The housing boom and bust of the early 2000's

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The following is from Thomas Sowell. Dismantling America. pp.142 - 147

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An Economic Whodunit

During bad times, the blame game is the biggest game in Washington. Wall Street "greed" or "predatory" lenders seem to be favorite targets to blame for our current economic woes.

When government policy is mentioned at all in handing out blame, it is usually blamed for not imposing enough regulation on the private sector. But there is still the question whether any of these explanations can stand up under scrutiny.

Take Wall Street "greed." Is there any evidence that people in Wall Street were any less interested in making money during all the decades and generations when investments in housing were among the safest investments around? If their greed did not bring on an economic disaster before, why would it bring it on now?

As for lenders, how could they have expected to satisfy their greed by lending to people who were not likely to repay them?

The one agency of government that is widely blamed is the Federal Reserve System— which still keeps the heat away from elected politicians. Nor is the Fed completely blameless. It kept interest rates extremely low for years. That undoubtedly contributed to an increased demand for housing, since lower interest rates mean lower monthly mortgage payments.

But an increased demand for housing does not automatically mean higher housing prices. In places where supply is free to rise to meet demand, such as Manhattan in the 1950s or Las Vegas in the 1980s, increased demand simply led to more housing units being built, without an increase in real prices— that is, money prices adjusted for inflation.

What led to a boom in housing prices was increased demand in places where supply was artificially restricted. Coastal California was the largest of these places where severe legal restrictions on building houses led to skyrocketing housing prices. Just between 2000 and 2005, for example, home prices more than doubled in Los Angeles and San Diego, in response to rising demand in places where supply was not allowed to rise to meet it.

At the height of the housing boom in 2005, the ten areas with the biggest home price increases over the previous five years were all in California. That year, the overage home price in California was more than half a million dollars, even though the average size of the homes sold was just 1,600 square feet.

Although California— and especially coastal California — was the biggest place with skyrocketing housing prices, it was not the only place. Other enclaves, here and there, with severe housing restrictions also had rapidly rising housing prices to levels far above the national average.

If the housing boom was so localized, how did this become a national problem? Because the money that financed housing in areas with housing price booms was supplied by financial institutions across the country and even across the Ocean.

Mortgages made in California were sold to nationwide financial institutions, including Fannie Mae and Freddie Mac, and to firms in Wall Street which bundled thousands of these mortgages into financial securities that were sold nationally and internationally.

The problem was that, not only were these mortgages based on housing prices inflated by the Federal Reserve's low-interest rate policies, many of the home buyers had been granted mortgages under federal government pressures on lenders to lend to people who would not ordinarily qualify, whether because of low income, bad credit history or other factors likely to make them bigger credit risks.

This was not something that federal regulator agencies permitted. It was something that federal regulatory agencies — under pressure from politicians — pressured and threatened lenders into doing in the name of "affordable housing."

The housing market collapse was set off when the Federal Reserve returned interest rates to more normal levels, but it was a financial house of cards that was due to collapse, sending shock waves through the economy. It was just a matter of when, not if.

A fuller account of all this appeared last year in my book The Housing Boom and Bust. The revised and expanded edition shows how more of the same kinds or policies today are making it harder for the economy to recover. It's not that politicians never learn. They learn how much they can get away with, when they can blame others.

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False solutions and Real Problems

Someone once said that Senator Hurbert Humphrey, liberal icon of an earlier generation, had more solutions than there were problems.

Senator Humphrey was not unique in that respect. In fact, our present economic crisis has developed out of politicians providing solutions to problems that did not exist— and, as a result, producing a problem whose existence is all too real and all too painful.

What was the problem that didn't exist? It was a national problem of unaffordable housing. The political crusade for affordable housing got into high gear in the 1990s and led to all kinds of changes in mortgage lending practices, which in turn led to a housing boom and bust that has left us in the mess we are now trying to dig out of.

Usually housing affordability is measured in terms of how much of the average person's income it takes to cover either apartment rent or a monthly mortgage payment.

There were certainly places here and there where it took half a family's income just to put a roof over their heads. Many such places were in coastal California but there were a few others, here and there, on the east coast and elsewhere.

But vast areas of the country in between — "flyover country" to the east coast and west coast elites — had housing prices that took no larger share of the average American's income than in the decade before the affordable housing crusade got under way.

Why then a national crusade by Washington politicians over local problems? Probably as good an answer as any is that "It seemed like a good idea at the time." How are we to be kept aware of how compassionate and how important our elected officials are unless they are busy solving some problem for us?

The problem of skyrocketing housing prices was all too real in those places where this problem existed. When you have to live on half your income because the other half goes for housing, that's a real downer.

Almost invariably, these severe local problems had local causes— usually severe local restrictions on building homes. These restrictions had a variety of politically attractive names, ranging from "open space" laws and "smart growth" policies to "environmental protection" and "farmland preservation."

Like most wonderful-sounding political slogans, none of these lofty goals was discussed in terms of that one four-letter word that people do not use in polite political society— "cost."

No one asked how many hundreds of thousands dollars would be added to the cost of an average home by "open space" laws, for example. Yet empirical studies have shown that land-use restrictions added at least a hundred thousand dollars to the average home price in dozens of places around the country.

In some places, such as coastal California, these restrictions added several hundred thousand dollars to the price of the average home.

In other words, where the problem was real, local politicians were the cause. National politicians then tried to depict this as a national problem that they would solve.

How would they solve it? By pressuring banks and other lenders to lower their requirements for making mortgage loans, so that more people could buy houses. The Department of Housing and Urban Development gave the government-sponsored enterprise Fannie Mae quotas for how many mortgages it should buy that were made out for people with low to moderate incomes.

Various economists and others warned repeatedly that lowered lending standards meant more risky mortgages. Given the complex relationships among banks and other financial institutions, including many big Wall Street firms, if mortgages started defaulting, all the financial dominoes could start falling.

These warnings were brushed aside. Politicians were too busy solving a national problem that didn't exist. In the process, they created very real problems. Now they are offering even more solutions that will undoubtedly lead to even bigger problems.

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I have some insight on this topic. Back in year 2000 I had a single black lady renting a house I owned in the development I live in. She ran a child care center in the house and that was her source of income. She was always behind in her rent. After she had been living in the house for about 10 years she notified me that she wouldn’t be continuing to lease — that she would be buying a house in our development. I was shocked. I was amazed that anyone with the difficulties she had in paying the rent would qualify to buy a house. Well, she did buy the house. Within a year we noticed her name in a list of people who had not paid their homeowner dues in our community newsletter. A year or two later the house was up for sale again. It probably took some time and legal process to get her out.

30 Apr 2024