The 2008 financial crisis has proven to be a bonanza for at least one industry: Book publishers have issued dozens of tomes about what went wrong and how to fix it. Lately, the Antiplanner has been reading as many of these as possible.
Most of the authors have an axe to grind and many blame the crisis on one chief player: the Federal Reserve, private bankers, the mortgage industry, bond rating companies, politicians trying to increase homeownership, etc. Of course, loyal Antiplanner readers know the real culprit was growth-management planning, a thesis few of the book writers recognize–the main exception being Thomas Sowell in The Housing Boom and Bust.
In reading the other books, my goal has been to sift out the overblown rhetoric about greed and malice to find as many useful facts and insights as possible. Here are a few of the more interesting points.
- According to Financial Times writer Gillian Tett’s Fool’s Gold, new financial tools such as collateralized debt obligations and credit default swaps were developed by J.P. Morgan to reduce risk and were successfully used by that company to avoid the worst effects of the recession. But when the same tools were employed by other companies who failed to adequately account for risk–such as Lehman Brothers, AIG, and CitiGroup–those companies collapsed and brought down the financial system.
- In A Colossal Failure of Common Sense, former Lehman Brothers vice president Larry McDonald shows that the company was run into the ground by an autocrat who lost touch with his employees and the market. For example, despite advice from many of his executives, the way Lehman’s CEO Richard Fuld dealt with risk in the housing market was to invest tens of billions in commercial property, as if a collapse in one would not lead to a collapse in the other.
- Mr. Market Miscalculates–essays from Grant’s Interest Rate Observer, a respected newsletter on the bond market–shows many investment companies were aware of the high risks in the mortgage markets and got out of those markets as early as 2005, more than a year before the bubble peaked. Grant also points out that, even after the bubble peaked, ratings companies such as Moody’s and Standard & Poors continued to rate collateralized debt obligations (CDOs) that consisted of nothing but BBB and BBB-minus rated mortgages as mostly (75%) AAA bonds.
- The Big Short by Michael Lewis (who wrote The Blind Side), focuses a money managers who saw the housing collapse coming and made millions shorting the mortgage market. They did so by buying credit default swaps on subprime mortgage CDOs that were structured to pay off if as few as 7 percent of the mortgagees defaulted.
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Lewis observes that bond ratings traditionally reflected the odds of default. “For example, a bond rated triple-A historically had less than a 1-in-10,000 chance of defaulting in its first year.” After the collapse in 2008, the ratings agencies hastily claimed that “they never intended for their ratings to be taken as such precise measurements. Ratings were merely the agencies’ best guess at a rank ordering of risk.” A cartoon in Grant’s Observer illustrated this with a destitute trader in a bar saying, “Thought I owned the good stuff—Triple-A. Incorrect. It seems I owned the other stuff—’triple-A.'”
Other books I’ve read to date include, in no particular order:
- Financial Fiasco by my fellow Cato scholar Johan Norberg, who politely devotes one paragraph to the Antiplanner’s theory but focuses most of his book on the idea that the crisis resulted from political pressure on banks to lend to subprime homebuyers
- The Great Hangover, a collection of 21 in-depth articles about selected aspects of the crisis from the fairly liberal but often fascinating Vanity Fair magazine
- No One Would Listen by Harry Markopolos, a “quant” who tried but failed to alert the SEC to the Madoff Ponzi scheme years before the scheme collapsed
- What Caused the Financial Crisis, in which free-market advocate Jeffrey Friedman brings together essays by a wide variety of writers to make his point (not supported by all of the other writers) that too much government regulation caused the crisis
Some books I am still working on, again in no particular order:
- Too Big to Fail by Andrew Ross Sorkin, which scrutinizes the actions taken in 2008 to deal with Bear Stearns, Lehman Brothers, AIG, CitiGroup, and the other large banks and companies that faced collapse
- Too Big to Fail, a 2007 book of the same title by Federal Reserve Bank of Minneapolis President Gary Stern and Vice-President Ron Feldman, on why we shouldn’t bail out big banks
- The End of Wall Street in which WSJ writer Roger Lowenstein focuses on the role played by subprime lenders such as Countrywide
- Freefall by Nobel prize winner (and big-government supporter) Joseph Stiglitz, who makes the case for more government regulation
- House of Cards by William Cohan, an investment banker who focuses on the Bear Stearns story
- Bailout Nation by Barry Ritholz, an economist who looks at the history of government bailouts in the U.S.
