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Tuesday, March 9, 2010

Reading List: The Housing Boom and Bust

Sowell, Thomas. The Housing Boom and Bust. 2nd. ed. New York: Basic Books, [2009] 2010. ISBN 978-0-465-01986-1.
If you rely upon the statist legacy media for information regarding the ongoing financial crisis triggered by the collapse of the real estate bubble in certain urban markets in the United States, everything you know is wrong. This book is a crystal-clear antidote to the fog of disinformation emanating from the politicians and their enablers in media and academia.

If, as five or six people still do, you pay attention to the legacy media in the United States, you'll hear that there was a nationwide crisis in the availability of affordable housing, and that government moved to enable more people to become homeowners. The lack of regulation caused lenders to make risky loans and resell them as “toxic assets” which nobody could actually value, and these flimsy pieces of paper were sold around the world as if they were really worth something.

Everything you know is wrong.

In fact, there never was a nationwide affordable housing crisis. The percentage of family income spent on housing nationwide fell in the nineties and oughties. The bubble market in real estate was largely confined to a small number of communities which had enacted severe restrictions upon development that reduced the supply of housing—in fact, of 26 urban areas rated as “severely unaffordable”, 23 had adopted “smart growth” policies. (Rule of thumb: whenever government calls something “smart”, it's a safe bet that it's dumb.)

But the bubble was concentrated in the collectivist enclaves where the chattering class swarm and multiply: New York, San Francisco, Los Angeles, Washington, Boston, and hence featured in the media, ignoring markets such as Dallas and Houston where, in the absence of limits on development, housing prices were stable.

As Eric Sevareid observed, “The chief cause of problems is solutions”, and this has never been better demonstrated than in the sorry sequence of interventions in the market documented here. Let's briefly sketch the “problems” and “solutions” which, over decades, were the proximate cause of the present calamity.

First of all, back in the New Deal, politicians decided the problem of low rates of home ownership and the moribund construction industry of the Depression could be addressed by the solution of government (or government sponsored) institutions to provide an aftermarket in mortgages by banks, which could then sell the mortgages on their books and free up the capital to make new loans. When the economy started to grow rapidly after the end of World War II, this solution caused a boom in residential construction, enabling working class families to buy new houses in the rapidly expanding suburbs. This was seen as a problem, “suburban sprawl”, to which local politicians, particularly in well-heeled communities on the East and West coasts, responded with the solution of enacting land use restrictions (open space, minimum lot sizes, etc.) to keep the “essential character” of their communities from being changed by an invasion of hoi polloi and their houses made of ticky-tacky, all the same. This restriction of the supply of housing predictably led to a rapid rise in the price of housing in these markets (while growth-oriented markets without such restrictions experienced little nor no housing price increases, even at the height of the bubble). The increase in the price of housing priced more and more people out of the market, particularly younger first-time home buyers and minorities, which politicians proclaimed as an “affordable housing crisis”, and supposed, contrary to readily-available evidence, was a national phenomenon. They enacted solutions, such as the Community Reinvestment Act, regulation which required lenders to effectively meet quotas of low-income and minority mortgage lending, which compelled lenders to make loans their usual standards of risk evaluation would have caused them to decline. Expanding the pool of potential home buyers increased the demand for housing, and with the supply fixed due to political restrictions on development, the increase in housing prices inevitably accelerated, pricing more people out of the market. Politicians responded to this problem by encouraging lenders to make loans which would have been considered unthinkably risky just a few years before: no down payment loans, loans with a low-ball “teaser” rate for the first few years which reset to the prevailing rate thereafter, and even “liar loans” where the borrower was not required to provide documentation of income or net worth. These forms of “creative financing” were, in fact, highly-leveraged bets upon the housing bubble continuing—all would lead to massive defaults in the case of declining or even stable valuations of houses.

Because any rational evaluation of the risk of securities based upon the aggregation of these risky loans would cause investors to price them accordingly, securities of Byzantine complexity were created which allowed financial derivatives based upon them, with what amounted to insurance provided by counterparty institutions, which could receive high credit ratings by the government-endorsed rating agencies (whose revenue stream depended upon granting favourable ratings to these securities). These “mortgage-backed securities” were then sold all around the world, and ended up in the portfolios of banks, pension funds, and individual investors, including this scrivener (saw it coming; sold while the selling was good).

Then, as always happens in financial bubbles, the music stopped. Back in the days of ticker tape machines, you could hear the popping of a bubble. The spasmodic buying by the greatest fools of all would suddenly cease its clatter and an ominous silence would ensue. Then, like the first raindrops which presage a great deluge, you'd hear the tick-tick-tick of sell orders being filled below the peak price. And then the machine would start to chatter in earnest as sell orders flooded into the market, stops were hit and taken out, and volume exploded to the downside. So it has always been, and so it will always be. And so it was in this case, although in the less liquid world of real estate it took a little longer to play out.

As you'll note in these comments, and also in Sowell's book, the words “politicians” and “government” appear disproportionately as the subject of sentences which describe each step in how a supposed problem became a solution which became a problem. The legacy media would have you believe that “predatory lenders”, “greedy Wall Street firms”, “speculators”, and other nefarious private actors are the causes of the present financial crisis. These players certainly exist, and they've been evident as events have been played out, but the essence of the situation is that all of them are creations and inevitable consequences of the financial environment created by politicians who are now blaming others for the mess they created and calling for more “regulation” by politicians (as if, in the long and sorry history of regulation, it has ever made anything more “regular” than the collective judgement of millions of people freely trading with one another in an open market).

There are few people as talented as Thomas Sowell when it comes to taking a complex situation spanning decades and crossing the boundary of economics and politics, and then dissecting it out into the essentials like an anatomy teacher, explaining in clear as light prose the causes and effects, and the unintended and yet entirely predictable consequences (for those acquainted with basic economics) which led to the present mess. This is a masterpiece of such work, and anybody who's interested in the facts and details behind the obfuscatory foam emerging from the legacy media will find this book an essential resource.

Dr. Sowell's books tend to be heavily footnoted, with not only source citations but also expansions upon the discussion in the main text. The present volume uses a different style, with a lengthy “Sources” section, a full 19% of the book, listing citations for items in the text in narrative form, chapter by chapter. Expressing these items in text, without the abbreviations normally used in foot- or end-notes balloons the length of this section and introduces much redundancy. Perhaps it's due to the publisher feeling a plethora of footnotes puts off the causal reader, but for me, footnotes just work a lot better than these wordy source notes.

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