Thomas Sowell provides an interesting and often counter-intuitive look at the economic issues facing the country.
Our Government Problem-Solvers
At election time, pols can’t help but “do something” — even if it makes matters worse.

By Thomas Sowell

We don’t look to arsonists to help put out fires but we do look to politicians to help solve financial crises that they played a major role in creating.

How did the government help create the current financial mess? Let me count the ways.

In addition to federal laws that pressure lenders to lend to people they would not otherwise lend to, and in places where they would otherwise not invest, state and local governments have in various parts of the country so severely restricted building as to lead to skyrocketing housing prices, which in turn have led many people to resort to “creative financing” in order to buy these artificially more expensive homes.

Meanwhile, the Federal Reserve System brought interest rates down to such low levels that “creative financing” with interest-only mortgage loans enabled people to buy houses that they could not otherwise afford.

But there is no free lunch. Interest-only loans do not continue indefinitely. After a few years, such mortgage loans typically require the borrower to begin paying back some of the principal, which means that the monthly mortgage payments will begin to rise.

Since everyone knew that the Federal Reserve System’s extremely low interest rates were not going to last forever, much “creative financing” also involved adjustable-rate mortgages, where the interest charged by the lender would rise when interest rates in the economy as a whole rose.

In the housing market, a difference of a couple of percentage points in the interest rate can make a big difference in the monthly mortgage payment.

For someone who buys a house costing half a million dollars — which can be a very small house in many parts of coastal California — the difference between paying 4-percent and 6-percent interest would amount to more than $7,000 a year.

For people who have had to stretch to the limit to buy a house, an increase of $7,000 a year in their mortgage payments can be enough to push them over the edge financially.

In other words, government laws and policies at federal, state, and local levels have had the net effect of putting both borrowers and lenders way out on a limb.

Yet, when that limb began to crack, the first reaction in politics and in the media has been to look to government to solve this problem because — as always — it was called the market’s fault, the lenders’ fault, and everybody’s fault except those politicians who created this dicey situation in the first place.

Markets often get blamed for conveying a reality that was not created by the market.

For example, the fact that “the poor pay more” for what they buy in stores in low-income neighborhoods is often blamed on those who run these stores, rather than on those who create extra costs through crime, vandalism, and riots.

If the store owners were making big profits, the big chain stores would be rushing in to share in the bonanza, instead of avoiding low-income neighborhoods like the plague.

Markets were also blamed for the Great Depression of the 1930s and New Deal politicians were credited with getting us out of it. But increasing numbers of economists and historians have concluded that it was government intervention which prolonged the Great Depression beyond that of other depressions where the government did nothing.

The stock market crash of 1987 was at least as big as the stock market crash in 1929. But, instead of being followed by a Great Depression, the 1987 crash was followed by 20 years of economic growth, with low inflation and low unemployment.

The Reagan administration did nothing in 1987, despite outrage in the media at the government’s failure to live up to its responsibility, as seen in liberal quarters. But nothing was apparently what needed to be done, so that markets could adjust.

The last thing politicians can do in an election year is nothing. So we can look for all sorts of “solutions” by politicians of both parties. Like most political solutions, these are likely to make matters worse.

— Thomas Sowell is a senior fellow at the Hoover Institution.

© 2008 CREATORS SYNDICATE, INC.

For those that thought the mortgage markets and the liquidity crisis was over, think again. Indy Mac Bank Corporation just posted a blog entry saying they will cease all wholesale mortgage operations and slash more than half of its approximately 7,200 employees. Below is an excerpt from their corporate blog.

As a result of the above, we have made the difficult decision, effective July 7, 2008, that we will no longer accept any new loan submissions or rate locks in our retail and wholesale forward mortgage lending channels, except for our servicing retention channel. We plan to honor all of our existing rate-locked loans and will continue to fund these loans in the coming weeks. While the managers and employees in these units have worked incredibly hard, these units are not currently profitable due to the continuing erosion of the housing and mortgage markets. At the same time, these operations take up significant balance sheet capacity and “feed” growth in the servicing asset, an asset we need to shrink given its size relative to our existing capital.

It is interesting to see that Wachovia just tightened its guidelines on its, “pick a payment” loans. This is especially interesting to me, because at the beginning of the year we had a presentation at our office from a World Savings executive that touted the flexibility of this loan. My opinion is well reverberated in Mike Mueller’s recent post on the Lenderama blog.

“Seriously, The Neg Am loan has a very valuable place in the finance world when properly used.  I believe Wachovia (world Savings) had the highest performing Neg Am Portfolio in the biz.”

These mortgage products do have there place in the financial world. I also agree with the executive that visited our office at the beginning of the year. These products are useful and powerful for the right individual situation. Maybe, the changes in Wachovia’s policy have more to do with their own business concerns and buying Golden West mortgage, then with the validity of the product that was successful for Word Savings for so many years. Just check out this CNN Money story that illustrates how 3.8% of Golden West’s pool of pick a payment mortgages went belly up after Wachovia purchased them in 2006.

The answer is that there are no bad loans in the marketplace. Loans are not people thus they can’t act good or evil. Mortgages are either placed by a person with the strategic knowledge to effectively care for an individual’s entire financial situation or they are not. I have many clients who have taken World Savings pick a payment loans and they have met their financial strategies without causing any despair or foreclosures.

I think the conversation in the marketplace needs to change from the loan product, to who is doing your loan. Are they competent to take care of your mortgage concerns with out betraying the other financial concerns that you have? Many banks and brokers have done mortgages with a blind eye to the customers financial situations and concerns. Often, you can’t even blame the person doing the loan, because they are not even competent to take care of their own financial concerns, let alone yours. Maybe contracting guidelines is not the answer for banks. Maybe, they should start to think about how they operate in regards to the knowledge of the people they have doing the loans. Maybe if they observed, assessed and acted to care for a clients mortgage in the context of their total financial situation they would have a huge stack of loans that could sell on Wall Street as mortgage backed securities. Warren Buffet eloquently explained the breakdown in the mortgage markets when he said, “In extreme cases, mark-to-market degenerates into what I would call mark-to-myth.”

Thanks Ocean Flynn for this flicker Photo.