Mar
30
National Bank: How to Fix the Housing Crisis for Less than 700 Billion in Bailouts
Filed Under Economics | Leave a Comment
Dane asked:
Recently the news has been dominated by developments with the 700 billion dollar bailout package, and rightfully so. 700 billion is an astronomical sum of money. The first problem is that the 700 billion dollar bailout adds a huge amount of money to the national debt. Not only that, some have hinted that the bailout is so large it could actually lower the US Credit Rating. The second problem is just as serious. There is no guarantee that the bailout will work.
The idea behind the bailout is that by taking on billions of dollars of toxic loans the government hopes to “influence” banks to start lending again. The past attempts of the government to “influence” banks have all failed. The fed lowered the fed rate to influence banks to lower mortgage rates. While the banks were appreciative of lower rates they did not lower mortgage interest rates. In fact after the fed cut rates the banks increased mortgage rates because they saw negative prospects in the housing market. In a similar way, after the US government takes over the toxic loans away from them the banks could continue to see negative prospects in the housing market and therefore would continue to have strict lending practices. The idea of spending 700 billion with no guarantees seems like a poor use of capitol.
When people hear the word “National Bank” the first thoughts are of a socialized banking system. A national bank would not replace the current banking industry. It also does not “introduce” government involvement into the banking industry. With the Fed influencing interest rates and the government rushing in to bailout every bank that runs into problems the government already has a large hand in the banking industry. I don’t want to argue whether the government should have a role in the banking industry. Currently the government already has a significant role in the banking/mortgage industry. My argument is that if the government does have a role it should be effective and cost efficient.
A national bank would be a cheaper and more cost effective way to steady the financial markets. To understand how a national bank would work lets first talk a little more about what is currently causing the housing crisis. The mortgage market operates a little like a basketball game. Lenders go from one extreme to another. For awhile lenders will lend to anyone that walks in the door with a pulse. During these periods lenders accept less and less qualified applicants in an attempt to gain market share. Then the lenders get freaked out (often because someone realizes they have been giving out billions in loans to unqualified applicants that are unlikely to pay their mortgages) and lenders run to the other extreme and practice extremely restrictive lending practices (the insurance industry sees the same cycles but that is another topic). If you haven’t already guessed currently we are in the second scenario with lenders practicing extremely restrictive lending practices. The problem with the second situation is that such extreme changes shocks the housing market and basically causes a financial crisis. The banks are in a catch 22. If collectively the banks don’t lend the housing market will continue to deteriorate. But no one wants to lend because they are worried the housing market will continue to deteriorate because collectively they are not lending. It’s kind of like at a party where you don’t want to be the first person to jump into the pool because if no one else does you look foolish. Substitute looking foolish with going bankrupt and you kind of see where banks are coming from.
The great depression and the S&L crisis were both basically examples of this same problem. Initially during the great depression the conventional logic was the government should not intervene. As the stock market continued to drop (it dropped over 80% in less than a year) and people realized how bad an economy can get (pretty bad) the idea of government intervention seemed more palatable compared to the alternative.
So now during periods where lenders are freaked the government attempts to “influence” lenders. The problem is its extremely expensive. Currently the government is taking on years and years of bad loans in an attempt to “influence” lenders to loosen their current restrictive lending practices for the next 6 months to pull us out of the housing crisis. This is kind of like trying to influence your local school to spend money on new textbooks by building them a new school. Not only is it ridiculously expensive after you build the new school you have no guarantee they will buy the textbooks. It’s not simply a poor use of government funds it’s utterly outlandish.
So how would a national bank operate? During periods where banks are giving out loans to everyone that walked in the door the national bank would practice have average lending restrictions with interest rates slightly higher than what is available at most banks and give out very few loans. When the banks became ultra restrictive the bank would again have average lending restrictions. During these periods it would give out more loans.
So the government would not practice the outlandish lending practices we saw during the boom they would not be as restrictive as the banks are now. In fact this would probably do more to influence banks lending practices than the 700 billion giveaway. Remember how we talked about banks not wanting to lend money because no one else was lending money therefore making them nervous about the prospects of the housing market. Knowing that money would always flow provides some stability to the market. Also it would be much less expensive. Having the government provide some loans over the next 6 months with average restrictions during a low point in the market would be much better than taking on years of crappy loans given out during the peak of the market to very unqualified home buyers.
