Don't Blame Greed for the Housing Bubble; That Would Be Like Blaming Gravity for Plane Crashes
From "The House That Uncle Sam Built: The Untold Story of the Great Recession," by Pete Boetke and Steve Horwitz:
"The Fed’s low interest rates, combined with Fannie and Freddie’s government-sponsored purchases of mortgages, made it highly and artificially profitable to lend to anyone and everyone. The banks and mortgage companies didn’t need to be any greedier than they already were. When banks saw that Fannie and Freddie were willing to buy virtually any loan made to under-qualified borrowers, they made a lot more of them.
Greed is no more to blame for these bad mortgages than gravity is to blame for plane crashes. Gravity is always present, just like greed. Only the Federal Reserve’s easy money policy and Congress’ housing policy can explain why the bubble happened when it did, where it did.
Of further significance is the fact that Fannie and Freddie were under great political pressure to keep housing increasingly affordable (while at the same time promoting instruments that depended on the constantly rising price of housing) and to extend opportunities to historically “under-served” groups. Many of the new mortgages with low or even zero-down payments were designed in response to this pressure (see chart above). Not only were lots of funds available to lend, and not only was government implicitly subsidizing the purchase of mortgages, but it was also encouraging lenders to find more borrowers who previously were thought unable to afford a mortgage."
60 Comments:
The government has increasingly spent money-time-effort creating problems, and then increasingly spent money-time-effort trying to fix those problems. It has become a vicious cycle, which is leading to a government takeover of the private sector.
And gravity isn't responsible for plane crashes? ;) Let's not let greed off the hook so easily: there was a lot of speculation in this real estate runup, whether by Wall Street or home buyers, and that has to be counted as the main reason why this bubble happened. Bubbles have been happening for millenia; crowds just go nuts about dumb ideas, whether tulips or dot.coms, once in a while and the market is a great mechanism to reallocate their money to the smart like Warren Buffett, who avoid going with the crowd. No doubt Fannie/Freddie and govt intervention are reason 1a, but let's not go overboard and inflate their role. As for the Fed bashers, to invoke Greenspan/Bernanke, who can at most monetize billions in treasury notes when there were trillions moving into housing this last decade, just shows their ignorance of how the money supply works.
Ultimately, my point is that markets work great, but it is a mistake to make the case that they're infallible, simply to counter the statist morons on the other side of the debate who claim that their bureaucrats are omniscient. Rather, one has to make the case that however fallible markets may be, the market record is many times better than govt regulators record, which is why it is a joke to even mention govt regulation as a solution (the dimwits at the SEC didn't even understand how derivatives work). That would be a honest debate about what really happened and would be more likely to convince someone, rather than both sides claiming they're infallible.
"Let's not let greed off the hook so easily: there was a lot of speculation in this real estate runup, whether by Wall Street or home buyers, and that has to be counted as the main reason why this bubble happened"...
Hmmm, I can only totally disagree to that point of view...
I think if the federal government had not interfered in the housing market in the first place there would've been no window of opportunity for this supposed greed to run rampant...
The GSEs were bad enough but then the whole CRA nonsense undercut any real possibility that minimal standards to float a home loan were thrown out the same window that greed came in...
OK, what was the gross amount of down payment? As home prices increased the % down payment might go down and still represent a substantial sum.
Of course, Canada has a different paradigm, but first time homeowners in canada are much older, 55 compared to around 35 in the US.
Banks cam blem government all they want, much of this they brought on themselves.
...it is a mistake to make the case that they're infallible, simply to counter the statist morons on the other side of the debate who claim that their bureaucrats are omniscient.
================================
Well said.
I think if the federal government had not interfered in the housing market in the first place there would've been no window of opportunity for this supposed greed to run rampant...
=================================
There would not have been any opportunity if the rating agencies had doen their job, either. where was the government interference in their ratings system?
