Lessons from the Housing Disaster

Of the roughly 56 million homes in the US today with mortgages, one in seven is “delinquent.”  That is over 7 million homes more than 30 days behind in mortgage payments.  Those homeowners face foreclosure procedures likely leading to evictions.  Very high (and still rising) unemployment levels guarantee rising mortgage delinquencies.

Mass media and political statements about government and banks helping people avoid foreclosures (“mortgage modification”) are often misleading.  Relatively few have been helped and the help has been too little.  Over half of “modified” mortgages re-default within 12 months.  Modifications, in short, do not remedy the underlying problem: homeowners by the millions earn too little to cover their mortgages and have few prospects in this economy of doing better anytime soon.

During the latest “real estate boom” (2002-2007), private banks pushed mortgage loans on borrowers with little or no “due diligence” verification of their ability to make the mortgage payments.  Those banks ignored the risk of defaulting mortgages because they had found a way to dump that risk onto others.  They sold the mortgage loans they made as fast as they made them.  If the borrowers failed to make mortgage payments, that was someone else’s problem.  The banks only made mortgage loans to collect the associated fees and then sold them immediately to special firms (“bundlers”) that bundled groups of mortgage loans together into a new kind of “mortgage-backed-security” (MBS) that they sold to investors around the world.  Those “bundler” firms paid still other companies (mainly Moody’s, Standard and Poor’s, and Fitch) fat fees to rate the risks of investing in the MBS.  Those “rating” companies somehow failed to see the actual risks.  So investors confidently bought many billions of MBS.

In 2005 and 2006, for example, private companies connected to banks handled over half of all MBS produced and sold.  The rest were handled by three government agencies: the GNMA (Government National Mortgage Association), the FHLMC (Federal Home Loan Mortgage Corporation), and the FNMA (Federal National Mortgage Association).  Once the crisis hit in 2007, investors discovered that the MBS they had purchased were fast losing value: the mortgage loans bundled into them were going into default because homeowners could not pay.  Suddenly, bundlers faced investors unwilling to buy any more MBS.  So the bundlers stopped buying mortgages from banks, which then stopped lending money for home-purchases.  The bankers, after all, knew how risky it would be to actually hold such loans.

There would have been an utter collapse of the US housing market in late 2007 or 2008 if our economy had relied on the private market that linked mortgages to bundlers to MBS investors.  The market that had once spurred the real estate boom was poised to demonstrate its equal capacity to produce a real estate bust.  Had that happened, we would today be looking at a US housing disaster far worse than what we now have: a 30 per cent decline in home prices (since late 2006).

What prevented an even worse real estate collapse was simply that the US government replaced the private market in MBS.  In 2008 and 2009, the GNMA, FHLMC, and FNMA together bought over 95 per cent of all mortgages for bundling into MBS.  Investors only bought those MBS because the US government effectively guaranteed them.  There has been no “private market” in housing throughout this crisis.  It has been suspended indefinitely.  Only US government guarantees and infusions of cash to GNMA, FHLMC, and FNMA (so that they can keep functioning despite defaults and other economic losses) are keeping the housing market alive today.  Without the government, virtually no one could obtain a mortgage: the many desperate to sell homes (especially the banks seeking to unload the homes they foreclosed) would face very few buyers.  The prices of homes would then sink like rocks.

The banks, bundlers, rating companies, and MBS investors brought the US housing market to crisis by seeking to maximize their companies’ profits.  They were doing what capitalist enterprises do.  They withdrew from the housing market once its crisis threatened their profits.  Some MBS investors had avoided or reduced their losses by buying insurance (“credit default swaps”) against possible defaults by mortgaged homeowners.  The biggest company selling that kind of insurance, AIG, did not have the money to cover its obligations on insured MBS when they lost value.  So, again, the US government entered, took over AIG, and used billions of public money to pay off those MBS investors who depended on those insurance policies to escape the worst of the crisis.  The government did for the private sector what it could not do: save capitalism from itself.  It bailed out chiefly those who had done the most to cause the crisis and had gained the most in the heady years leading to the crisis.

Should we celebrate the state over the market?  Hardly.  The state, in our capitalist economy, is beholden mostly to the capitalists.  That’s why all the laws passed in the past to prevent such crises did not do the job.  That’s why state regulators missed all the signs of impending disaster.  That’s why the recovery meets the crisis needs of banks and insurance companies and MBS investors far, far more than those of the millions unemployed and facing foreclosure.

Punishing some bankers, insurers, bundlers, or risk raters solves nothing.  Leaving our economic system unchanged would only drive them or their replacements to behave in the same way in the future.  Allowing capitalists to keep receiving the profits of work guarantees that they will use those profits to expand their wealth and control the state.  When have they ever done otherwise?  An unchanged economic system will then resume, yet again, the march to the next economic collapse.

Real economic change would make workers their own bosses (democratize the enterprise) and require them to share the disposition of profits with the communities interdependent with those enterprises (democratize the economy).  With such change, the people’s interests could finally govern what enterprises do and what the state does: the situation only capitalists enjoy now.

Richard D. Wolff is a Professor Emeritus at the University of Massachusetts in Amherst and also a Visiting Professor at the Graduate Program in International Affairs of the New School University in New York.   He is the author of New Departures in Marxian Theory (Routledge, 2006) among many other publications.  Check out Richard D. Wolff’s documentary film on the current economic crisis, Capitalism Hits the Fan, at www.capitalismhitsthefan.com.  Visit Wolff’s Web site at www.rdwolff.com, and order a copy of his new book Capitalism Hits the Fan: The Global Economic Meltdown and What to Do about It.

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