Would some banks go under? Yes. But you know what they should. Bailing out foolish banks that threw caution to the wind and had wildly risky lending practices almost guarantees that we will be faced with another housing crisis in the future. Instead we should allow some of these banks to die. First it prevents these banks without a sense of risk from causing these problems again. Secondly, it influences other banks to exercise more caution during boom times. The bailout sends a message to banks that during the boom they should ignore caution because the government will come in and take all their bad loans away like some kind of bizarre magical bad loan tooth fairy.
I realize this article might bother people that want the government to have no role in the banking/mortgage market. But if we accept that the government already has a role in the banking industry (the possibility of the government taking itself out is pretty much nill for the next decade) to stabilize markets at the least it should do so in a way that is effective and cost efficient.
Tim
Recently the news has been dominated by developments with the 700 billion dollar bailout package, and rightfully so. 700 billion is an astronomical sum of money. The first problem is that the 700 billion dollar bailout adds a huge amount of money to the national debt. Not only that, some have hinted that the bailout is so large it could actually lower the US Credit Rating. The second problem is just as serious. There is no guarantee that the bailout will work.
The idea behind the bailout is that by taking on billions of dollars of toxic loans the government hopes to “influence” banks to start lending again. The past attempts of the government to “influence” banks have all failed. The fed lowered the fed rate to influence banks to lower mortgage rates. While the banks were appreciative of lower rates they did not lower mortgage interest rates. In fact after the fed cut rates the banks increased mortgage rates because they saw negative prospects in the housing market. In a similar way, after the US government takes over the toxic loans away from them the banks could continue to see negative prospects in the housing market and therefore would continue to have strict lending practices. The idea of spending 700 billion with no guarantees seems like a poor use of capitol.
When people hear the word “National Bank” the first thoughts are of a socialized banking system. A national bank would not replace the current banking industry. It also does not “introduce” government involvement into the banking industry. With the Fed influencing interest rates and the government rushing in to bailout every bank that runs into problems the government already has a large hand in the banking industry. I don’t want to argue whether the government should have a role in the banking industry. Currently the government already has a significant role in the banking/mortgage industry. My argument is that if the government does have a role it should be effective and cost efficient.
A national bank would be a cheaper and more cost effective way to steady the financial markets. To understand how a national bank would work lets first talk a little more about what is currently causing the housing crisis. The mortgage market operates a little like a basketball game. Lenders go from one extreme to another. For awhile lenders will lend to anyone that walks in the door with a pulse. During these periods lenders accept less and less qualified applicants in an attempt to gain market share. Then the lenders get freaked out (often because someone realizes they have been giving out billions in loans to unqualified applicants that are unlikely to pay their mortgages) and lenders run to the other extreme and practice extremely restrictive lending practices (the insurance industry sees the same cycles but that is another topic). If you haven’t already guessed currently we are in the second scenario with lenders practicing extremely restrictive lending practices. The problem with the second situation is that such extreme changes shocks the housing market and basically causes a financial crisis. The banks are in a catch 22. If collectively the banks don’t lend the housing market will continue to deteriorate. But no one wants to lend because they are worried the housing market will continue to deteriorate because collectively they are not lending. It’s kind of like at a party where you don’t want to be the first person to jump into the pool because if no one else does you look foolish. Substitute looking foolish with going bankrupt and you kind of see where banks are coming from.
The great depression and the S&L crisis were both basically examples of this same problem. Initially during the great depression the conventional logic was the government should not intervene. As the stock market continued to drop (it dropped over 80% in less than a year) and people realized how bad an economy can get (pretty bad) the idea of government intervention seemed more palatable compared to the alternative.
So now during periods where lenders are freaked the government attempts to “influence” lenders. The problem is its extremely expensive. Currently the government is taking on years and years of bad loans in an attempt to “influence” lenders to loosen their current restrictive lending practices for the next 6 months to pull us out of the housing crisis. This is kind of like trying to influence your local school to spend money on new textbooks by building them a new school. Not only is it ridiculously expensive after you build the new school you have no guarantee they will buy the textbooks. It’s not simply a poor use of government funds it’s utterly outlandish.
So how would a national bank operate? During periods where banks are giving out loans to everyone that walked in the door the national bank would practice have average lending restrictions with interest rates slightly higher than what is available at most banks and give out very few loans. When the banks became ultra restrictive the bank would again have average lending restrictions. During these periods it would give out more loans.