I keep having to help people move out of houses they could not afford and are now being foreclosed. Many of these are family and friends who I tried to help by telling them they were getting in over their heads, but they decided to listen to the experts.
These people often are not finanacially literate, and they rely on other people such as bankers and mortgage lenders to tell them what to do (of course, we wish there were more informed). Would we be upset to find doctors advising their patients to smoke three packs of cigarettes a day and drink a fifth of whiskey? How is this any different?
It was possible to achieve a "soft landing," or mild recession, through significant tax cuts and shifting profits to wages. So, output and employment would've been higher.
If a soft landing wasn't achieved, a V-shaped economic recovery could've been accomplished.
Unfortunately, the tax cuts were too small, and offset by tax hikes by many states; wages remained depressed, while firms hoarded cash; regulation increased; and uncertainty continued.
So, the result was a hard landing and a soft recovery, which is the worst combination possible.
"There would not have been any opportunity if the rating agencies had doen their job, either. where was the government interference in their ratings system?"...
Hmmm, that's funny hydra but let me suggest you do some homework on what the CRA is and its history...
This comment has been removed by the author.
Professers Roberts and Perry have combined their talents for a succint and compelling chart. The gravity analogy might be further carried out as: the U.S. government promoted a system of ever bigger and more dangerous aircraft for the speculators to fly.
Rising median ages for the U.S., Japan, Germany, and China suggest slower future economic growth in those countries.
China's median age has increased sharply over the past 10 years, because of its one-child policy. It increased from below 30 in 2000 to over 35 in 2010. It seems, China will age without acquiring much real per capita wealth.
The U.S. median age is about 37, which increased slightly since 2000. Both Japan and Germany had sharper increases in median ages since 2000. Japan's median age is about 45 and Germany's median age is slightly above 44.
Remarkably, Uganda's median age is 15.
There you go, invest in Uganda.
How does decreasing national economic growth with age correlate to the fact that American Seniors are accumulating more weath and faster than the younger generations?
I know what CRA is, but still, how would those packaged securities get sold if the ratings agencies came out and called them junk?
isn't it possible that government is at fault?
That they government opened the window a crack to let n some fresh air, and then the bankers drove a truck through it?
Hydra, Americans in general accumulate more real wealth than other countries:
Economy of Germany Wikipedia
"A problem, pointed out by Gabor Steingart, is that the country's investment ratio (investment/GDP) has sunken from 18% in 1970 to 3%, and is now only a third of that of the United States. In Western Europe (including Germany) no new company has made it to the top 100 in the last 20 years - some consider this a problematic issue, while others cite it as an indicator of fair competition and lack of monopolization. This is in stark contrast to the United States, where newly founded high-tech companies have experienced significant increases."
Bankers need to be broken into the few large national banks, regional banks, savings banks, barely regulated mortgage brokers and then wall street bankers that made the bump/correction worse. B Frank knew the bubble would break and was willing for us to have the pain but did not anticipate the leverage by liberal, greedy, connected wall street.
You think CRA was bad before. Dodd Frank has put CRA on steroids expanding the targets and with serious punishment for those that dare to not put their bank at risk through making loans that will not be paid back. Better up the loan loss reserves.
What I don't understand is why commercial real estate--including large properties bought by institutional investors--had a mirror collapse to the residential market.
This undercuts the "gummint did it" argument.
Ultimately, my point is that markets work great, but it is a mistake to make the case that they're infallible, simply to counter the statist morons on the other side of the debate who claim that their bureaucrats are omniscient. Rather, one has to make the case that however fallible markets may be, the market record is many times better than govt regulators record, which is why it is a joke to even mention govt regulation as a solution (the dimwits at the SEC didn't even understand how derivatives work)....
It is more than that. In a free market those that make the errors are punished and the losses are not socialized as they are when governments intervene.
Why is Barney Frank still a free man?
"I know what CRA is, but still, how would those packaged securities get sold if the ratings agencies came out and called them junk?"...
