It's not a mortgage crisis

Back about two hundred years ago, the British army had rigorous standards for its recruits. They were required to have at least two teeth, and those two teeth had to be opposite one another in the front of the man's mouth. I suppose a pulse and four limbs were also required, but this wasn't listed in the rules. Even with the primitive state of dental hygiene in the 18th century this spread the recruiting net wide, which was the point.

So it was in the mortgage industry, up until a short time ago. A pulse and the ability to sign a contract made one a candidate for a mortgage and homeownership. The banks bundled up the resulting loans into so-called Collateralized Debt Obligations, sliced them into shares, got them rated triple-A by complaisant bond rating companies, and sold them to all and sundry. Ever since this scheme started collapsing it has been called “The Mortgage Crisis.” This is akin to calling a head-bashing spree by a pipe wielding maniac “The Fractured Skull Crisis.” We need to go one step back in the process.

Ten years ago the housing industry and the mortgage industry were looking for more customers. One problem was those pesky loan requirements – sufficient income, assets, cash for a down payment. What to do about those marginal, extra risky situations? A sub prime mortgage. Structure the mortgage for low initial payments, even if it means a crippling balloon payment or interest rate jump down the road. Bundle those mortgages and sell them off as noted above. Housing prices were rising, so it was no problem if a few people defaulted. Either these unfortunates could resell their house and pay off the loan, or else the occasional default would be absorbed and hidden by the bulk of the good loans bundled with it. Sadly, even the best scams only last for a while.

The problem was one of income. Selling a few overpriced houses to a few overstretched individuals was not a big deal. When the entire housing market suddenly jumped to almost double its 50 year average it got beyond affordability for many people. It is affordability that puts an upper limit on the value of housing, and the U.S. market overshot that limit. The result has been foreclosures, unsalable homes, and the collapse or near collapse of home builders, banks, and investment firms. It has resulted in “jingle mail,” when a homeowner realizes that the house is worth less than the balance left on the mortgage and walks away, mailing the keys to the bank. It is, ultimately, a home value crisis. If housing was more affordable there would be continued demand, supporting prices. If prices were still going up, or at least steady, the defaulting borrowers could sell out and pay off their mortgages.

Our situation is not without precedent. The present collapse is close to a rerun of the savings and loan fiasco of the late 80's and early 90's, with deregulation, reckless lending, and the bundling and reselling of risky loans. That one cost us about $160 billion. The situation is also comparable to the telecom boom and bust. In the late 90's a cohort of companies installed tens of thousands of miles of fiber optic communications cable in anticipation of unlimited demand. That demand was not forthcoming, so most of them went bankrupt. A second cohort of companies bought the fiber optic lines at fire sale prices and actually made money renting them out. The same process will probably happen with residential housing.

Congress has dithered about this while the Federal Reserve has thrown cash at failing financial institutions. The best our government can come up with for regular folks is a sad little $600 tax rebate. Given that we are in deficit, this means borrowing billions more on international markets, to be paid back later with interest.

I have a couple of suggestions for our elected representatives that attack the value problem behind the mortgage problem.

First, raise the minimum wage. Raise it significantly, and raise it quickly. This will put money in the hands of those who need it and will spend it, boosting the economy without going further in debt to the Chinese. This will also tend to elevate the rest of the wage scale above it, pushing more people into the realm of homeowners.

Second, repeal the Taft-Hartley Act and replace it with legislation more protective of people who want to organize or join unions. Two thirds of Americans want to join unions, according to polls, but many of them are rightly afraid of retaliation from employers. Taft-Hartley is discouraging union membership and therefore denying American workers the higher wages and benefits that come with it. More well-paid union members mean more possible homeowners.

Third, bring our income tax rates back to the levels of the 1950's and 60's. Back then, millionaires and corporations paid a bigger percentage and ordinary working schmoes paid less. Somehow we thrived, despite the dent in the yacht and mansion industries. We had enough tax revenue to build and maintain infrastructure and working people had money in their pockets.

In the long run housing prices are pegged to the number on the average American W-2 form. Eventually they will drop back to something like 60% of what they are now. The graph I linked to above tells the story. Artificial schemes for propping up unsustainable housing prices will fail, costing us both time and money. It is counterproductive to throw driblets of borrowed money at Americans and truckloads of borrowed money at banks. The same goes for lowering interest rates till the dollar crashes. Insulating reckless banks and investment firms from the consequences of their actions will set us up for the next boom and bust scenario.

Perhaps it is asking too much, but it would be useful if Congress could learn a few lessons from its mistakes. Deregulating the financial industry always creates trouble. Booms always become busts. Bailouts encourage risky behavior. The health of the economy is not indicated by the Dow Jones Average but by the economic strength of the average American. The best thing our government can do about the mortgage crisis is to improve the long term economic position of potential home buyers.

Comments

[a reader]

I disagree with you on the union idea, H.

Both American labor and management are driven by greed, and letting either side gain an upper hand is counterproductive. For example, look at our terrific auto industry as a model of what unions can achieve.

Maybe it's time for a do-over at business school? I remember reading something like "Capitalism is the worst business plan, the only thing worse is all the others." I don't know what to replace it with, but it's not unions.

[marianne]

I agree with you on most of your points. As a first time home buyer, my husband and I have been waiting waiting waiting for houses in our area to be "affordable" again and we have a fairly high income.

So what happens if we don't pay off all this debt created by the repackaging of these mortgages? Why can't we just let all the banks involved in this scheme fail? Use our tax dollars to refund people's savings. Why are we refunding bad investments? If there is a shortage of cash available for loans then open a national bank. This would be better than buying all the repacked overpriced "bad" debts-- for which we will get very little in return.