Wait! Government did cause the housing bubble.

Congress's Community Reinvestment Act, aimed at helping the poor afford housing, did lead banks to make much riskier mortgage loans, a new study finds. 

|
Don Ryan/AP/File
In this 2011 file photo, a foreclosed house with sale pending sign is shown in Tigard, Ore. A new study finds that government incentives fueled the subprime lending boom and the housing bubble.

Austrian business cycle theory explains the general pattern of the boom-bust cycle — credit expansion, lowered interest rates, malinvestment, crash, liquidation — but the particulars differ in each historical case. (Austrians sometimes distinguish “typical” from “unique” features of each cycle.) To explain particular episodes, we appeal to specific technological, regulatory, political, legal, or other conditions. For example, in the 1990s, much of the malinvestment was channeled into the IT sector, where uncertainty driven by rapid technological change made entrepreneurs particularly susceptible to forecasting errors. In the 2000s, of course, malinvestment appeared largely in real estate, the result of government programs designed to relax underwriting standards and otherwise increase investment in particularly risky real-estate assets. In other words, ABCT tells us to look for malinvestment during the boom, but not where that malinvestment will show up.

Regarding the latter example, however, there has been a persistent dispute among mainstream economists about the role of government housing policy, particularly the Community Reinvestment Act which was used, in the 1990s, to make banks increase their lending to particular low-income neighborhoods. Paul Krugman asserts, for example, that the “Community Reinvestment Act of 1977 was irrelevant to the subprime boom.” Actually, no. A new NBER paper (gated) on the CRA is causing quite a stir. Authored by four economists from NYU, MIT, Northwestern, and Chicago, the paper is the first to use instrumental-variables regression to distinguish changes in bank lending caused by the CRA from changes that would likely have happened anyway. (The authors use the timing of loan decisions relative to the dates of CRA audits to identify the effect of the CRA on lending.) The results suggest that CRA enforcement did, contra Krugman, lead banks to make substantially riskier loans than otherwise. Raghu Rajan puts it in a very Austrian-sounding way:

The key then to understanding the recent crisis is to see why markets offered inordinate rewards for poor and risky decisions. Irrational exuberance played a part, but perhaps more important were the political forces distorting the markets. The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans. And the willingness of the Fed to stay on hold until jobs came back, and indeed to infuse plentiful liquidity if ever the system got into trouble, eliminated any perceived cost to having an illiquid balance sheet.

I’d reverse the order of emphasis — credit expansion first, housing policy second — but Rajan is right that government intervention gets the blame all around.

You've read  of  free articles. Subscribe to continue.
Real news can be honest, hopeful, credible, constructive.
What is the Monitor difference? Tackling the tough headlines – with humanity. Listening to sources – with respect. Seeing the story that others are missing by reporting what so often gets overlooked: the values that connect us. That’s Monitor reporting – news that changes how you see the world.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to CSMonitor.com.

QR Code to Wait! Government did cause the housing bubble.
Read this article in
https://www.csmonitor.com/Business/The-Circle-Bastiat/2012/1228/Wait!-Government-did-cause-the-housing-bubble
QR Code to Subscription page
Start your subscription today
https://www.csmonitor.com/subscribe