Housing Boom And Bust

Without question, bubbles run outof control and all the related mechanisms are promoted in place to causeexcessive credit exposure.  Here we get aquick history in which wishful thinking and a laudable aim to place folks inhomes got nudged into overdrive.  Sowhat!  Every market once it is in motionattracts the same forces that normally have hard learned governors inplace.  Here the lessons of the thirtieswere chucked because of a severe lack of imagination or simply the stupid andgreedy got to call the shots.

A credit pricing rule needs to beimplemented that forces credit granters to tie loan ratios to a five yearaverage value in the housing and general real-estate industry rather than tocurrent value as appears to be the present practice.  Automatically, in the face of rising prices,greater equity is necessary and demanded. As critical, it makes diddling the numbers practically impossible.

Equally important in the face ofdropping prices, the ratios become naturally more generous.

Most important if effectivelyblocks spiraling credit granting growing much faster than the real market.

It really is that simple and putin place; prices will adjust to allow all participants to be treated fairly.

Today, the entire USA housingmarket could be shifted upward one hundred percent by taking foreclosure inventoryoff the market presently driving downward pressure and allowing presentinterest rates to support the price structure. This has happened in Canadawere there is no significant foreclosure inventory.

The housing boom and bust

by RUSS ROBERTS on APRIL 13, 2011

Here is an updated version of Case-Shiller’s housing index for thecountry. (Thesource for the updating and the image is The Big Picture and TBPreader Steve Barry.) It is of course somewhat misleading because there is not anational housing market. But it does capture factors that affect all housingmarkets.

Some people explain the recent 15 years as being caused by “animalspirits” arguing that if you think prices of an asset will go up, then thatbelief can be sufficient to cause a bubble. True, no doubt. But what causesthat belief to take hold. Some people say it’s just random. A fad. The madnessof crowds. Could be. I suspect that thesystematic attempt by federal government policy that began in earnestin 1995 and ran through the Clinton and Bush II administrations had a lot to dowith it.

The housing boom and bust, part 2

by RUSS ROBERTS on APRIL 13, 2011

http://cafehayek.com/2011/04/the-housing-boom-and-bust-part-2.html

In this post,I suggested that the spike in housing prices starting in 1997was due more togovernment housing policy and less to animal spirits or a self-fulfillingbubble that somehow got started out of the blue.

The picture is from Barry Ritholtz’s blog, The Big Picture.

Barry responds in the comments:

Be wary of squishy thinking.

While its easy to blame Uncle Sam, you need to show the data thatsupports that argument — so far, no one has successfully done that. NO ONE.

The much more persuasive case has been made that the combination ofultra low rates, shadow banking system, corrupt rating agencies, foolishlenders, irresponsible borrowers and dumb bond fund managers were the primarycauses.

The DATA provides an overwhelming viewpoint of where the Housing boomand bust came from Barry, I think you’re confusing the subprime crisis with thehousing boom.

 They are related but they’re notthe same thing. The Fed’s low interest rates between 2002 and 2004, forexample, did have something to do with the subprime crisis. And artificiallylow interest rates did inflate the housing market generally. I don’t think theyhad  anything to do with housing prices in 1997. And yes, the shadowbanking system had a lot to do with the run-up in prices after 2003 or so. Andyes, there were a lot of dumb, myopic lenders, borrowers and bond-fundmanagers. But why did they start getting dumb in 1997.

My other thought is that we don’t have particularly good models ofbubbles, by definition. So when you say there no one has produced the data, I’mnot sure what standard to use to evaluate it. What I think you really meant whenyou wrote that was that Fannie and Freddie and the CRA can’t explain why BearStearns and Lehman and a bunch of other cowboy waa-hoos went crazy on MBS. Andyou’re right. But that’s not all that I meant by government housing policy.

Here’s the outline of my narrative. Sure, it’s squishy in parts. Allnarratives are. Yours, too, I suspect, but I’ll let you make the call on thatone.

The role of government in the housing market goes back decades to thedeductibility of mortgage interest, FDIC insurance, and the creation of FannieMae. But those interventions were done a long time ago and they stayed in placewith minor variations. They weren’t the cause of the crisis. You have to find achange in government policy. My narrative starts in the early 1990′s. Checkout thisarticlefrom 1992. (And don’t worry, even though I’m going to use theletters “CRA” in consecutive order in what follows, I don’t think the CRA isthe main cause of the subprime crisis. I, like you, blame most of that onshadow banking. But the CRA has something to do with it…)

It’s about how ACORN and others used provisions of the CRA to get urbanbanks to make loans in neighborhoods that hadn’t been receiving loans:

The Philadelphiabanks in the program, Mellon, Continental and Fidelity,, say their experienceshows that a well-structured program can break even in the short run andpromises intangible and financial gains over the long haul. The banks chargesufficient fees to cover costs and work hard to keep delinquencies andforeclosures low.

“These are not conventional loans and we make sure that we don’t losemoney,” Mr. Desiderio said. “But they are totally beneficial to us because theyimprove our trade area. In the long run this will drop to the bottom line.”

Bankers believe that as poor neighborhoods stabilize, the entire regionbenefits, which affects a bank’s future profitability.