So the government would not practice the outlandish lending practices we saw during the boom they would not be as restrictive as the banks are now. In fact this would probably do more to influence banks lending practices than the 700 billion giveaway. Remember how we talked about banks not wanting to lend money because no one else was lending money therefore making them nervous about the prospects of the housing market. Knowing that money would always flow provides some stability to the market. Also it would be much less expensive. Having the government provide some loans over the next 6 months with average restrictions during a low point in the market would be much better than taking on years of crappy loans given out during the peak of the market to very unqualified home buyers.
Would some banks go under? Yes. But you know what they should. Bailing out foolish banks that threw caution to the wind and had wildly risky lending practices almost guarantees that we will be faced with another housing crisis in the future. Instead we should allow some of these banks to die. First it prevents these banks without a sense of risk from causing these problems again. Secondly, it influences other banks to exercise more caution during boom times. The bailout sends a message to banks that during the boom they should ignore caution because the government will come in and take all their bad loans away like some kind of bizarre magical bad loan tooth fairy.
I realize this article might bother people that want the government to have no role in the banking/mortgage market. But if we accept that the government already has a role in the banking industry (the possibility of the government taking itself out is pretty much nill for the next decade) to stabilize markets at the least it should do so in a way that is effective and cost efficient.
Tim
Mar
26
Is the pending economic stimulus legislation an attempt to nationalize the home mortgage industry?
Filed Under Economics | 4 Comments
Bopped asked:
Seem like raising the caps on federally insurable mortgages and having the various gov’t underwriting agencies purchase unvetted portfolios of mortgages effectively nationalizes the home mortage industry. SInce I am reading that there may be $2 trillion of bad loans out there, I suspect that means we as taxpayers will then be on the hook for that much in bad loans. Why do I think we are seeing another Savings and Loan Scandal? I sure hope I am wrong.
Alan
Seem like raising the caps on federally insurable mortgages and having the various gov’t underwriting agencies purchase unvetted portfolios of mortgages effectively nationalizes the home mortage industry. SInce I am reading that there may be $2 trillion of bad loans out there, I suspect that means we as taxpayers will then be on the hook for that much in bad loans. Why do I think we are seeing another Savings and Loan Scandal? I sure hope I am wrong.
Alan
Mar
24
Subprime Mortgage Lending
Filed Under Economics | Leave a Comment
Alex Tragnitz asked:
“Subprime Mortgage Lending and Its Effect on The Economy”
In the 1990’s the United States saw a rapid growth of subprime mortgage lending. Lending institutions started to give credit for mortgages to millions of borrowers who may have been denied credit in the past. Homeowners who were not as fortunate as others were now able to borrow credit to meet their needs. As this created a good opportunity for some people it has also “been associated with higher levels of delinquency, foreclosure, and, in some cases, abusive lending practices.”(1) It now seemed that anybody could get a mortgage due to these subprime loans. What people did not realize was that during the 90’s the economy was good and interest rates were low. Later on rising interest rates caused many problems and forced many lenders and borrowers into trouble. Subprime mortgage lending did not turn out as great as everyone thought it would be and it ended up negatively effecting the economy.
To explain the effect subprime mortgage lending has on the economy you must first understand what subprime lending is. Subprime lending is when a person who does not qualify for loans from mainstream lenders borrows money from a subprime lender. These people are called subprime borrowers. They are unable to qualify for prime financing terms but can qualify for subprime financing terms. The main reason these people are unable to qualify is because of low credit scores. Lenders judge borrowers credit history based on a “Fair Isaac and Company (FICO) credit score.”(2) An average credit score below 620 is viewed as a high risk and makes that borrower unable to receive a prime loan. However, research shows “about half of subprime mortgage borrowers have FICO scores above this threshold.”(3) When a borrower takes a subprime loan they have to pay a high interest rate depending on their credit score. The lower the credit score the higher the rates will be. Because of the greater risk and higher costs of subprime lending, subprime loans have a greater interest rate. Subprime lending seemed to be a great way of giving everyone a chance to be able to get a mortgage but in the long run it ended up causing many problems and hurting the economy.
As subprime mortgage lending started to become very popular, many problems started to occur. “By 2005 26% of mortgage loans were subprime.”(4) It seemed to be an incredible opportunity but later on “interest rates rose and customers were unable to continue making their loan payments.”(5) This caused many problems and there was a great amount of mortgage defaults and foreclosures. Many lenders had no choice but to give up their businesses. On top of that their bond funds became worthless. These losses caused many lawsuits with companies and individuals who were hoping to have some sort of recovery. The Federal Reserve started to get involved to help lenders who were in deficit. In an article from “Americans For Fairness In Lending” the Federal Reserve was said to “lower its rate to lenders and adjust its collateral standards in a quick effort to soften the blow of the collapse on Wall Street.”(6) The Federal Reserve was forced to help out subprime lenders because they were the first to be affected by the large amount of foreclosures. Lenders and borrowers were not the only ones to experience losses. Major banks and financial institutions all around the world were said to have “reported losses of approximately 240 billion U.S. dollars.”(7) Also corporate, individual, and institutional investors suffered when the value of mortgage assets declined. Stock markets have declined in countries all over the world as well.
