Friday, March 06, 2009

Who caused the housing mess? It depends on how you vote.

A conservative's view of the housing bubble and financial crisis:
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.

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.
And a liberal view:
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.


  1. >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.<

    Good point. I generally agree that the Big Boys at the table, i.e., Greenspan, blew it, but I can't let the politicians off the hook. My reasons have nothing to do with the writers you cited, but with the power of Congress, through its hearings, to ask probative questions and raise issues.

  2. Who wants to hear about bubbles while so much money is being made? And woe be to any politician who tries to shut the party down in mid-swing.

  3. How bout the rating agencies regarding the CDOs? Lawyer drafts up the prospectus, saying YOU CAN LOSE MONEY. No one reads it - no one ever does - except the rating agencies, who grade the instrument accordingly.

    These are new, havent been stress tested so the agencies dont know how to grade them to appropriate risk. So they hire a technogeek to work up some algorythm about how many will default, then grade (AAA, BB) accordingly.

    Wall st buys based on the grade, mortgage brokers keep making more of them game goes forward.

    Turns out the default rates were wrong! Had these been graded as junk from day 1, wall st wouldnt have become infatuated with them, brokers would have no market to peddle toxic assets, etc. etc.

    Its amazing to think the whole world has decoupled because of some technogeek who plugged in the wrong algorythm!

  4. Yes, there is so much blame to go around, but all of the actors needed to cooperate in order to create a mess of this magnitude. Many of the actors could have stood up in ~2003 and raised an alarm.

    Whether or not that would have helped, I don't know. Wall St was making money hand over fist, and they would have fought any attempts to regulate this. The Bush Administration for the most part had a hands-off view of how government should regulate things - so even if an alarm had been raised, it isn't clear that anyone would have done anything about it.

  5. There's definitely plenty of blame to go around, and I don't mean to imply that politicians are completely blameless, but some people deserve greater blame than others. I blame the Fed the most, but if Greenspan hadn't been chairman and some other generic economist had his job, that generic economist probably would have made the same mistakes Greenspan did. That's the point I'm trying to make.

  6. Yea there's plenty of blame to go around but Wall Street has got to be at the top of the list. As Greenspan said in his mea-culpa to congress, Wall Street firms acted against their own long-term interests. Their level of greed and short-sightedness is astounding.

    It's funny that the conservative article blames 17 year old regulations, a 30 year old law and 40 year old institutions. Anything to avoid blaming the last 8 years!

  7. "In 1992, Congress gave a new affordable housing "mission" to Fannie and Freddie..."

    Hey! What a novel take on the crisis: "Clinton did it!"

  8. that's like blaming meteorologists for a blizzard. but what caused the blizzard? precipitation (Fed credit), pressure (special interests- both liberal and conservative), and a myriad number of other variables.

    if anything, the meteorologists can be blamed for not warning policy makers so they could then decide whether to inform the masses about the coming blizzard.

  9. guy n. cognito said...
    "that's like blaming meteorologists for a blizzard. but what caused the blizzard? precipitation (Fed credit)..."

    Sorry, but meteorologists don't create precipitation. Economists (working at the Fed) do create Fed credit. The Fed sets interest rates based on economic theory. Meteorologists don't set precipitation based on meteorological theory. Your analogy is seriously flawed.

  10. Who's to blame?
    -Congress-for ignoring the warnings that the house appraisers raised when they were told "make the numbers work or get blackisted"

    -The ratings agencies-for failing to stand up and say "these investments are not AAA", the ratings agencies were also threatened with being blacklisted if they didn't rate the housing securities AAA. Had they shown some backbone and told the Wall Street crowd putting together the deal to find someone else to grade their junk AAA (which the Wall Street crowd would not be able to do) then these securities would not have been the darlings of hte investment world. Junk bonds II, this time the whole planet takes the financial hit.

    -Most economists-the ones who believed 'this time its different' who used all kinds of computer models to prove all would be all right, but fogetting the forst law of comuting GIGO garbage in garbage out

    -Greenspan-who talked up alt A and adjustable mortgages and housing in general, he was pumping and cheerleading houses as much as David Liar-eah. Any other Fed Chairman would have worked on adjusting interest rates and money supply for the WHOLE ECONOMY ,not just for housing.

    -The public-as much as it pains me to say this, the public who bought into housing is partly to blame. Considering that in the 1990's during the IPO craze and the dot com mania (and its financial disaster afterwards) the public did Not learn its lesson that nothing can go up forever, they thought that housing was different from stocks and housing was not possibly speculative in nature.
    Now they have learned otherwise.

  11. Thqat should have read
    'first law of computing GIGO garbage in garbage out'
    sorry for the typo

  12. "'first law of computing GIGO garbage in garbage out"


    (I agree with you though)

  13. "Your analogy is seriously flawed."

    probably, i just like being argumentative.

  14. "Your analogy is seriously flawed."

    agreed. i just like being argumentative.

    "Economists (working at the Fed) do create Fed credit. The Fed sets interest rates based on economic theory."

    that d*mn Fed again.

  15. guy n. cognito said...
    "i just like being argumentative."

    OK. Argumentation keeps the blog alive. Carry on.

    Sorry about the comment moderation. Bubble Meter is experiencing a problem with link spam from China.