The Housing Crisis: Personal Responsibility and Wishful Thinking

Since Greenspan bashing is all the rage, here is an alternative viewpoint of Alan's contribution to the housing crisis, credit crunch, et al, from Investor's Business Daily:

Ex-Fed chief Alan Greenspan has spent the past few weeks denying he deserves blame for the housing crisis. Sorry, maestro, you do deserve some blame -- but not for the reasons people think..

Those who blame Greenspan for the housing crunch usually say he kept interest rates too low for too long, thereby encouraging market speculation with cheap borrowed money. Indeed, he kept rates at a record-low 1% from June 25, 2003, to June 30, 2004.

The problem with this argument -- and Greenspan's defense of himself -- is it has things exactly backward. The trouble came not from being too loose with credit, but too tight.

It's easy to say in retrospect that any market boom was a bubble. But as we've noted here before, the U.S. and the rest of the world undergo periodic financial crises, typically after a bout of central bank tightening. How soon we forget.

It has happened over and over -- in 1987 with the stock market collapse; in 1990 with the S&L crisis; in 1995 with Mexico's peso meltdown; again in 1997 with the Asian crisis; once more in 1998 with the Long-Term Capital Markets disaster and Russian ruble collapse; and in 2000, with the largest stock market decline ever, at least as measured by the bellwether Nasdaq.

And, oh yes, with the housing market crash last year, brought on by yet another round of Greenspan-engineered Fed tightening -- not by "cheap money," as critics would have it.

The funds rate was slashed by 2003 to 1%, where it stayed for a year. A mistake, as critics insist? Hardly. The economy had taken massive hits from the stock market collapse, a recession and 9/11. Greenspan was right to cut; he just did it too slowly.

Now some say this caused the bubble in housing prices. It didn't. Prices and sales had been rising steadily for years, well before the 1% fed funds rate. Indeed, from 1995 to 2001 -- a recession year -- new home sales shot up 36%, even after two rate-hike cycles.

No, a bubble exists only once it bursts. And the bursting of housing's bubble happened because the Fed was too aggressive with its rate hikes, beginning in 2004, when it launched 17 in a row.

If we are to believe that the Fed's rate hikes caused the housing crisis, I suppose we'd have to ignore the following:

• ARM Mortgages originated at a level where the borrower could only afford the teaser rate, meaning that ANY reset would put the individual into a situation where they couldn't afford the house.
• People who bought more home than they could afford and hoped they could avoid trouble via refinancing
• People who abused the housing ATM
• The fact that between 25-33% of all homes were purchased by speculators who hoped to make a quick profit and who likely sold to other speculators, meaning there was never truly a market for these homes comprised of people who actually planned to live in them.
• Home builders who built homes based on demand generated by the above
• Lax lending standards resulting in people qualify for loans who shouldn't, and/or people qualifying for more money than they could service
• Rampant abuse in the Alt-A lending sector
• All of the above powered by CDOs that weren't rated properly, banks over-leveraging into mortgage backed assets that had unrealistic expectations around repayment, etc, etc.

In other words, we'd have to pretend that the actions of lenders and borrowers didn't cause the housing crisis, and pretend that they were just innocent victims of the Big Bad Fed who raised interest rates too high. I find this commentary indicative of the type of thinking that wouldn’t accept that the housing boom was built on a shaky foundation, and seeks to blame the media, a lack of confidence, and rising interest rates over bad lender and borrower behavior. It’s the type of mindset that says: “I’m making money so things just “have” to be good, and if things start go wrong someone is victimizing me”.

Blaming the housing on increased rates is nothing more than childish optimism at best and outright ignorance at worse, because it forces us to live in a world where the current economic morass wasn’t at all caused by bad decision making on the part of lenders and borrowers.

If anything, Greenspan raising rates slowed things down before they got even more out of a hand and a bigger crisis arose.

While I readily criticize Greenspan for supplying the cheap money and not regulating mortgage lenders enough, it doesn't change the fact that borrowers and lenders engaged in idiotic behavior that provided short-term gains and short-circuited their medium to long-term interests. Trying to act as if borrowers and lenders are just the innocent victims of fiscal policy is patently fatuous, when a dollop of common sense and better decision making would’ve prevented 90-95% (if not all) of the troubles we’re facing right now.