- On the Brink presents former Treasury Secretary Henry Paulson’s view of what happened
- Busted by New York Times reporter Edmund Andrews, who admits he himself went broke because he bought a home he couldn’t afford
- The Quants, in which WSJ reporter Scott Patterson blames the mathematicians who developed some of the recent investment tools
- Financial Shock by Moody’s economist Mark Zandi, who carefully blames everyone except the ratings agencies (such as Moody’s) that gave triple-A ratings to subprime mortgage-based CDOs (he says he doesn’t discuss the ratings agencies because to do so would be a “conflict of interest”).
The growing conventional wisdom represented by most of these books is that the crisis resulted from an orgy of greed and financial speculation that provided short-term riches for the ratings agencies, mortgage companies, banks, and insurers, none of whom paid enough attention to long-term risk, and all of whom were aided by the fed’s low interest rates and pressure from Congress to get Fannie/Freddie to buy subprime mortgages. All of this was based on the assumption that (as McDonald repeats three times in two pages of A Colossal Failure) “the U.S. housing market had never dropped more than 5 percent in any year since the Great Depression.”
What they failed to recognize was that growth-management planning had completely changed housing markets in New England, Florida, and the West Coast (where roughly 40 percent of American housing was located), making housing both far less affordable and far more volatile than it had ever been before. If prices hadn’t been increasing thanks to artificial land shortages, speculators would not have entered the markets and pushed prices up even more. If Congress had understood why housing was unaffordable, it might have pressured states to relax their land-use regulation rather than pressuring banks to lend to subprime borrowers. If the ratings agencies had recognized the increased volatility, they would have rated mortgage-backed CDOs lower. If banks had understood that volatility, they would have demanded down payments that were more, rather than less, than 20 percent. If insurers such as AIG had understood that volatility, they would have demanded higher premiums or (more likely) refused to insure the risk through credit default swaps.
My main concern is that the mortgage crisis will lead to a backlash against homeownership–a backlash that ironically plays into the hands of growth-management planners who think more people should live in apartments. That backlash might be valid if the crisis was caused by government pressure to increase homeownership regardless of whether people could afford homes. It is much less valid if government was the reason why people couldn’t afford homes in the first place.
The Antiplanner wrote:
My main concern is that the mortgage crisis will lead to a backlash against homeownership–a backlash that ironically plays into the hands of growth-management planners who think more people should live in apartments. That backlash might be valid if the crisis was caused by government pressure to increase homeownership regardless of whether people could afford homes. It is much less valid if government was the reason why people couldn’t afford homes in the first place.
Though many of those growth management planners also tout condominium apartments as the perfect solution to all of our problems, while still giving people the federal (and sometimes state) tax benefits of owning a home.
Said planners frequently ignore the fact that condominium apartments have common areas, and those common areas can require expensive maintenance repairs – which the owners must fund.
Of course, loyal Antiplanner readers know the real culprit was growth-management planning,
Repeating falsehoods over and over don’t make them true.
DS
In Wisconsin, housing prices have largely remained flat over the past several years, although activity is way down. The main exception to this is in condominiums, where prices have fallen precipitously.
As with many societal problems this one had many causes. From artificially high land prices to accounting rules that made some securities worthless on the books while still retaining real value. Each and every one of these problems should be addressed in a rational manner and potential remedies examined.
