Housing Finance Reform: Government Reinventing the Wheel Rather Than Sticking With What Worked

Housing Finance Reform

Housing finance reform has been at the center of debates on how to ensure a stable economy since the Great Depression. Recently, in light of the 2007 economic crisis, lawmakers introduced a new bill in the Senate to address reforms. The bill is the Housing Finance Reform and Taxpayer Protection Act of 2013, authored by Sens. Bob Corker (R-Tenn.) and Mark Warner (D-Va.). The main aim of the legislation is to back mortgages by private investments rather than taxpayer money. However, perhaps the most significant aspect of the bill is what it utterly fails to address – bringing back the financial protections that have already proven to work.

The most successful U.S. housing finance reform law was the Glass-Steagall Act, which adequately protected the economy from 1933 until 1999. In 1999, President Bill Clinton signed into law the Gramm-Leach-Bliley Act, which repealed many of the important protections of Glass-Steagall. Some economic experts, such as SEC head William Donaldson, saw the error in repealing the time-tested protections, but President George W. Bush blocked regulation efforts. Inevitably, in 2007, our economy and the world experienced the worst financial crisis since the Great Depression.

Glass-Steagall prohibited banks from gambling on subprime mortgages and other risky investments. In other words, Glass-Steagall prohibited exactly what caused the 2007 economic crisis. After the repeal of Glass-Steagall, Wall Street investment banks began to use federally-insured money to buy subprime loans, bundle thousands of them into securities called “mortgage-backed securities” (“MBSs” for short), and then sell the MBSs to investors for a profit.

First, lending banks, such as Washington Mutual, issued loans to people that it knew could not afford the loans (“subprime loans”). Second, Wall Street investment banks (i.e., Goldman Sachs) then used federally-insured money to buy the subprime loans, which were then bundled into MBSs. Third, the investment banks would then sell the MBSs to investors such as Fannie Mae and Freddie Mac. The homeowners then predictably defaulted on the toxic loans that the lending banks knew they could not afford, and went into foreclosure. These homeowners were then without money and financing to buy new homes. Without potential home buyers, property values fell. Since the property values fell, the MBSs quickly became worthless. The economy thus crumbled due to risky gambling by Wall Street – gambling that would not have occurred had the Glass-Steagall regulations been in place.

Now, to some, it might appear obvious from the start that when you remove a safeguard that fixed the Great Depression, you will just enter into another Great Depression. For others, this only becomes obvious when it actually happens, such as when the repeal of Glass-Steagall actually did lead to another Great Depression in 2007. And then there are our lawmakers, who still do not get it. Hence, Congress is devoting time and taxpayer money to tryng to reinvent the wheel with the Housing Finance Reform and Taxpayer Protection Act rather than simply re-enacting Glass-Steagall.

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