Monday, September 14, 2009

Events Leading to the Great Bailout: Part Two

In a previous post Thomas Sowell's book The Housing Boom and Bust was used as a source reference to explain some fundamental problems that led to a subsequent economic disaster and the historic bailout. The problems cited involved supply and demand and legal restrictions on land use that decreased land availability for home construction.

This blog entry will draw from information supplied in the second chapter of The Housing Boom and Bust. Sowell notes a political developmemt stressing the desireability of increased home ownership and the concept of affordable housing at the outset of the chapter. Leaders from both major parties have promoted home ownership. While there is nothing intrinsically wrong with home ownership, the formulation of political policies designed to make home ownership universal has a utopian air to it and the wisdom of it is highly questionable. Political policies manifested in the form of a revision of credit requirements for home purchases by the Fannie Mae Corporation. The intent being to enable minorities and lower income people to secure mortgages for homes.

Good intentions do not necessarily lead to sound lending policies. Loan standards are as old as loans and protect both the lender and recipients of loans. The housing bust was preceded by the granting of massive amounts of mortgage loans to individuals who would not have qualified for them in the past. The road to easy credit will be detailed in a subsequent blog entry.

Sowell provided useful indicators for the term affordable housing. For individuals it can be viewed as a ratio of mortgage payments to income. For the purpose of regional comparisons it is better viewed as the ratio of median home payments to median income. When sound loan standards are in effect individual applicants for mortgages will be approved and rejected based largely on payment to income ratio data. If payments consume too high a percentage of income not enough will remain for other essential spending like food, clothing, car expenses etc. It is not in the interests of lenders or consumers to have loans granted to those who cannot maintain the payments. We can see from the events of recent history that it is also not in the interests of the American economy as a whole to encourage unsound lending practices.

Sowell correctly pointed out an implicit assumption that has seeped into American political policies i.e. the belief that the government should ensure that home ownership is affordable. That view along with the related belief that there existed a shortage of affordable housing prompted calls for federal intervention. It's essential to understand the actual causes for housing problems in some localized areas of the United States so that effective solutions can be fashioned. It is also imperative for the economic health of this nation that people understand that skyrocketing home prices were not prevalent throughout this nation but rather tended to be localized in regions where government land use policies severely impacted real estate values.



Reference:

The Housing Boom and Bust by Thomas Sowell; Published by Basic Books; Copyright 2009; Chapter 2, Pages 30-36.

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