The Housing Bubble

‘Who opened the gates to Dumbass Ranch?’

I am working on a chapter about the housing bubble problem and the solution (making sure it never happens again). IMO, the source of the problem must be clearly identified, which is why I hope you guys will take up this question and help me out. This was in the W&W post yesterday:

‘In the wake of the financial market turmoil that arose over the summer, there has been a remarkable lack of finger-pointing so far over the cause of the crisis. But one observer, Tom Schlesinger, the founder and executive director of a think tank that has followed the Federal Reserve closely for the past decade, believes the blame for the crisis falls squarely on the Fed and accuses the central bank of ‘regulatory foot-dragging’ that has harmed the public.’

I have come to believe the root cause of this financial mania can be traced to the unaccountability of three groups: the US congress, the Wall Street investment banks and the Federal Reserve.

So I ask you, who did open the gates?

U.S. Congress gets voted in by popular election. I’ve never really held a high opinion of popular opinion. I’m definitely one who believes that converting the Senators from State choice to popular vote was an inconceivably bad idea, which has been singlehandedly responsible for the reduction of States rights. People serve who puts them in power. Senators used to have to serve the state. Now they serve the same people the Representatives do; only for longer.
Off the soap-box, if financial mania can be traced to the U.S. Congress failing to keep accountability, then it can be traced further to the U.S. public for failing to keep accountability on the people it elected.
The price of freedom is eternal vigilance; or the periodic watering of the Tree of Liberty with the blood of patriots. Take your pick.

Where I see congress’ unaccountablity is the fact that incumbents are almost always re-elected. Wall Street is ‘too big to fail’ and the Federal Reserve is unelected, secretive, aloof and has never turned in an audit to our government.

Just look at the actions of these guys; the Fed says a bubble isn’t possible, and if it did exist isn’t their problem. Now Greenspan won’t shut up about it and there is no accountability.

Congress just stamps their feet and uses the bubble mess to fund pork and skim votes. Wall Street makes a fortune and lobbys for hand-out!

As an ex-political science major, let me tell you incumbancy is a big issue. 97% re-election rate in the House.
And I think Wall Street is not ‘too big to fail’. We’re going to watch it fail first hand. It could have a very deletorious effect on the economy.
Bail-outs of the magnitude required just can’t happen, it’s against the laws of economics, as I understand them.
Accountability starts at home, but if there is no accountability; well, there’s still those final accounts to pay at the end of the day.
I’m still not an “ARMageddon” predictor, but I do think we’re going to see a major economic event.

Henry Paulson, the US Treasury Secretary, is seeking to persuade the White House to offer financial compensation to American mortgage lenders that try to help troubled homeowners by renegotiating the terms of their loans.

The Times has learnt that Mr Paulson is lobbying President Bush to provide funds so that mortgage lenders can reduce the loss that they would incur from either reducing the rate of an adjustable home loan or extending the life of the mortgage to make it cheaper for the property owner.

http://tinyurl.com/38c3hu

I lay it entirely at the feet of IBs, hedge funds and other assorted greedy pigs of that ilk. Of course, the Fed accommodates them but the masterminds of this money grab are on WS. It’s no different than the stock bubble. They seem to spend all of their time trying to scheme up ways to separate J6P from his money or Juan6P as the case may be this time. I could spin you out a whole Truman Show tinfoil hat masterpiece but I assume you actually want to sell your book

‘I think Wall Street is not ‘too big to fail’

I completely agree, I’m just saying they proceed as if it is so.

Many here will flat out reject this but the irresponsibility in housing finance is merely a symptom of a greater, more sinister problem. It goes hand in hand with “deregulation”, the “laffer curve”, “supply side” etc. This crap has been going on since 1981 and we’re now seeing another display of wreckage from the insane path we’re on. Why are so many so blind to the fact that they were tossed in the garbage heap 30 friggin years ago? I have no idea but the CrimeSyndicate that has been calling the shots for 30 years can proclaim Veni, Vidi, Vici.