With all of the discussion on needed regulations, cheap money, bad fiscal policy etc, it doesn’t change the fact that the bigger problem is just bad decision making. Can regulation and better fiscal policy ever replace the need for consumers, lenders, investors, etc, to make good decisions? Can regulation ever truly replace the need for people to take responsibility for their own fates and make smarter decisions?

I doubt it.

Finally the author is correct that many a financial crisis has followed after a series of rate hikes, but is that because rate hikes cause financial crises or that they just make it harder for certain individuals to hide their activities/keep them from impacting the economy?

Sources:

IBD "Greenspan's Guilt" -- April 11, 2008.

Comments

[User 143167]

In a "perfect Greenspan's world", eternal economic growth would be attained if the Fed can lock low interests, as long as they can adjust calculus models to "control" inflation.

[AmesTiedeman]

Housing is done for the next 10 years. People who see gains just around the corner need to study history.

[z28rgr8]

Thanks for telling it like it is. The root of the majority problem is people borrowed more than they could afford and lenders provided funds to people that did not qualify and could not pay it back. Standard unethical behaviors driven by greed and to some extent an entitlement mentality.

[Simple Simon]

Refreshing to hear the 'real assesment'. It's nice to know the statistic re. almost a 1/4 of the population was engaged in speculative buying and 'flipping'. When I heard the term, 'flipping', it gave me pause; the same pause I had when silcon vally IPO's were raking in enormous amounts of capital, and hadn't had any sales , or prospects of sales and profit of any kind. All one has to do is wake up and notice the ubiquitous availability of gambling, on the reservations, and even at the local stop and go -the lottery, that touts 'the education of our children'...when in fact the schools are having to cut staff, etc. What's wrong with that picture? It has a lot to do with vice, and good old fashioned narcissistic avarice. Some poor old "ignorant" small town hicks call this sin. Perhaps you've heard of it?

[Sell_Everything]

Human behavior rarely changes in the aggregate, so while blaming this on people's poor decision making is mostly correct, just hoping that people learned from their mistakes and won't do it again is a little naive.

It's like throwing bags of money into a river with piranhas under the water and not telling everyone the piranhas are there. Sure, you can blame the people for not being suspicious and at least checking it out by slowly inching in or waiting until other idiots went in and got eaten, but it's human nature to initially want to go in after it. While the people who watched other people get eaten firsthand will probably think twice about doing it next time, there are still other people that will jump right in next time there is "free" money in the water.

My point is that in a free market, things like this must happen from time to time. If there was no risk in the market and no downtime, then our upside would be limited as there would never be risk premia. The only way to regulate human behavior is to take away access to those things that drive that human behavior, and I'm not a fan of a strong central government and excessive regulation.

["Magazine-Cover-Indicator"Indicator....]

Good article.

[Malkiel]

I agree that it's too much of a stretch to blame low interest rates for the housing bubble directly, as though all the corruption required of institutional players to enable a bubble were somehow foreseeable; the argument that raising rates tipped the cow is an interesting one that has some validity, but again it requires the belief that the FED would have known how badly (and perhaps illegally) the usual cast of reliable institutional players were conducting their business.

To persistently place blame at the foot of the borrowers on the bottom of the food chain is a prejudice born of personal enmity people (including journalists) seem to feel toward anyone who took advantage of what they did not during the boom. A responsible assignment of blame looks at who was the "smart money" and what responsibilities they had in the chain.

The first blame goes to mortgage lenders: they are institutions with armies of professional accountants and managers operating under formal laws and standards who were fully in command of the tools and knowledge needed to know what practices or products were unsound, yet they broke all the rules and standards.

The next down in the blame chain are builders, who also had sizeable armies of accountants and lawyers who should have been able to see the unsoundness of the agreements going on between them and their buyers. The fact that builders also have vast actual cash sunk into the enterprise should have given them a greater sense of danger than the next villains,

The mortgage brokers. These are the people who gamed the system when they noticed the banks and builders were asleep. But they still operate within legal and professional frameworks and knew by training that many of their clients were being placed in unsustainable loans. They had a professional responsibility not to do that.

Realtors. Their blame is relatively light given their disconnect from the lending side, but they also could see the unsound lending practices at ground level, and could have steered the most vulnerable borrowers away from the worst choices.

