Sunday, February 15, 2009

My Thoughts on the Economic Crisis

I’m still trying to figure things out but here is my best guess so far.

Alan Greenspan cutting interest rates to 1% and keeping them there for a long time was a huge part of the problem. This brought mortgage rates down and inflated the housing bubble. It also made mortgage-backed derivative securities (with their fantasy AAA ratings) extremely attractive to yield starved investors who were desperate for a better return on their money.

The culture of Wall Street and the finance industry ties everyone’s earnings to the short-term production of transactions regardless of risk rather than the long-term stability in returns of either assets or company. This is a situation that has been building since the Reagan years with plenty of blame to go around.

Deregulation itself really wasn’t the problem because much of this, e.g., credit default swaps, was brand new crap that had never really been regulated in the first place. However, the philosophy that underlies deregulation—i.e., that the free market should be trusted to make the optimum risk allocation decisions—was a huge part of the problem. This was a philosophy that Greenspan and the Republicans unquestioningly defended.

From what I have read, Fannie and Freddie stayed in the very safest part of the mortgage market, i.e., fully documented non-jumbo conforming loans, until pretty late in the game and only then ventured into slightly riskier areas. However, given their size and the fact that they got involved when the bubble was already stretched to the limits, it would not surprise me if they made the popping of the bubble that much messier. However, I am still developing my understanding of this.

I have CNBC on in my office and I cannot count the number of times during the years before the housing bubble burst that I heard officials from the administration tout record levels of home ownership as proof that Bush’s economic policies were good for everybody. On top of this, consumer spending driven by home equity loans and mortgage refinancings was what kept the economy humming from 2002 onward. This makes me highly skeptical that Republicans ever had any will to reign in the housing market. My instinct is that Republican attacks on Freddie and Fannie were driven primarily (if not overwhelmingly) by partisanship and ideology although I definitely have more to learn on this.

At present, I have not run across much to convince me that the conduct of the Democrats was particularly praiseworthy in any general way. Their only redeeming virtue seems to be that the Republicans controlled the House, the Senate, and the Oval Office from 2003-2006. I suspect that there may be a few cases that I don’t know about yet where Democrats acted on principle, but I would not be surprised to find a Republican or two who did so as well.

The CRA didn’t have diddly squat to do with anything. The argument is a bullshit red herring driven by a "blame-Clinton-for-everything" mentality.


  1. You're almost there. Now factor in the sudden increase in the price of oil.

  2. To pick a nit, the GOP control of the Congress didn't take effect until January 2003. (And, of course, they stayed in office until January of 2007.) But 2003-2006 would be the accurate way to express this, because they were in control for the entirety of those four years.

  3. ChrisB,

    I suspect that the increase in the price of oil was a byproduct of the easy credit that fueled the housing boom rather than a root cause of the problem.


    Your nit is well picked. Thanks.

  4. The housing boom didn't fuel the price of oil.

    The price of oil (helped) popped the housing bubble.

  5. The housing boom didn't fuel the price of oil.

    Easy credit fueled both. The final big spike in oil from $70 to almost $150 actually took place after the housing market had already started down.