A Request for an Overview Discussion of the Financial Meltdown

I have received a request that I provide an overview discussion of what I believe caused the home mortgage and financial crisis we suffered. Robert G. Curry wrote:

I wonder if you have given some thought to the causes of the current financial meltdown. The history leading up to what happened this year, etc.

Have you covered any of this on your blog?

It would be informative to be able to get an overall picture of the actions from the Carter years to the present of who did what, and who's primarily to blame, both through actions or neglect of action, for the meltdown.

How did we get from the so called "Fair Housing Act," through the "No Red Lining," to the "NINJA" loans, to the packaging of junk mortgages as A rated bonds, to the insuring of those bonds by the people at AIG, to the bailouts?

My response to Robert was:

I have discussed it a number of times, but not as comprehensively as you are suggesting I do. Partly, this is because it is a complex history. Partly, because the time period from Sep through Dec is our busy season in my laboratory, though all of 2008 was very busy for me. But, there is also a very critical component to the housing and financial meltdown which is due to problems caused by local and state governments in addition to the unhealthy contributions to the problem made by the Federal government. This really complicates the issue. I have addressed some of the local problems in a few posts as well.

When you look at where the mortgage defaults have occurred, you find that they are very far from an even distribution across the country. Mostly, the problem spiked in those areas where local and state government have such restrictive policies on home-building that home prices have become inaffordable for most people who in other parts of the country could readily buy a home with their income. In California, the average home buyer is paying 8 times his income to buy a home, when paying more than about 2.5 times your annual income for a home makes you a sub-prime borrower. We can argue that the average home buyer in California has no business buying a home, but human nature being what it is, they still badly want a home. In large part, the fact that homes cost so much in California is because of local and state government policies. For the most part, this is the pattern of where mortgage defaults are occurring. In Nevada the problem is that the Federal government owns 84.5% of the state and land around Las Vegas is not available because it is penned in by Federal land. Florida is another area with a spike of failures, where apparently there is a lot of speculation in homes based on quick improvements and rolling over the homes. This may have other explanations, maybe just that a lot of baby boomers are retiring or will soon and home values may have been rising due to their plans to move there upon retirement and it became an easy money fad to buy homes in anticipation of an easy resale at a higher price. Ohio and Michigan have elevated mortgage failures due in part to the very bad business climate in those states, which is causing them to lose jobs badly.

Because of these local issues, many people have put more and more pressure on Congress for affordable housing. In effect, many present home owners in local areas were happy with the rising home values due to government restrictions and maybe did like less traffic on the roads, lower taxes due to having fewer public schools to build, and more parks, but others wanted housing they could afford and some of the home owners are probably feeling guilty for favoring restrictions that they must realize are causing homes to be unaffordable. Congress does nothing to address the local building restrictions, so they have done as much as they can to press the envelope on lowering the costs of home mortgages. Many of the problem programs you named resulted in good part in response to some very vicious local housing affordability issues.

Of course, this then becomes a good lesson in how excessive government meddling in economic matters and in matters of property, causes all sorts of problems, the attempted responses to which cause still more problems.

Robert has a grasp of much of the path taken at the national level to attempt to make housing more affordable. He understands that this process began long ago and has resulted in a major problem for the economy. I was on the verge some time ago of addressing this side of the problem more thoroughly, but upon looking into it, it became clear that it was even more complex even on the federal affordable housing side of the issue than I had thought. It was going to take some real effort to sort it all out. In the process of looking into that, I realized that a good part of the reason pressure was put on the federal government to make home mortgages more available and less expensive was due to problems already caused by local and state governments which made housing in some substantial parts of the country ridiculously expensive.

There is a push-pull problem here of massive proportions. Government creates a bad problem, then government responds to the screams of pain that result by appearing to address the problems at least in part. Only then it is found to have planted many dozen rattlesnakes into our prairie dog colony. We suffer a financial meltdown and Wall Street and the banks become beggars who are put on the dole. Meanwhile, many home buyers are still sub-prime borrowers and they now cannot get loans. The home building and real estate industries then suffer, but mostly in those areas where most homes are very expensive for most potential buyers.

Meanwhile, the local and state governments are still very happy to follow policies that greatly increase the cost of housing in many communities. There is little movement on their part to address the prime reason for the housing and, ultimately, the banking and financial institution problems. Zoning restrictions, green park policies, antiquated and expensive building codes, excessive federal land ownership, disallowing pre-assembled housing so more local tradesmen will be hired, requiring excessively large home lots, high-handed and unavailable county building inspectors, and many more policies that cause home prices to be much higher than they need to be remain very popular in many communities.