Obviously you really don't know what the CRA is really about...
If you had then your comment about banks and ratings agencies would've have been wasted effort on the face of it...
"What I don't understand is why commercial real estate--including large properties bought by institutional investors--had a mirror collapse to the residential market.
This undercuts the "gummint did it" argument."
That's been explained to you in the past, but you likely rejected that explanation as it didn't fit your worldview. In your world, there will never be an answer to your question.
Michael Hoff said...
"Why is Barney Frank still a free man?"
That's a really good question, and I'm not sure there's a good answer, but we should probably ask it about a long list of other names also.
What I don't understand is why commercial real estate--including large properties bought by institutional investors--had a mirror collapse to the residential market.
The cause is very similar. When you have a central bank that can manipulate rates so that it can try to keep the liquidity created party going people who make decisions have an incentive to be bold and to take risks that they would not take if interest rates reflected market reality. This would be the case even if they were fairly certain that there was a bubble.
This undercuts the "gummint did it" argument.
It does no such thing. You simply can't see it because your knowledge of economics is very poor.
How do you sell a security rated below junk?
and the losses are not socialized
================================
Let's see, the wins are socialized through prograssive taxation, whats the difference?
And, where does th efree market you describe exist?
Let's see, the wins are socialized through prograssive taxation, whats the difference?
Progressive taxation is theft. Bailing out bad decisions with tax revenues is theft and stupidity.
And, where does th efree market you describe exist?
It does not. There is usually some regulations around to interfere with most markets. But the argument is still valid. The freer the market and the more secure the property rights the better the outcome.
Hydra, the ratings agencies had a govt-mandated oligopoly because of the idiotic NRSRO designation, so it is more accurate to chalk up the failure of the ratings agencies to govt interference. As for the CRA, while it no doubt played a part, my understanding is that the volume of loans it affected was a small part of the overall housing mess.
Hydra, Americans in general accumulate more real wealth than other countries:
==============================
Is that because we work harder and longer and take fewer vacations, because we are generally yankee skinflints, or because other governments interfere even more than ours?
+++++++++++++++++++++++++++
WalMart Pricing:
Today they had a sheet cake decorated to say "Go Patriots".
They wanted $17.00 and I offered them $2.00. Couldn't make a deal.
"The single most important criterion is that the rating agency is widely accepted in the U.S. as an issuer of credible and reliable ratings by the predominant users of securities ratings."
---------------------------------
The article only talked about their profits. Where is it written that fewer suppliers necessarily means rotten quality, fraudulent design, and non-existent ethics?
Jeez, even if there is only one other farm in the county, I can't stay in business with crappy products.
OK, so I sell my (more or less average) grain to a grain elevator and they bundle it with everybody else's grain. They tell the world they have the greates grain ever - sure fire weight gain for your livestock. It is all a total fraudulent lie, but they sell a lot of grain and a lot of stock in their company.
When it all goes south, someone tracks some of the grain back to me and says, hay, JackLeg, you were selling regualar grain to the SuperGrain elevator, you caused them to fail, and now we want you to bail them out.
?????
How is THAT the governments fault? Because the government failed to recognize the effect of greed?
Even if it is true that government facilitated what happened by favoring a few companies, it is most probably also true that those companies lobbied for special treatment.
Besides, if this is the cause, it still centers around the rating agencies, and not all the other subsidiary causes like overpromoting home ownership, easing credit standards, crooked loan originators, greedy house flippers, and lousy accouting at Freddie Mac.
It still boils down to ratings agencies that made it possible to sell as safe, securities that they KNEW were garbage, or at least not sufficiently researched.
Without that, no repackaging and resale of mortgages, slower flow of money into the system, and higher requirements for those that get money.
sorry, I don't buy the argument that the ratings agencies were cheats and frauds because the government made them do it.
Nor do I buy the argument that government was involved in a giant conspiracy to create those cheats and frauds in order to advance their housing goals and pump the economy.
