This seems like a good question to have answered before we run off and regulate Wall Street and hopefully the mortgage brokerage industry as well. Robert Shiller at Yale, an expert on housing, has written:
Few economists predicted the current economic crisis, and there is little agreement among them about its ultimate causes. So, not surprisingly, economists are not in a good position to forecast how quickly it will end, either.
It is truly distressing that if you ask a simple question, ‘what is the single most important factor in explaining why the recession occurred,’ there is very little consistency in the answers given by economists, according to Shiller. NPR still doesn’t recognize that there was even a bubble and collapse in housing prices. The Washington Post, too, has odd takes on the matter and so does The Wall Street Journal.
In fact, while Shiller himself has written a book explaining the causes of the recession, Paul Krugman has taken economists, himself included – or more correctly “economics”--to task for not understanding things well enough to see it coming. But he over generalizes. Many did see it coming and understood what was happening. Unfortunately, those people were not in power, were making too much money from it or did not have the bully pulpit and no one wanted to listen. The big money was flowing at the top just fine, thank you.
Before the Great Recession, Nouriel Roubini, Shiller and several others, myself included, predicted the housing crash and that it would take the economy down with it. While Brad DeLong of the University of California, and Paul Krugman, Nobel Laureate in economics, busied themselves throwing stones at the Chicago School, it was in fact a University of Chicago economist, Raghuram Rajan, at a 2005 conference held to honor Greenspan’s tenure at the Fed, who presented a paper warning that the financial system was taking on potentially dangerous levels of risk and was faced the prospect of a collapse. He was mocked by those present, including Larry Summers, who all put patted him on the head and did say the poor fellow and his warnings were “misguided.”
For his failure of foresight, Summers was promoted to the current President’s Chief Economic Advisor, and Paul Krugman thereafter won a Nobel prize, after being so surprised by the recession and after earlier in fact recommending that what we needed was a “housing bubble” to get the economy moving again after the dot.com bust. I mean the boom-bust model was right under his nose.
Go figure.
A further irony was that the conference was to honor Greenspan, “a long-time supporter of financial deregulation whose rejection of calls to rein in subprime lending or address the ever-inflating housing bubble rested in large part on the belief that modern financial economics had everything under control” as one economist described Greenspan's views and actions.
More irony here was that it was Larry Summers, then working in the Treasury, who did all he could to repeal and nullify regulation in the financial markets before the recession and crash. Later, however, it was Greenspan who was saying that he was in a state of “shocked disbelief,” because “the whole intellectual edifice” had “collapsed” into recession. He and Krugman. Krugman wrote his sort of “mea culpa” piece for The New York Times, which really, in the last analysis, blamed it on the state of economics. This was just a diversionary cover-up that hoodwinked too many. Summers was smart enough to be quiet as a mouse.
So how was the recession predictable? Certainly not by devising a measure to gauge waning “animal spirits” and certainly not by understanding the nuanced disputes between the saltwater economists and the freshwater economists. It was predictable by knowing something about what was going on Wall Street and by understanding the housing market. That was what it took and that is where so many economists failed, including Krugman, Greenspan and Summers (who talks a mile a minute and runs over anyone who disagrees with him like a steamroller).
Krugman, in particular, should have known better for earlier having asked for and then, with Greenspan’s cooperation at the Fed, having gotten a “housing bubble.” Bubbles do burst. Moreover, the fact is, as many good economists understand, the real prices of houses, real rentals and real house construction costs have to, and for many years did, move together or there would be what amounts to arbitrage possibilities between those markets. Housing began to bubble up and real housing prices rise much faster and out of alignment with real rents and real construction costs starting soon after Krugman and a few others called for a "housing bubble” and Greenspan listened, starting just after the mid 2000s.
The Fed accommodated, by easing credit and dropping interest rates excessively and by rejection of calls for regulation of everything from mortgage brokers, to derivatives, to mortgage backed securities. Larry Summers, meanwhile worked hard to not only block new regulation but repeal what was in place. The net effect was the housing market boomed horrifically. Everyone and their brother were after the big upfront fees on mortgage loans, CDSs and other derivatives and on MBSs and no one cared about the consequences. It was grab the money and run, all facilitated and made possible by Greenspan, the Fed, Krugman, Summers and several others of like mind and disposition.
The systemic financial risk was obvious to anyone who was not an idiot. CDSs had no reserves or backing, CMOs were being overrated by the credit agencies after being pressured by the Houses and housing prices would obviously at some time have to drop, inasmuch as that is what happens to bubbles -- they burst. The prospects of danger were redoubled and made much worse by the fact that the housing and housing related sectors of the economy were, by artificial means, already hugely overinvested and bloated substantially beforehand because of long and persistent government interference in the housing market.
Such interference included the interest tax deduction on mortgage loans, closing cost deductions, and the development of the government backed secondary mortgage market, involving both Freddie Mac (FRE) and Fannie Mae (FNM). All of these factors made for excessive investment in housing relative to other markets, before the engineered “housing bubble” even got going. More than 1/6 of all employment was in those markets and almost all new growth in employment soon came to be in the housing and housing related markets. Red flags were flying everywhere. Some were asleep at the wheel. Others had no clue. Yet others were rapidly engineering the foundations for the Great Recession.
That some economists missed what was going on shows either how little they knew or how badly they were not paying attention. Many, of course toil away with models and teaching in academia, and don’t have a clue about Wall Street or the housing and housing related markets. Others of considerable prominence just flatly missed entirely too much to now be seriously involved with US economic policy making or recommendations. Their credibility is compromised; only the problem is too many don’t know it. It is all part of the great cover-up on who is to blame for the mess. There is to be no pointing of fingers or casting of aspersions, which is exactly what I am doing here, as to important economists.
Well, when the housing bubble burst, a major portion of the economy quickly collapsed and Wall Street’s house of cards came tumbling down, which impacted and damaged other portions of the economy and the negative and adverse effects of falling aggregate demand and rising unemployment spiraled throughout the economic system to give us the Great Recession. First subprime, then prime and finally other mortgage loans categories tanked and the financial Houses could not made good on their CDSs, MBSs and CDOs as housing went underwater, credit markets froze and the house of cards collapsed in panic.
Is this all too hard to figure out, or is the latest feigned ignorance or "confusion" about what caused the Great Recession simply a part of the grand cover-up, so the public does not learn the names of those at fault and what they did? I leave that one to the readers.
Disclosure: No positions
