The U.S. experience, Free markets in money: a contradiction in terms!

In the U.S. individual households have the freedom to borrow funds if they need to do so; other households have the freedom to offer their surplus funds to the financial markets. These simple freedoms hide the fundamental reality that these two types of households are in an unequal financial position. Borrowing means that future income levels will be needed and used to repay outstanding debt levels. Savings means that additional income out of savings is added to income levels in future. The borrowing households, nearly always the lower and middle-income classes, face the loss of their homes or seriously reduced income levels if they can no longer afford to repay outstanding debts. The saving households, usually the better off classes, might see their income out of savings reduced, when economic times become tougher, but face less risks over their principal income. In this paper over the period 1997-2008, the actual mortgage lending patterns of U.S. banks, including Fannie Mae and Freddy Mac, have been studied. Such patterns reflect the supply side of money for this particular use. On the other hand the paper has elaborated on a “need for funds” approach. This need for funds reflects the demand side of funds based on two factors: the physical need for shelter and the long-term ability to repay outstanding mortgages out of current income levels. The U.S. needs about 1.8 million new homes annually. The mortgage borrowers need to see their income growth more or less in line with house price developments in order to sustain debt servicing. The supply side of mortgage funds, represented by the banking and financial markets sectors, is based on different parameters than for the demand side. For the supply side the availability of funds, the profit motive, competition and regulatory controls are the most important. Regretfully, over the period 1998-2007, the powers of the supply side overwhelmed the “need for funds” approach. More mortgage lending can create more homes being built, but it can also force house prices up faster than the income growth levels of the lower and median income classes. The financial regulators did not see this as a threat until it was too late. The balance of power had swung too strongly in favor of the banks, rather than to the borrowers. The supply motives drove the equilibrium further and further away until breaking point. In future, one may need to ensure that the “need for funds” approach prevails over the supply side. As this was not done, the effects of the financial crisis were devastating. 22.1 million households faced foreclosure proceedings over the period 2006-2013 or one in six households. 5.8 million homes were repossessed. Between January 2008 and October 2009 7.8 million individuals lost their jobs. In 2013 median households incomes were 8% lower in real terms than in 2007. The government added an extra $7.7 trillion to its debts as a consequence of the financial crisis. The Fed bought about $4.2 trillion in government bonds and mortgage-backed securities. Mortgage borrowers repaid on a net basis $1.24 trillion of their outstanding mortgages over the period 2008 to first quarter 2015. The future is not all bleak. Unemployment rates are substantially down. Median income levels are improving and house prices according to the needs for funds approach are currently in line with actual house prices.