If Fish Had Wings
By Arnold Kling
From a systemic point of view, the real issue is that predatory lending on a large scale helped to massively inflate the housing/credit bubble of the aughts. If the home loan market had been regulated stringently enough to keep mortgage lending relatively sober, the bubble most likely would have been half the size it ended up at…
Well, yes, if a regulator had stepped in and required 10 percent down payments, the bubble would have been much smaller. That is excellent hindsight. But in the real world, with real politicians, there is no way that a regulator would have done that. The result would have been to drive first-time homebuyers, particularly minorities, out of the market. That was an inconceivable policy decision in 2004 or 2005.
One of the assumptions about the “markets fail, use government” folks is that government always knows what it’s doing. I guarantee you that the next financial bubble will be something that the regulators miss, just as they missed the last one.
I would also add that I am skeptical about a regulator’s ability to keep smart financial firms from separating dumb investors from their money. As they say in software, you can’t make a system that is idiot-proof. They will just build a better idiot.
But let me reiterate here that the people who were most taken advantage of in the housing bubble were not the folks who bought houses. They were the professional money managers who invested in AAA-rated securities. And ultimately the people most taken advantage of were the taxpayers who bailed out those investors.
Finally, on the issue of those taxpayer losses. We are seeing reports that TARP is costing less than expected. I hope that is the case, but the reports are premature. The housing market imbalances are not behind us yet. And I don’t know how much of the reduction in losses at various banks merely represents a transfer of risk to the Fed (which, as far as I know, carries its mortgage securities at book value and does not hedge their interest-rate risk), Freddie Mac, and Fannie Mae.