The root is Greed (…the love of money…), normally held somewhat in check by Capitalism, ie greedy crooks keeping each other in check through competing self-interest. But lack of transparency has subverted checks and balances. The housing bubble has been a classic pump-n-dump. To assign blame, just ascertain who got the vig.

Yeah, but we can really fix the human nature stuff. Also, Mozilo is greedy, but I see him as a bit player. Many others like him would do the same thing. What I am searching for are the players and institutions thatthat we could take action on to prevent a housing bubble in the future.

A lot of them are likely overseas. Got a big budget to retain Blackwater?

‘In the wake of the financial market turmoil that arose over the summer, there has been a remarkable lack of finger-pointing so far over the cause of the crisis.”

If there has been a remarkable lack of finger pointing it’s because they are all co-conspirators. The very magnitude of corruption from the lowest levels of private sector extending through the government all the way to the highest levels, along with other national events, should awake all freemen to a sense of our awful situation.

“Henry Paulson, the US Treasury Secretary, is seeking to persuade the White House to offer financial compensation to American mortgage lenders that try to help troubled homeowners by renegotiating the terms of their loans.”

Who would pay such compensation? Perhaps Big Hank and some of his Wall Street buddies would consider putting together a bailout fund out of their personal fortunes?

“‘I think Wall Street is not ‘too big to fail’

I completely agree, I’m just saying they proceed as if it is so.”

Plunge protection ramps up systemic risk, as invester willingness to make stupid decisions is buoyed by a perception of no downside risk. Eventually, global market forces will overcome the paralyzing effect of national-level market manipulation.

todd puts my feelings into words better than I can
http://www.minyanville.com/articles/C-db-jpm-bac/index/a/14607

it’s the Fed w/help from WS sleaze (which is now 90% of WS)

Ooooh! Now I get it.
Well, as has been said elsewhere on this blog, the housing bubble is just an asset bubble by any other name, so the answer to ensure that a new housing bubble doesn’t blow is to ensure no more asset bubbles. What inspires bubbles?
1) Mania - human nature, unchangeable. Therefore there will be bubbles, but mania by itself leads to small bubbles. I’ll join Greenie and call it ‘froth’.
2) Fraud - human nature as well, particularly with regards to sales. The solution here is strict enforcement of tough fraud penalties–at all levels. Definition of fraud may have to be broadened to catch more, but there’s always the hazard of including innocent people in punishment when you broaden criteria. Again to the FF, better that 1000 guilty men go free than an innocent man go to jail. (paraphrasing of course)
3) Unwise investing. People follow the mania and make it more manic. But unless they’re fraudsters (see #2 above) then it’s just stupidity. Let the market hand them their lumps.

If we force stupid money to lose value for investing in mania, and control fraud future bubbles will inherently be small.

Right?

I will throw my two cents in here and that’s really all this opinion is worth…..I think this scam has been more political than anything and before I continue this comes from a 30 year registered republican that is a physical conservative and a social moderate….I believe it was all about gun’s & butter…..The federal reserve holding hands with the Bush administration to keep the Indians quiet (awash in $$) while we pursue our philosophical agenda at home and abroad….Remember “Ownership Society” President Bush June 2004..Go here to see…Fact Sheet: America’s Ownership Society: Expanding Opportunities…. It fricken worked !!….Most of the Indians did not give a rats ass what was happening to our civil liberties, outright thieving and fraud or the havoc that we were going to pour into the middle east….They were to busy buying escalades that were pulling $50,000. boats, flipping houses and anointing themselves as developers….I put the blame squarely in the lap of Greenspan for not maintaining the independence of the Federal reserve and being a lap dog for this administration….

