Connecting dots to the housing crisis

Housing policy and regulations relaxing mortgage requirements dating back to the 1990s paved the way for the 2008 - 2009 housing crisis.

Paul Sancya/AP Photo
In this file photo from September 2009, a foreclosed home is shown in Owosso, Mich. New research and writing connects initiatives stretching back to the 1990s aimed at lowering mortgage standards with the 2008-2009 housing crisis.

There are enough books about the events of 2008-2009 to fill a library. Nevertheless, there is no coherent framework that integrates the various factors in the dramatic boom-and-bust cycle that goes back to the late 1990s and may still be with us yet. Bruce Yandle offers a welcome synthesis in the Independent Review, centered on trust-building devices and their dissolution.

Mr. Yandle identifies several market-generated mechanisms that created trust in credit instruments—ratings, accounting standards, credit default swaps. While not specific to mortgage-related securities, these were used extensively to back up such securities as the property bubble expanded. Had the real estate market been relatively free from political meddling, the mechanisms would have likely remained intact.

But housing is catnip to politicians of all stripes. Bill Clinton’s “affirmative action” for housing set quotas for Fannie Mae and Freddie Mac to buy poor-quality mortgages given to low-income households. George W. Bush signed a law to channel more money in the same direction. Members of Congress – such as Barney Frank, who now presides over financial “reform” – pressed Fannie and Freddie to loosen mortgage standards.

What a show of bi-partisanship! All to bestow home ownership on families who could not afford it and in the long run would have been better off not overextending their credit, at a cost to taxpayers that boggles the mind.

Mr. Yandle argues that while those intercessions were necessary for creating the boom, they were not sufficient. To accommodate the political push for expanding home ownership, something else had to happen. That was the Federal Reserve’s easy money policy, starting in 2000 in response to the bursting of the 1990s stock bubble—itself arguably encouraged by the Fed’s rate cuts in 1998.

In any event, through 2005 interest rates remained low by past standards. Once the Fed started to tighten, people who had taken out adjustable-rate mortgages found that they made a mistake. The air started to come out of property prices, mortgage-backed securities wobbled and that undermined ratings and credit default swaps.

Mr. Yandle’s contribution is to show how the policy pieces fit together in inflating the bubble. No single element would have been sufficient on its own, he says—the combination is what led to the financial crash. Among the policies that came to play was the government mandate that empowers the three rating agencies. Another was regulators’ requirement of credit default swaps to offset the risk of mortgage-backed securities held by financial institutions.

As long as money was easy and demand for housing grew in leaps and bounds, there were hardly any defaults—you could always refinance or sell your house for more than you paid. Therefore the danger lurking behind default swaps and triple-A ratings was obscured. These assurance devices, as Mr. Yandle calls them, were politically distorted and once the consequences showed up, trust disappeared.

The result is that government hierarchies and regulations are taking the place of market devices that created trust. Hierarchies and are regulations are blunt, expensive and – as endless examples demonstrate – often ineffective. However, all that may be a minor complaint compared to the damage to our liberty.

This is not a pleasant story and Mr. Yandle offers no help for our current predicament. His version may not be the full story, but it goes a way in knitting together the threads.

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