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...