National Bank – How to fix the housing crisis for less than 700 billion
Recently, the news has been dominated by developments with the $700 billion bailout package, and with good reason. 700 billion is an astronomical sum of money. The first problem is that the $700 billion bailout adds a huge amount of money to the national debt. Not only that, some have suggested that the bailout is so big that it could actually lower the US’s credit rating. The second problem is just as serious. There is no guarantee that the rescue will work.
The idea behind the bailout is that by accepting billions of dollars in toxic loans, the government hopes to “influence” banks to start lending again. All previous attempts by the government to “influence” the banks have failed. The Fed lowered the federal rate to influence banks to lower mortgage rates. While banks appreciated the lower rates, they did not lower mortgage interest rates. In fact, after the Federal Reserve cut rates, banks raised mortgage rates because they saw negative prospects in the housing market. Similarly, after the US government takes over bad loans, banks could continue to see negative prospects in the housing market and therefore continue to have tight lending practices. The idea of spending 700 billion without guarantees seems like a bad use of capital.
When people hear the word “National Bank”, the first thoughts are of a socialized banking system. A national bank would not replace the current banking industry. Nor does it “introduce” government involvement in the banking industry. With the Fed influencing interest rates and the government rushing to bail out all the troubled banks, the government already has a large stake in the banking industry. I don’t want to discuss whether the government should have a role in the banking industry. Today, the government already has a significant role in the banking/mortgage industry. My argument is that if government has a role, it must be effective and cost-effective.
A national bank would be a cheaper and more profitable way to stabilize financial markets. To understand how a national bank would work, let’s first talk a bit more about what is currently causing the housing crisis. The mortgage market works a bit like a basketball game. Lenders go from one extreme to another. For a while, lenders will lend to anyone who walks through the door with a pulse. During these periods, lenders are accepting fewer and fewer qualified applicants in an attempt to gain market share. Then the lenders freak out (often because someone realizes they’ve been making billions in loans to unqualified applicants who are unlikely to pay their mortgages) and the lenders go to the other extreme and practice extremely restrictive lending practices. (the insurance industry sees the same cycles but that is another topic). If you haven’t already guessed, we are currently in the second scenario with lenders practicing extremely restrictive lending practices. The problem with the second situation is that such extreme changes shake up the real estate market and basically cause a financial crisis. The banks are in a trap 22. If the banks do not lend collectively, the housing market will continue to deteriorate. But no one wants to lend because they are concerned that the housing market will continue to deteriorate because they are collectively not lending. It’s like at a party where you don’t want to be the first to jump into the pool because if no one else does you look stupid. Substitute looking dumb for going bankrupt and you’ll see where the banks come from.
The great depression and the S&L crisis were basically examples of this same problem. Initially, during the great depression, the conventional logic was that the government should not intervene. As the stock market continued to fall (it fell over 80% in less than a year) and people realized how bad an economy can get (pretty bad), the idea of government intervention seemed more acceptable. compared to the alternative.
So now, during periods when lenders are scared, the government tries to “sway” the lenders. The problem is that it is extremely expensive. The government is currently taking on years and years of bad loans in an attempt to “sway” lenders into loosening their current restrictive lending practices over the next 6 months to get us out of the housing crisis. This is like trying to influence your local school to spend money on new textbooks by building a new school for them. Not only is it ridiculously expensive after the new school is built, but you have no guarantee that they will buy the textbooks. It’s not just a misuse of government funds, it’s completely outlandish.
So how would a national bank work? During the periods when banks make loans to everyone who walks in the door, the periods when the national bank would practice would have average credit crunch with interest rates slightly higher than those available at most banks and make very few loans. When banks went ultra tight, the bank would go back to average credit crunch. During these periods you would give more loans.
So the government wouldn’t practice the fancy lending practices that we saw during the boom, they wouldn’t be as restrictive as the banks are now. In fact, this would probably do more to influence banks’ lending practices than the $700 billion giveaway. Remember how we talked about banks not wanting to lend money because no one else was lending money, so it made them nervous about the prospects for the real estate market. Knowing that money will always flow provides some stability to the market. Also, it would be much less expensive. Having the government provide a few loans over the next 6 months with average restrictions during a low market would be much better than accepting years of poor quality loans made during the peak market to highly unqualified homebuyers.
Would some banks fail? Yes. But you know what they should. Bailing out dumb banks that forgot about caution and had wildly risky lending practices almost guarantees that we will face another real estate crisis in the future. Instead, we should allow some of these banks to die. First prevent these riskless banks from causing these problems again. Second, it influences other banks to exercise more caution during good times. The bailout sends a message to banks that during the boom they should ignore caution because the government will step in and take all their bad loans like some kind of bizarre magical bad tooth fairy.
I realize this article might upset people who want the government to have no role in the banking/mortgage market. But if we accept that the government already has a role in the banking industry (the chance of government pulling out is slim to none over the next decade) to stabilize markets, it should at least do so in a way that is effective and profitable.
