09.30.2009 0

Consumer Financial Protection Agency Misses the Mark

  • On: 10/20/2009 09:29:23
  • In: Economy
  • By Robert Romano

    This week, the House Financial Services Committee will continue work on the creation of a new federal agency: the Consumer Financial Protection Agency (CFPA). Ostensibly, the agency would attempt to protect consumers from risky financial products, ala the subprime and adjustable rate mortgages thought to have played a role in the continued credit crunch.

    Unfortunately, in the process, the House is attempting to create yet more labyrinthine regulations, treating the symptoms of very loose money by punishing the private sector for the policies that the government is completely responsible for creating.

    Throughout the crisis, and in its aftermath, the government has attempted—unsuccessfully—to stem the rate of foreclosures through various moratoria, subsidies, and mortgage modifications. It attempted to subsidize losses in the mortgage securities market, of which it is purchasing hundreds of billions of dollars-worth of bad debt to date first via TARP and now via TALF and other facilities. It took over AIG, the insurer of those risky securities, so that it could pay out losses on mortgage derivatives. It took over Fannie Mae and Freddie Mac, to keep the secondary mortgage market afloat.

    Overall, it has put taxpayers on the hook for as much as $12.8 trillion in high-risk bailouts.

    All of these actions have been—and continue to be—in reaction to the fallout of the problem. But none of the “fixes” thus far proposed by the government, including the creation of the CFPA, actually address the root cause of the problem. Instead, they create boogeymen of “predatory lenders” to suit a political narrative contrived to deflect blame from the true culprits of the monetary miasma that is still unraveling to date. It has even proposed putting the very cause of systemic risk in charge of regulating it: the Federal Reserve.

    We’ve read this story before. As Andy LaPerreriere noted writing for the Wall Street Journal in April 2008, “Mortgage lenders, home builders, real-estate speculators and millions of average people who borrowed too much were caught up in a mania. They were responding to misleading market signals that told them to write more reckless loans, build more houses and borrow as much as the bank would lend them. After all, people who did these things during the boom profited handsomely year after year.” Chief among the “misleading market signals” were those put in place by the Federal Reserve. In particular, the federal funds rate—the rate at which banks borrow from the government—was too low, incentivized poor lending and borrowing practices, and fueled the housing boom and then bust.

    LaPerreriere continues, “The housing boom began in earnest when the Fed slashed interest rates in response to the 2001 recession, and kept rates too low for too long. The lower interest rates cut monthly mortgage payments and fueled the first wave of home-price appreciation, which began to take on a life of its own. Artificially low interest rates reduced returns on safer investments like government and corporate bonds, so investors moved funds into riskier assets (like subprime loans) to increase returns. Low interest rates also made it profitable to borrow heavily in order to invest in mortgage-backed securities and other financial assets, and leverage grew at a breathtaking clip.” How widespread was the credit expansion in mortgages?

    Outstanding mortgage debt appreciated from $3.805 trillion in 1990 to $14.568 trillion in 2007—a 383 percent increase. The national debt itself increased from $3.23 trillion to $9 trillion, a 278 percent jump. The money supply, too, jumped, from $1.787 trillion to $5.268 trillion over the same period, according to the Ludwig Von Mises Institute. And prices followed: gold rose from $386.20 an ounce to $695.39, a 180 percent increase; and oil rose from $23.19 a barrel to $64.20, a 277 percent increase. The national housing price index too followed suit, increasing from 171.91 in 1990 until it peaked at 226.6 in April 2006.

    During the same period, mortgages were sold on the secondary market, and the money flowed back into the banks so that more loans could be given. Government Sponsored Enterprises (GSE’s) Fannie Mae and Freddie Mac played a tremendous role in the secondary mortgage market through the securitization of trillions of dollars of mortgage-backed securities (MBS) and related debt. It amounted to some $4.7 trillion as reported by Bloomberg News by November 2007 rising to over $5 trillion by the time of TARP according to the Wall Street Journal. And, they were sold all around the world. Those in turn were turned into the more than-$400 trillion derivatives industry, the losses of which were in part insured by companies like AIG.

    When the losses due to loan defaults hit on the consumer side, the repercussions were felt throughout the entire system. The government has spent more than two years reacting.

    But the simple fact is that none of this would have even been possible without government’s own very loose monetary policies to begin with. And now, the government wants to pretend that the crisis that it created can be “fixed” by keeping the monetary policy looser than ever. The federal funds rate stands at an historic low near zero percent.

    The regulations now proposed and all government actions to date have simply been designed to exist in the world of loose credit engineered by powerful unchecked central banks like the Federal Reserve.

    This is like pretending that there is a “safer” way to drive home from the bar drunk. This will not end well. And the economy, the dollar, and consumers, borrowers, and lenders will still wind up rushing towards a train wreck—with taxpayers footing the bill, and the new CFPA enacting ever more regulations to attempting–and failing–to keep the train from recklessly careening out of control.

    Robert Romano is the ALG Senior News Editor.

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