These guys get it..a little of it, anyway

It wasn’t household debt that caused the Great Recession.  So who was to blame?

Princeton University professor Atif Mian and University of Chicago Booth School of Business professor Amir Sufi pin the blame squarely on policymakers, but not for any of these three reasons, all of which are variously popular with policymakers on different sides of the political divide in Washington. Instead, in their just-released book, House of Debt, they argue that the Great Recession was the result of a sharp fall-off in consumption due to the unevenly accumulated household debt in the first six years of the 21st century.

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How did this happen? Why did lenders suddenly shower less-creditworthy borrowers with trillions of dollars of credit? Mian and Sufi demonstrate this was enabled by the securitization of home mortgages by investment banks that did not seek federal guarantees from Fannie and Freddie…

How did this happen?  The housing bubble of the early 2000s was enabled by the policies of the federal government with respect to mortgage lending.  According to Forbes:

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.

This just in: lending money to people who aren’t going to be able to pay it back is bad business.  The Community Reinvestment Act, as well as the securitization of these bad mortgages by Fannie Mae and Freddie Mac, led to a massive amount of ‘sub-prime’ housing loans being made to people who couldn’t pay them back.  Loan terms included interest-only payments, no-money-down loans for up to 125% of a house’s assessed value, and adjustable rate mortgages (ARMs) that offered a low interest rate for the first 3 to 5 years of the loan.  Borrowers were often shocked to find that their mortgage payment doubled once the ARM period expired and the interest rate adjusted to the market rate.

It’s not just the ‘right wingers’ from Forbes who noticed this.  From the left-of-center Atlantic magazine:

Congressman Frank, of course, blamed the financial crisis on the failure adequately to regulate the banks. In this, he is following the traditional Washington practice of blaming others for his own mistakes. For most of his career, Barney Frank was the principal advocate in Congress for using the government’s authority to force lower underwriting standards in the business of housing finance. Although he claims to have tried to reverse course as early as 2003, that was the year he made the oft-quoted remark, “I want to roll the dice a little bit more in this situation toward subsidized housing.” Rather than reversing course, he was pressing on when others were beginning to have doubts.

His most successful effort was to impose what were called “affordable housing” requirements on Fannie Mae and Freddie Mac in 1992. Before that time, these two government sponsored enterprises (GSEs) had been required to buy only mortgages that institutional investors would buy–in other words, prime mortgages–but Frank and others thought these standards made it too difficult for low income borrowers to buy homes. The affordable housing law required Fannie and Freddie to meet government quotas when they bought loans from banks and other mortgage originators.

At first, this quota was 30%; that is, of all the loans they bought, 30% had to be made to people at or below the median income in their communities. HUD, however, was given authority to administer these quotas, and between 1992 and 2007, the quotas were raised from 30% to 50% under Clinton in 2000 and to 55% under Bush in 2007.

Even the extremely leftist Mother Jones pins the blame on the federal government:

Matt Steinglass is arguing with his “Hayek-inflected” colleague W.W. about the origins and causes of the housing bubble. Roughly speaking, the two sides take the following positions:

(a) Federal government policies played a strong role in promoting the housing bubble.

(b) No, it was primarily the excesses of the private sector that powered the housing bubble.

Just to be clear: by position (a) I don’t mean the kind of childish Fox News dimwittery that blames everything on the CRA and Fannie Mae. I mean the grown-up critique that more generally blames federal encouragement of homeownership, Fed monetary policy, federal tax policy, and various kinds of federal regulation of the financial industry. What’s interesting here is that these two positions can collapse into each other pretty quickly. Let’s rephrase them like this:

(a) Government regulations encouraged the private sector to lever up and make lots of bad loans in the housing sector.

(b) The financial industry used its enormous influence to lobby for deregulatory legislation, which allowed the private sector to lever up and make lots of bad loans in the housing sector.

Both of these statements are more or less accurate. And of course, deregulation is merely shorthand for a different set of regulations and policies, so our two positions can collapse even further if we like:

(a) Changes in government policy encouraged home buyers to borrow too much and encouraged the financial industry to lever up and make too many bad loans.

(b) Changes in government policy encouraged home buyers to borrow too much and encouraged the financial industry to lever up and make too many bad loans.

When even the extreme left knows whats up, you know that there is a problem.

But the root of this problem was the government’s reliance on the works of an old dead white man economist (who didn’t know much about economics):

In The General Theory of Employment, Interests(sic) and Money, University of Cambridge economist John Maynard Keynes argued in 1936 that the distribution of income mattered for the stability of the macroeconomy. Increased spending, be it from consumers, government, greater exports, or investment, will multiply as it works its way through the economy. If additional income goes into the hands of those with a high marginal propensity to consume then the multiplier for consumption demand will be relatively larger. But if additional income goes into the hands of those with a lower marginal propensity to consume then the multiplier on consumption demand will be relatively weaker.

Mian and Sufi agree:

Mian and Sufi’s research leads them to conclude that the crisis was avoidable if only economists had used the right framework to see what was happening around them at the time.

“Economic disasters are man-made,” they write in the opening pages, “and the right framework can help us understand how to prevent them.”

Yes, and most economic disasters come from listening to PhD economists.  Keynesian economics is crap.  Like Whose Line is it Anyway, it’s all made up and actual economic actions don’t matter.

The right framework is there.  Unfortunately, modern economists don’t follow it. Heterodox economists, primarily from the Austrian school, not only saw what was happening and were the only ones to warn that a crisis was coming.  And if the world would have listened to them, the Great Recession may never have happened.

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Categories: Borrowing, Fannie Mae, Freddie Mac, Government Shenanigans, Housing, Stupid People

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