US housing dream turns into nightmare
Updated: 2011-05-13 10:58
By Xiao Gang (China Daily European Weekly)
Govt policy was one of the main causes of the subprime crisis
If the global financial crisis has caused a decline in the popularity of the free market system, then Reforming America's Housing Financial Market, a report to Congress submitted by the United States Treasury and the Department of Housing and Urban Development virtually implies an end to the government's flawed home policy.
The US real estate market had more government involvement than nearly any other sector. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), known as government-sponsored enterprises (GSEs), issued trillions of dollars in bonds to purchase or guarantee and securitize home loans made by commercial banks and other creditors. By the end of 2009, Fannie Mae and Freddie Mac owned or guaranteed about $5.5 trillion (3.9 trillion euros) worth of home mortgages, providing adequate funds to home lenders and facilitating consumers' home purchases.
As a result, a mortgage became almost a synonym for owning a home, making American families, including middle-class and low-income people, heavily indebted. Finally, the housing price bubble burst and the financial system seized up.
After being taken over by the US government, the GSEs have received nearly $150 billion of taxpayers' money, forming the most costly part of a bailout scheme. Moreover, we may not yet have seen the end of the affair, and the cost could increase.
Home ownership has become an important part of the "American dream". The US Congress has passed many laws that encourage people to own a home. For example, in addition to setting up the GSEs, income tax deductions for mortgage interest were permitted and exemptions from capital gains tax were allowed. The purpose of these measures was to make mortgages more easily available to people eager to buy a home.
Politicians, of course, are keen to take popular positions to gain votes and people's support. The GSEs, making "affordable housing goals" their mission, have aggressively grown their businesses at a rapid pace in the past few decades.
Recently, the US Senate Permanent Subcommittee on Investigations issued a 635-page report, Anatomy of a Financial Collapse. The report provides enough evidence to lay the blame on financial institutions, regulators and ratings agencies. But it would have been more complete if it directly pointed flawed government policies that distorted the housing market. There is no doubt that the government policy was one of the main causes of the crisis, and that policymakers should shoulder their responsibilities.
Historically, financial innovation arose from the desire to avoid existing regulations to make greater profits. This process of avoiding regulations can be viewed as "loophole mining". In other words, it is a cat-and-mouse game between financial institutions and regulators. US regulators planned to pursue civil claims against the former chief executive of Freddie Mac over failures to appropriately disclose the company's exposure to high-risk mortgage loans.
A similar case was registered against Citigroup and two of its executives. The regulators are expected to file up to 100 lawsuits against executives of bailed-out banks in the next two years. But it is very difficult to judge whether the bankers have actually broken the laws or have just exploited regulatory loopholes to develop financial innovative products. On the contrary, it is clear that government policies increased home loans and pumped up home prices, leading to massive mortgage defaults in the end.
An economic principle tells us: "You don't get something for nothing". This is certainly true of governments. In the 1980s, the loss of the billions of dollars of farmer and student loans required the US government's bailout. At that time, there was growing concern over the health of the federal credit agencies. So the government set new rules that required such agencies to increase capital to offset any potential losses. Too bad, that history repeats itself, and this time the government's bailout has been even more costly.
Admittedly, the GSEs used to play an important role in developing the real estate financial market, which boosted US prosperity for a quite long time and helped countless "average people" realize their dream of homeownership. But things will develop in the opposite direction when they become extreme. Now it is time for the government to take corrective action.
The newly proposed reform of the housing financial market in the US redefines the relationship between the government and the market, shifting the government's role from that of an active player to that of a "janitor". Therefore, the US government wants to gradually exit the housing financial market. Since this April, the US Treasury has begun to sell its $142 billion holding in GSEs' bonds, which it bought during the worst period of the crisis, at the rate of $10 billion each month.
To invest in the GSEs' bonds is truly profitable. Bank of China used to be the biggest bondholder among domestic peers, and has still been getting a normal payment of principal and interest in the three years since the US housing bubble burst, hitting the GSEs.
Currently, Standard & Poor's has reduced its outlook on US debt from "stable" to "negative", the first time in 70 years. The stock markets reacted with shock, but investors still played down concerns over the US' creditworthiness, regarding investing in US sovereign debt as "risk-free". Recognizing that the US deficit is a political problem, financial institutions across the world continue to operate on the assumption that the US will continue to protect investors' interests in its debt.
The biggest lesson for the government policy stems from pursuing excessive homeownership. Japan's was a similar case in the 1970s and 1980s. Chasing this "American dream" and "Japanese dream" encouraged financial institutions to misallocate too much capital and credit into the home markets.
Failure is the mother of success. As long as governments can learn lessons from their experiences and make appropriate policy changes, a more balanced, job-creating economy can definitely be attained.
The author is chairman of the board of directors of Bank of China.
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