My answer is more in the category of “what” opened the ranch gate, not “who.” In the past, it was generally accepted that certain people — the very young, the poor, the uneducated, and those possessing bad credit histories — probably should not be lent large sums of money. That principle got replaced with the idea that home-ownership was a universally- desirable, universally- attainable goal. Politicians pandered, lenders grew greedy, and our gatekeepers — the federal regulators and local property appraisers, especially — capitulated. And, far too few parents, grandparents, and preachers taught the risks of excessive borrowing and the price of greed.

“If we force stupid money to lose value for investing in mania, and control fraud future bubbles will inherently be small.

Right?”

And then the fattest cats who profited so handsomely from the current bubble will not be able to do so in the future, right?

And then they will not be able to send campaign contributions to fund their most supportive Congressmens’ reelection campaigns, right?

Good luck on this.

I think the roots go back decades.

In 1987, the stock market collapse and the Federal Reserve dropped Fed Funds to 0%. This caused the markets to rebound and did not impact the dollar. Federal Reserve intervention in routine markets became the rule.

As manufacturing continued to decline in the US, to maintain any economic growth (even bogus growth), the US developed into a “bubble economy”. Primarily in Financial industries including insurance, the Federal Reserve allowed previously risky investments to occur. In 1994, the Federal Reserve in its March, 1994 meeting even questioned whether their policies would lead to asset bubble growth. In 1995 all reserve requirements were lifted on bank lending on houses for loan amounts less than $1.4MM. In 1999, the Glass-Steagall act was rescinded, allowing banks and financial institutions to take unprecedented risk. Et voila.

This housing bubble is just one aspect of an enormous credit bubble. I blame the Federal Reserve. The Federal Reserve could have said at any time to the government to rein in its spending. The Federal Reserve could have said ‘we cannot finance the government debt’. Instead the Federal Reserve went along with tax cuts and increases in government debt that have bankrupted the nation. These policies did not help the average American, the policies were designed to benefit a very few.

Realtors and mortgage brokers both honest and dishonest can only buy/sell and lend based on the heavenly fathers
(the Fed,Wall street, Banks, Congress etc.). Slack underwriting with no solid revue of loans in pipeline, appraisers being chosen by brokers not lenders and the Fed not understanding the way the housing markets functions when rates are at historic lows all caused the crisis we are in now. The housing market is going to be in a slump for a very long time and it will impact our credibility in world financial markets for years to come.
After 9/11 Bush wanted us to shop til we dropped and the policies set in place by the Fed/government allowed us to do just that. Housing became our cash cow with no reguard for real income. ” We have met the enemy and the enemy is us”.

Securitization without Regulation, they all cheered.

http://en.wikipedia.org/wiki/Securitization

I think a demographic factor has been at work. When Boomers were young, the focus was on competition for good jobs. When Boomers reached mid-career, they became more interested in speculative investing and less interested in working. Stocks became expensive relative to bonds, but then stocks swooned, driving the speculative money to go somewhere else. REIC was ready and willing to anoint itself the Investor’s Dream. Couple that with the tendency of people over 50 to become “self-employed” and you have a huge increase in the number of realtors AND in the number of investor/fixer/flippers. An astute observer (Grantham?) has pointed out that Boomers cannot all cash out simultaneously — they are just trying to sell their assets to one another, or to each other’s children, so that all can afford to keep up consumption of food, energy, medical care, etc. It can’t work out.
How to prevent another housing bubble? Easy. This one will not be repeated until forgotten. I’d say two generations or maybe two and a half. Sixty years or more.

The Federal Reserve is the actual culprit. Without funny money, none of this nonsense could go on to nearly the extent it has.

The Austrians would quickly point to the Fed as the primary culprit. Here is a pretty good primer (watch the 2006 edition) on Austrian economics vs. Keynsian economics.

http://www.auburn.edu/~garriro/ppsus.htm

The keynsians (which is what most of the government follows) believe this sort of bubble shouldn’t be possible, so they don’t have an explanation for it. The bubble starts with the lower interest rates from the FED, wall street guys/bankers (these are the ones that get the money first) find some place to dump all that liquidity and we inevitably see a bubble in some asset. A few years ago, it was the stock market (tech stocks were popular), more recently it was real estate.

