October 05, 2009 | Graham

Government intervention prime cause of sub-prime debacle

Home-ownership can be a curse, according to Saul Eslake.
In this interesting op-ed in The Age Eslake argues that it wasn’t unregulated markets that caused the sub-prime crisis, it was a misguided desire to increase home ownership by directing banks to fund people into houses who couldn’t really afford them.

One of the means adopted during the Clinton administration to this end was to use the Community Reinvestment Act to require banks and other mortgage lenders to be ”innovative and flexible” in helping households ”that lack cash to buy a home or make the payments” – that is, to loosen their lending requirements.
Another was to add an ”affordable housing” mission to the charters of the government-sponsored mortgage agencies, Fannie Mae and Freddie Mac, which were required by 2007 to show that 55 per cent of their mortgage purchases were loans to low and moderate-income borrowers, of which 25 per cent were to be loans to low and very low-income borrowers. Fulfilling this mandate required Fannie Mae and Freddie Mac to purchase a growing volume of mortgages that did not conform to their traditional requirements.
These undoubtedly well-intended measures prompted a more general lowering of lending standards, as private sector mortgage underwriters came up with ”innovative” products that allowed borrowers to take out larger loans with lower initial payments in an environment of unusually low interest rates, while Wall Street and European investment banks came up with new ways of distributing securities based on these products to a wider investor market.

The Age sub-editor’s Recycle Bin also saw the original last two pars of Saul’s piece which read:

This figure [Australian mortgages 90 days or more in arrears] represents less than half of one per cent of the more than 5½ million mortgages outstanding (and less than one-tenth of the corresponding US figure). The ability and willingness of the vast majority of Australian home-buyers to keep up their mortgage repayments is one of the main reasons why Australia’s experience of the global financial crisis has been much less severe than in America’s.
Another important lesson of these contrasting experiences is that if we do genuinely want to improve housing affordability, and sustainably to increase home ownership rates, we need to increase the supply of (affordable) housing, rather than continue to put cash into the hands of buyers irrespective of their means, cash which ultimately ends up in the pockets of vendors.

In other words, the extreme good health of the Australian financial system may be partly because we chose a quasi-market solution and funded purchasers rather than mandating via refulation that banks make loans. While this policy has increased housing prices it hasn’t increased financial risk to the same extent as occurred with different measures in the US.
It may also perversely be partly due to bad management of housing supply. If state and local governments had more rational planning systems, and didn’t hit the development industry with so many upfront taxes, we’d have more housing supply and more defaults and our banks might look more like those in the US.

Posted by Graham at 2:45 pm | Comments (5) |
Filed under: Economics


  1. Yes Graham,you and Saul are both right.We have to eliminate Govt taxes on building houses.37% of a land/house package is Govt taxes and charges.Imagine we put a 37% tax on food and clothing.There would be a national uproar.Shelter is a basic necessity.
    The other issue is supply of land.Govts limit the supply of land to maximise their returns.Should this be the function of Govt? Profit?
    The other way to put downard pressure on house prices is to have fast, efficient transport systems that make cheap land accessable.Now what do we do?Put in expensive tolled roads with only 2 lanes each way.
    I’ve looked into doing developments myself and I have all the tools skills and workshop to do it myself,but it is not financially viable,so we in NSW have a housing shortage.They just won’t listen.

    Comment by Arjay — October 5, 2009 @ 5:29 pm

  2. “These undoubtedly well-intended measures prompted a more general lowering of lending standards, as private sector mortgage underwriters came up with ”innovative” products”
    I think this phrase carries more weight than the actual statements around the raising of mortgages against risky or non-existent collateral. The creation of CDOs and then derivative swaps on those CDOs was not mandated by legislation. In fact it was the lack of legislation that allowed these products to be traded. It was free market ideologues like Greenspan who oversaw the debacle. Attempts to pin the blame for market failure on the poor are unedifying and unconvincing. Poor effort by you and Eastlake. I suggest you read “The Two Trillion Meltdown” by Charles Morris.

    Comment by PatrickB — October 6, 2009 @ 10:01 am

  3. Patrick B,the free market was not allowed to operate.It was Clinton who originally deregulated the finance system to provide cheap loans for the poor without real equity or responsibility. Yes the Federal Reserve was negligent in that it did not perform it’s prime most important function ie the responsible supply of credit.
    I actually like Ron Paul,lay the whole debacle at the feet of the Fed.It’s power over the US economy and the world should end.

    Comment by Arjay — October 6, 2009 @ 3:48 pm

  4. Graham,
    This is just another example of blame the victim.
    To suggest it was the fault of the borrowers is like saying that Abu Graib was the fault of the enlisted personnel who carried out the humiliation and torture and not reflective of a wider culture.
    Are you seriously suggesting that Lehman Brothers et al collapsed because they and the rest of the financial system were forced to lend money to people who couldn’t repay the debt? Are you seriously suggesting that the commissions sytem which underpins the sale of “financial products” was not the driving force which led to people being offered loans which they had no prospect of paying off or that people weren’t enticed into second mortgages in order to fund lifestyle spending?
    The GFC has brought into sharp relief major structural faults in free market ideology. To suggest that it was the fault of over-regulation and government interference is clutching at straws.

    Comment by Barney Langford — October 10, 2009 @ 10:36 pm

  5. Who’s blaming the borrowers Barney?

    Comment by Graham Young — October 11, 2009 @ 12:53 pm

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