If government was that smart, we ought to let them run the economy, and be done with it. How does one argue that the government is incompetent AND capable of running giant conspiracies?
This comment has been removed by the author.
Hydra, your arguments are getting loopy. To begin with, the ratings agencies were not the main reason for this mess, maybe reason 4 or 5. However, they helped the banks with their MBS scam, by stupidly rating securities as AAA that shouldn't have been. And the blame for that falls mostly with the govt, as those bad ratings likely wouldn't have happened if there had been real competition, so that 3 ratings agencies didn't control 94% of the market. This is the same reason we get horrible service from our local internet service providers, because the monopoly cable provider in most markets knows you can only go to one other company, the monopoly phone company, for internet service at a comparable price. The govt appointing one or two firms as designated "private" providers and then keeping all competition out is not a market, as we have seen repeatedly in all the emerging economies that privatize in such a crony capitalist way. Hence, the blame from such situations goes to the govt, because they stupidly created an untenable situation solely to have more control, with tons of lobbying dollars coming back their way to maintain the status quo, until it all blows up. Then guess who has to pay for the whole mess? The taxpayer.
Vange-
Do you have formal training in economics? If so, what?
Most people with a strong affiliation for the gold standard are not trained economists.
Hydra, yes, Americans work longer and harder than Western Europeans. However, the mix of output is different.
For example, a government worker in France may earn $35,000 a year redistributing income. That's counted as GDP (since income = output).
So, in Western Europe, many people pretend to work, but actually don't produce much, if any, value.
That's why Americans live in bigger houses (twice as big than Western Europeans), drive bigger autos, consume more goods (including imports), etc.
Americans earn over $10,000 a year more than Western Europeans, and that doesn't include the gains in consumption (which aren't counted in GDP).
The Chinese work harder than Americans. However, that's what happens when spoons instead of shovels are used, and worthless "pyramids" are built.
Do you have formal training in economics? If so, what?
I am an engineer by training. My economics courses were taught by Marxists and Keynesians so I am well aware of the problem with the mainstream.
Most people with a strong affiliation for the gold standard are not trained economists.
What is a trained economist? I know lots of economists trained in the USSR, Yugoslavia, PRC, or South America. The fact that they were trained does not make them knowledgeable of real world economics. I love it when my ten and twelve year old sons laugh at stuff that Kudlow or Krugman says on TV because they recognize an error that the commentators really believe was true. Last year I saw a geologist and finance guy laughing in the isle as their CEO was scrambling to answer a simple question from my then eleven-year old. He had just seen a Doug Casey speech and asked the CEO how he can be confident in his prospect generator model given that many of the JV agreements had payment clauses that were in fiat money and extra buy-in clauses that would give away 10-20% of the project for the cost of a nice dinner. The poor guy was not the only one disturbed by the question because it became apparent that more than a few other companies had made similar errors.
The fact that Keynesians, Monetarists, or Marxists do not like gold is of no concern to me because sound economic theory, economic history and the empirical data is on my side. Frankly, it helps my cause if there are lots of proponents for fiat currencies because it makes it easier for me to become richer as I bet against them.
The Chinese work harder than Americans. However, that's what happens when spoons instead of shovels are used, and worthless "pyramids" are built.
The Chinese may have built far too many buildings in certain markets but when prices collapse those buildings will be used by someone else who needs a place to live. They may have all those nice new highways, power plants, railway lines, airports, bridges, etc., but those will provide use for them for many years.
On the other hand, we have seen lots of housing also built in the US that will not be needed by people moving from the countryside into cities. We did not see the US spend much in building more efficient airports, railway lines, bridges, and highways. But we did see the US spend nearly a trillion to fight two wars and billions for new military hardware that does not have much of a use for defense purposes.