Borrowers. Borrowers are consumers, amateurs without training and often without the formal education in any economic or mathematical field that would have given them the tools to analyze the soundness of a loan product. The borrowers reasonably assumed that institutional lenders or mortgage brokers would only let them have amounts they "qualified" for, since the patriarchal relationship between bank and borrower is an old American tradition. Borrowers were the least qualified party to analyze the soundness of what was being offered, and bear the least blame for the crisis. And that's the objective fact even if you hate your neighbors for having been given a $700,000 mortgage you couldn't qualify for and they shouldn't have...

[BasicFinance]

TheDanza has a good point regarding pirhanas. I think many on this discussion board knew the dangers of the housing market as early as 2003 or 2004, but you had Time magazine touting the house as ATM myth as late as 2005. I think most of us stay away from Time, but lots of people DO read it. The fact is that most people have no idea how to properly value an asset. If we are going to regulate anything, how about mandatory econ 101 for all high school graduates?

I also question how someone like Greenspan pretended not to recognize the bubble. You CAN recognize a bubble before it bursts. When an asset no longer can be related to the rent it can/will generate, it is overvalued. In some ways, the .com bubble was a bit harder to spot because the underlying assumptions for future revenue were so hard to pin down. Maybe people will buy everything online...maybe they won't. Who knew? With housing, no such upside argument could ever be made. Why would rents increase to the level needed to make the 2005 prices reasonable? No convincing argument was ever given.

[erx]

Excellent analysis Malkiel, I too am sick of the way this blame game is being played without keeping in perspective the very different roles and resources of the various players involved.

I agree with your hierarchy but would go even further. The mortgage bankers don’t merely belong on the top of this list, I would argue that they deserve the overwhelming majority of the blame themselves.

Everyone else was more or less doing their job. Homebuyers trying to get into a decent home – no surprise. RE agents and builders selling houses, brokers getting funds for their customers – just doing what they do. Obviously during the boom lots of folks pursued their respective endeavors beyond reasonable standards of ethics or prudence, but my point is the bankers didn’t do their job at all.

Is it not the role of the bankers to evaluate lending risks? Why else are they there? What other responsibility are they paid so handsomely to perform? Seems to me they are the ones who utterly failed to do what they were there to do.

And yes Greenspan should be blamed, for applying too much stimulus and especially for not exercising enough oversight during his tenure as ‘Banker in Chief’.

[ponchovilla]

Let's see: Greenspan is the driver of the booze truck to the fraternity house during rush week. Two students die, others have car accidents and the fraternity house catches on fire. Should he have seen this coming? Only with open eyes..but his boss loved the money made on the deliveries and the benefits were good while they blasted.

[QualifiedBuyer]

While I agree with everything in the article, and appreciate the author's clear and complete analysis, it’s frustrating that the same entities responsible for the crisis (lenders, mortgage brokers, builders and speculators) are the exact entities the government is supporting at the tax payers expense. There is no risk without consequence, and when our government removes the consequence by providing tax breaks, discount lending (that may never get repaid) or equity handouts, there's nothing preventing a repeat of the crisis. In a true free market economy, the markets need to correct, and the chips should fall where they may. No discount lending, no home builder tax breaks, no tax payer backed discount mortgages and equity. Otherwise, the consequence is to those that did not participate. And those that took the risk will be looking for the next opportunity.

[ArnoldCountry]

A very important consideration in the banking/mortgage banker relationship of the last few years over the historically traditional past is they no longer had a stake in the game. While they may have been servicing the loan, they did not own them. Instead they pooled them, bundled them and sold them to the likes of Bear Stearns, Lehman and a host of other wall street firms who sliced and diced them for selling securities to other unsuspecting investors who bought bonds with good ratings. The very persons evaluating the consumer quite frankly did not care. That loan was sold as fast as it closed. A new modern method of banking that allowed a fast track to very questionable lending practices and deceptive loan products.

[Gavin]

Did everyone forget to blame the house appraisers who were in cohoots with the banks and realtors. I believe many appraisers are paid either kickbacks or percentages when a property is sold. Does anyone want to jump in here and tell me that they were not part of the problem too?

