In his latest piece, Thomas Sowell effectively argues that the “housing crash” is mostly the responsibility of government policies. Sowell points out two policies in particular: local government restrictions on building, coupled with state and federal policies that push lenders to lend to high-risk borrowers.
In effect, there was a higher demand for loans when lenders were encouraged and sometimes forced by the government to give loans to those who otherwise would not be able to afford them. Then at the same time, in many areas there was a shortage in housing thanks to various environmental, “smart-growth” and “open space” policies that restricted the construction of new homes. Thus, due to the laws of supply and demand, housing prices went up.
Still, encouraged by the government giving them the power to receive loans at the lenders’ behest, those with lower incomes went for housing loans for which they could not afford to even apply before. Lenders, meanwhile, who are businesses, and thus need to make decisions based on the best possible way to make money, were forced to exploit loopholes in the government policies that they thought would still allow them to make money. The result: sub-prime lenders offering interest only loans to borrowers who were applying for homes that were beyond their means.
Now, we’re left with record numbers of foreclosures and sub-prime lenders going belly-up…and a stagnant housing market. And all of this could have been largely avoided had the market been left to decide, as opposed to meddlesome politicians.
As Sowell points out, politicians are quick to cry “exploitation” when lenders offer high-risk applicants a high interest rate that accurately reflects the risk involved in lending the money. After all, lenders are risking their own capital, putting it out there under the assumption that it will be paid back in full, plus interest for the service of putting it out there to begin with. If there is a higher risk that it will be defaulted, a higher interest needs to be paid, so if the loan eventually defaults, they can recoup as much back as possible. This is why when you apply for a credit card, or any sort of bank loan, whether it be consumer, auto or home, your credit score is checked, and you are given a lower rate if you have a good credit score, higher if it is bad.
However, the same politicians are now crying exploitation again after lenders were able to find a loophole in the policies enacted by those very same politicians that allowed them to offer loans to high-risk borrowers that had low, interest only payments at first, but then ballooned as the principal was factored in. This, factored with the skyrocketing costs of existing homes due to local restrictions on building, led to people of modest incomes to stretch well beyond their means in order to be able to afford a home at all, thus compounding the problem.
Of course, politicians love to blame, but hate to take responsibility for the effects of their seemingly well-intended, but misguided policies. As expected, the blame is being placed on “aggressive lending” practices by sub-prime lenders, even though because of government policies, these businesses were forced to get creative in order to feed the propped-up demand for loans.
The lesson learned here: leave such things to the market; meddling by politicians, as well-intentioned as it may seem, is no match for the laws of supply and demand, and will nearly always lead to disaster.