Subprime mortgage lending has now become a “subprime crisis.” It started to have a negative effect on economic growth and effected investments, which are a crucial part of supporting the economy. Housing prices have sky rocketed in many areas and there has been a lower percentage of home construction. This puts a negative effect on the housing market because there is not enough money to build new homes to sell. Because of rising interest rates expected to continue United States legislatures and the U.S. Treasury Department are developing a plan to help the economy. As interest rates continue to rise more of the economy is going to be negatively effected.
Subprime mortgage lending has not only effected the large economy but has effected borrowers, neighborhoods, and local economies as well. The Federal Reserve has been helping lenders and the larger economy but they have not given any money or passed any legislation to help out these suffering consumers, neighborhoods, and local economies. Homeownership due to subprime lending has caused unstabalized communities and a loss of family wealth. A statistic from the Center for Responsible Lending shows that “Subprime loans made during 1998-2006 have led or will lead to a net loss of homeownership for almost one million families.”(8) If losing their homes wasn’t bad enough these families will lose the money they have invested in them as well. With each foreclosure property value can go down too. “It is estimated that each foreclosure lowers the property values in its neighborhood by about one percent.”(9) All of this will hurt neighborhoods and will take money away from what these borrowers can spend on goods and services. When these borrowers have less money, then they will have less money to spend in their respective communities. Neighborhoods will become poorer and crime and violence can occur. Subprime mortgage lending has seriously taken a turn for the worst with the booming interest rates and has seriously hurt subprime borrowers.
Many corporations and financial services have been greatly effected in the past few months from subprime mortgage lending as well. According to an article by CNN, New Century Financials “shares plunged nearly 70 percent.”(10) In the same article Fremont General Corporation was said to “lose a third of its value after it announced it would exit the subprime sector because of the demands of regulations and market conditions.”(11) Due to loss of money and an increasingly large number of foreclosures the “Center for Responsible Lending” asked for tougher standards for lenders who make subprime loans. This seemed to get into other firms minds as the mortgage financing firm “Freddie Mac” said “it would no longer buy subprime loans on the secondary market that have a likelihood of excessive payment shock and possible foreclosure.”(12) These new guidelines along with a new set of proposed federal rules are going to leave many borrowers unable to qualify. With less people able to qualify the less the subprime loans there will be. This will hopefully stop the rising amount of foreclosures, which hurt the economy so greatly.
Subprime mortgage lending has seriously effected the economy in a negative way. The stock market has declined and interest rates are still rising. The Federal Reserve has made changes to help cut interest rates and the proposal of “the economic stimulus package signed by President George W. Bush”(13) has been made to help encourage economic growth and give financial markets some confidence. These things will help but it is going to take a while for the economy to bounce back. Subprime mortgage lending was thought to be a great opportunity at first, but in the end it hurt the economy greatly.
Ella
“Subprime Mortgage Lending and Its Effect on The Economy”
In the 1990’s the United States saw a rapid growth of subprime mortgage lending. Lending institutions started to give credit for mortgages to millions of borrowers who may have been denied credit in the past. Homeowners who were not as fortunate as others were now able to borrow credit to meet their needs. As this created a good opportunity for some people it has also “been associated with higher levels of delinquency, foreclosure, and, in some cases, abusive lending practices.”(1) It now seemed that anybody could get a mortgage due to these subprime loans. What people did not realize was that during the 90’s the economy was good and interest rates were low. Later on rising interest rates caused many problems and forced many lenders and borrowers into trouble. Subprime mortgage lending did not turn out as great as everyone thought it would be and it ended up negatively effecting the economy.
