Did regulation cause the housing crisis?

True, it is easy to get upset with our government for the 30 year mortgages that pushed lending institutions to bundle mortgages and resell them in the first place. But underlying that problem was the problem of so many municipalities not wanting any piece of land in their jurisdiction to have less than set amounts of taxation available, which led to bigger and more expensive homes. In a way, the subprime loan was government trying to solve the problem of people who could not otherwise afford to live in the city where their job was.

I think that this will be very hard to prove. There is a much stronger case that lack of government regulation is more of the cause of the meltdown. Back in the 80′s, bond trader Lou Raineri and Solomon Brothers set up the mortgage-backed securities scheme, which included government entities buying up much of the debt (Fannie/Freddie). These entities were really the only one’s big enough to handle this type of transaction. This government involvement was really a hand-out to Wall Street, not so much a politically motivated move to give mortgages to poor people (although this talking point didn’t hurt). Incidentally, Lou Raineri and Wall Street got rich. The name of the game was originating as many mortgages as possible, to be sold, re-sold, and eventually pooled for securities. Everyone in the scheme made tons of money, and Fannie/Freddie were generally left holding the majority of the risk.

In order to originate as many mortgages as possible, unregulated fly-by-night lenders came up with “no doc” loans (where the borrowers do not have to show any proof of income). You just walk in to the unregulated mortgage company and pretend that you make $1 million a year. You get a huge loan, no questions asked. Keep in mind that mortgages used to be regulated by a rule that required an FDIC institution to issue them. However, the mortgage lobby came up with unregulated “mortgage companies” that skirted this regulation, allowing no-doc loans.

This scheme also promotes fraud on the part of the originators. Under a legal principle known as “holder in due course,” the holder of the mortgage cannot be sued for fraud committed before he bought the mortgage. In general, the fly-by-night originators are out of business every few months, changing names and locations frequently, so they can’t be sued. Now, anyone trying to sue for fraud has to go after the entity holding the mortgage. However, that won’t stick because the entity is a “holder in due course.” The homeowner is out of luck. This protection for the holder, usually a large Wall Street firm, or Fannie/Freddie, added to the problem. Again, government did not regulate this.

I think that there is a better argument that this scheme, with the no-doc loans, the selling and re-selling, the pooling and securitization, and faulty risk calculations caused this problem. All of this was allowed because of a lack of regulation, not the other way around.