’s grip on the populace. They want to push us past the point of no return.

The country is in such grave danger because few people understand the real causes of our troubles. Overwhelmingly, politicians, opinion leaders, and academicians have pinned the blame for the current crisis on capitalism. They maintain that we can regain prosperity only if the federal government spends money like never before, bails out failing companies, and exerts far more regulatory control over what’s left of free enterprise...

...In Meltdown, Woods explains the truth: government blundering got us into the current recession and if we allow the politicians to exploit it to increase their power, we will have made a gigantic, perhaps fatal mistake. The book gives the reader an excellent, clear discussion of the causes and consequences of the housing bubble, but goes further to provide a convincing explanation of the Austrian theory of the business cycle. After reading the book, readers will be familiar with the names von Mises and Hayek; they will understand why it is impossible for the government to make a nation wealthy by inflating the supply of money; they will know why we would be much better off if we took control of money and credit entirely out of government hands...

Woods has two main objectives, first to set the record straight regarding the housing bubble and the frantic governmental efforts to deal with its aftereffects, and second to explain what policy changes are necessary to prevent future bubbles. He succeeds admirably in both.

Fearing that they would be blamed for the economic turmoil, leading politicians (including both the Democratic and the Republican presidential candidates in 2008) proclaimed that it was not due to government meddling, but instead had been caused by “laissez-faire philosophy” and greed. And intellectuals, eager to protect their stake in the alleged benevolence and wisdom of federal economic regulation – people such as Paul Krugman – leaped up to say that the crisis couldn’t be blamed on the government. Woods clears away the fog of self-serving falsehoods, showing that the collapse of the housing market was the entirely predictable result of federal policies for which the politicians and intellectuals were happy to take credit as long as they seemed to be “working.” He writes, “Following a familiar pattern, government failure has been blamed on anyone and everyone but the government itself. And of course, the same government failure is being used to justify further increases in government power.”

The home-loan debacle

The first part of the book examines the government’s policy blunders, beginning with the very notion of federal housing policy. The Constitution says nothing about housing, but in 1938 Congress and President Roosevelt created the Federal National Mortgage Association, usually called “Fannie Mae.” They did so because they thought it was a good idea to promote home ownership and figured that establishing a “government sponsored entity” to buy mortgages from lenders would do that. Of course, there were millions of Americans who owned houses prior to the creation of Fannie. There was no problem that needed to be solved, but the politicians thought it would be a popular move, so they went ahead, never contemplating that getting the government into the home-financing business would one day lead to disaster.

Fannie’s mortgage-backed securities were sold to investors worldwide, most of whom assumed that the paper was sound, backed by the U.S. government. Woods writes, “Everybody knew that if the GSEs [Fannie and its younger sibling, the Federal Home Loan Mortgage Corporation or “Freddie Mac,” are known as government-sponsored enterprises – GSEs] ran into trouble, they would be bailed out at taxpayer expense.” They ran into enormous trouble and were bailed out, but hardly anyone has had the guts to blame these political pets and call for their abolition.

Another of the culprits Woods identifies is the Community Reinvestment Act (CRA), which used political leverage to compel banks to make more loans “in their communities.” This law (again, outside the constitutional authority of Congress but enacted anyway) was a power play to force banks to make loans they would not otherwise choose to, directing capital in ways that please the activists and politicians. Under the Clinton administration, this statute was used to compel banks to meet quotas of home loans to high-risk people. At the same time, Clinton forced Fannie and Freddie to purchase high-risk mortgages. Woods shows, in short, that political pressure was used to undermine the traditionally cautious lending standards in the mortgage industry.

Politicians in both parties took delight in crowing that home ownership was increasing, especially among minority voting groups, without realizing that home ownership is not necessarily good for everyone. For persons with low and unsteady incomes, home ownership can be a costly mistake, as later proved to be the case for millions who had taken out loans they couldn’t repay.

The main culprit

By themselves, however, Fannie, Freddie, and the CRA could have done only minor economic damage. Woods identifies the main villain in this drama as the Federal Reserve System. For years, the Fed under long-time chairman Alan Greenspan pumped up the money supply so as to drive interest rates down to artificially low levels. Artificially low interest rates tricked people into acting differently than they otherwise would have. Home ownership and housing construction looked like great investments during the years 2002 to 2006 because of the outpouring of credit from the Fed, steered by politicians toward the housing market. If interest rates had remained at market levels, the housing bubble could not have grown to the enormous size it did.

When the Fed finally stopped its wildly expansionary policy and interest rates began rising, many borrowers found that they couldn’t afford to keep the homes they had been lured into buying, and many builders found that projects they had started couldn’t be completed because of insufficient demand. Institutions that had invested heavily in mortgage-backed securities discovered that their portfolios were nearly worthless. Firms collapsed and the stock market plunged.

Woods makes it clear that the government’s desperate moves to shore up unsound investments through bailouts are exactly the wrong policy. All the politicians are doing is taking resources from the healthy sectors of the economy to prop up the unhealthy, thus obstructing the efficient use of resources and rapid recovery from its cheap credit binge. Instead of getting the government out of the mortgage market, repealing the foolish CRA, and abolishing the Federal Reserve, the politicians are taking us further into the interventionist swamp with massive increases in government borrowing, spending, and economic controls...MORE...LINK