Housing and financial markets are in distress, and Congress is
ready once again to ride to the rescue. Needed long-term
reforms to government-sponsored Fannie Mae and Freddie Mac, as
well as the Federal Housing Administration, may be swept up in the
process, but Congress is mainly looking to help troubled homeowners
now. There is precious little good Congress can do in the near
term, and much harm. To maximize the first and minimize the second,
Members should keep three simple issues in mind.
Issue 1: The Problem
The central economic problem the nation faces today is that
markets are passing through dual asset bubbles-one in housing and a
related one in financial markets-and there's no alternative to a
full correction. In many areas of the country, housing prices rose
too fast for too long and are now coming back to Earth. Thousands
of borrowers have mortgages they cannot afford, and based on those
mortgages, the financial markets have constructed complex assets
that are declining rapidly in value.
The root causes of these bubbles are that mortgages were
underwritten for borrowers who often were not credit worthy, often
on terms even credit-worthy borrowers could not afford for long,
and for properties that were often overvalued. Many elements led to
these circumstances, and many people in and out of government made
mistakes. As a result, many investors and many current and former
homeowners are going to suffer serious losses.
Recovering from asset bubbles is painful and rarely smooth,
but there is no safe or prudent way to short-circuit the
process by which assets find their new, lower, and proper values
based on economic fundamentals. Congressional attempts to slow
or soften the process would only serve to prolong and ultimately
accentuate the pain. The sooner these asset prices find their
proper levels, the sooner families, investors, and businesses can
get on with restoring their finances and resuming normal business
activity. Anyone offering an elixir to prevent or short-circuit
this correction is selling snake oil.
Issue 2: The Solution
With housing values falling significantly in some cities and
states, the values of related financial assets falling in tandem,
and great uncertainty operating in many markets, the private sector
is under tremendous strain. Yet, once again, market
forces-individuals and firms in pursuit of their own best
interests-are proving up to the task.
The economic healing process underway is, foremost, one of price
discovery. Housing and credit markets are discovering the new,
proper price levels for their troubled assets. Neighborhoods
that saw unrealistic home price appreciation are learning how far
prices must fall. Homeowners who paid too much or borrowed unwisely
are learning whether they will be able to stay in their homes.
Investors who bought securities related to these assets are
learning how much in losses they must suffer.
Markets are also working to make sure that past mistakes are not
repeated. Financial markets have learned the price of inadequate
disclosure and transparency, risk management and assessment.
Participants understand that losses happen in a profit-and-loss
economy. But they also work hard to avoid unnecessary losses, and
that means learning from past mistakes. They have a powerful
incentive to learn today's lessons in full: According to one recent
study, these mistakes will cost U.S. financial institutions about
$460 billion, while financial institutions globally will suffer
about $1.2 trillion in losses.
Faced with such losses, shareholders are demanding more
information from the firms they own. Corporate boards have
woken from their slumber and are exercising their oversight
responsibilities more vigorously. Institutions are demanding more
information from the counterparties to their transactions. Private
credit rating agencies are demanding more information from those
who sell securities, while investors are demanding that credit
rating agencies be more thorough in attaching credit ratings to the
The sole role of government in this process is to ensure that
markets are functioning, that full and accurate information is
available, and that contracts are honored. While the private
market, unfettered by foolish policy and red tape, is capable of
seeing this process through, a light touch by government can help
to accelerate the process. An excellent example of such a light
touch is the Hope Now program, orchestrated in October 2007 by the
Departments of Treasury and Housing and Urban Development to help
credit-worthy homeowners keep their homes.
Hopes Realized with Hope Now. When homeowners
fall behind on their mortgages, lenders are often able and willing
to work with them to restructure the terms. Lenders are
willing to renegotiate because the foreclosure process is expensive
and because lenders are generally ill-equipped to take possession
of and resell a property. In short, it's often cheaper for the
lender to keep the homeowner in the home.
The incentives for lenders to be flexible are even greater when
housing values are falling. The homeowner has even less
incentive to try to keep up payments if the face value of the note
exceeds the new, lower value of the property. If the lender
receives the property following a foreclosure, the lender is still
faced with the loss from a property worth less than the note and is
then faced with the prospect of finding a new owner under
unfavorable market conditions. Hope Now was launched to amplify
ongoing private efforts to rework existing, at-risk mortgages.
Hope Now is a voluntary alliance of scores of servicers,
investors, counselors, and other mortgage market participants
ranging from Catholic Charities to the Bank of America. Many
troubled homeowners fail to contact their mortgage companies until
they've missed a number of payments and are possibly already in
foreclosure proceedings. Participants in the alliance seek to reach
out aggressively to potentially at-risk, credit-worthy homeowners
to help them rework their mortgages. With the help of the Hope Now
alliance, the mortgage industry is helping more than 160,000
families a month to keep their homes either by modifying their
loans or by developing more realistic repayment plans. Since the summer of 2007, the industry
overall has reworked over one million mortgages to help homeowners
stay in their homes.