I think that your analysis has to run a bit deeper. From what I see the Chinese have increased their standard of living at a far greater rate than the US and uses far more steel, copper, coal, nickel, cement, cotton, wheat, soya, etc., than the US does. That makes China the biggest consumer of commodities in the world by volume and probably gives China the world's biggest economy when adjusted for purchasing power.
VangelV, the dominant form of economics taught in the U.S. is the Scientific Method of NeoClassical Economics.
People without degrees in economics and call themselves economists, e.g. Kudlow and Reich, tend to be false prophets. Krugman is a political extremist, but an excellent economist (most people don't know what economists really do).
VangelV, the Chinese are helping the U.S. become an even bigger economy, because it exports a huge proportion of its output.
And the U.S. fought two wars cheaply, while they were financed (before and during) by our trading partners.
VangelV, the dominant form of economics taught in the U.S. is the Scientific Method of NeoClassical Economics.
Scientific? What does that mean?
The real world is dynamic and non-linear. It can't be analyzed using false assumptions of equilibrium and simple linear equations. When the self-proclaimed experts pretending to know something that the do not, their use of math does not make you scientific. It only shows that they are either stupid, blatant liars, or deluded.
And the U.S. fought two wars cheaply, while they were financed (before and during) by our trading partners.
More than a trillion is not cheap. And if you don't pay back what you borrowed the USD becomes toast as a reserve currency. Cheap is clearly not a word that I would use.
VangelV, the Chinese are helping the U.S. become an even bigger economy, because it exports a huge proportion of its output.
Trade has been of benefit to both sides. But both sides have governments that do some very stupid decisions.
I think Europeans live in smaller houses because of tight building restrictions. Certainly in UK all building rights were nationalized after the war. Preserving green rings around the city became a religion, along with historic preservation.
The ratings agencies were nit stupid, they were criminal. Some people resigned because of what was happening.
Yes, more competition MIGHT have brought in a little honesty, but probably not. An honest firm would have brought in nowhere near as much profit, and would have been crushed.
Even if their position was protected by the government, like a trash hauler, there was no reason for them to pass on bad securities. It was their JOB not to, and they didn't do it.
None of the rest could have happened without those ratings.
The push to get those ratings only means that had there been more ratings agencies, the banks could have shopped around more and gotten crooked ratings at a lower price.
There used to be a lot more auto companies and a lot lower quality.
You have not convinced me that government protection or favoritism led them to cheat.
I put the failure of the ratings agencies as a root cause.
I think scientific method implies you can run experiments and compare the results against a control.
Economics cannot often do that, so it remains a descriptive science like botany or minerology.
Hydra, one can fantasize about what the govt-protected ratings agencies should have done all one wants, the fact is they had little incentive to get it right because of their protected status, just like a protected trash hauler. Of course competition is no guarantee they'd get it right, as private banks do stupid things too, but when JP Morgan Chase had its money on the line, it got out of housing and became the largest US bank soon after the crisis. Funny how knowing you could go bust clarifies your thinking. ;) And no, the ratings were not actually that important, for the converse reason you give with competition, because nobody really paid attention to the ratings anyway. Everybody on Wall Street knew the ratings agencies were a joke, they were just there to rubber stamp some securities for the few sucker funds and investors that didn't know it. There was also higher quality with more auto companies, a fact you ignore. I have not convinced you because you are apparently ignorant of the incentive effects of competition and of the minor role of the ratings. You can't convince someone who is ignorant of the basic issues. ;)
Hydra,
Rating agencies:
Something you are missing is the fact that part of the reason for AAA ratings was because the MBSs in question were backed by mortgages held by Fannie & Freddie, which have implicit government backing. How much much safer could they be? As it turns out, that backing has become explicit, so the high ratings were pretty much justified.
As for gravity, it may be involved in every plane crash, but it's also the reason planes are able to fly in the first place, so it's a mixed blessing. :-)
VangelV, you don't need pinpoint accuracy to understand economics. Anyway, no one has the capacity to think in hundreds of dimensions (i.e. vectors in n-space).
