So, the bubble has burst, the banks have been bailed out, but there still remains the question: what caused the subprime mortgage collapse? There are, generally, three competing hypotheses: the stereotypical left-wing explanation that it was underregulation; the wishy-washy sudden-outbreak-of-greed theory; and the stereotypical right-right explanation that it was government meddling. In this post, I want to try to list all the pros and cons of each theory, and hopefully elucidate the causes of the collapse.
Left-wing explanation: not enough regulation!
This hypothesis most often blames the Gramm-Leach-Bliley Act of 1999, which repealed parts of the Glass-Steagall Act of 1933. Passed in the wake of the Great Depression, the Glass-Steagall Act – among other things – drew a thick line between "investment" and "commercial" banks. Investment banks made wild bets, and commercial lending banks kept your money safe. This distinction formally melted away in 1999 with the Gramm-Leach-Bliley Act, when banks were able to be both commercial lending banks and investment banks. The argument goes that this encouraged what were otherwise commercial banks to get into the risky subprime business – to play roulette with your bank deposits. Though figures as public as Paul Krugman have all-but-endorsed the theory, Alex Tabarrok at Marginal Revolution demolishes this myth. In studies done with the benefit of hindsight, "unified" banks (i.e., those that took advantage of the diversification that the repeal of Glass-Steagall allowed) actually did better through the subprime crash than solely investment banks.
Wishy-washy explanation: too much greed!
Unfortunately, this is probably the most popular explanation. It's popular among politicians, because it allows for a lot of grand-standing without any real solutions. Like I wrote yesterday, you cannot use basic human proclivities to explain one-off crises.
Right-wing explanation: too much regulation/intervention!
Readers of this blog will know that this is where I stand: the government, from back to the Clinton years, has been using homeownership rates as a proxy for general welfare, and both Clinton and Bush II have tried their damnedest to ride roughshod over free market financing and cram as many mortgages down as many throats as they could. Russ Roberts at Cafe Hayek has done an excellent job in documenting all of the ways in which government has intervened in the housing market, by way of the GSEs, the FHA, HUD, and the CRA. There are various retorts to this, depending on which government agency you think caused the crisis. When presented with evidence that Fannie and Freddie were big players in the subprime game, opponents of this theory will point out that they were forced to get out of the subprime business before the bubble burst. When questioned about the Community Reinvestment Act, opponents will point out that though the reinterpretation of the CRA did lead to a "flurry of CRA activity," it was over by 2001. Still, though, given that Fannie/Freddie/FHA/HUD/CRA combined for sure accounted for the majority of the mortgage market, it's not difficult to imagine a situation in which government mortgage agencies kicked off the bubble, and then the increasing housing prices gave the situation a momentum of its own (subprimes aren't risky when home prices are constantly climbing), so that even if by the end there were no government players, they were still ultimately responsible.
Edit: Another explanation is a change of tax policy in 2007, which I discuss in a post on September 23.
Monday, September 22, 2008
Cause of the mortgage crisis
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3 comments:
You forgot an explanation:
This is suspiciously like the Orange Alert! Terra! Terra! "crises" we had during the last presidential election cycle.
Not the entire explanation, but it certainly is piled on top of the unfettered greed, too little regulation and series of speculative bubbles that were allowed to happen under the neocon-neolib failed experiments.
DS
But why would the Bush administration want to cause an economic collapse? This clearly hasn't helped him or John McCain (who, by his own admission, really doesn't know anything about economics). And that doesn't really make sense when you consider that there really WAS a bubble.
And as for "too little regulation," where do you see that? I mean, what's changed? The only thing I can see is Glass-Steagall, but like I said, that clearly didn't cause the bubble.
And I would also contest your use of the term "neocon-neolib." There's really nothing free market about the American housing market, if that's what you meant by "neocon-neolib."
But why would the Bush administration want to cause an economic collapse?
Perhaps I was unclear.
This "crisis" of 'hurry up and trust us, we must act quickly or else the car will be off the lot' combined with the 'two weeks ago there were no problems, but today there is one and we must give total power to my appointee and transfer our treasure to my benefactors' problem and it is a ginned-up terror alert.
BushCo did not want to cause a collapse, but their incompetence and blatant plunder (KBR/Halliburton) are helping to cause this one. We are in one now.
Second, my first career was in banking. Things are very different today with all this under-reserving and risk-taking and debt-hiding cr*p. The regulations to keep banks away from investment and insurance houses went away. These regulations that went away would have prevented this.
DS
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