Regulation and the Law of Unintended Consequences

The current financial crisis is a result of the law of unintended consequences of two political policies promoted by both Republicans and Democrats since the Great Depression: 1) encouraging homeownership for all Americans regardless of whether they can afford the costs and 2) over-regulation of the financial community. Both policies have turned into a deceptively sweet bubble of air in the veins of the economy.

First, the government artificially inflated residential real estate sales through several laudable — but sloppily executed — policies such as: 1) tax breaks on interest and property taxes for homeowners; 2) implicit government guarantees of the debt of Fannie Mae and Freddie Mac to purchase conforming home mortgage loans; 3) relaxed credit standards on home mortgage loans permitted by the banking regulators; and 4) encouragement of the collateralization and sale of mortgages to investors.

In the short term, these policies had the beneficial effect of subsidizing housing costs and injecting extra liquidity into the housing market. Over the long term, these policies weakened the economy by inflating housing prices and by encouraging the financial community to make risky loans to homeowners who would not otherwise get a loan in the unregulated mortgage market. The results, as we now see, are disastrous.

Specifically, American consumers were encouraged to buy homes whether they could afford them or not. Homeowners were also lulled into believing that homeownership was an investment and not a housing expense. The annual costs of homeownership with mortgage payment, property taxes, insurance, utilities and maintenance can be over 10 percent of the value of a home. That means a home has to appreciate more than 10 percent annually in order for it to be a good investment. These housing policies significantly contributed to driving up the prices of residential real estate over the past 20 years. They also contributed to over-leveraged homeowners and more risky mortgage loans held by banks and investors.

Don't think for a moment that the passage of today's federal government's far-reaching and historic plan to bail out the nation's financial system, which President Bush signed into law, will resolve these woes and return our economy to stability. Yes, the House voted 263-171 to make this possible and it's well-known in Washington elite circles that this will only give a temporary reprieve to Wall Street and lobbyists. It will, however, do nothing for everyday Americans who will continue to lose their homes and life savings because of unbelievable greed and highly calculated risks that went South.

Stay tuned: Much more to come.