More free stuff!

What a week it’s been in politics.

On the campaign trail in California, President Obama cried out, “Free stuff! More free stuff!” The administration is again pushing banks to make taxpayer-subsidized mortgages to those with weaker credit ratings. While it is laudable to want folks to own houses, we continue to pursue policies that increase risk in the housing market. Have we learned nothing from the Great Recession?

While those on the left love to hate corporations and their profits, it is instructive to observe how the profit motive works. A corporation is simply a group of people. Groups of stockholders amass capital, labor, and know-how to provide something that the public wants. They do this because they desire to make a return on their capital investment. In the process, they create jobs, pay wages to employees, and shell out huge sums of taxes to state, local, and Federal government coffers. Evil stuff, huh?

Now the key to making a profit is to avoid booking a loss. In the banking scenario, that means loans must be granted conservatively. Defaulted loans (such as home foreclosures) are very expensive, and many successful (performing) loans are required to offset the expense of each failing one. As a result, banks extend mortgages very carefully, controlling the risk they are undertaking by assessing the ability of mortgagees to repay their loans. You might say that banks are conservative precisely because of their profit motive.

And that they are, until Uncle Sugar steps in with promises to subsidize losses. This reduces the risk that banks face and makes them less conservative, more willing to make loans to those who wouldn’t otherwise qualify. This is precisely what happened in the run-up to 2008 and we are still all paying for the collapse.

There is another path. The safest and most effective way of getting more folks into their own homes is to make sure that they have good jobs. Government policies should focus on economic growth and job creation. (A recent Pew poll revealed that both Democratic and Republican voters agree on this simple priority). Instead of more free stuff, let’s rely on economic growth and the dignity of work.

Because, at heart, we really understand that nothing is free. Someone always pays.

Slapped by the facts

Abandoned farm home - Great Depression

Home ownership is typically the largest financial asset of most American families. Equity (the excess value of your home above its mortgage balance) can be tapped to buy a needed new car, finance renovations, or send your kids to college. In retirement, with the mortgage discharged, the home may be sold to finance a nice retirement in Florida, Texas, or some other low tax (and high sun) haven.

Further, home ownership has proved to foster a sense of community far stronger than that of transient rental populations. Neighborhoods with high individual ownership rates tend to be neater and calmer and just nicer to live in. So it’s no wonder that government has fostered the notion that taxpayers’ pockets should be tapped to increase the general overall home ownership rate. What’s not to like about this?

Therefore in bipartisan fashion (meaning both Democrats and Republicans), we passed the Community Reinvestment Act (CRA) in 1977. The CRA was intended to coerce banks to make loans that they would not otherwise make. This is odd in that the language of the CRA also required that banks maintain sound and prudent lending practices. In typical government fashion, the banks were put into a bind that they could not escape. If they declined to make loans to uncreditworthy applicants, they would be punished. But if they made loans to uncreditworthy applicants, they would be punished. What’s a poor banker to do?

Since the punishment for not making loans was far greater, the loans rolled out. In association with other government “affordable housing” initiatives, down payments fell as low as 3.75% and losses were insured by the Federal Housing Authority (FHA). Lenders were incented to lend (protected from losses) and borrowers were incented to borrow, all lubricated by taxpayer largess.

The CRA was amped up in 1995 (Clinton) and again in 2005 (Bush). Politicians of both parties love to give our money away. And what did this largess gain us?

The financial crisis of 2008.

While there has been much argument that the CRA (and related government “affordable housing” programs) had no effect on the economy nor led to the financial crisis, a simple application of common sense might indicate otherwise.

• Would a down payment of 20% result in a sounder applicant than 3.75%? In other words, on a $200,000 loan, would you be more likely to walk away (default) if you had paid $40,000 down versus $7,500?

• As a mortgage originator, would you be more or less likely to grant a loan if you knew that the government would cover your losses?

Well, a recent study published by an independent, nonpartisan economic think tank has given us some answers. The National Bureau of Economic Research (NBER), based in Cambridge Massachusetts, has studied the impact of the Community Reinvestment Act. In their report, the NBER pulls no punches. “Did the Community Reinvestment Act(CRA) lead to Risky Lending? Yes, it did... We find that adherence to the act led to riskier lending by banks."

Read more here: http://voices.kansascity.com/entries/yes-community-reinvestment-act-encouraged-banks-make-risky-loans/#storylink=cpy

Barney Frank, who famously gambled with our money in 2003, had this to say then: “I want to roll the dice a little bit more in this situation towards subsidized housing." But by 2010, Rep. Frank had come to realize the error of his ways: "…it was a great mistake to push lower-income people into housing they couldn't afford and couldn't really handle once they had it." Even Barney was jarred into reality when slapped by the facts.

This sad tale reinforces the damage that the government can inflict when meddling with free markets. Although the intentions were admirable, the outcome was disastrous. Sometimes it’s best to let common sense, and a deep understanding of human nature, reign.

Lies, damned lies, and the financial meltdown

Luther Burbank, visionary, namesake.

A recent article in the Attleboro Sun Chronicle welcomes three new principals to our local school system (“Class Acts”, 9/3/2012). It is a heartwarming article and we all share in the excitement and promise of these promotions. But then, almost an afterthought, we notice something – the three new principals are all female.

There is a little known statistic that approximately half of our population is male. So when three executive positions are filled in the district, mightn’t we expect that at least one would be male?

Curious, we check the district’s website. Of the ten executive positions (nine principals and the superintendent), two are male and eight female. It looks pretty grim for the local guys.

On its face, just based on the numbers, this is highly discriminatory.

But there are lots of good reasons for the disparity. There are cultural and social forces at work that make the pool of female educators much larger than that of males. Females enter the profession at a much higher rate than males. The federal government (National Center for Education Statistics) reports that as of 2008, 76% of all public school teachers were female. So the fact that 80% of Attleboro’s school executives are female is not far off the mark.

It just goes to show that sometimes prima facie (“on its face”) discrimination can be explained by a deeper understanding of background facts.

Meanwhile, there is a small California savings and loan institution named after Luther Burbank, the famed botanist. Luther Burbank Savings was founded in 1983, committed to serving and retaining its customers rather than profiting public stockholders.

The bank is financially conservative and handily survived the financial meltdown of 2008. It did so by avoiding exotic financial vehicles such as sub-prime mortgages and collateralized mortgage obligations. It held the mortgages it issued for its own portfolio and did not sell them off. The funds released to mortgage borrowers came from the bank’s own depositors to whom it owed a fiduciary duty of care. It was successful because it required borrowers to qualify for the mortgage commitments they were about to undertake.

It would seem that this behavior should be congratulated and emulated. If more banks had behaved like this, there would have been no housing bubble and no financial meltdown.

So to honor Luther Burbank, your Department of Justice sued them for maintaining loan policies that had a “disparate impact” on African-Americans and Hispanics. The government observed that loans were made to the minority community at a statistically lower rate than their population.

The bank, admitting no guilt, settled the suit to avoid ruinously expensive litigation. It has loosened its lending standards and its depositors money is now at much greater risk. This is all due to the government’s “disparate impact” theory which says, regardless of fundamental causes, that if statistical variances exist, they must be discriminatory. No analysis of underlying causes is permitted.

If the problem is that minorities fail to qualify for standard mortgages, then we need to address those core issues. Holding a figurative gun to the head of a small community bank and forcing it to take greater risks runs counter to the lessons learned since 2008. And basing this on superficial statistics seems nonsensical at best.

If similar reasoning were applied to the Attleboro School district’s hiring policies, heads would roll.