Keep Government Out of Mortgages

There is serious thinking in Washington , DC and Wall Street that the solution to the credit crisis is for the Fed to buy up all the mortgages that are in trouble. Not so fast!

Rick Santelli, CNBC analyst working in the trading pit, urged Ben Bernanke not to buy triple-A mortgage securities. "The Federal government, in a capitalistic society, should not own real estate unless you're going to put a Hammer & Sickle on the flag!" His remark was in response to both the Barney Frank bill and a CNBC host that gleefully suggested the Fed swallowing up all of the bad debt at banks across the country, "just put it on the Fed's balance sheet," she suggested. She obviously received her economics degree at The University of Karl Marx. He implied that this is banking socialism, and we all know that socialism has been totally discredited.

However, the government has done quite enough, intervening in the market. Act after act, pushing banks to lend in riskier areas, creating excess housing demand. Then another act, messing things up, then another act to fix that, only to find it made it worse, then yet another act. Now there is talk of government buying all the bad loans. This has to stop!

As they are saying over at DownsizeDC, in today's member email:

The current housing crisis, and all that flows from it, comes from two main sources, both deriving from Washington .  

• First, Congress passed something called the "Community Reinvestment Act" in 1977, resulting in the creation of bureaucratic regulations designed to encourage, or even compel, financial institutions to make loans to people with lower incomes. These regulations were then amended in 1995 and 2005 to create different rules for institutions of different sizes, so that various kinds of institutions would be better able to meet the government's goals for fostering home ownership in lower income communities.
• Second, the Federal Reserve starting making loans available to the banking system at extremely low interest rates.
• Third, steps one and two combined to make cheap housing loans available to people who could not have afforded or qualified for them before. This caused an increased demand for housing that sent home prices spiraling upward.
• Fourth, mortgage lenders managed the risk involved in making these loans by selling their mortgages to other companies, which in turn thought that they were managing their own risk because they had a wide variety of mortgages, from many different types of borrowers, in their portfolio.
• Fifth, these decisions about how to manage the increased risk created by the "Community Reinvestment Act" were all in error, because the Fed's policy of easy money had falsely inflated the value of ALL homes. This meant that good mortgages could not be used to manage the risk involved in questionable mortgages, because the value of ALL homes was falsely inflated.
• Sixth, as with all inflationary booms, increases in home prices finally absorbed the increased purchasing power provided by the Fed, leading to a slow-down in home purchases. When this moment arrived, everyone realized that the homes they had purchased were not really, worth what they had paid for them. The defaults and foreclosures then began, along with the collapse of the financial institutions that owned these unsound mortgages.

The convoluted scenario described above has been simplified in reporting to two words: sub-prime loans. These two words, combined with lies that lenders took advantage of poor unsuspecting customers, supposedly explains it all. However, that is simple-minded and false.

A study by the Mortgage Bankers Association tells the true story. In the third quarter of last year fixed rate mortgages accounted for 45% of foreclosures, while sub-prime ARMs accounted for only 43%.

It is not hard to understand why. Who wants to owe more than what your home is really worth? Many borrowers are choosing to default, and walk away. This is especially happening with speculators who bought houses in order to "flip" them. To cope with these foreclosures banks have offered their bad mortgages as collateral to borrow money from the Federal Reserve.

The money the Fed lends through this process is created out of thin air. This has two shocking consequences. First, the Fed is coming to effectively own an increasing portion of America's stock of housing, and two, these Federal Reserve loans, and the Fed printing presses are inflating the money supply, causing prices to rise all through the economy.

As the Fed creates more and more new dollars, the value of all the previously existing dollars declines. This forces people to seek ways to protect their wealth against the devaluing effects of inflation. Thus . . .

• People buy other currencies, causing the exchange value of the dollar to fall
• They buy gold, pushing the price up above $1,000 an ounce
• And they buy oil futures, driving up those prices too.

But it gets worse . . .

Inflation is making foreign investors reluctant to buy U.S. Treasury bonds. Who wants to hold bonds denominated in dollars when the Federal Reserve is reducing the value of the dollar?

The "London Telegraph" reports that foreign participation at a recent auction of U.S. Treasury bonds fell from 25% to less than 6%.

Unfortunately this will continue. The Federal government will only have two options for funding its ever-growing deficits. The government must either pay higher interest on its bonds, to compensate lenders for the monetary inflation, or it must sell its bonds to the Federal Reserve System, which will buy the bonds with yet more money created out of thin air, adding still more fuel to the inflationary fire.

The more the Federal government has to pay in interest, the larger the deficits will grow, or, the more it borrows from the Federal Reserve, the more it will have to pay in interest to private lenders. It is a vicious bind. Finally, everyone realizes that the more rapidly growing inflation is unstoppable. Ludwig von Mises, the great Austrian economist called what then happens, “Crack-up Boom.” The mother of all bubbles bursts. The dollar is finally worth next to nothing.

There is one thing the Federal government could do immediately to lessen this bind. It could cut spending drastically to balance its budget, thereby reducing inflationary pressures. Please use the DownsizeDC "Unfunded Liabilities" campaign to ask Congress to do exactly that.

Add your personal comments. CONGRESS MUST BALANCE THE BUDGET NOW.

You can send your message here, at DownsizeDC.org .

Then, do one more thing: Send Congress a second message asking them to pass Ron Paul's "Honest Money" bills. Use your personal comments to tell Congress that you are aware that the current crisis was caused by a combination of the "Community Reinvestment Act" and the Federal Reserve's easy credit policy. Tell them you want Ron Paul's "Honest Money" bills to curb the ability of the Fed to inflate the money supply.

You can send that message here, at DownsizeDC.org.