[curious cat]

ponchovilla, greenspan didn't drive the truck to the frat. to extend your analogy, he just drove it to the liquor store. the store owner sold it without checking id or the teenagers bought it using fraudulent id. however, people who buy homes are not teenagers.

erx, just because the devil urges you to jump off a cliff, does not mean you have to do it. well, maybe you do if you're a lemming. still, excusing people for buying above their heads, because they were trying to get into a decent home is the same excuse you can make for a cat burglar. they took risks and they knew it.

how do i know that? well, i've bought two homes now and the closing takes hours because every piece of paper has to be explained to me, over my protests, even though i'm a lawyer. is it possible that the only place in the country that explains these confusing aspects (eg. monthly payment amount) of purchasing a home to prospective home owners is the great state of alabama?

thedanza, in your analogy, you can make the piranhas well fed and sleepy. regardless, the swimmers should at least have known whether they could swim or not.

malkiel, i have no personal enmity for those at the bottom of the food chain. i was born there and worked my way up. i love this country and the many opportunities it provides.

basic finance, you certainly have one thing right. our kids should not graduate high school without some kind of basic finance course. lord knows we should also give i.q. tests to anyone who wants to drive or have children, too. we don't and we don't hold people accountable for the financial decisions they make, either. that's the beauty of this country, you are allowed to be an idiot, but you are given the opportunity to learn.

[mallarde]

Speculative borrowers and banks and bad investors were the CAUSE of the bubble and the bust. No one is to blame, as long as those that gambled and lost are allowed to lose their money. Is someone to blame when someone loses $100 at blackjack? The dealer? The casino? No. Not even the player is to blame. Now if the casino bars the door and takes $1 from every patron and gives it to the player that lost $100 at blackjack so he can leave the same way he came in, then that is a problem. That is when I get really mad.

[mallarde]

Let's not forget the real engine of all the speculative buying -- the dupes that bought up all of the securitized loans hoping to get a little bit extra return on their cash. The investment banks we see going under, etc. They provided the cash to make all this stuff go.

Are they to blame? Not really. As long as they are allowed to lose on their gamble and not get bailed out. They gambled big time on these loans. They should have realized they were essentially speculating in the housing market, not buying AAA-rated bonds. We see most of them writing down their securitized loan holdings now by the billions.

Actually, I do blame one party -- the government. The government continues to subsidize home-buying. Particularly when home-buying becomes an investment strategy, this is an unfair subsidy that penalizes renters such as myself.

[LostMitigation]

This is my second time around working for a company that is trying to stem credit losses by working with borrowers, lenders, insurers and the GSE's to create loan workouts. I was intimately involved in this same activity in the mid eighties to early nineties -I guess that was Desert Storm to today's Iraq.

One stark observation differentiating the two cycles is the borrower beahvior.

As ahs been noted in numerous publications, a significant number of borrowers this time were pure speculators.
Many misrepresented their intent to occupy the home inorder to price the loan more favorably.

While I agree that there is contributory blame within the entire food chain we cannot excuse borrower behavior based on ignorance. While I'm sure many did not fully understand the ramifications of Neg Am.

It has been correctly noted that the disclosure documents at closing are enough to choke a horse. I can't imagine what more can be disclosed to ensure that a prospective homeowner -or a reasonable man in his.her position- understands all the potential ramifications of a mortgage. However, it looks like the market has put forth the solution; no one will be originating Option Arms for a long while.

The walkaway trend and encouragement by financial sages to do so is also disconcerting. A the end of the day the sanctity of a contract is being eroded simply because the market value of a home is eroded. Should the converse be acceptable: when the home value rises should the banks be allowed to ignore the mortgage contract and foreclose on the home so they could make a profit?

I'm not suggesting a strict approach to repossesion.
However,the tsunami of home retention initiatives from Federal, State and local governments and every component of the aforesaid food chain should help any distressed borrower who wants to retain his home to do so.
Some of the largest banks, the GSE's and all the private and govy mortgage insurers are doing everything possible to preserve homeownership through proactive loan conversion, e.g. soliciting borrowers with Option Arms to convert to 1/5 ARMS with no Neg AM.
Even those borrowers who are delinquent and in foreclosure are receiving help through very creative programs.

These remedial initiatives, while not expressions of institutional altruism, are assisting many homeowners and neighborhoods .