Think Tank: Mortgage Regulators Not Asking Right Questions

The following is an editorial by members of the American Enterprise Institute For Public Policy Research. In it, the group discusses what needs to be done in resolving the mortgage industry’s current bad credit home loan crisis, and suggests that the some of the questions being asked by federal regulators may be off the mark…

On hearing Federal Reserve officials reassure the public that the present problems in the subprime (bad credit mortgage) market are nothing about which to worry, one cannot help feeling that one has seen this before.

For it was as recently as 2000 that many of these same officials were assuring the public that the bursting of the stock market bubble was something that would not have a meaningful macroeconomic impact.

Moreover, they continued doing so for many months before the Fed was forced to cut interest rates aggressively to prevent the stock market debacle from causing a deep recession.

Federal Reserve reassurances to the contrary, today’s acute problems in the U.S. market for bad credit mortgages are better viewed as the canary in the coal mine forewarning about very much broader housing market problems to follow.

For the same forces that drove up U.S. home prices to dizzying heights over the past six years are finally beginning to operate in reverse. By so doing, those forces will inevitably lead to a prolonged reduction in home prices that could have potentially damaging consequences for the overall economy.

Robert Shiller, renowned Yale University scholar and expert on the housing market, has correctly observed that the 75 percent run up in home prices in constant dollars between 2000-2006 has no remote precedent in the past 120 years.

Never before in our history have so many factors conspired to fuel a pronounced and prolonged housing market upswing of this scope.

Among the more important factors underlying the U.S. housing boom was the ample provision of liquidity by the Federal Reserve in the aftermath of the bursting of the home equity bubble in March 2000.

Not only did the Federal Reserve cut interest rates by 550 basis points following the stock market crash, but it kept rates at 1 percent for a prolonged period of time.

Adding fuel to the boom was a remarkable relaxation in lending standards along with the introduction of an array of mortgage instruments aimed primarily at those previously excluded from the housing market.

No longer did borrowers need good credit records or income verification to obtain home mortgage loans. No longer did they need to be burdened in the initial phases of the loan with high interest or amortization payments.

Adjustable rate mortgages (ARMs) or negative amortization loans became the norm. This gave rise to an explosion of bad credit mortgage lending, which in 2006 accounted for around 20 percent of all mortgage lending.

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