The Housing Crisis: Caused by Lax Regulation

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Mr. Toplin is a professor of history at the University of North Carolina at Wilmington, and a writer for the History News Service. He is the author of a dozen books.

After Wall Street went into a tailspin because of problems with sub-prime mortgages, Democratic presidential candidates demanded stronger standards for the mortgage industry. Hillary Clinton, Barak Obama and Christopher Dodd asked Congress to exercise more control over the risky lending practices that have harmed homebuyers and frightened investors.

We've heard such sage advice before. But in the past, no one heeded it. Now it's time for leaders in Washington to stop the abuses.

The Democratic candidates' call for tougher regulation looks a lot like the campaigns of reformers in earlier periods of American history. When hazardous practices created troubles in the past, leaders in Washington established new rules for the conduct of business. Free market fundamentalists often denounced these regulatory efforts as meddling by bureaucrats in Washington, but twentieth century history suggests that effective regulation can help both business and the public.

The first significant market crisis of the 20th century occurred in 1907 when some speculative schemes by powerful bankers began to fail. Investors reacted by pulling their money from banks and trust companies. The stock market lost nearly half its value.

J.P. Morgan, Wall Street's most influential figure, helped to end the crisis by encouraging financiers to pump money into banking institutions. But since congressmen didn't want to rely on tycoons like Morgan in future emergencies, they created the Federal Reserve System in 1913. Congress established a central banking authority that promoted stability in the financial sector and discouraged panics.

The importance of the Federal Reserve System is in evidence today. Since the mortgage crisis threatens to spread trouble throughout the economy, Americans are looking to the Fed to help restore confidence.

Unfortunately, leaders at the Federal Reserve could not avert the big shakeup of the 1920s. In that period some bankers speculated recklessly in the stock market and promoted risky loans. Their practices contributed to the Wall Street crash of 1929 and the Great Depression of the 1930s. Investigations conducted by Congress revealed that banks and brokerage firms had operated with few rules (somewhat in the manner of mortgage brokers in recent years). Reform was necessary.

President Franklin D. Roosevelt demanded protection for depositors and investors. His New Deal organized the Securities and Exchange Commission to monitor the stock market. New legislation required the separation of banks and brokerage businesses, insured bank deposits, and created standards aimed at making business practices more transparent, including the sale of stocks.

The lessons of the thirties appeared to be lost during the 1980s, when President Reagan's administration championed "deregulation," an initiative that contributed to the Savings and Loan crisis. In the early Reagan years important rules for the operation of S & Ls disappeared. Some S & L executives then provided questionable loans and rushed into highly speculative investments. When their institutions got into trouble in 1985, the executives tried to conceal embarrassing information from the public. Eventually, many S & L's went under.

As had been the case many times earlier, leaders in Congress had to step in to clean up the mess. Their efforts cost the federal government (and American taxpayers) $125 billion. Funding the rescue  sharply increased the U.S. budget deficit. A painful recession  followed in the early nineties. Americans paid dearly for the experiment in radical deregulation.

The current problems that have triggered fears about sub-prime mortgages can be traced, as well, to a loose, generally unregulated business environment. During the house-buying frenzy of recent years, unscrupulous brokers handed out low interest mortgages to applicants who were not well qualified to take on large debt.

Lenders failed to document applicants' claims of income and they promoted adjustable rate mortgages because those instruments promised greater profits than fixed-rate loans. Now many poorly informed homebuyers are defaulting on those mortgages.

Almost everybody is threatened in some way by the risky practices. An estimated 1.7 million Americans are likely to lose their homes to foreclosure this year and next. Many more Americans (as well as investors around the world) are vulnerable because they hold securities in corporations that had a large stake in the sub-prime lending business. Market analysts fear that the mortgage crisis will create a credit squeeze, undermine business and reduce employment.

Clinton, Obama and Dodd want to establish firm rules for mortgage lending that screen out unscrupulous brokers, establish licensing standards, and give borrowers clearer information about mortgage obligations. Obviously, these senators are proposing remedies to win support for their presidential campaigns. They are on the right track, nevertheless.

