The real causes of the crisis of 2008
FOR all the latest furore surrounding bankers’ bonuses and the rest, we have yet again lost sight of how the crisis actually began, and politicians and regulators’ central role in promoting it. There were many factors, of course, with private institutions often behaving foolishly – but sub-prime lending, the crisis’ central catalyst, was promoted by the US government and encouraged by its agencies to boost homeownership among the poor. We forget this at our peril.
Governments have long tried to help the poor own their own homes, almost always for noble reasons. Some attempts, such as Margaret Thatcher’s right-to-buy council house policy, worked as it required a real payment and targeted the aspiring, successful working class. Most other attempts, which gave homes away entirely for free or provided subsidised loans to those who couldn’t afford them, failed disastrously. One of the oldest attempts was Abraham Lincoln’s Homestead Act of 1862. Adults could simply apply and claim for free unused land outside the original 13 colonies, with the only requirement being that they improved the land and enclosed it. Around 2m homesteaders took advantage of the scheme and settled in the new West – and about 60 per cent of them eventually failed, a little-known fact dug out by Bruce Yandle, a US economist, in his fascinating paper Lost Trust: The Real Causes of the Financial Crisis, to be published in the Winter 2010 issue of the Independent Review.
The evidence is clear. The subprime problem started off as an “affordable home” program by which traditional, market-based constraints were eroded and private firms bullied and incentivised into lending badly. The impetus came with congressional strengthening of the Community Reinvestment Act, the Federal Housing Administration’s loosening of downpayment standards, and pressure exerted on mortgage lenders by the Department of Housing and Urban Development to lend to the unqualified. Democrats and Republicans are equally to blame. Bill Clinton introduced affirmative action quotas for Fannie Mae and Freddie Mac – the government-backed and created agencies which exert a massive influence in the US mortgage market, which is far from free – to buy poor-quality mortgages made to low-income families. In December 2003, George Bush signed “the American Dream Downpayment Act” to allow those who couldn’t afford deposits to buy homes.
It worked a treat. From 1993 to 2003, subprime accounted for a tenth of mortgages. In 2004, subprime’s share rose to 26 per cent; in 2005, to 28 per cent; in 2006, to 40 per cent. From 2005 to 2007, Fannie Mae and Freddie Mac bought $1 trillion in subprime and low-quality mortgages, in many cases floating rate mortgages that everybody knew would become unaffordable if rates were to rise; this intervention by Fannie and Freddie allowed the risk to be removed from the market. The government thus supported and encouraged private lenders to target poor borrowers while turning a blind eye to their inability to repay, in the knowledge that it would soon cease to be their problem.
Everybody interested in the real cause of the crisis should google Yandle’s paper. It is a breath of fresh air at a time when the abysmal quality of the present UK debate on the bubble, macroeconomic management and bank regulation is little short of scandalous. email@example.com