You can see it in the streets of Cleveland, or Buffalo, or Minneapolis. On all those streets, the working poor who five years ago lived in their own homes, are back in cramped apartments, paying rent to their landlords. On the streets where they used to live, their old houses sit boarded up and rotting. Every week, some of these homes come down, as city governments spend millions to demolish houses abandoned because of what is being called the “subprime” mortgage crisis. It should be called the “free-market” housing crisis. What these streets tell us is the catastrophic failure of a decade long experiment in using the free-market to regulate housing policy in the United States.
Go back to 1999. Then U.S. Federal Reserve Chairman Alan Greenspan put his weight on the scales to block new regulations for interesting things called “derivative products.” Any new regulations would be a “major mistake” he told the Futures Industry Association in March of that year.[1] Derivatives are complex financial instruments whose value is related to an underlying asset. They can become enormously complex. But Greenspan – at the time arguably the most powerful financial manager in the world – used his authority to make sure that the trading in these derivatives should be very loosely regulated. Greenspan is a free-market evangelist.
A loosely regulated derivatives market encouraged the creation of “exotic” investment vehicles, including the practice of combining consumer debt (credit card debt, automobile, mortgages, etc.) from hundreds and thousands of different customers, dividing up the resulting amalgam into smaller portions, calling them “securities,” and then selling these securities for a profit. The underlying assumption was that behind these “exotics” were real assets – debt that was going to be repaid.
Move ahead to 2001. The long stock market expansion rooted in the 1990s came to a sudden halt. The enormous speculation in high tech industries was unsustainable. The stock index most closely associated with the high tech sector – the NASDAQ – suffered a collapse that rivaled that of the Japanese stock market ten years earlier.
Greenspan’s response was to cut interest rates to almost zero – effectively, printing money and making it available on the cheap to banks and other financial institutions, to keep the US economy out of recession.
But this had another effect. Other interest rates came down as well, including those for mortgages. With interest rates for mortgages at historic lows, a new industry emerged – selling mortgages to people who had low incomes, who had never thought of buying a house.
From the standpoint of the poor, it was a good move. If low interest rates meant that a mortgage was cheaper than rent, then why not invest in a mortgage? Millions did so. This in turn fed the practice of repackaging this debt as exotic derivatives, and increasing portions of these derivatives had mortgages as the underlying asset – and many of those were the mortgages taken on by the poor, the ones we have come to call “subprime”.
Don’t blame the poor for the consequences. According to Mark Seifert of Cleveland’s East Side Organizing Project (ESOP) “predatory lenders targeted inner-city, African-American neighbourhoods, where they fudged property values and signed up thousands of borrowers without explaining the details of the loans.”[2]
Lenders and investors were locked in a toxic tango – lenders pushing “cheap” mortgages on the working poor, investors creating a billions-dollar market for the derivatives based on these “cheap” mortgages. As long as the tango lasted, both lenders and investors made huge sums of money in fees and bonuses.
The low rates driving this tango could not last. In the years after 2001, the U.S. Federal Reserve sent interest rates steadily higher. The low interest rate policy had saved the stock market, but it had created another problem – a weakening of the U.S. dollar, which was slowly losing strength against other currencies. To protect the dollar, interest rates rose higher and higher.
By 2007, the problems created were massive. The rise in interest rates meant that mortgage payments were floating up, not down. The low “teaser” rates were ending, and millions of working poor did not have the income to make their payments. The home ownership mirage of the early 21st century had, in the words of British analyst Robin Blackburn, “avoided the real problem, which is the true extent of poverty in the Untied States and the folly of imagining that it can be banished by the waving the magic wand of debt creation.”[3]
Predictably, the working poor were driven from their homes. Their mortgages were unsustainable. They returned to cramped apartments, the locks on their foreclosed homes were changed, windows boarded up, a target for wind, rats and vandalism.
The result is an enormous mess. The subprime/derivatives tango had encouraged real estate speculation sending house prices through the roof. With defaults on the rise, the housing market is being flooded with homes, and predictably prices are now collapsing. But the derivatives market based on mortgages and based on assumptions of continuously rising real estate prices had become truly massive. The Federal Reserve has abandoned its high interest rate policy in an attempt to reduce the damage. This has had some impact – the U.S. economy is not yet in an official recession. But it is exposing the U.S. to other risks, as the return to low interest rates has accelerated the decline of the U.S. dollar.
But the real victims of the subprime crisis are on the working class streets of Cleveland. In 2003, there were 200 foreclosures in Cleveland Ohio. In 2007, there were 7,583. “On average, 20 Cleveland homeowners faced foreclosure every day last year.”
“Many streets” are “lined with vacant buildings. Most have been stripped of windows, doors, siding and even copper wiring and pipes.” And after a while, there is nothing to do with an abandoned house except to tear it down. “Last year, Cleveland spent $7-million demolishing abandoned homes, compared with about $1-million a couple of years ago.” That demolition bill might rise to $70 million to deal with all the vacant buildings.[4]
This is not just a Cleveland story. Chicago Heights mayor Anthony De Luca said that “city officials are planning a major wave of demolitions of homes and businesses that have been left in disrepair.”[5] And governments in Cleveland, Baltimore, Buffalo and Minneapolis “have all filed lawsuits against lenders or developers based on the devastating effects foreclosures have wreaked on their communities.”[6]
“I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk” said the Greenspan in his very defensive autobiography. “But I believed then, as now, that the benefits of broadened home ownership are worth the risk.”[7] But Greenspan was wrong on derivatives and wrong on mortgages, and the result has been an economic and social mess.
Here’s a modest idea. Instead of pushing people out of apartments and into houses, and then back to their apartments, instead of boarding up their abandoned homes and then spending millions to demolish them, instead of spending additional millions to sue the lenders and developers who profited from this mess – instead of this frenzy of unproductive spending, lets instead invest in public housing. Instead of tricking people into financing this public housing with risky mortgages, lets make these new houses geared to income. Instead of leaving the managing of housing to speculators and developers, lets manage housing ourselves through the well-established principle of housing co-ops. There will be some who object, saying "that's a socialist housing program." Whatever you call it, it's a bit more rational than the chaos left behind by ten years of the free market.
© 2008 Paul Kellogg
References
[1] Nelson D. Schwartz and Julie Creswell, “What Created This Monster?”, New York Times, March 23, 2008; cited in Robin Blackburn, “The Subprime Crisis,” New Left Review, 50, March/April, 2008, p. 82
[2] Paul Waldie, “Is the U.S. housing mess headed our way?", The Globe and Mail, January 19, 2008, p. F.1
[3] Blackburn, p. 73
[4] Waldie
[5] David Schwab, “30 buildings to be demolished this summer,” The Southtown Star, May 4, 2008
[6] Julie Kay, “Empty Homes Spur Cities’ Suits,” The National Law Journal, May 9, 2008, www.law.com
[7] Alan Greenspan, The Age of Turbulence: Adventures in a New World, New York 2007, p. 233; cited in Blackburn, p. 82
