Wednesday, March 19, 2008

What Went Wrong In Housing?

There's a great article today in the WSJ about what went wrong in the housing market. Short version -- a lot of people and institutions dropped the ball big time.

Democrats are quick to blame Republicans, who were in power during the housing bubble and subprime lending frenzy. For years, America's leaders failed to restrain the markets, companies, investors and consumers from the missteps that led to the most pervasive financial crisis in decades.

But in hindsight, the failure stretches across government and across party lines. At bottom are two strong currents. From the Republican president to urban Democratic congressmen, homeownership was pushed as an overriding and unquestioned goal. And many significant attempts at regulation were obstructed by the prevailing belief that the economy did best when financial markets operated as freely as possible.

The Bush administration coupled cheerleading for homeownership with pressure on government-sponsored mortgage lenders Fannie Mae and Freddie Mac to provide funding for riskier mortgages. Both Democrats and Republicans stood by as Fannie and Freddie invested heavily in securities backed by subprime loans. Democratic congressmen pushed a federal law to restrain lending practices later discredited, but Republicans with some Democratic allies blocked or countered with weaker versions.

And at the Federal Reserve, Chairman Alan Greenspan, revered by both parties for his economic management, resisted using the Fed's authority to more aggressively regulate lender behavior.

The blame spreads beyond Washington, to state capitals. In California, home to most of the country's subprime lenders, Democratic state lawmakers didn't support laws that would have imposed tougher regulations on a prized local industry. Politicians of all stripes cheered on the lower interest rates that sparked the boom in housing and excesses in credit.

Let me chime in with a few observations.

1.) There's a fundamental belief that regulation is bad and deregulation is good. That's a horrible over-simplification. It's important to remember that at the base of capitalism is greed. Some greed is a good thing -- it can inspire people to make better products more efficiently which means the end result costs less. That's good and I think it's safe to say we all like better products cheaper. Too much greed compromises ethics. That's bad. There are plenty of situations in the last 25 years that demonstrate that. For example, the S&P crisis, Enron and Worldcom and now the housing mess. The line between the good and bad effects of greed is very fine and it moves regularly.

2.) There is such a thing as too much regulation. Red tape is a bad thing if it gets in the way of innovation or development. A classic example is the lack of building new refining capacity in the US since the 1970s. Like it or not, the US uses a ton of oil products and our demand for oil products has increased greatly since the late 1970s if only by reason of population growth. Yet we are still using the same refining plant developed when my parents were in their prime. That's a problem. And no -- this is not a call from Bonddad to pollute or cause a ton of environmental damage. But it is a call to deal with the situation in a far better way then we are dealing with it now. Frankly, that probably means developing a national energy policy -- which we should have done 30 years ago.

3.) The government's role is to play referee. Before his resignation, Eliot Spitzer was one of the best things to happen to Wall Street in a very long time. Why? Because he enforced the rules -- which is something that has to be done. Here's s simple question: how many food recalls have there been in the last three years? A ton. Why? Because the government isn't enforcing the rules. I don't know about you guys, but I like the idea of my food being safe to eat. Maybe I'm different. But when the CEO of the latest company to initiate a meat recall said in open testimony on Capital Hill that he was using sick animals I almost become a vegetarian (almost). That's the end result of not enforcing the rules. That does not mean we make it impossible to do business. But we do need to make sure the rules are followed and that means enforcement.

That's my rant on the topic.