There is very little doubt that the underlying cause of the current credit crisis was a housing bubble. But the collapse of the bubble would not have led to a worldwide recession and credit crisis if almost 40% of all U.S. mortgages—25 million loans—were not of the low quality known as subprime or Alt-A.And a liberal view:
These loans were made to borrowers with blemished credit, or involved low or no down payments, negative amortization and limited documentation of income. The loans' unprecedentedly high rates of default are what is driving down housing prices and weakening the financial system.
The low interest rates of the early 2000s may explain the growth of the housing bubble, but they don't explain the poor quality of these mortgages. For that we have to look to the government's distortion of the mortgage finance system through the Community Reinvestment Act and the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. ...
Long-term pressure from [Barney] Frank and his colleagues to expand home ownership connects government housing policies to both the housing bubble and the poor quality of the mortgages on which it is based. In 1992, Congress gave a new affordable housing "mission" to Fannie and Freddie, and authorized the Department of Housing and Urban Development to define its scope through regulations.
Shortly thereafter, Fannie Mae, under Chairman Jim Johnson, made its first "trillion-dollar commitment" to increase financing for affordable housing. What this meant for the quality of the mortgages that Fannie—and later Freddie—would buy has not become clear until now.
On a parallel track was the Community Reinvestment Act. New CRA regulations in 1995 required banks to demonstrate that they were making mortgage loans to underserved communities, which inevitably included borrowers whose credit standing did not qualify them for a conventional mortgage loan.
From his earliest days in office, Bush paired his belief that Americans do best when they own their own homes with his conviction that markets do best when left alone. Bush pushed hard to expand home ownership, especially among minority groups, an initiative that dovetailed with both his ambition to expand Republican appeal and the business interests of some of his biggest donors. But his housing policies and hands-off approach to regulation encouraged lax lending standards.This financial crisis is not the fault of politicians. It is the fault of economists, specifically the many economists who ignored the housing bubble, insisted there was no housing bubble, or insisted it was not the Fed's problem.
The Great Depression and the current recession were both caused by asset bubbles, yet modern macroeconomic textbooks largely ignore discussing bubbles. The economics profession knows little more about bubbles than it did on the day Irving Fisher uttered the words "permanent plateau". (The modern equivalent of "permanent plateau" is "new equilibrium".)
This recession is a failure of the economics profession.