Resident Scholar Vincent R. Reinhart

The search for causes of the housing-market collapse has begun. Two key congressional leaders claim to have identified some main culprits, but their explanations are incomplete.

Sen. Christopher Dodd (D., Conn.), chairman of the Senate Banking Committee, points to the lack of regulations mandating adequate disclosure in mortgage-lending documents. His counterpart in the House, Rep. Barney Frank (D., Mass.), chairman of the Financial Services Committee, blames securitization of mortgages for exacerbating the boom and bust.

Mr. Dodd is right on one important point. Disclosure requirements in most retail-lending documents have been woefully inadequate for a long time, and that should be a source of embarrassment to banking regulators. These lending documents typically prize length over clarity thanks to the lawyerly writers' interest in racking up billable hours.

But the role of these disclosures is overstated. Signing a few pages of turgid prose is a mere speed bump in buying and financing a home. The real fuel for that decision is the American Dream of getting rich quick.

Many households have few open avenues for wealth creation through asset accumulation--with one critical exception. Considerable resources are available to help people make leveraged bets on residential property, and the government offers multiple forms of incentives--such as the tax deductibility of mortgage interest payments--to do so.

As a consequence, many of those who want to accumulate wealth are funneled into the volatile housing market. Most personal portfolios are disproportionately invested in housing, especially those of households with middle and lower-middle incomes.

A few years back, a hot housing market seemed to promise sizable capital gains, and many scrambled for a piece of the pie. When the boom turned to bust, a significant fraction of those people found themselves stretched to the breaking point. True enough, enhanced efforts to improve financial literacy and to open up more opportunities for wealth creation should be undertaken. This may include alternative types of investment retirement accounts, and tax incentives to encourage saving. Better disclosure of mortgage lending documents should be a part of those efforts. But only a part.

The decision to borrow using a residential property as collateral is typically the first link in a chain joining those who need funds with those who have them. The borrowing--a mortgage--is often facilitated by a broker who matches a household with a depository willing to lend. The depository, in turn, may hold the loan on its books, or more likely sell it to someone who pools similar mortgages to act as support for an asset-backed security. The security may be held by a final investor, or pooled with still other securities to create a more complicated structured credit.

Mr. Frank, for his part, has correctly identified asset securitization as helping to enable the housing bubble. The problem with securitization is that it dilutes individual responsibility. The mortgage broker can easily become disconnected from the outcome of the initial lending decision. Federal regulation is needed to ensure that mortgage originators perform the appropriate due diligence in matching potential borrowers with loan products. Underwriters should be required to retain an interest in what they issue.

At the same time, it is critical that we not throw out the baby with the bathwater. Widespread home ownership was in part made possible by giving people a broad range of alternative ways to fund house purchases. The transfer of loans from banks to investors through asset securitization helped open up those opportunities.

Securitization also provides some important benefits that have helped to contain the current crisis. Mortgage-backed securities are typically better diversified than the original set of loans that a depository originates. Furthermore, securitized mortgage products are distributed far more widely, including overseas, than whole mortgages. In effect, our trading partners have shouldered some of the burden of the U.S. housing crisis.

Policy makers are indeed responsible for finding ways to help those who were misled in the process of purchasing their homes. This probably requires targeted government relief, but it should be accompanied by strict enforcement of the laws against fraud.

While Messrs. Dodd and Frank are partially right in their diagnosis of the housing crisis, that's not good enough. Half-baked explanations lead to bad policies.

Vincent R. Reinhart is a resident scholar at AEI.