What is more, these mortgages help banks fulfill somewhat vagueobligations of the Community Reinvestment Act of 1977, which requires banks toinvest in communities that provide them with deposits.

It also talks about the role of Fannie and Freddie. Remember, this is1992, right around the time HUD starts pushing Fannie and Freddie to buy moreloans than they had bought before in poor neighborhoods.

But the mergers that have helped create the lending programs are also acause of concern for some. LaVerne Butts, a Philadelphia Acorn official, fearsthat mega-mergers may leave the poor in the dust. “Where’s the accountability?”she asked. “We’re doing wonderful things, but we’re still swimming against thetide. Many of these banks still don’t view low- and moderate-income people aspeople. When they get so big, who do you lean on?” Aiming at Secondary Market

Yet at present, the three Philadelphiabanks seem responsive. They have lobbied with Acorn in Washington to find ways to make it easier topackage these mortgages and sell them in the secondary market. This wouldreduce the banks’ risk and free up more money to lend.

The biggest buyer of mortgages is the Federal National MortgageAssociation, known as Fannie Mae, which resells them to investors. But FannieMae has been reluctant to buy such unconventional mortgages. Acorn hopes thatlarge commitments like that of Nationsbank will help bring pressure on FannieMae. Already, Nationsbank is talking about joining with Acorn’s Washington lobby.

Fannie was reluctant, but they got over it. They made an enormousamount of money when they were “forced” to lower their standards. They weren’treally forced. They liked being thrown into the briar patch.

Remember, this is 1992. In 1995, the CRA got revised and was madetougher. Fannie and Freddie’s were required to buy more mortgages made tolow-income buyers. In 1995, President Clinton announced the 1996 Home OwnershipStrategy. Readabout it here. Go to the end of the document. It details all the activitiesthat would increase home ownership.

And it worked. Or something did. Correlation is not causation. The factthat home ownership rates started to rise in 1995 doesn’t mean the policyworked. But that was the goal of the policy and the stated activities relatedto that goal (Making Financing More Available, Affordable, and Flexible) wouldincrease home ownership. Of course, you have to look at the data. You have toshow that financing did become more available, affordable, and flexible.This 2001paper by Josh Rosner makes the case pretty convincingly. But maybe I’mbiased. You tell me where Rosner goes wrong. He does have a lot of data.Remember, this is 2001. Long before the important part of the subprime crisis.

I summarize the role of Fannie and Freddie’s increased willigness tobuy mortgages they wouldn’t have bought before, here.I’m agnostic about their direct role in subprime. I don’t think they boughtvery much of it. They bought a lot of subprime MBS. But maybe someone elsewould have bought that anyway. It was awfully profitable for a while.

So my claim is that between 1995 (and maybe a little earlier) and2001, there was a lot of government policy that pushed up the demand forhousing. Increases in demand usually increase prices. There are exceptions. Ifsupply is sufficiently elastic, the price increase can be minimal. But Ithink it’s pretty clear that in some cities, supply was quite inelastic, forboth geographic reasons and zoning restrictions. So the push in demand helpedcreate the rise in prices you see in the graph.

It probably didn’t create the subprime crisis directly. But it doesn’thave to in my story. In my story, the increase in demand (driven by housingpolicy, somewhat well-intended (getting people into homes who couldn’t affordthem before), somewhat very nasty self-interested cronyism (NAR, NAHB, Fannieand Freddie) pushed up the price of housing between 1995 and 2001.

Once the price of housing started rising dramatically, it becameprofitable to bet on the rise continuing. So a lot of people, smart and stupid,tried to ride that meteor as it shot upward. And that’s where the shadowbanking system and the low interest rates come in. The shadow bankers pumpedtrillions into that market via all those innovative new assets (CDO’s, CDOsquared etc). They use borrowed money because they could. The lenders lentthe money because thegovernment had signaled that lenders would get made whole even whenthe bets their loans financed were worthless. I learned part of that storyfrom a fine book called BailoutNation. I think you’ve heard of it. So moral hazard had something and maybea lot to do with the last part of the housing bubble and especially thesubprime part. But why did the moral hazard spend itself in the housing marketrather than somewhere else? That was because that market was rising nicely. Butwhy was it rising nicely. Animal spirits or government policy that kicked offthe madness? I think the government had a lot to do with it.

Here’s where my story is squishy. It’s not enough to say that demandwent up, so prices went up. You have to show that the magnitudes arereasonable. You have to show the areas where Fannie and Freddie were mostactive between 1995 and 2001 were the areas where price rose. I’ve seen onepaper that argues that Fannie and Freddie’s affordable housing goalshad a limited impact on providing liquidity. Could be. But it is hard to teaseout independent effects. I suspect this debate and empirical evidence will keepgoing for a while. But it’s a reasonable debate. It’s not silly.

And yes, I know other countries had housing bubbles but didn’t have aCRA or Fannie or Freddie. You can increase subsidies to home ownership withouthaving the same named entities. Again, it’s an empirical question. And Icertainly agree that monetary policy and the coddling of cronies in the shadowbanking system made the whole thing many times worse than it otherwise wouldhave been.