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The Housing Bubble: Whose Fault?

April 12, 2007

Tags Money and BanksInterventionismMoney and Banking

Now that the housing bubble is starting to burst, it's time to address the really important questions: whose fault was it? And who will wind up paying the bill? Congress has begun to line up on this issue.

It is now becoming clear that a substantial fraction of the mortgages issued over the last few years will go into default, along with the issuesrs. Foreclosures are increasing and the mortgage lender implode-o-meter is currently at 55.

Bloomberg reports that the bond holders should be liable:

The top Democrat and Republican on the House Financial Services Committee said investors in mortgage bonds should be liable for deceptive loans made by banks.

Democratic Chairman Barney Frank of Massachusetts and Spencer Bachus of Alabama, the committee's highest-ranking Republican, said such legislation would discourage lenders from extending loans to people with poor credit histories by making it more difficult and expensive for the banks to sell the mortgages.

This seems a bit of a stretch to me. The loans were contracted between the banks and the borrowers. Did the banks offer loans to people who had no realistic ability to pay them back? Certainly. But one could equally well argue that the borrowers defrauded the banks by lying about their income (the popular "no doc" loans are widely referred to as "liar's loans"). The banks repackage the mortgages into securities and sell them to investors. How did the investors become liable for purchasing the cash flows resulting from completed transactions between two other parties?

If you don't think that the bond holders should be left paying the bill, the tax payer is always a popular choice. Bloomberg reports that a bailout is being proposed:

U.S. Senator Charles Schumer and other members of a key banking committee said the federal government should spend ``hundreds of millions of dollars'' to bail out subprime mortgage borrowers facing foreclosure.

Non-profit groups would distribute the money to help homeowners refinance loans they can't repay, Democratic Senators Schumer of New York, Robert Menendez of New Jersey and Sherrod Brown of Ohio said today at a news conference in Washington. All three are members of the Senate Banking Committee.

``We are just making a general proposal here that the federal government step in and help refinance'' delinquent home loans that ``would be in foreclosure soon if nothing was done,'' Schumer said.

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