9/18/2008

New Analysis piece up at Fox News: Reckless Mortgages Brought Financial Market to Its Knees

My newest piece can be found here:

With the government takeover of Freddie Mac and Fannie Mae as well as other bankruptcies in the financial sector, there are a lot of questions. The strangest fact is that the housing sector is having such problems when the economy otherwise has been doing well. Why have there been so many defaults when the economy has not been in a recession? Defaults have been at historically high rates despite reasonable economic growth and a relatively low unemployment rate of 6.1 percent.

Some, such as James H. Carr, the CEO of the National Community Reinvestment Coalition, argue that the high default rates are a result of "unfair and deceptive practices, steering customers to high price loans . . . High upfront payments made it so that they couldn't later pay their mortgages."

Surprisingly, research done by economists a decade ago in 1998, particularly by Professors Ted Day and Stan Liebowitz at the University of Texas at Dallas, predicted the current problems and tried to warn people of a different cause. Starting during the early 1990s, mortgage-underwriting standards have been consistently weakened. Many of the names involved in the forefront of those changes, Freddie Mac and Fannie Mae as well Countrywide and Bear Stearns, , have been the most prominent financial entities to become insolvent. . . .

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8 Comments:

Anonymous Anonymous said...

Yes, reckless mortgage lending is bring down much of the U.S. financial system. However the crash didn't begin in the '90s. All of the real bad stuff began much later in 2004. What changed?

This Web site provides many of the sordid statistics:

2004 and 2005 Mortgage Vintages: At Peril?
Thursday, January 11th, 2007 at 9:22 AM
http://wallstreetexaminer.com/blogs/winter/?p=301

9/18/2008 11:45 PM  
Blogger John Lott said...

What changed was that the problem arose as soon as property values began to decline.

9/18/2008 11:52 PM  
Blogger ec said...

John,

With all due respect, which economists besides yourself are seriously trying to blame the housing crisis on excessive government regulation of the industry? The reason why we have an unprecedented bust in housing without the typical concommitant spike in unemployment is because this crisis was driven by excessive liquidity and supply rather than a demand-led boom-bust cycle. I think you agree with this.

Most mainstream economic analysis that I have seen attributes this supply-driven boom to interest rates that were kept too low for too long, as well as the lack of any restrictions on sub-prime loans. Banks were lending out 10x an individual's gross income without so much as a pay stub. They were not doing this because the government suddenly changed the rules in 2003 or 2004 on who banks must lend to. Rather, they were doing it because banks and mortgage brokers were making a ton of money lending to people and believed that the risks of default were de minimus in an environment of 20% per annum housing price increases. Adding fuel to this fire were the exotic CDOs and other securitized paper that were to magically make purses out of sow's ears but in reality only spread the junk around widely, from Wall Street banks to municipal governments to sovereign funds. All of this occurred without government oversight, not because of too much regulation. No less a source than Warren Buffett has called for greater regulation of such risky derivative securities that fueled this fire, while no greater a force than Republican laissez-faire dogma maintained it for too long.

While you do not wrongly blame the housing crisis on Democrat-supported Fannie and Freddie as many Republicans do, you do claim that the government is still somehow to blame. But this argument is bogus because you fail to show just how the government rules designed to prevent racial or other improper discrimination and to generally broaden home ownership (i.e., the same goal Bush talks about in his "ownership society" mantra) coincided with much less actually caused the crisis of bad debt we are seeing today.

More fundamentally, while it is correct to put blame on the homeowners that took too much risk, that the private market could bring itself to its knees and require a massive government intervention calls into the question the laissez-faire dogma that you and other Republicans promote like a religion. The market, which is up some 700 points since word of government intervention was announced, has spoken clearly and has stated that sometimes the state does have an important role to play. It is too bad that a Republican controlled Federal Reserve, White House and Congress did not take more modest government steps to avert disaster before the risks and costs spun out of control.

9/19/2008 6:37 PM  
Blogger John Lott said...