Greed was part of the problem but greed has always been with us and managed in a way to promote economic growth and reward those who drive it. How and why did our controls fail us in this instance?
The role of high energy costs must also be examined as it again is rearing up and threatening our economy.
What is amazing to me is how we all knew the bubble was there, we knew it would burst, and we did noting to diffuse the situation. Of course when I say we I mean the Federal Reserve, the Treasury, and various other economic agencies that supposedly protect us all.
Many people just look at the demand side of pushing price.
The restricting supply is a factor too. That is true for LV & Phx too. Look at LV; it is the 5th most dense UA. Why? Land buying, the BLM. Phx has dumbass-growth & there are many globalist-redistribution elements–see ASU sustainability (Malthusian).
Lower price good, right? Why is that not seen in housing?
The economist Thomas Sowell does explain it well in his book The Housing Boom and Bust. It’s a shame that people blame non-factors & don’t understand the housing bubble. It was not free market & not dereg.
It was a dozen factors.
Who wants to learn?:
http://fora.tv/2009/06/29/Thomas_Sowell_The_Housing_Boom_and_Bust#fullprogram
http://www.newgeography.com/content/00369-root-causes-financial-crisis-a-primer
http://www.newgeography.com/content/00583-housing-price-bubble-learning-california
http://fee.org/doc/the-house-that-uncle-sam-built/
http://www.thefreemanonline.org/headline/have-economists-been-bought/
http://www.cato.org/pub_display.php?pub_id=12557
http://money.cnn.com/2008/01/30/real_estate/congress_subprime.fortune/
http://www.discoverthenetworks.org/Articles/Democrats%20Behind%20CRA%20Cover%20Up.html
http://causesofthecrisis.blogspot.com/
Don’t forget to read Peter Schiff, who predicted the collapse while others were in total denial.
Particularly insightful is How an Economy Grows and Why It Crashes.
Well it seems there is about as much consensus here as there is amongst the economist. I find it funny that so many people think they can point to this one thing and say “That’s what did it.” Maybe, just maybe, each argument has some truth to it and pointing one finger in one direction is what is the biggest misguided action in the aftermath of the crisis.
It is hard for me not to blame the credit rating agencies as it is their job to evaluate risk. You had to look no further than television ads advertising “no job and no money down” loans to know housing was in an extreme bubble.
If the credit agencies had lowered the ratings on the bonds and tranches then the whole pyramid would have stopped growing.
Borealis has a good point: the rating agencies colluded with the finance industry to hide the risk in the collateralized debt obligations, and to to a lesser degree mask the credit default swap issue. Bankers shuffled paper around like a pea under cups and all the while inflated their earnings. Of course, no one on Wall St paid for these transgressions against the commonweal, and there is little in place to stop them from moving yet more money upward out of our pockets into theirs. After all, that is the advantage of bubbles. We have known this for centuries.
DS
You left out this book:
http://www.businessweek.com/magazine/content/09_47/b4156079791251.htm
How Markets Fail, by John Cassidy.
Credit rating agencies were a big part in the dozen factors.
Improper techniques were used to measure mortgage risks & value.
One can go back to the previous lending standard of lenders requiring 20% down & verifying income for future mortgage payments, which the gov changed, in the name of affordability & poor owning homes & vote-getting, etc.
If they did risk assessment was done accurately, the bubble would have been much less.
Anyone notice how housing prices are higher & ownerships rates lower, in high density? Takes wind out of the sail & the purported benefits.
The best transit in the US is in the NYC area & they cannot even cover transit cost & housing is sky-high. Is it so great that 1/2 in NYC don’t own cars?
Also, look at Texas: all the UAs have lower than national avg for housing prices, EXCEPT Austin, which practices dumb-ass growth & other restrictions. Austin also has bad congestion, due to improper planning of how people travel.
An extra $1/gallon tax will do wonders for funding roads.
