Saturday, July 25, 2009

The housing bubble: a government failure, not a market failure

John Makin has written an excellent article on the causes of the housing crisis: "A Government Failure, Not a Market Failure." Here's a short summary:

The housing collapse and its painful aftermath, including that $15 trillion wealth loss for U.S. households (so far), do not … represent a market failure. Rather, they represent the dangerous confluence of three policy errors: government policy aimed at providing access to home ownership for American households irrespective of their ability to afford it; the Fed’s claim that it could not identify bubbles as they were inflating but could fix the problem afterward; and a policy of granting monopoly power to rating agencies like Standard & Poor’s, Moody’s, and Fitch’s to determine the eligibility of derivative securities for what are supposed to be low-risk portfolios, such as pension funds.

The long-term solution is for government to stop playing favorites, as it has for decades with housing. Home ownership should neither be penalized nor favored under government policy. We have seen how that distortion led inexorably to a degree of wealth destruction we have not seen in our lifetimes. The distortion of the market introduced by government intervention can and must be brought to an end.


Bill said...


Do you think the large number of predicted defaults in the CMBS market will derail the recovery? I've heard we're only 10% through these defaults

Scott Grannis said...

I'm not an expert on this question, but I can offer some observations. For one, this is very old news; the only thing we don't know is the exact number of defaults, but the market definitely knows that lots are coming. Prices of commercial mortgage backed securities have fallen dramatically, but they have actually rebounded in the past month or so (see my post on CMBX and ABX prices), which suggests that with the outlook for the economy improving, commercial mortgage defaults will be less than previously expected. A growing economy is much better for defaults than a shrinking economy.

It's also important to recognize the power of easy money to alleviate default problems. Easy money is every debtor's friend.

Public Library said...

I would argue that the government is actually more involved in the housing market than ever before pumping out loans to under qualified applicants with fractional down payments. That means as FNMA, GNAM, FHLMC expand faster than the Universe, you and I will be on the hook when these loans go sour the next time around.

Public Library said...

It is comments like these that make me fearful of our future. Our coutnry is run by meglo-maniacs and I am sure he feel real "disgusted".

Federal Reserve Chairman Ben Bernanke on Sunday said he engineered the central bank's controversial actions over the past year because "I was not going to be the Federal Reserve chairman who presided over the second Great Depression."

"When the elephant falls down, all the grass gets crushed as well," Mr. Bernanke said. He described himself as "disgusted" with the circumstances that led him to rescue a couple of large firms, and called for new laws that would allow financial firms other than banks to fail without going into bankruptcy."