Economist Thomas Sowell appeared on Dennis Prager’s radio show May 27:
Tom: If the results weren’t so serious, all this would make a great Gilbert & Sullivan musical, with all the mutually contradictory statements by the politicians…
Dennis: The president said the other day that we don’t have any money.
Tom: What that means is that they are going to have to print some…and that means inflation.
The deficit run up by this administration will exceed the deficits run up by all other administrations.
Dennis: I don’t know what it would take to awaken the American people.
Tom: I have a terrible feeling that it will take an American city in radioactive ruins to wake up some of them.
Dennis: Was the housing boom artificial?
Tom: Yes, in two senses. It started off as a great political crusade for affordable housing. Now, most of the housing across most of the United States was more affordable than it had been ten years earlier or twenty years earlier, but in some particular places, particularly coastal California, the housing was so expensive that people were paying half their family income just to put a roof over their heads. But the politicians tried to turn this into a national problem so that they could have a federal program. So they started leaning on banks to start making loans to people they wouldn’t make loans to otherwise and who couldn’t meet the standards, and similar pressure was put on Fannie Mae and Freddie Mac, who were assigned quotas of how many mortgages they bought had to be for low and moderate income people…
The net result was that they lent money to people whose likelihood of repaying them was low, but the banks didn’t care, because once the banks made the mortgage, they sold the mortgage to Fannie Mae, for example. Then it became Fannie Mae’s problem, which meant it became the taxpayer’s problem.
Fannie Mae issues their own securities. As they take on more and more risky mortgages, their own securities in a free market would decline in value because people would be afraid to buy them. But as everyone knew the government would be willing to step in to keep Fannie Mae afloat, they bought Fannie Mae securities because even if the securities were worthless, the government would come in and make up for it.
Dennis: Where did the issue of Wall Street’s incredible inventiveness in packaging these lousy loans and leveraging themselves at 30-1, what part did that play?
Tom: That made matters worse. Since the mortgages they were packaging together were new, they were not only more risky, but no one knew how risky they were. They relied on the credit-rating agencies like Moody and Standard & Poors to give these things a rating, but Moody’s and Standard & Poors had very little data over the years on these particular kind of mortgages. They had data going back a century on conventional 30-year fixed mortgages. So therefore their ratings were reliable. But as someone who once worked for Moodys said, it was like using a century’s worth of statistics on weather in Anartica to predict the weather in Hawaii.
Dennis: I’ve been told by economists that Canadian banks are doing just fine because they could never get into the debt that American banks can get into.
Tom: Canadian regulators are not pushing banks to lend to people who can’t repay the loans.
I hold government 90% responsible for housing crisis. People blame greed in Wall Street. You can’t make money making loans to people who can’t pay you back.
The rating agencies didn’t really have competition to keep them straight. The government designated which rating agencies would be recognized for the purpose of government transactions with government entities.
The Democrats took the lead but George W. Bush pushed the idea of low downpayment mortgage loans by the Federal Housing Administration. The last time I checked, the Federal Housing Administration is still making loans with less than 4% down. That’s just another accident waiting to happen.
Dennis: Why was it particularly severe in California?
Tom: It’s more than zoning, it is a whole panoply of restrictions, more than environmental restrictions, we’re talking open space laws, historic preservation, farmland preservation. You name it. If it will stop building, it’s flourishing in coastal California. It’s amazing that people don’t understand that if you take half the land in a county off the market and forbid anybody to build anything on it, then the price of the other half of the land is going to shoot off the roof.
Prior to these restrictions, which came in prior to the 1970s, California housing prices were the same as housing prices everywhere else. It is only since then that housing prices in California have skyrocketed so that they are three times what they are elsewhere.
Barney Frank’s storyline now is that it was all due to inadequate amounts of regulation, which was due to the Republicans.
When the boom was booming, Barney Frank took credit for pushing for looser lending practices. In one place, he said, I want to roll the dice a little more.
When you roll the dice and it comes up snake eyes, suddenly he didn’t want any responsibility for it.
Dennis: What about all these tranches and these derivatives?
Tom: Those things facilitated third-parties financing the mortgages… But the crucial problem, without which there wouldn’t be a problem, was that the monthly mortgage payments from millions of people stopped coming in. And when that happened, it didn’t matter which types of sophisticated financial securities you had on Wall Street, if the money is not coming in…
Dennis: European banks did their version of this with Eastern European economies. We had a worldwide banking crisis.
Is there any solution?
Tom: I would like to see a constitutional amendment forbidding the federal government from having any effect on the housing market.
Fannie Mae and Freddie Mac serve no purpose that a private mortgage buyer can’t do, except that politicians can get Fannie Mae and Freddie Mac to do things that a regular business won’t do, things that are helpful to a politician’s constituents and therefore to politicians.
Caller: How much would you attribute this crisis to amoral capitalists?
Tom: Zero because greed is always there. It’s there in good times and bad times. You can’t attribute the bad times to greed. People don’t satisfy their greed by lending to people who can’t pay them back, which is what government pushed for, lending to people who don’t meet the standards.
Caller: The symptom is foreclosures but the disease is defaults. By the government treating the symptom of foreclosure they are making the disease of defaults worse. In California, when you let someone stay in their home with a loan modification or reduce their principal balance, why would their neighbor keep making their mortgage payments?
Tom: He’s absolutely right. The laws of Canada do not allow you to default and walk away. In Canada, they can go after your other assets.