From housing to Wall Street, government prodding and over-
regulation have caused more problems than they've solved.
When Congress passed the Dodd-Frank Wall Street Reform and
Consumer Protection Act last month, the rationale for yet another
monolithic regulatory bill was that the economic and housing bubble
crisis was caused by too little regulation.
In fact, the evidence is becoming increasingly clear that over-
regulation and Washington interference were the major culprits.
All bubbles burst, so the key question is not "Why did housing
collapse beginning in 2007?", but "Why did the bubble appear in the
The answer has many facets, but a common element is government
support for home ownership.
History of interference
As far back as 1913, Uncle Sam carved out a tax deduction for
interest that has since become the politically sacrosanct but
economically unsound tax break for home loans. Essentially, this is
welfare for the wealthy, since it primarily benefits rich
homeowners. Even worse, a comparison with other countries that don't
provide such a deduction shows that this tax break doesn't
necessarily help home ownership.
Government increased its role in housing during the Great
Depression with the creation of Fannie Mae, which was designed to
create a liquid secondary mortgage market, thus freeing lenders to
make more loans. Washington expanded this effort in the 1970s by
creating Freddie Mac.
Prior to the federal government getting into the business of
financing houses, banks didn't need a lot of regulations to keep
them from lending to borrowers with poor credit history. Without the
moral hazard of knowing that they could unload questionable mortgage
loans on to taxpayer-supported entities, banks required at least a
20 percent down payment and a satisfactory credit history.
But over time, as the government passed regulations such as the
Community Reinvestment Act of 1977 to encourage lending to marginal
borrowers, banks were pressured into unloading their loans on the
government, thereby letting the taxpayers assume the risk of
nonpayment. As a result, banks didn't have to worry about
nonpayment, only about how many fees they could generate by
originating the loans.
This trend accelerated during the Clinton years when Congress
made the first $500,000 of capital gains on the sale of a home tax
free, making real estate a very lucrative investment. And the
Clinton administration pushed excessively high quotas on Fannie and
Freddie to buy mortgages made to low-income borrowers.
In 2004, President Bush helped put the icing on the cake when he
pushed for a new "Zero Down Payment" program for federally insured
home loans. Soon thereafter, a whole new bracket of income-earners
could afford homes.
Given the distorting nature of these incentives, what is
remarkable is not that the mortgage market collapsed, but that the
collapse was not even more severe. Nor was the purported rationale
of these heavy-handed regulations - that it would encourage home
ownership - ever vindicated.
Many other developed countries have achieved far higher rates of
home ownership without encouraging banks to make bad loans, allowing
banks to unload loans on taxpayers, or rewarding their richest
citizens with tax benefits and subsidies of up to a million dollars
for buying the most extravagant homes. …