Dear EC:

Well, you can follow some of the links (e.g., Day and Liebowitz). The piece also mentions Mankiw and there is also Glen Hubbard, but seriously my guess is that most economists understand this problem. What you mean by "economic analysis" refers to discussions in the media. I am referring to academic economists.

"But this argument is bogus because you fail to show just how the government rules designed to prevent racial or other improper discrimination and to generally broaden home ownership (i.e., the same goal Bush talks about in his "ownership society" mantra) coincided with much less actually caused the crisis of bad debt we are seeing today."

I thought that the argument was clear, but if you need more info, look at Liebowitz's paper by following the links.

9/19/2008 10:23 PM  
Blogger ec said...

John,

I carefully read the Leibowitz, et. al. piece and still have problems with the analysis of these "academic economists." The problems I have specifically are the following:

1. they fail to establish a strong causal link much less quantitative proof that the mortgage crisis is caused by the factors they site (i.e., government-induced loosening of rules); this seems odd since the crisis occurred much later than the regulatory changes occuring in the 80's and '91 that they cite, and because the worst use of ARMs and alt-A products occurred not in the inner cities where anti-racial-discrimination related regulation was predominant but in places like Henderson, NV or Riverside, CA. The timing and geography of their account is at odds with the worst of the lending practices.

2. they cite anecdotal data about GSE's leading the problematic loosening of lending rules but fail to account for the fact that the default rates for non-GSEs, private banks are running at 2x the GSE rate, a fact that would seem to contradict the analysis

3. they fail to mention other factors that many other economists have cited as primary causes of the crisis: low interest rates, the passage of Graham, Leach, Riley Act, widespread use by private entities of CDO's, CMO's, and the like, the participation of hedge funds in these securitized markets, et. al.

4. Their analysis is limited to the formation of risky loans, but the crisis has spiralled out of control as the market began to price the debt inefficiently; they provide no explanation for how the market has begun to impute 35% foreclosure rates and 50% recovery rates when such scenarios are 5-6x worse than the most bearish economist forecast.

5. While you kind of chastised me for conflating "economic analysis" with more layperson's/journalistic reporting, the piece you rely upon reads like a journalist piece in that it cites nothing by way of math or statistics to make their case, and I see no reason to lend it more weight than other accounts in the popular press. I would weight accounts made by capital market experts, such as Warren Buffet, David Einhorn or William Gross more heavily than the so-called experts you rely upon.

I would be curious whether you have more robust data to make your case. But as an investment manager myself, I must say that even my Republican friends and colleagues are not blaming the crisis on bad government regulation or deregulation concerning discriminatory lending practices, but are instead criticizing investment banks, hedge funds, money center banks and other private market participants for the worst of the lending and securitization practices. That the GLRA and other GOP-led deregulatory measures helped to facilitate this process also appear to be at fault, alongside overly loose monetary policy.

You appear a minority voice even amonst economists in blaming the crisis on attempts to eliminate unfair lending practices (real or perceived) occuring in the inner cities of NY, Chicago or Detroit.

9/20/2008 5:39 PM  
Blogger ec said...

John, still waiting a response from a professional economist. Silence would imply concession of the argument...

9/21/2008 7:49 PM  
Blogger John Lott said...

Dear EC:

Sorry, but I haven't had time to go through this with you and I didn't think that your points really responded to what I said and that there was a high return to debating this with you. Sorry.

9/21/2008 9:14 PM  
Blogger ec said...

John, to back up an article published in a major media outlet you have cited as "evidence" a piece that has no or very little explanatory power for the financial crisis and, when called on it, can provide no quantitative/economic evidence for the explanatory power you allege. Yet you don't want to respond??? Are you a trained economist or a political pundit? It's articles like yours that hurt democracy by perpetuating untruths that confuse voters. I have found your article cited by conservatives on two blogs to justify voting for McCain, when McCain and his old economic advisor Phil Graham are part of the problem, part of the cause. It's pretty sad that you make these claims and cannot back them up...

9/21/2008 10:26 PM  

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