New Theory on What Caused The Housing Bubble

Published by peter | Filed under Market Trends, Miscellaneous

A new white paper was released yesterday by the Cato Institute which boldly claims that the cause of the housing bubble isn’t what everybody else has been talking about for the past few years. In this policy analysis, Randy O’Toole argues that the blame rests on a regulatory system known as growth management, saying (read the rest after the jump.)

Some people blame the Federal Reserve for keeping interest rates low; some blame the Community Reinvestment Act for encouraging lenders to offer loans to marginal homebuyers; others blame Wall Street for failing to properly assess the risks of subprime mortgages. But all of these  explanations apply equally nationwide, while a close look reveals that only some communities suffered from housing bubbles.

Needless to say, I found the topic intriguing and thought I would provide a “readers digest” version of my interpretation of the paper today. This is most likely not a critical read for somebody looking to buy or sell a home, but if you are a concerned citizen and wonder why housing costs are so high, this is a well written paper worthy of your attention. 

Usual Suspects Only Fueled The Fire

It has always been my opinion (at the street level) that the housing bubble was caused by a new, vigorous appetite for housing that began in 2000 because of many colliding factors:

• GSEs (Fannie and Freddie) were created to make home ownership possible for all
• The crash of the tech stocks caused many to pull money from mutual funds
• Excess money out of the market created boom in 2nd home market
• Baby boomers invested in 2nd homes
• As the housing market started to cool in 2004, new loan programs were created to keep a hot market growing
• The subprime market boomed, pumping in even more money for lenders to use to create loans

I have always felt the real culprit in all of this was consumer greed, and I am not so sure that this is not still my belief. One year ago, I read about comments made by then Treasury Under Secretary for International Affairs Davi McCormick during an interview on CNBC where he discussed what the government planned to do to restore stability in the global markets. In a nutshell, this is how he explained the market meltdown:

Regulators and investors alike showed a growing complacency toward risk. These factors blended into a dangerous cocktail of underlying conditions ripe for instability.This imbalance between risk and reward was most evident in the U.S. housing market, where lenders significantly loosened credit standards, particularly for a new generation of adjustable-rate mortgages. Yet aggressive financial innovation went well beyond mortgages. Banks and brokers created an alphabet soup of products with simple names like CDOs, CLOs, and SIVs, which were in fact complex and opaque investment products and structures. Credit-rating agencies responsible for assessing and rating these assets, as well as investors who purchased them, failed to question the chances of these underlying investments going bad.

Even one year later, I think this opinion stated by McCormick is spot on. Easy money made buyers out of all of us (which does not excuse any of us from being part of the causation). However, rather than view easy money and risk complacency as the reason (for the bubble), I have to say the Mr. O’Toole’s paper has me understanding how Growth Management initiatives most likely would have lead us to the same condition at some point in time.