So, as incensed as I am about the many bad choices made by the federal government regarding their powers to influence and control the lending institutions and to put pressure on them to follow unwise and risky lending policies, I do not want us to lose focus on the most fundamental of the originating problems. We allow local and state governments, with some assistance from the federal government, to infringe upon our property rights and thereby to deny many of us the much improved housing that we, in our pursuit of happiness, could have otherwise attained.

Thomas Sowell's "Economics Too Complex?" Series

One of the most basic principles of life and also of politics is that wishing something does not make it real. Yes, wishing for something may well serve as an effective means to get us to act to achieve something, but short of the act to achieve it, that value will not materialize in simple response to our wish. Most people come to understand this in their personal life when they have matured past adolescence. Unfortunately, it seems that most people do not understand that the same principle applies to the realities that politics are supposed to deal with!

Many of my recent commentaries have made a point of examining issues as a matter of supply and demand, because in reality, this is how things are priced absent government interference, and ultimately, in various perverted ways even with government interference. If government says that only the graduates of accredited medical schools can perform the duties of doctors and then government acts to limit the number of medical internships which then prevents medical schools from training more doctors, then there will be a shortage of doctors as the population grows and ages. This is what has happened over the last 20 or so years. The shortage of doctors means that doctors can charge more for their services, or if Medicare says they cannot, then they may work fewer hours or retire early. Patients will have less time to discuss their symptoms with the doctor and he will have less time to treat them, to consider interactions between the several drugs a patient might be on, or to review how effective a given treatment was. These issues are not dominated by a desire on the part of doctors to serve patients badly. They were not due to government bureaucrats thinking that it would be good to have a shortage of doctors. There is probably little intentional evil being done here, but there is evil afoot nonetheless. There is the evil of not thinking through important issues in a rational way and then taking foolish actions with the government's monopoly on force while not understanding very understandable issues. It is a shirking of responsibility for thinking, usually in favor of the emotional appeal of nonsense. The real problem here and in a very great many political issues is one of the supply of limited resources and the demand for those limited resources. Unfortunately, politics is usually ruled by politicians pandering to and often encouraging people only to decide issues upon emotional criteria, while ignoring entirely, or at least largely, the basic issues of supply and demand.

Thomas Sowell has just written a series of three commentaries on whether economics is too complex for people to understand or is it that they simply prefer the emotional appeal of thinking only in terms of heroes and villains? In Part 1, he talks about the price of oil to illustrate the preference for false emotional ideas of heroes and villains rather than a critical discussion of supply and demand.

In Part 2, he illustrates this with affordable housing as an issue, though he briefly alludes to restrictions on drilling oil put in place by politicians who are then the loudest in protesting higher prices for oil. He notes: "So long as politicians can get some people's votes by publicly feeling their pain when it comes to housing costs, and other people's votes by restricting the building of housing, they can have a winning coalition at election time, which is their bottom line." Then "So long as voters prefer heroes and villains to supply and demand, this game will continue to be played. It is not because supply and demand is too "complex" to understand, but because it is not emotionally satisfying."

In Part 3, Sowell writes about the tendency of government to object to large businesses selling goods and services for less than smaller local businesses may be able. He talks about San Francisco banning chain stores from some parts of the city. He talks about how the mistaken notion of "a living Constitution" has come to destroy property rights. This results in the economies of scale not being passed along to consumers who can then buy products for less. He mentions the bias against Wal-Mart and the Robinson-Patman Act of 1936, which was known as the anti-Sears, Roebuck law. He mentions the Standard Oil Company and Great Northern Railroad Trust break-ups, despite the fact that they provided ever lower prices. Over and over, Fair Trade laws were used to keep consumers from the enjoyment of lower prices. The reason was that it was more effective politically to indulge people's emotions against so-called villains than it would have been to rationally analyze the costs in terms of supply and demand. Sowell says: "Neither economics nor property rights are too "complex" to understand. But both get in the way of willful people who seek to deny other people the right to make their own decisions." Instead of personally refusing to use a chain store, the villain-destroying person assumes that they have the right to stop others from using their own freedom of choice on whether to shop at the chain store.

Without thinking issues through on the basis of supply and demand, it is very easy to identify the good guys as the villains and the villains as the heroes. A large fraction of the population makes a habit of doing just this.