To the People

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Thursday, April 05, 2007

Congress Creates the Subprime Mortgage Mess (and ACORN too)

The market for subprime mortgage loans is melting down and regulators, lawmakers and consumer groups are all pointing the fingers of blame, none of that at themselves. Hmm.

So, what power of forces created this mess? Here is Leo's tour of l'histoire.

Low interest rates:
As inflation ebbed in the 1990s, the Fed lowered interest rates to historical lows so that in 1994 the rate on a 30 year fixed mortgage was only 5%. For some perspective, the rate on a same loan in 1984 was 15% and in 2000 was 8.75%. When interest rates fall, housing prices shoot up. The reason is that about 80%+ of a monthly fixed mortgage payment is interest so low interest rates enable people to afford much more house, pushing up house prices to record levels. While overall monthly payments did not increase nearly so much as the prices, the downpayment requirement did, which shut more and more people out of a traditional mortgage with 20% down.

The mortgage brokerage industry: Commercial banks are highly regulated and often do not resell the loans the make so they are therefore conservative about the loans they issue. A cottage industry of independent mortgage brokers and lenders like New Century (which just filed for bankruptcy) emerged to meet the demands of people who could not get traditional loans through banks because they didn't have downpayments, had bad credit or couldn't really afford the homes they wanted. Mortgage brokers, like most brokers, are incentivized to move products and push the most expensive ones. Unlike stock brokers, though, they are not regulated in any real sense and have no "suitability" requirement, meaning that the loans they write must be suitable to the client. Considering that for most people their home is their biggest investment, this is a big regulatory lapse.

Congress and the tax code: Congress tends to point fingers at catastrophes that are of their own making and this case is no different as they point fingers and call for reform.Yet Congress is itself very much to blame by creating a tax code that favors home owners to the detriment of renters. The mortgage interest tax deduction makes taxpayers feel that they are throwing away money on rent and therefore need to buy something, at almost any cost. In a market in which prices keep increasing, that feeling becomes almost desperate. For those with high incomes, the MITD is the only deduction that doesn't phase-out. This means that if you make more than 150K per year you lose the ability to itemize completely and deduct, say, charitable contributions or medical expenses unless you have a mortgage, in which case you can itemize. So if you are giving money to Harvard, you better have a mortgage. The MITD also inflates the value of housing by the rate of the tax code (peaking at 35%), causes just about everyone to feel desperate to own, even if it does not otherwise make sense for them, causes urban sprawl, and makes many people buy more than they should, creating the demand for subprime loans.

Housing advocates: While groups like ACORN are outraged about the subprime mess, they, like Congress are not looking within as to how wise it is to push just about everybody into home ownership. Instead, they attack "financial apartheid" without ever questioning whether home ownership is suitable for every single American, regardless of stability and financial/personal circumstances.

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