by Mitch Kokai
Senior Political Analyst, John Locke Foundation
What caused the financial crisis? How can we prevent another one from happening again? The answers you most often hear to those questions are (1) greed and deregulation and (2) the Dodd-Frank law.
But they’re patently inadequate. Greed — or the desire for monetary gain — has always been with us and always will be. And no one has convincingly linked financial deregulation to the crisis. Dodd-Frank, enacted to increase regulation, confers too-big-to-fail status on very large financial institutions, which incentivizes unduly risky behavior and penalizes smaller competitors.
The real problem was housing finance, argues my American Enterprise Institute colleague Peter Wallison in his new book “Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again.” Without changes in housing finance policy, he says, there would have been no financial crisis in 2008.
Government policies encouraged the granting of mortgages to non-creditworthy homebuyers, and government-sponsored enterprises Fannie Mae and Freddie Mac funneled securities laced with high-risk mortgages into major financial institutions. When house prices suddenly and unexpectedly dropped in 2007, these mortgage-backed securities became unsellable and the financial crisis quickly followed. …
… Could it happen again? Wallison points out that government regulators are once again reducing the credit standards for mortgage seekers. The argument, as in the 1990s and 2000s, is that traditional standards are misleading and unduly prevent low-income and minority households from buying homes.
Fannie and Freddie are now purchasing the large majority of mortgages and announced last month they would buy mortgages with only 3 percent down payments. The qualified mortgage standards laid down by HUD and other regulators in October allowed for mortgages with zero down payments.
That sounds like a recipe for another housing bubble — and for mass foreclosures, which hurt the policies’ intended beneficiaries — and perhaps for another financial crisis as well.