As far as who chooses which asset class gets pumped up? I don’t know..probably the same thing that causes fads to come in and out, it just happens that way. But the main point here in my mind, is that the combination of fiat money along with the government supported monopoly and the influence of the big bankers on the money supply causes this type of bubble.

When banks lent out their own money they had to be careful to be sure that the borrowers could pay it back. When investors started to buy the loans from the banks (and later the non-bank loan originators), the banks didn’t have to be careful. The investors didn’t think they had to be careful because the securitizers told them that mathematical models (and the slicing and dicing) and historical models of loan failures told them that the investments were safe. But the mathematical models only took into account the good facts about securitizing - that the investors didn’t have to worry about local economic risks like a plant closing which might wipe out the loan portfolio of a local bank. The models didn’t take into account that prices might ever go down or that the riskier borrowers would have worse repayment rates or that people would report fraudulent incomes or that so many buyers would be investors with no emotional attachment to the house.

Add together no risk assement by the loan originators and desperately inadequate risk assessment by the securitizers and investors, no regulation to fill in the gap and innumerate borrowers and you have a recipe for total disaster.

The relationship between housing and securitization is symbiotic. They fed on each other on the way up and they are feeding on each other on the way down.

It’s all about risk…analogous to the S&L debacle in the 80’s. Borrowers speculate with other peoples money, unqualified borrowers are loaned outrageous amounts of money with no hope of ever being able to pay it back by Brokers/lenders/CDO/SIV packagers who take their cut and pass the risk onto….us, our pension funds, insurance company investments and who knows what else.
I think that this is just further proof that governments role is to regulate markets with reasonable, fair, transparent, uniformly enforced rules for the sake of stability.

“The relationship between housing and securitization is symbiotic. They fed on each other on the way up and they are feeding on starving each other on the way down.”

Yep, that’s much better.

Housing Inflation expectations caused this bubble.
The “smart borrowers” used ARMs and bought the biggest house possible with the most leverage just knowing inflation will make all well in a few years, it always has they would say. Just look at their parents homes how they were hardly affordable at the time but now their biggest asset. All the rich people got that way in RE, this was a common theme in CALI and true in many cases.
How to prvent this from happening again? easy don’t bail anyone out.

Not if the banks, govt, Fed, etc. have created a big smokescreen the averge Joe can’t see through. They play by different rules. Not that one isn’t responsible for their own actions, but sometimes it’s very difficult to see the big picture, esp. if you’re being forcefed propaganda by NAR, Heli Ben, ad nauseum…

Ben, et al,
In one of the first posts I had contributed, I attempted to call attention to the cause. I had attempted to point out that when it began to unravel, it would be important to note the cause, and ensure folks who understand the problem attempt to voice it.

It isn’t because of foreigners, immigrants, hurricanes, fires, lack of terms limits, etc. It is because we’ve been living in socialism. The Fed sets the price of money, and the Congress attempts to determine the best place for the money through their tax legislation (a central body determining the production and distribution of goods and services). I suppose it can work well (although certainly not in the contract laid out in the Constitution). However, if those doing the central economic planning make an error, (and it is obvious they gravely miscalculated the housing phenomenon), the entire structure/state that participated is at risk. Without the central planning, it is much more likely that small percentages will be affected. This isn’t the case.

With the de facto tie of the dollar to oil (making it the reserve currency of the world), the Fed could cheapen the currency and the effects here were kept moderately in check. That is no longer the case. Look at the trouble that is being caused by other nations moving away from the Fed Notes. Look at the gameplan being developed by the Treasury to penalize Iran for moving away from the Fed Notes for their oil sales. When supply goes up while demand goes down, the price must go down-and it holds true for money as well.

