https://mpra.ub.uni-muenchen.de/7427/1/MPRA_paper_7427.pdf Paul Davidson, How to Solve the US Housing Problem and Avoid a Recession
Jan 8, 2008
[This article posted on January 8, 2008 is available on the Internet,
https://mpra.ub.uni-muenchen.de/7427/1/MPRA_paper_7427.pdf.]
A sage once said “Those who cannot remember the past are
condemned to repeat its errors.” So let’s look at what history
can teach us about what “caused” this housing bubble and how
we can relieve the distress. After U.S. Stock Market Crash of
October 1929, one out of every five banks in the U.S. failed.
Several years after the Crash and the beginning of The Great
Depression of the 1930s, a U.S. Senate committee held
hearings on the possible causes of the Crash. These hearings
indicated that in the early part of the 20th century individual
investors were seriously hurt by banks whose self-interest lay
in promoting sales of securities that benefited only the banks.
The hearings concluded that a major cause of the Crash
was that banks, in the 1920s, significantly increased their
underwriting activities of securities.
Consequently, in 1933,
Congress passed the Glass-Steagall Act, which banned banks
from underwriting securities. Financial institutions had to
choose either to be a simple bank lender or an underwriter
(investment banker or brokerage firm). The Act also gave
the Federal Reserve more control over banking activities.
As a result, for several decades bank originated mortgage loans
were not resalable. The originating bank lender knew that he or
she would have to carry the mortgage loan debt security over its
life. If the borrower defaulted, the lender would bear the costs
of foreclosure. Thus, the originating bank lender thoroughly
investigated the three C’s of each borrower—Collateral, Credit
History, and Character—before making a mortgage loan.
In the 1970s, deregulation of U.S. banking activities
began when brokerage firms began offering money market,
high interest, check writing accounts that competed with
traditional banking business.
In the 1980s the Federal Reserve
reinterpreted the Glass-Steagall Act to allow banks to engage in
securities underwriting activities to a small extent. In 1987 the
Fed Board allowed banks to handle significant underwriting
activities including those of mortgage-backed securities, despite
objections of Fed Chairman Paul Volker. When Alan Greenspan
became chair of the Fed in 1987, he favored further bank
deregulation to help U.S. banks compete with foreign banks,
where the latter are often universal banks which are permitted
to act as investment banks, take equity stakes, and the like...