What Really Happened?
Our ongoing financial turmoil began in the mortgage market...
Among the prominent results: the nation’s two largest mortgage finance institutions, the government-sponsored Fannie Mae and Freddie Mac, have gone into bankruptcy-like “conservatorship.” Major investment banks, insurance companies, and commercial banks have gone bankrupt outright (or have been sold for cents on the dollar) because of their heavy exposure to real estate lending. Prices and trading volumes in mortgage-backed securities have shrunk dramatically. Doubts about the value of mortgage-backed securities have led naturally to increased doubts about the solvency of institutions heavily invested in those securities, making it hard for those institutions to borrow at accustomed rates. So what made the mortgage market boom and bust?
What Didn’t Happen
The housing-finance boom and bust are not the results of a laissez-faire monetary and financial system. We didn’t have one. The boom and bust happened in a system with an unanchored government fiat money and extensive legal restrictions on financial intermediation. Nor have we had banking and financial deregulation since the bipartisan Financial Services Modernization Act (the Gramm-Leach-Bliley Act), signed by President Clinton in 1999. Far from contributing to the recent turmoil, moreover, that Act has clearly been a blessing in containing it by allowing acquisitions, such as the acquisition of Bear Stearns by JP Morgan Chase or of Merrill Lynch by Bank of America, that have shielded bondholders from losses...
The housing boom and the aftermath of its bust arose from market distortions created by the Federal Reserve, the government backing of Fannie Mae and Freddie Mac, the Department of Housing and Urban Development, and other federal interventions. We are experiencing the unfortunate results of perverse government policies, compounded in some degree by private mistakes.
The remedy for private business mistakes is bankruptcy. The remedy for the mistaken government monetary and regulatory policies that have produced the current financial train wreck is to identify and undo policies that distort housing and financial markets, and dismantle failed agencies whose missions require them to distort markets. We should be guided by recognizing the two chief errors that have been made. Cheap-money policies by the Federal Reserve System do not produce a sustainable prosperity. Hiding the cost of mortgage subsidies off-budget, as by imposing “affordable housing” regulatory mandates on banks and by providing implicit taxpayer guarantees on Fannie Mae and Freddie Mac bonds, does not give us more housing at nobody’s expense.
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My thoughts: A good analysis.
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