NCPA - National Center for Policy Analysis

Another Housing Crisis on the Way?

March 4, 2014

America will soon experience another mortgage-related banking crisis, say Charles W. Calomiris, the Henry Kaufman Professor of Financial Institutions at Columbia Business School, and Stephen H. Haber, the A. A. and Jeanne Welch Milligan Professor in the School of Humanities and Sciences at Stanford University.

Banking crises are not as unpredictable as central bankers and officials like to suggest. They are not random shocks. When banks take on large amounts of risk in loans and investments, and when regulators allow those loans to be backed with low levels of capital, you get a financial crisis.

Calomiris and Haber contend that this "toxic combination" is nearly always due to a political deal. The subprime mortgage crisis, for example, involved large banks that wanted support for their merger plans, activist groups that wanted subsidized mortgage credit for constituents, and Fannie Mae and Freddie Mac, which wanted lax regulation and the ability to repurchase and securitize loans backed by borrowed money. When politicians joined in, what resulted was a set of permissive underwriting standards and thin capital requirements, leading to the worst recession since the 1930s.

Since the crisis, has the United States made the kind of reforms necessary to prevent this kind of deal-making from occurring again? No, say Calomiris and Haber. The reforms that have been put in place are weak, indicating that deal-making has once again taken place.

  • For example, the Consumer Financial Protection Bureau recently issued rules on "Qualifying Mortgages." The original proposal had strict standards, such as a 20 percent down payment and a housing-cost-to-income ratio of 28 percent. Those requirements were replaced with a total-debt-to-income ratio of 43 percent.
  • Similarly, the Volker Rule was meant to prevent banks from using depositors' money to invest in securities. But as enacted, the rule exempts real estate-related securities -- the very ones that were involved in the subprime crisis.

In short, there has been no real reform in the mortgage industry and there is unlikely to be real reform anytime soon.

Source: Charles W. Calomiris and Stephen H. Haber, "The Illusion of Reform and the Next Housing Crisis," Economic Policies for the 21st Century, February 25, 2014.


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