The Federal Reserve's Role. The Federal Reserve
is playing a similar role in assuring orderly financial markets.
Markets sometimes "seize up" as asset prices seek their new, lower
levels. Resistance to surprisingly lower sales prices meets buyer
uncertainty about fair prices, and, suddenly, no transaction is
In recent months, a number of financial markets have seized up
temporarily, beginning last summer with the commercial paper
market. During these periods of extreme stress, the Federal Reserve
has properly stepped in by providing liquidity directly to those
markets in trouble, accepting as temporary collateral the excess
amounts of assets for sale and thus restoring orderly
The Fed has taken even more aggressive steps to assure orderly
financial markets in husbanding the acquisition of the failed
investment firm Bear Stearns by another investment firm, J.P.
Morgan. In the transaction, Bear Stearns shareholders were
practically wiped out, but Bear's various employee, business, and
client relationships were largely maintained. The Fed's action
also provided markets with a needed dose of confidence by
demonstrating its willingness and ability to take bold steps to
assure that markets remained open and operated properly so that
private participants could exchange as they see fit.
Issue Three: Federal Government's Heavy-Handed
HELP NOT WANTED
The private sector is working effectively to sort through the
problems in both the housing and financial markets by acknowledging
its mistakes, admitting its losses, and working to keep troubled
but credit-worthy borrowers in their homes. Yet Congress seems
determined to "do something." Before it acts, Congress ought to
consider a few simple questions:
- Is the real intent to prop up values and bailout homeowners
If so, then Congress should understand that their good
intentions will come to naught, and may do great harm by creating
even more uncertainty. For example, Senator Isakson's (R-GA)
proposal for a $15,000 refundable tax credit proposal would do
nothing to help current homeowners stay in their homes.
- If the intention is to improve the working of the markets,
can the legislation be implemented soon enough to matter?
Representative Barney Frank (D-MA) and Senator Chris Dodd (D-CT)
have proposed legislation effectively injecting the Federal Housing
Authority (FHA) into the already operating Hope Now alliance.
However, there is little chance that this would have any direct
effect on homeowners until late in the fall of 2008 and less chance
that it would add to what Hope Now is already accomplishing.
- Would the effects of the legislation disrupt the
normalizing market processes already underway in the housing
sector, thus prolonging the period of recovery?
The Frank-Dodd bill and similar approaches threaten to disrupt
and slow the private sector's efforts to help troubled borrowers,
because either borrowers or lenders may believe they could get
taxpayer-subsidized terms under the new FHA-based arrangements when
they do become available.
- Would the effects of the legislation disrupt the
normalizing market processes already underway in the financial
sector, thus prolonging its period of recovery?
Financial markets are working diligently to correct the mistakes
that have led to enormous losses. The circumstances are difficult,
even with the current known legal and regulatory frameworks.
Congressional threats to impose intrusive new regulations on
financial markets represent yet another new and ill-defined source
of uncertainty. The result would likely be a quick halt to
many of these private corrective actions.
- Would the legislation make sense in the absence of current
troubled conditions in the housing sector or financial
If the legislation is ineffective in the near term, then at
least it should be good long-term policy. Of particular concern is
the inclination to expand the roles of the housing GSEs and the FHA
and to create new ad hoc tax provisions relating to housing. A
greater role for these agencies would not have prevented the
current troubles, would not do so in the future, and would expose
taxpayers to greater future costs.
Many American homeowners are facing financial hardships
resulting from onerous mortgages and falling home values. Many
investors are facing financial losses as the risky instruments they
bought in happier times decline in value. These processes must work
through to conclusion for the economy to regain a sound footing,
and the private sector is working effectively toward this end.
Congressional action cannot change this reality, except by
prolonging and exacerbating the situation. Congress should focus
its energies on policies to strengthen the economy coming out of
the current slowdown.
Ph.D., is Norman B. Ture Senior Fellow in the Economics of
Fiscal Policy in the Thomas A. Roe Institute for Economic Policy
Studies at The Heritage Foundation.
federal housing government-sponsored entities (GSEs) are Fannie Mae
and the Freddie Mac, established in 1936 and 1970, respectively, to
support housing in America primarily by creating more stability in
housing markets, more affordability of homes, and more liquid
secondary markets for mortgage-backed securities. For a discussion
of the needed reforms, see Ron Utt, "Time to Reform Fannie Mae and
Freddie Mac," Heritage Foundation Backgrounder
June 20, 2005, at www.heritage.org/Research/GovernmentReform/bg1861.cfm.
Estimates are from an analysis by Goldman Sachs economist Andrew
Tilton, released March 26, 2008, as reported in Reuters and other
facilitating the transaction, the Federal Reserve also originally
pledged $30 billion in guarantees for specific Bear Stearns assets
of uncertain quality. However the transaction concludes, this part
of the Federal Reserve's involvement raises a number of important