Housing Bubble – Government Creation?

Housing Bubble

With Obama’s announcement that he is interested in creating conditions that will lead to another housing bubble, it’s interesting to go back and revisit the conditions that led to the most recent bubble.

It has long been my position that it was the government that was responsible for the conditions that created the housing bubble that burst in 2007.  That it was the government’s role in pushing home ownership levels to higher and higher values that eventually led to the condition where people who couldn’t afford homes finally began to default resulting in the crisis.  A crisis that we haven’t truly recovered from.

To be sure, there were private industry players that contributed to the crisis.  There were vehicles that were created that also led to that crisis.  But, in the end, it was the government’s desire to increase home ownership among lower income and “at-risk” households that drove the poor behavior of those private individuals and the creation of those vehicles.

Not everyone agrees with me.  In fact, blog favorite Scott Erb often takes me to task, most recently in the comments of the above post.  More specifically, he’s pointed me to a book that he claims supports his position: “All The Devils Are Here”.

As part of my attempt to make MY case, I’ll be quoting from this book in an effort to show that it was government goals that was the genesis of the whole meltdown.

Here’s the first such example:

Here’s a surprising fact: it was the government, not Wall Street, that first securitized modern mortgages.  Ginnie Mae came first, selling securities beginning in 1970 that consisted of FHA and VA loans, and guaranteeing the payment of principal and interest.  A year later, Freddie Mac issued the first mortgage-backed securities using conventional mortgages, also with principal and interest guaranteed.    In doing so, it was taking on the risk that the borrower might default , while transferring the interest rate risk from the S&L to a third party party: investors.  Soon, Freddie was using Wall Street to market its securities.  Volume grew slowly.  It was not a huge success.

In the example above, it would be my position that the government created the conditions that eventually led to Wall Street marketing those loans in the early 70’s.  Did Wall Street actors engage and participate in the process?  Sure, it’s clear they did.  Were they all above board?  Perhaps but likely not.  However, the initial push, the lighting that struck primordial mud and created carbon life was government.

And it’s my case that the same thing happened long ago that resulted in the crash of 2006-2007.

4 responses to “Housing Bubble – Government Creation?

  1. There is nothing wrong with securitizing mortgages IF there is reporting and regulation, and if it is done properly. That’s why you didn’t get problems from the VA loans or Ginnie Mae. In fact, there are good reasons to securitize mortgages on a limited and controlled level.

    The problem came after 2002 when derivative trade went through the roof. Derivative trade was $40 trillion in 2000, it hit $180 trillion in 2007, thanks to the bonds the big banks were churning out. Unlike early efforts to securitize, there were no real lending standards in the 2000’s. The VA, Ginnie Mae and others had real lending standards, but after 2000 once the big banks saw massive profits from derivative trade, they didn’t care – they’d buy ANY mortgage that was offered. The thought they had no risk because they were selling the bonds as AAA, but what they were doing was creating systemic risk.

    Thanks to cheap credit (and that you CAN blame the government for – the federal reserve kept credit very cheap) and a refusal to regulate derivatives (Greenspan said ‘the market can do it best’ – he later recanted, realizing that somethings markets don’t do as well as the government!), the banks went out of control. Then you have the various mortgage companies who went for high fees and loans to anyone (e.g., stories of a person making $50,000 being approved for a $900,000 home) knowing they’d sell them right away. That created the bubble. If the banks hadn’t demanded those mortgages, you’d not have had such a run up in prices. If mortgage companies had not gotten rid of lending standards, you’d not have had so many defaults. The mortgage companies avoided Freddie and Fannie because they still had standards.

    And of course the real damage was not the housing bubble bursting, but the toxic assets that the banks had created rippling through the entire economy. I do blame government in one very key way: blinded by a free market ideology they ignored their responsibility to regulate the financial sector and hold the banks accountable. Countries like Germany who kept tight regulations and assured risk could not simply be sold away are doing very well. Countries who followed the deregulatory trend of the US (Iceland and Ireland) are doing very poorly.

    • There is nothing wrong with securitizing mortgages IF there is reporting and regulation

      We’re closer now. At first I thought it was your position that it was Wall Street that was to blame for the vehicle of securitizing mortgages. Now we know that it’s okay, we just need regulations.

      I do blame government in one very key way: blinded by a free market ideology they ignored their responsibility to regulate the financial sector and hold the banks accountable.

      We’ll see. I’ll keep digging 😉

  2. And I’ll add that the Clinton Administration really oversaw the most damaging regulatory shifts that help set up the bubble. So it’s not a Republican or Democratic thing, both parties thought that the US had found the way to economic success, and that it was an onward and upward new economy!

    • So it’s not a Republican or Democratic thing

      To be sure. All Presidents have touted the home ownership number as a gauge to measure economic success.

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