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Washington Still Not Learning from Its Mistakes, Home Loans to Bad-Credit Borrowers Edition


Sometimes, one can seriously wonder whether Washington politicians will ever learn from the mistakes of the past. While we’re still dealing with the catastrophic effects of previous government housing subsidies, the Obama administration is pushing banks yet again to extend loans to people with poor credit. The Washington Post reports:

President Obama’s economic advisers and outside experts say the nation’s much-celebrated housing rebound is leaving too many people behind, including young people looking to buy their first homes and individuals with credit records weakened by the recession.

The Obama administration is engaged in a broad push to make more home loans available to people with weaker credit…officials say they are working to get banks to lend to a wider range of borrowers by taking advantage of taxpayer-backed programs — including those offered by the Federal Housing Administration — that insure home loans against default. Housing officials are urging the Justice Department to provide assurances to banks, which have become increasingly cautious, that they will not face legal or financial recriminations if they make loans to riskier borrowers who meet government standards but later default.

That’s the same FHA that was in bad shape and the subject of much controversy not too long ago. The American Enterprise Institute even has a Federal Housing Administration Watch website to monitor how much trouble the agency gets itself in, while also suggesting solutions how to fix it. In fact, the Post mentions AEI’s Ed Pinto in the story: 

Obama pledged in his State of the Union address to do more to make sure more Americans can enjoy the benefits of the housing recovery, but critics say encouraging banks to lend as broadly as the administration hopes will sow the seeds of another housing disaster and endanger taxpayer dollars.

“If that were to come to pass, that would open the floodgates to highly excessive risk and would send us right back on the same path we were just trying to recover from,” said Ed Pinto, a resident fellow at the American Enterprise Institute and former top executive at mortgage giant Fannie Mae.

And it’s not as if the government isn’t already deeply involved in the housing market:

Deciding which borrowers get loans might seem like something that should be left up to the private market. But since the financial crisis in 2008, the government has shaped most of the housing market, insuring between 80 percent and 90 percent of all new loans, according to the industry publication Inside Mortgage Finance. It has done so primarily through the Federal Housing Administration, which is part of the executive branch, and taxpayer-backed mortgage giants Fannie Mae and Freddie Mac, run by an independent regulator.

The FHA historically has been dedicated to making homeownership affordable for people of moderate means. Under FHA terms, a borrower can get a home loan with a credit score as low as 500 or a down payment as small as 3.5 percent. If borrowers with FHA loans default on their payments, taxpayers are on the line — a guarantee that should provide confidence to banks to lend.

Do you think that this type of loan guarantee will give banks the proper incentives to be a good steward of taxpayers’ money? No. In fact, a plan that ensures that banks won’t lose money or their government guarantee if and when their loans go bad — hardly the best way to promote prudence.

This is another case, like the SBA situation I wrote about yesterday, in which a market-failure argument is used to make the case for government intervention. In fact, it’s almost the same argument: Banks are too risk-adverse and and won’t lend money to deserving borrowers. See:

“If the only people who can get a loan have near-perfect credit and are putting down 25 percent, you’re leaving out of the market an entire population of creditworthy folks, which constrains demand and slows the recovery,” said Jim Parrott, who until January was the senior adviser on housing for the White House’s National Economic Council.”

But, as the story correctly notes, the alternative to not buying a house if you can’t afford it isn’t living in the street; it’s renting as one builds a credit score and saves money.

We shouldn’t forget that we are only a few years removed from the financial crisis that was the result of reckless behavior by government, banks, and borrowers, mostly driven by the illusion that there is such thing as a free lunch (see this great piece on the financial crisis by economist Russ Roberts. called “Gambling With Other People’s Money”).

But make no mistake, while this plan is presented as a way to help hopeful home buyers, the main beneficiaries will once again be the banking and real-estate industries. David Stockman’s new book has an entire chapter called “From Washington to Wall Street, Roots of the Great Housing Deformation.” Here is a great quote from the housing cronyism of the 80s:

For that reason, the guarantee fee catalyzed the forces of crony capitalism like rarely before in the history of federal housing programs. Home builders and suppliers of lumber, hardware, HVAC, and electrical products joined real estate agents, mortgage bankers and brokers, title lawyers, and dozens more in a mighty coalition to keep private enterprise humming on cheap, socialized credit. 

Here is the Post’s article. 


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