Housing Bust: Speculators Sounded the First Alarm, Not Government

Aug. 9.09 | About: iShares U.S. (IYR)

It is interesting to note that speculative markets, not government institutions were the first to sound the alarm when it came to the US housing bubble. And actually... not only were government institutions asleep at the wheel in terms of warning people that prices had gone too far, but they were actually contributing to the problem and helping to inflate the bubble further.

It was speculative markets that sounded the alarm in 2007, keeping future capital away from jumping off a cliff, and preventing the bubble from running longer and crashing harder. (Hat tip to one of our readers for this great nugget)

It was not just a Wall Street phenomenon, but one pushed by our government, legislators, regulators, and even academics (for evidence, see Stan Liebowitz’s “Anatomy of a Train Wreck“)… the Federal Housing Administration was, and is, offering loans with only three percent down, and during the boom, the Department of Housing and Urban Development promoted a program where even this minor investment could be paid for by the homebuilder. … In light of this governmental housing exuberance, I doubt that a more powerful government would have mitigated the boom — rather, it would have made this crisis worse. Indeed, it was only the collapse of the subprime market at the beginning of 2007 as reflected by the ABX-HE subprime housing index that alerted people to the severity of this problem, and shut off financing by mid-2007, six months later. Market prices, not legislators, instigated the end of the insanity. How quickly are failed governmental initiatives usually stopped, once identified?

...speculative markets were the first of our institutions to clearly say we had overestimated housing values. If we want more such error-correction in the future, we should empower such institutions more, not less.