That's why a sound general equilibrium model of a large economy hasn't been developed. Nonetheless, you can tie-together partial equilibrium models, input-output models, optimization models, contemporaneous models, etc. for a crude understanding.
Hydra, are you saying if Europeans didn't have "tight building restrictions," their houses would be twice as big?
Also, if European houses are much smaller because of "tight building restrictions," then why aren't they making-up for their small houses by driving bigger autos and consuming more other goods (including imports)?
Moreover, I may add, small economies can grow quickly. I've stated before:
In 2007, U.S. per capita income was $45,000 and China's per capita income was $2,000. If the U.S. gains $700 and China gains $300 for each $1,000 in trade, then U.S. income (or living standards) rises less than 2% and China's income rises 15% (however, unfortunately for China, when social costs are included, the U.S. may capture all the gains in trade).
Sprewell says: "As for the CRA, while it no doubt played a part, my understanding is that the volume of loans it affected was a small part of the overall housing mess"...
Exactly right sir but how big of a shawdow did those few run ins with the CRA mandates cast over the whole of the home loan industry?
I'm unsure if the primary problem was the low or no down payment as it was the lack of complete documentation of income and ability to pay.
I think Europeans live in smaller houses because of tight building restrictions.
That is part of it. The other part is the fact that Europeans are much poorer.
The ratings agencies were nit stupid, they were criminal. Some people resigned because of what was happening.
Wrong. The agencies have an oligopoly and satisfied the people who paid them by making assumptions that were convenient for their clients. There was little downside to their lies so they acted as would be expected by any rational observer.
Yes, more competition MIGHT have brought in a little honesty, but probably not. An honest firm would have brought in nowhere near as much profit, and would have been crushed.
A free market would have made a difference. If lousy decisions were not backstopped by the taxpayers people would be a lot more diligent and would pay for their own rating advice. The companies that were more accurate would get more and more of the business while those that were incompetent would lose their customers and close down. That is the way things should work but do not because governments and central bankers get in the way and put up barriers to competition even as the protect their favorite patrons.
Even if their position was protected by the government, like a trash hauler, there was no reason for them to pass on bad securities. It was their JOB not to, and they didn't do it.
On what planet do you live? To figure out why things happen you need to look at incentives. If you lie you get rich but may lose some of your reputation in a few years. If you tell the truth you have a good reputation but don't make much money and have to work for a very long time before you can retire. Given those choices what do you think that most people would do? And what do you think happens to the ones who choose to be honest?
You have not convinced me that government protection or favoritism led them to cheat.
That is because you have no idea how the system works.
I put the failure of the ratings agencies as a root cause.
Given the structural incentives it makes no difference which companies are given the ratings monopoly because the outcome will be exactly the same as long as taxpayers bail out the people who make bad decisions. If the banks who bought the bad papers knew that they would be liquidated if that paper went bad they would not have bought as much of it and would have paid for their own analysis.
I think scientific method implies you can run experiments and compare the results against a control.
Economics cannot often do that, so it remains a descriptive science like botany or minerology.
Economists can't ever do that.
VangelV, you don't need pinpoint accuracy to understand economics. Anyway, no one has the capacity to think in hundreds of dimensions (i.e. vectors in n-space).
No you don't need 'pinpoint accuracy.' But you can't pretend that there is an empirical foundation for your beliefs and that they are anything other than speculation.
That's why a sound general equilibrium model of a large economy hasn't been developed. Nonetheless, you can tie-together partial equilibrium models, input-output models, optimization models, contemporaneous models, etc. for a crude understanding.
No you can't tie in a bunch of approximations and guesses to create something accurate. That is not the way that the real world works. But in the real world human beings choose actions that they prefer to the alternatives. And those actions depend on incentives. That is why people who understand that are so much better at predicting outcomes than those that pretend that their theory is scientific and that they can tell what happens by looking at incomplete and often inaccurate data.
Post a Comment
<< Home