Mortgage brokers took dangerous gambles and violated the public's trust recently, much as the promoters of wildcat commercial activities did before 1907, 1929, and 1985. Stronger requirements are sorely needed -- rules that promote fair and responsible lending practices. Such regulation would serve not only the citizens on Main Street but also the investors on Wall Street.

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Dee Far - 9/17/2008

RE: "Can you show me any instance in history in which rates did nothing but drop for thirty years?......"

Yes, I can. FHA mortgage rates were 4.25% in 1950 and 14.63% in 1980.

William J. Stepp - 8/21/2007

How, then, would you explain the fact that, in an increasingly more-regulated housing market from 1933-1965, homeownership went from about 40 percent of the population to 65 percent?

Two things, recovery from the Hoover-FDR depression and post-war economic growth, with a heavy emphasis on the latter.

George Robert Gaston - 8/21/2007

Returning WWII vets, and pent up demand from the 1930s depression were largely responsible for the post war housing boom.

While there was regulation, the government actively encouraged home ownership. For example, vets received government-insured mortgages with no down payments. In addition, home loan interest rates were quite low until the late 1960s. A final factor is that typical home prices were much lower through the era you cite. Houses were also more modest. A typical three bedroom, two bath house provided about 1500 square feet of living space. In 1955 this would have cost less than $20,000 dollars.

Since that time, there has been no sequence of events to cause a generational housing shortage like the one after the war.

Lawrence Brooks Hughes - 8/21/2007

Unlike the other article on this page, you correctly identify unsound lending practices as the cause of our current malaise, and I think your entire account of it is generally correct. Unfortunately, the same cannot be said for your account of the S&L crisis of the 1980s, in which you paint Congress as charging to the rescue (which they did) as a white knight, (which it was not). Congress, and more specifically Democratic Rep. Freddie St. Germain from Rhode Island, were basically responsible for the whole mess when Freddie slipped in an enormous increase to $100,000 per account for federal deposit insurance, very late in a session when nobody was looking.

Rick Perlstein - 8/20/2007

Jason, you write: "more regulation will mean fewer good loans when market conditions merit them, and thus fewer homes for earnest, hard-working Americans."

How, then, would you explain the fact that, in an increasingly more-regulated housing market from 1933-1965, homeownership went from about 40 percent of the population to 65 percent?

Jason Blake Keuter - 8/20/2007

I noticed mention of the Federal Reserve System in 1913 providing financial stability and then no mention of its role in triggering the Great Depression.

I notice also that you mention "poorly informed' borrowers. I recall when I took out my mortgage in 1999 being told that I could take a variable rate mortgage at a lower rate, to which I said, you mean lower current rate. Yes, but there's really no indication that rates will be going up, if anything, they'll be going down. How long is the mortgage for? Thirty years. Can you show me any instance in history in which rates did nothing but drop for thirty years?......

I don't recall reading any fine print with a giant magnifying glass. Borrowers were not misinformed. They were overly optimistic. Unfortunately for the health of the pro-strangulation...I mean pro-regulation political bias of this pseudo-economic call for greater regulation based on cherry-picked historical evidence, there really are no victims in this story. It's a great boon for liberals anxious to shore up a middle -class constituency for the welfare state (by bribing foolish home buyers with bailouts); but, of course more regulation will mean fewer good loans when market condditions merit them, and thus fewer homes for earnest, hard-working Americans. Let's not forget the real story here: ther are more people keeping homes that they bought with variable rate mortgages than there are people losing them...and, there are more people keeping homes with the competitive, low fixed rate mortgages than there are people losing them. As a matter of fact, those highly advantageous, fixed-rate mortgages in the 5 and 6 percent range existt because of the competive pressure of the riskier variable rate mortgages. We should be praising the astute, who got homes at a good interest rate, instead of wringing our hands and rending our garments over those who lost money in a speculative housing market.

To be a victim requires that an injustice be done, or at least that something bad happen due to circumstances beyond your control. Being "poorly informed" about loans ranging from $100,000 to $1,000,000 makes one a fool, not a victim. To pile on delusion based regulations will do nothing for present home owners, but will artificially (and wrongfully) restrict future buyers from getting ggood buys thanks to their wisdom and good decision making as consumers.