Tolls & per mile fees will help too, but have extra admin costs & don’t promote better mpg, among other drawbacks.
Back to housing: Why isn’t living near job promoted?
The view on separate zoning seems to assume that residential, industrial, retail, etc. are many square miles each, w/huge distances between. Not true.
Living above a store or a block away w/mixed zoning has very little impact.
“Of course, loyal Antiplanner readers know the real culprit was growth-management planning”
The older I get, the more I think anyone who purports to “know” the cause of a major event in an economy with 300 million human agents and 50 million plus corporate and business entities, to say nothing of millions of trusts, non-profits, and public institutions, is just full of hot air and arrogance.
There are far too many variables and random events to produce such certainties, to say nothing of the influence of outside events (since America is not a closed economic system).
The height of arrogance in economics is that it is a real science with testable and measurable and repeatable results that will conform to predictions of theory, just like say, chemistry.
Andrew, True that econ is inexact, but many behaviors, patterns & such are know, and can be predicted & tracked.
For the bubble, it was housing supply not keeping with demand–in selected markets, where there were restrictions–some (minorly) geographic, but local policy in permitting building.
Alternate history case:
It can be tough to consider “what if”, but for the SF Bay Area with a population of about 7 million, if there was more liberty in property rights & zoning, it could easily be at 9 million people, and have lower housing prices. Liberals are very selfish & prefer non-humans over humans & want to use others’ property ($ & land).
Andrew, if you look at the statistical tests of results in economics, they explain a little bit of the variance. Trouble is, the deceivers and the ignorant want you to believe the results explain more than they
actually do.
DS
I think the main culprit is our dumbass citizenry. Bubbles are truly the fault of the people who are dumb enough to think “this time it is different”.
It used to be people saved at least 10% or better yet 20% to make down payment, and that they purchased houses with a cost in reasonable proportion to their income (i.e. price = a maximum of 3 times annual income, and ideally 2 times annual income or less). Its all just plain commonsense personal money management and risk aversion.
These rules of thumb were still evident up to circa 2003 outside of California, which was alone with its exotic products like 40 year mortgages and balloon loans.
Then the insanity started, and people seemed to think you were an idiot if you weren’t buying a $500,000 house on a $75,000 family income, and housing prices zipped through the roof. Prices in my old neighborhood in the city of Philadelphia doubled in 4 years for no discernable reason from $160K for a typical house to $320K. There wasn’t a lack of land, as several hundred new single family detatched houses were built in 4 large developments and various small infill lots within 1.5 miles of me around that time and sold for higher than average prices. Salaries only went up about 20% in that time. Now the prices are back down to $225K, which is probably in line with where they should be.
It was just plain old tulipmania. “Get in now before you are left out forever.”
Bubbles are the result of bank credit expansion. Ending fractional reserve banking would go a long way to end asset bubbles.
“The/real/main/primary culprit” is a dangerous idea because all of the culprits discussed in this post played their part. Each ideological side likes to point the finger at the culprit that is ideologically convenient for them. Planners like to opine that wall street greed, predatory lending, and immoral practices of the private sector were the problem. Antiplanners like to blame government planning. Fiscal conservatives like to blame the idiots that over extended themselves. Liberal like to blame rolling back financial sector regulations and lack of oversight.
I like to think it was a clusterfu@k of ineptitude spread across the board. There is no “the/main/real culprit.” It was a team effort.
One of the problems is that many people looked to buy a house and the real estate agent would tell them how much they could “afford” to pay for a house.
I will let others debate whether government (FHA, VA, Fanny/Freddie) or the free market set the standards, but at some point standards which used to be 20% down and payments of no more than 40% of annual income became 0% down and delayed balloon payments. At that moment, the housing bubble and bust was inevitable.
Don’t forget what Paul Krugman wrote, way back in 2005, in an op-ed entitled That Hissing Sound.