To explain the effect subprime mortgage lending has on the economy you must first understand what subprime lending is. Subprime lending is when a person who does not qualify for loans from mainstream lenders borrows money from a subprime lender. These people are called subprime borrowers. They are unable to qualify for prime financing terms but can qualify for subprime financing terms. The main reason these people are unable to qualify is because of low credit scores. Lenders judge borrowers credit history based on a “Fair Isaac and Company (FICO) credit score.”(2) An average credit score below 620 is viewed as a high risk and makes that borrower unable to receive a prime loan. However, research shows “about half of subprime mortgage borrowers have FICO scores above this threshold.”(3) When a borrower takes a subprime loan they have to pay a high interest rate depending on their credit score. The lower the credit score the higher the rates will be. Because of the greater risk and higher costs of subprime lending, subprime loans have a greater interest rate. Subprime lending seemed to be a great way of giving everyone a chance to be able to get a mortgage but in the long run it ended up causing many problems and hurting the economy.
As subprime mortgage lending started to become very popular, many problems started to occur. “By 2005 26% of mortgage loans were subprime.”(4) It seemed to be an incredible opportunity but later on “interest rates rose and customers were unable to continue making their loan payments.”(5) This caused many problems and there was a great amount of mortgage defaults and foreclosures. Many lenders had no choice but to give up their businesses. On top of that their bond funds became worthless. These losses caused many lawsuits with companies and individuals who were hoping to have some sort of recovery. The Federal Reserve started to get involved to help lenders who were in deficit. In an article from “Americans For Fairness In Lending” the Federal Reserve was said to “lower its rate to lenders and adjust its collateral standards in a quick effort to soften the blow of the collapse on Wall Street.”(6) The Federal Reserve was forced to help out subprime lenders because they were the first to be affected by the large amount of foreclosures. Lenders and borrowers were not the only ones to experience losses. Major banks and financial institutions all around the world were said to have “reported losses of approximately 240 billion U.S. dollars.”(7) Also corporate, individual, and institutional investors suffered when the value of mortgage assets declined. Stock markets have declined in countries all over the world as well.
Subprime mortgage lending has now become a “subprime crisis.” It started to have a negative effect on economic growth and effected investments, which are a crucial part of supporting the economy. Housing prices have sky rocketed in many areas and there has been a lower percentage of home construction. This puts a negative effect on the housing market because there is not enough money to build new homes to sell. Because of rising interest rates expected to continue United States legislatures and the U.S. Treasury Department are developing a plan to help the economy. As interest rates continue to rise more of the economy is going to be negatively effected.
Subprime mortgage lending has not only effected the large economy but has effected borrowers, neighborhoods, and local economies as well. The Federal Reserve has been helping lenders and the larger economy but they have not given any money or passed any legislation to help out these suffering consumers, neighborhoods, and local economies. Homeownership due to subprime lending has caused unstabalized communities and a loss of family wealth. A statistic from the Center for Responsible Lending shows that “Subprime loans made during 1998-2006 have led or will lead to a net loss of homeownership for almost one million families.”(8) If losing their homes wasn’t bad enough these families will lose the money they have invested in them as well. With each foreclosure property value can go down too. “It is estimated that each foreclosure lowers the property values in its neighborhood by about one percent.”(9) All of this will hurt neighborhoods and will take money away from what these borrowers can spend on goods and services. When these borrowers have less money, then they will have less money to spend in their respective communities. Neighborhoods will become poorer and crime and violence can occur. Subprime mortgage lending has seriously taken a turn for the worst with the booming interest rates and has seriously hurt subprime borrowers.
Many corporations and financial services have been greatly effected in the past few months from subprime mortgage lending as well. According to an article by CNN, New Century Financials “shares plunged nearly 70 percent.”(10) In the same article Fremont General Corporation was said to “lose a third of its value after it announced it would exit the subprime sector because of the demands of regulations and market conditions.”(11) Due to loss of money and an increasingly large number of foreclosures the “Center for Responsible Lending” asked for tougher standards for lenders who make subprime loans. This seemed to get into other firms minds as the mortgage financing firm “Freddie Mac” said “it would no longer buy subprime loans on the secondary market that have a likelihood of excessive payment shock and possible foreclosure.”(12) These new guidelines along with a new set of proposed federal rules are going to leave many borrowers unable to qualify. With less people able to qualify the less the subprime loans there will be. This will hopefully stop the rising amount of foreclosures, which hurt the economy so greatly.
Subprime mortgage lending has seriously effected the economy in a negative way. The stock market has declined and interest rates are still rising. The Federal Reserve has made changes to help cut interest rates and the proposal of “the economic stimulus package signed by President George W. Bush”(13) has been made to help encourage economic growth and give financial markets some confidence. These things will help but it is going to take a while for the economy to bounce back. Subprime mortgage lending was thought to be a great opportunity at first, but in the end it hurt the economy greatly.
Ella