The views expressed in this column are those of the author and not SVB Financial Group.
Now that The Restoring American Financial Stability Act of 2010 is on the books, Congress has discovered it is time to address the actual source of the most recent financial instability. We are, of course, referring to the massive government intervention in the mortgage market, which progressed over a period of decades to the point where market distortions were commonplace. With the endorsement of Congress and the balance sheet power of Fannie Mae and Freddie Mac, loans to unqualified borrowers became standard practice. The private sector probably would have created the subprime mortgage loan on its own. There are after all pay-day lenders and finance companies that regularly do business with individuals further down in the credit rankings. Would it have grown to $2.7 trillion without government insistence? Not a chance.
As it turns out, the role of government is a key question in the debate and a key misunderstanding in Congress. Despite the best intentions, government intervention always produces unpredictable market distortions and the greater the intervention the greater the distortion. Although the idea that a few politicians and administrators can successfully plan an economy as complex as ours is well-entrenched in Washington today, there are no historical examples where that has been case. The House Financial Services Committee was no better at directing the national mortgage markets than the Soviets were at managing their markets for shoes, cars or vodka.
On July 14, 2008, only a few months before Fannie and Freddie were placed in government receivership, Committee Chairman Barney Frank made this statement on CNBC: "I think this is a case where Fannie and Freddie are fundamentally sound, that they are not in danger of going under. They're not the best investments these days from the long-term standpoint going back. I think they are in good shape going forward." Although Congressmen Frank has now seen the error of his previous view and is calling for the abolition of Fannie and Freddie, others have more learning ahead of them.
Last week the Treasury hosted the conference on the Future of Housing Finance and the question of what to do with the massive housing market infrastructure composed of Fannie, Freddie, the FHA, Ginnie Mae, the Veterans Administration and the Federal Home Loan Banks. During the conference, Treasury Secretary Tim Geithner made the case for continued government intervention in housing by proposing a taxpayer guarantee that he said would be appropriately priced so that taxpayers would not suffer losses. But this is exactly the system we had in place that led to the collapse. As we see in the comment from Congressman Frank, government regulators have no meaningful capacity to measure and price risk because in the final analysis they are playing with other people's money. Pricing risk is always better left to private markets where those making the decisions will ultimately suffer personally for their mistakes.
According to Secretary Geithner, "a full retreat by private financial institutions from many forms of mortgage and consumer lending provides a compelling illustration [of what would happen without a government role]." Unfortunately, he has this exactly backwards. As the private sector became unable to compete with the government lenders, those financial institutions were driven to take on insane risks. We will stipulate that they were misguided to chase Fannie and Freddie down this rabbit hole. The reason the private sector now accounts for less than 10 percent of mortgage lending is that the government has forced it out of the market by continuing to take risks that have no consequences other than the billions of losses which will fall to taxpayers. The government has unlimited capital to support loan losses, whereas the private sector does not.
We need to look at all of the elements distorting the housing industry today. That would include the assorted foreclosure avoidance programs which are running a re-default rate close to 50 percent. These programs are simply delaying the price adjustments necessary to bring the market back to alignment and stability. If we want to support low income housing, it should be done on budget with direct grants to those homeowners rather than attempting to manipulate sources of private capital. The analysis must also include the possible elimination of all the tax subsidies around the housing asset class. Housing real estate is the only asset class with tax subsidies for acquisition, tax subsidies for financing the holding period and tax subsidies for the capital gains upon sale.
In his remarks, Secretary Geithner referred to other countries, but he failed to cite the case of Canada. In Canada, none of these distortions exist, yet the Canadian home ownership rate is higher than the United States. And, there was no mortgage default crisis in Canada because the private sector with private risk capital set the terms and conditions for the loans.
Based on the opening statements at last week's conference, there is no reason for optimism that any lessons were learned from the recent financial collapse resulting from 75 years of mortgage market manipulation. If you are in the government, the answer to any problem is simply another or different government program.
The French Way
The French government announced last week that it will soon be deporting hundreds of gypsies to their countries of origin. Under EU rules freedom of movement is guaranteed between countries, subject to local regulations. After three months in France, however, new arrivals must demonstrate that they are working or studying full-time, have a source of financial support, and have sufficient funds to pay for their own healthcare. Each family will receive € 300 per adult and € 100 per child to ease their resettlement back home. Authorities are also collecting biometric information to be able to identify those that return to France illegally in the hopes of collecting a second relocation bonus. "We are not stigmatizing a community, but making people respect the law," explained Interior Minister Brice Hortefeux.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.