I quote from that op-ed (with emphasis added):
Then there are the numbers. Many bubble deniers point to average prices for the country as a whole, which look worrisome but not totally crazy. When it comes to housing, however, the United States is really two countries, Flatland and the Zoned Zone.
In Flatland, which occupies the middle of the country, it’s easy to build houses. When the demand for houses rises, Flatland metropolitan areas, which don’t really have traditional downtowns, just sprawl some more. As a result, housing prices are basically determined by the cost of construction. In Flatland, a housing bubble can’t even get started.
But in the Zoned Zone, which lies along the coasts, a combination of high population density and land-use restrictions – hence “zoned” – makes it hard to build new houses. So when people become willing to spend more on houses, say because of a fall in mortgage rates, some houses get built, but the prices of existing houses also go up. And if people think that prices will continue to rise, they become willing to spend even more, driving prices still higher, and so on. In other words, the Zoned Zone is prone to housing bubbles.
And Zoned Zone housing prices, which have risen much faster than the national average, clearly point to a bubble.
Dan posted:
Repeating falsehoods over and over don’t make them true.
Please read Krugman’s words. Are you also going to call him a liar?
The problem with Krugman’s analysis is that there is another difference between “Flatland” and “Zoned Zone,” and that is that “Flatland” is actually flat.
Let’s look at Scott’s example regarding the Bay Area. Where would the housing for the additional 2 million people go? Most of the remaining “close-in” vacant land around San Francisco Bay is vacant because it is undevelopably steep, landslide-prone and earthquake fault-riven. There are some notable and glaring exceptions to this, but not enough to fit single-family houses for 2 million more people.
So the Bay Area could have increased housing primarily by replacing single-family housing with higher density multi-family housing. But wait a minute – isn’t the antiplanner of the mindset that most people hate such housing (note his claim that “planners” are trying to force people into apartments)? In actuality, the antiplanner and others who sometimes post here are ideologically much more hostile to high density housing than the American public is.
And, although the Antiplanner is undoubtedly too much of a libertarian to let his distaste for high density housing trump his belief in free choice and free markets, the same cannot be said for the people in existing Bay Area communities who have been fed lies and exaggerations of the horrors of such housing, and have acted resolutely to exclude such housing from their communities.
Guaranteed that someone would bring up the Krugman piece, as is always done here. It is people’s choice to zone. They are free to zone, despite the harrumphing opprobrium of someone not living there.
Of course, I’ve said here a thousand times that Euclidean zoning has given us this mess we have today. But as gordon says, flatland is flatland. Not many want to live there. Of course, as I’ve said here a thousand times equilibrium rents keep going up in nice areas. That is:
Please read Krugman’s words. Are you also going to call him a liar?
He is not blaming the bubble on zoning. Thanks!
BTW, generally in the newer looser-zoned developments that eschew the ticky tack large-lot SFD development, the denser well-designed developments have held their value better than the far-flung boxes all in a row. Which I’ve said here many times as well.
Lastly, gordon brings up another point I’ve made here many times when people harrumph about the Bay Area: where is the buildable land? No one ever – ever – e-v-e-r has an answer.
Repeating false things seems to be a theme today!
DS
“where is the buildable land?”
Under the sea/
Under the sea/
When the sardine/
Begin the beguine/
It’s music to me/
What do they got? A lot of sand/
The Dutch would know where to get the land. Of course this woudln’t make the SF Bay worshippers very happy.
CPZ:
“Please read Krugman’s words. Are you also going to call him a liar?”
Actually, the major thing about the coastal areas is the constriction of land available at all within reasonable distance of workplaces. If you think of cities as existing in the center of a circular area, look what is in that area in some places.
Boston, LA, and NYC both lose about 1/3 of the circle to the Ocean.
Chicago loses 1/3 of the circle to Lake Michigan
SF loses 1/2 of the circle to the Pacific, and another large chunk out of the middle to the SF Bay.
