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Lessons from the Mortgage Mess By: Bill Steigerwald
FrontPageMagazine.com | Wednesday, April 30, 2008

By now everyone with a roof over his head has heard about the subprime mortgage mess. Understanding why so many homeowners are defaulting on their mortgages or what mortgage foreclosures have to do with the collapse of the housing market, however, is another matter. To get a better grasp of the mortgage mess I called Ron Utt, The Heritage Foundation’s expert on housing policy. I talked to him Thursday, April 24, by phone from his unforeclosed home in Fredericksburg, Va.

Q: Where did the mortgage mess come from?
A: In the mid-1990s, when the whole lending profession was looking for greater and more expansive opportunities, they determined that by lowering the standards on mortgage credit they could greatly expand the volume of mortgages they wrote and simultaneously expand the volume of the number of people who became homeowners.

Q: In other words, we made it a lot easier to buy and borrow for a home?
A: Right. My estimate is that by going from the traditional lending standards of the past 50 years to the new modern or liberal lending standards, you added probably about 4 million to 5 million new households to the market. Every one of these people yielded some benefit, some profit, some commission, some revenue to all of the participants in this market, whether they are a real estate agent, a home builder, a mortgage broker, a surveyor, a home inspector.

Q: This subprime mortgage mess has been sold and publicized "as a national crisis." But your Heritage Foundation map of foreclosure rates around the country shows that Pennsylvania is only 6.6 percent. Ohio (13.7 percent), Michigan (12.3 percent) and Minnesota (12.4 percent) are the worst states.
A: The thing is, the whole mortgage credit problem is really a series of completely independent and often regionally based problems. In the case of the states you just cited, these are the Rust Belt states, where the use of subprime loans was not in excess of the national average. But defaults in those states have been very high, and for the most part that’s a function of adverse economics. With a reliance on manufacturing, and with many manufacturing firms having a difficult time competing, there have been a lot of layoffs in those states.

Q: So we shouldn’t be blaming the subprime mortgage crisis for the high numbers in those states?
A: Right. Not in those states. Then you have pockets in other different places. What happened in the Detroit metropolitan area? Or in the economically healthy Atlanta metropolitan area? From what I can determine, essentially what you had was a combination of a lot of predatory lenders and predatory borrowers combining to enhance each others’ well being.

Q: The national U.S. average for subprime foreclosures is 8.7 percent. What is the normal foreclosure rate on mortgages?
A: Well, historically pre-subprime it was close to about 1 percent. It bounced around between 1 percent and 2 percent. Many prime mortgages are experiencing problems now but nowhere near the level of the subprime market.

Q: Can we pin the blame on any one or any thing or any group for this crisis?
A: Not that I can tell. Unfortunately the real estate market tends to be as bubble-oriented or more so than any other. What happens is that otherwise sophisticated people who should know better begin to believe that the risks that we thought were there are really not there and they begin kidding themselves. What happens is that once people recognize that underwriting standards have declined, and that when you write a mortgage the person that you sell it to isn’t going to ask for documentation, then all kinds of sharpies come into the market and take advantage of this.

There’s so much money to be made in this. The typical mortgage originator made a commission between $750 and $1,500 on every mortgage they brought in. So if you’re talking about that kind of money, as long as a person can breathe and sign their name and nobody really cares beyond that, you’ll go out and put them in a house.

Was it any one person’s fault? Was there any particular law? No. It was just the gradual decline in standards as sort of a license for the quasi-criminal elements out there to come in. If everybody in Pittsburgh decided to leave their keys in their cars, for example, you’d probably expect auto thefts to soar, right? It’s the analogy to the mortgage credit market.

Q: If you could wave a magic wand, what would you do to end the crisis? Or do you just let it unravel?
A: I don’t have anything specific, but what we have to recognize is that in 1995, the homeownership rate was a little bit below 65 percent. That’s essentially where it had been in the 30 years up to that point. In 2004, thanks to the subprime market, it reached 69 percent, and that was a homeownership rate that was sustainable only through fraud and risk and irresponsible lending activities.

Now that we’ve returned to normal credit standards -- and that is you actually have to prove you can pay back the loan in order to get it -- we’re going to be drifting back to the 64 percent or 65 percent homeownership rate. That means that over the next couple of years, somewhere between four and five million people who are now homeowners are going to be “un-homeowners.” Simultaneously, that number of homes is going to come back on the market.

What Congress is essentially trying to do … is to figure out how can we sustain that 69 or 68 percent. And the only way you can do that is by perpetual bailout because we simply got to that rate by allowing unqualified people to become homeowners.

What we need is an orderly transition back to … a more normal and more sustainable and stable housing market. But that’s going to be an awkward transition. Through that process there is going to be a lot of foreclosures. And a lot of financial institutions are going to take big losses, but I think at this point they are capable of doing that. Out of this we learn important lessons and that should be the limits of government’s responsibility.

Bill Steigerwald is the Pittsburgh Tribune-Review's associate editor. Call him at (412) 320-7983. E-mail him at: bsteigerwald@tribweb.com.

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