Housing bubbles on the East and West coasts

Washington Post Editorial:

NO ONE can say how or when the subprime mortgage crisis will end. But the next act will not -- or at least should not -- include Fannie Mae and Freddie Mac riding to the housing market's rescue. That became clear Tuesday when Freddie reported an all-time record quarterly loss of $2 billion, just 11 days after Fannie Mae reported a $1.4 billion loss. It would be nice if the two government-sponsored enterprises (GSEs), which back $4.8 trillion worth of home loans, could help prop up home prices and hold down interest rates. But their own safety and soundness come first.

This is not what leading Democrats in Congress have been saying since the subprime crisis began. Searching, understandably, for a fresh source of short-term liquidity, they have suggested such measures as authorizing Fannie and Freddie to "securitize" larger loans in high-cost housing markets and lifting the limits on their total portfolios that federal regulators imposed after accounting scandals at the two companies. Sen. Charles E. Schumer (D-N.Y.) continues to make that argument. "It should come as no surprise that Fannie and Freddie's businesses have been negatively impacted," he said. That "does nothing to lessen the critical role that the GSEs must play in providing much-needed liquidity to a struggling market."

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Lurking behind the financial difficulties of these to entities is huge unfunded liability in the form of a guarantee from the US government. Pushing them into insolvency by bailing out bad decisions made by both borrowers and lenders would be very costly to tax payers.

One of the myths of the housing bubble is that it was caused by "predatory" lending practices, but this overlooks the significant and substantially losses incurred by those lends in the billions of dollars because the borrowers could not pay. Wall Street firms, other than Goldman Sachs have been the primary losers as well as the top executives for the firms that lost big. To suggest that they made money off bad loans is to take a vacation from the reality of lending.

The primary reason the loans were "bad" is because the underlying asset on which the loan was based was overvalued. If it had a value equal to the loan a borrower could just sell the property and pay off his loan if he could no longer afford it. That is why lenders used to require substantial down payments to buffer against this possibility and to give the borrower a something to lose if he decided to default.

By not requiring the down payments of that size at a time when Congress changed the bankruptcy laws to make it difficult to impossible for borrowers to walk away from their credit card debt, the debt they could walk away from was their mortgage by giving up the asset. This had a cascading effect on the housing market depressing prices as more walk away houses came on the market.

What the "predatory lenders" were doing when they made the bad loans was propping up the costs of building restrictions which limited the supply on the East and West coasts. At this time there is no such housing bubble in Texas where homes have remained much more affordable because of fewer building restrictions. Markets can be unforgiving sometimes, particularly when outside factors distort the price.