San Diego loses 1/2 of the circle to the Ocean and another chunk to Mexico.
Seattle loses 1/2 of the circle to the Puget Sound and another chunk to Lake Washington.
Miami loses 1/2 of the circle to the Atlantic.
Tampa/St. Pete loses part to the Atlantic and part to Tampa Bay.
When you take away that much land, it simply drives development further out in the directions that are available (sprawl!), and it incentivizes bidding much higher prices to purchase close-in housing in desirable areas to shorten the daily commute. Many people would apparently gladly pay $50+ per hour less daily commuting, meaning housing prices driven hundreds of thousands higher.
The three that fail to be well explained by this are Orlando, Las Vegas, and Phoenix. There the problem is more that a huge portion of the economy was tied up in housing construction and tourism. When the economy goes pop because of a housing bust, they lose the two main props of their growth.
Of course this woudln’t make the SF Bay worshippers very happy.
Nor the engineers when a quake hits the levees and liquefaction occurs.
Nonetheless, the loss of circles to water is one amenity that drives up rents and demand. Darn people bidding up rents to obtain amenities!
DS
Nodrog wrote:
The problem with Krugman’s analysis is that there is another difference between “Flatland†and “Zoned Zone,†and that is that “Flatland†is actually flat.
Dunno about that. The counties around Washington, D.C. are relatively flat, yet definitely part of what Krugman calls that “Zoned Zone” (and have been for many decades).
Dan wrote:
Guaranteed that someone would bring up the Krugman piece, as is always done here.
I am a liberal Democrat, and I like and respect Krugman, even though I think he was wrong on the (now canceled) rail tunnel between North Jersey and Midtown Manhattan.
It is people’s choice to zone. They are free to zone, despite the harrumphing opprobrium of someone not living there.
I cannot recall any zoning or land use provision in my home state of Maryland (save for one controversy involving a slot machines parlor) that has ever gone to voter referendum.
Of course, I’ve said here a thousand times that Euclidean zoning has given us this mess we have today. But as gordon says, flatland is flatland. Not many want to live there. Of course, as I’ve said here a thousand times equilibrium rents keep going up in nice areas.
Do you want no zoning, as they have in Houston, Texas?
Price is a function of both supply and demand. There are obvious reasons why the most expensive real estate in the US is on Manhatten ISLAND and the San Francisco PENINSULA. Los Angeles and Chicago have a lot of wealth, but there is much more supply in those cities.
I wouldn’t draw too many conclusions from outlier data.
Speaking of repeating, we’ve talked here about the fallacy of zoning in Houston too, many times. The hits keep coming!
Speaking of totems, the libertarian fave Glaeser loooooves cites, and has been advocating higher density. Let’s trot out some Glaeser while we’re at it!
DS
And just to make the point stronger, there are millions of acres of land with just as good or better amenities than Manhattan island and SF peninsula. But the snob factor is the most important function at the highest price end of just about everything.
Just claiming that “zoning” causes extra high housing prices is wrong. There is much more to it.
Look more at the not allowing for building & the many restrictions.
The SF Bay Area at 7,000 sq. mi. can easily fit 5 million more people. The UA is only about 800 sq. mi.
People have been leaving there for a decades, losing about 800,000 in domestic migration (to other states). It’s strange that immigrants pick the most expensive areas to move. Perhaps because of welfare. CA has double the rate of people receiving tax benefits.
Marin County has some of the most selfish people & has plenty of room.
Also, Monterey & Santa Cruz Counties can hold 3 million more.
CPZ; I am a liberal Democrat, and I like and respect Krugman, even though I think he was wrong on the (now canceled) rail tunnel between North Jersey and Midtown Manhattan.
THWM: I’m a conservative for that matter.
Any ways, what NJT was planning didn’t make any sense, it couldn’t be used by Amtrak or LIRR trains. With this kind of a project you want to get the most bang for a buck!