Can Economic Crises be avoided?

I often feel lucky to have grown up in a country where the government was powerful enough to control its people. I know this may sound crazy but that experience enabled me with a keen intuition and a desire to be less governed. After all, this desire to be less governed prompted me to come to America. Following is simply my perspective on the government’s power to interfere with the housing market that has been the epicenter of the current economic crisis; a crises that is impacting not only the United States but the entire world.

We’ve been programmed to think that these events are the result of the “instability of the free market”. Great excuse that supposedly justifies more government regulation of the mortgage business and the housing industry.

Inviting government to step in and regulate the life out of business may be the status quo today but a handful of people – including myself – believe more rules and regulations to be even more detrimental to our frail economy in addition to the threat to our individual liberties. As a matter of fact it is the government interference that largely contributed to set this disaster in motion.

Few of you may know that during the 1990s the Federal government began a huge regulatory push to create “affordable housing”, under the presumption that the cost of acquiring a home was out of reach for a growing number of American families. Democratic and Republican members of Congress and both, President Clinton and President Bush administrations put pressure on lending institutions to lower their credit rating standards. So, we ended up with banks offering loans with low or no down payment, to people with marginal credit and unstable income and employment, many of these loans being adjustable rate mortgages with low introductory rates that would increase after 2, 3 or 5 years.

Initially banks were not happy to take on such a risk but there are few primary reasons that led to ultimately “convince” them to do it. One of them was the intimidation from the bank and mortgage regulators. They threatened with anti-discrimination law suits if banks did not increase their lending to targeted socio-economic groups that were less credit worthy. The other way to convince them was by allowing them to sell their loans to the two semi-governmental agencies, Fannie Mae and Freddie Mac. What that did was to transfer the risk (of a subprime marginal borrower’s loan) from the banks to Fannie and Freddie agencies. We all know how in 2008 these agencies have been declared insolvent and were put under government conservatorship. In short, the risk of such loans had been transferred from the banks to the American tax payer.

Another major factor that contributed to the housing collapse was the monetary policy of the Federal Reserve. In 2003 and 2004, the Central Bank kept interest rates artificially at historically low levels. As explained by the Austrian School of Economics – Murray Rothbard, in particular in “Economic Depression, their Cause & Cure” – when interest rates are suppressed via Central Bank and are NOT a result of a free market, it leads to malinvestments. I will discuss more about malinvestments occurring during Economic Bubbles in a separate article. For now, just keep this thought in mind…”Malinvestments”.

In conclusion, could the economic Bubble/Bust have been avoided? Absolutely, if only the government did not interfere with the markets! No imposed lower credit rating standards, no bailouts of Fannie & Freddie, no bailouts of companies that offered Credit Derivatives, no rate manipulation triggered by the Federal Reserve Bank, and our lives and children’s future would most likely not be as threatened today.

“Government means always coercion and compulsion and is by necessity the opposite of liberty.” Ludwig von Mises

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  1. #1 by Gayna Flake on February 5, 2011 - 12:06 am

    Carmen, well said.

    I’d like to add to not for forget the CMBS (Commercial Mortgage Backed Securities). As I understand it, the CMBS’s were sold in large grouping of the loans. Apparently after bundling the loans they broke the combined income stream into layers of the bottom, middle, and top parts of the loans and assigned them different risks. These tranches were sold with various ratings assigned to their risk as stock offerings. Since these loans were originated with banks and loan brokers who made money when the loans were originated and they turned them over to the CMBS’s, they had no economic reason to care what happened to the loans after that. Also, the banks and mortgage brokers were pressured by the government to make them widely available with the same kind of pressure of the loans that were sold into Freddie Mac and Fannie Mae.

    There are billion of dollars of the CMBS loans which are coming due. There is little replacement financing for the loans since the CMBS system stopped in Sept of 2008. Since then the CMBS system has yet to revive in any meaningful amount.

    My personal opinion is that the entire financial meltdown would have been a normal business cycle if only one simple rule had been put into place:

    Not allow any institution to sell a loan into the secondary market (both CMBS and Freddie Mac & Fannie Mae) unless the borrower showed the ability to pay for the loan payments at the maximum amount that the loan could become based on the highest interest rate that the loan could become.

  2. #2 by Anonymous on February 5, 2011 - 12:04 am

    Carmen, well said.

    I’d like to add to not for forget the CMBS (Commercial Mortgage Backed Securities). As I understand it, the CMBS’s were sold in large grouping of the loans. Apparently after bundling the loans they broke the combined income stream into layers of the bottom, middle, and top parts of the loans and assigned them different risks. These tranches were sold with various ratings assigned to their risk as stock offerings. Since these loans were originated with banks and loan brokers who made money when the loans were originated and they turned them over to the CMBS’s, they had no economic reason to care what happened to the loans after that. Also, the banks and mortgage brokers were pressured by the government to make them widely available with the same kind of pressure of the loans that were sold into Freddie Mac and Fannie Mae.

    There are billion of dollars of the CMBS loans which are coming due. There is little replacement financing for the loans since the CMBS system stopped in Sept of 2008. Since then the CMBS system has yet to revive in any meaningful amount.

    My personal opinion is that the entire financial meltdown would have been a normal business cycle if only one simple rule had been put into place:

    Not allow any institution to sell a loan into the secondary market unless the borrower showed the ability to pay for the loan payments at the maximum amount that the loan could become based on the highest interest rate that the loan could become.

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