The Mortgage Debacle, Part 2

In my first post, I discussed the current real estate collapse and its predecessor in the late 1980s. This post will add some background and venture into commentary. Just to review, the real estate market collapse in the mid 80s was directly attributable to Washington’s implementing two policy goals: first, to redirect investors away from real estate, and second, to end persistent inflation. The tool Congress used was a radical change in tax laws which upset two generations of precedent.

Congress’ goals were rational and well-intentioned, but their methodology was flawed. Had Congress applied changes in the tax laws to new real estate projects only, the market would have gradually adjusted. Instead, Congress’ wholesale revision of fundamental tax structure quickly destroyed the wealth of thousands of taxpayers who, following long established rules, had been investing in real estate "tax shelters." They could do so because S&Ls made the loans that made that possible.

When prices began to fall, the collateral supporting the S&Ls' loans disappeared, and when loans went bad, the properties couldn’t be sold for enough to pay off the debts. At the same time, the Federal Reserve Bank set interest as high as 16% and private money was available only at rates exceeding 18% at the peak. Bank and S&L portfolios couldn’t earn enough money to pay depositors, and the banks bled money until credit became unavailable. Everyone went broke, which does indeed discourage taxpayers from investing in real estate.

Congress successfully blamed the S& L debacle on "greedy" and "incompetent" S&L operators. There were indeed some badly run S&Ls owned by greedy operators, but the underling cause of the disaster was Congress’ good idea.

So, we can chalk up that debacle to the inability of Congress think through a complex problem, or to anticipate what the effect of the changes they put in place would be.
　
The disaster we are living through now was only partly created by Congress: the rest was caused by greedy, opportunistic individuals. Congress decided, in accordance with fundamental precepts of the Republican party, that federal regulations were holding back the true profit potential of the individuals who made generous political donations to the senators and congressmen. And if de-regulating airlines was good, de-regulating banks and financial institutions such as investment banks was even better, because the people who ran that fun-house were the best and the brightest. Free-market dogma holds that such institutions will be "self -regulating".

People were offered, and took, loans they knew they could never hope to repay without selling the property, but since property prices were shooting up like fireworks, they figured that if they didn’t get on the band wagon, they’d be left behind.

The comedian Lewis Black describes Democrats as the party of no ideas and Republicans as the party of bad ideas, and warns us that when Democrats and Republicans agree on something, that's when we're in real trouble. He’s absolutely right.

Before "deregulation," banks kept the loans they made and worked with their borrowers if they ran into trouble. But the new methodology was for banks to make loans and sell them in bundles as investments, so they can get more money to make more loans. Banks began looking to the origination fees as their principal source of profit, not the long term collection of well made loans. When they focused on the short term profits they set an inevitable train wreck in motion and no one in Congress noticed.

What Congress failed to consider was that "the people" would get the wind of real estate profits in their sails, and would conclude that prices would always go up. Only suckers didn’t risk buying houses they couldn’t really afford, because before the loans came due, or before the interest rates went up, everyone could sell at a profit and pay off those goofy loans.

And, when the excrement hit the fan, we were told that the banks were "too big to fail" and we the people had to save them with money we didn’t yet have (government deficits). So the bankers got to keep their bonuses and everyone else got to pay to make that possible.
What happened is we privatized profits and socialized risks, and nobody will ever be held to account for the debacle. The public voted the Republicans out and now criticize the Democrats for not being able to quickly fix the problem. If the American public had any real self interest we would have voted every sitting representative and senator out of office and started fresh. Just who’s crazy?