In this manner, the politicians were able to literally promise their constituents something for nothing. Since most folks realize that isn’t possible, during this time, others were getting nothing for something. The rules have been changed, and it remains to be seen if they can be changed back. I don’t think so, and the cause is the change of the basic apportionment of taxes and a central bank.

Folks need to grasp how taxes that are apportioned make representatives directly accountable (a republican system of governance, not to be confused with the private political party). Without a private central bank to lend their notes to the government for a low interest rate, the elected officials would have to make spending equal income. This isn’t the case. The officials can appear to promise something for nothing. Katrina spending and fire spending means we’ll all get taxed through inflation, yet most folks don’t realize it (I am in no way attempting to state my value beliefs as to whether funds should be spent or not-simply that we will be taxed, and probably through inflation). Instead of officials asking if it would be acceptable to tax the entire union for these expenditures, it is done with the knowledge that the Fed will buy more debt and tax us all through inflation.

This fiscal and monetary system we have are the problem, assuming most Americans believe in liberty and the Constitution. If folks believe in collectivism, then the problem would be the folks in the elite positions. If not, then it is most certainly the system.

Blue: you’re right, of course. How many people do you know who are clear on the organization of the banking system, even starting as recently as JP Morgan (the banker, not the bank) and moving toward the present?

These people are the epitome of rational self-interest…of the variety which cedes not one whit to any other interest. Their brilliance at gulling the ever-gullible is impressive.

My fantasy is for a handful of the enormously wealthy providing backing for a strong real news service….as a public service. Oddly, there are more than two who are honest, concerned fellows. If anyone could create an engine for profit, I’d think it would be these folk….by way of getting a reasonable return on their cultural investment.

Excellent replies, all!

IMO, the cause of the credit bubble is multi-faceted, but is centered primarily on the relationship between banks and politicians (money and power).

It seems that something changed when Ronald Reagan became president. The credit markets seemed to be unleashed and this may well be the impetus for the “growth” we’ve experienced since around 1982.

Credit markets take from the poor/working class and give to the wealthy. Ultimately, this money is only in circulation on a temporary basis, as lenders expect to get all their money returned, with a premium (interest). This money is not the same as money that is exchanged for goods and services. As credit markets grow, the wealthy become even wealthier while the workers become more indebted — forcing costs up, which force workers to borrow more, which forces costs up in a seemingly endless spiral (inflation).

Add to this a tax code which rewards capital over labor (15% LT cap gains tax vs. 25%+ on labor), and there is a much greater incentive to “invest” rather than do productive work. This funnels ever more money into the hands of the few who now have exceeding large amounts of money looking for a place to “invest”. Add to this the money made by Boomers in a very inflationary environment over the past few decades (largely caused by the change in population they, themselves, caused), and you have the makings of a supply-driven credit bubble.

Because there was so little demand for loans after the stock market bubble, the lenders/investors got desperate and began making riskier and riskier investments.

Those who were supposed to regulate and enforce financial laws encouraged all of this and turned a blind eye to the obvious fraud and dangerous risk-taking that was going on. The people who are largely at fault are: the president(s), congress, the OTS, the Fed, Treasury, ratings agencies, SEC, unregulated and opaque investment funds & institutions, regulatory bodies and associations of the REIC, and many more.

Let’s not forget the Fed lowering rates and the Treasury eliminating the 30-year bond when rates were at historic lows, (forcing long-term investors into shorter-term maturities which may have forced rates down in the 10-year and below).

Ultimately, I think the fault lies with the credit cycle, where we reached a point where too much money was being hoarded by wealthy investors looking for a place to go. All the above-mentioned players just tried to keep the party going because they were the beneficiaries of the credit bubble.

“Pulled out …”

And naturally, bullish investers buy the story hook-line-and-sinker, driving up CFC’s share price on the news that the full kitsch-and-sink have been thrown in to current earnings.

I don’t buy it, CFC is just guessing things will get better and like most of the “should know better people” will be wrong and saying how this just couldn’t be predicted. Government has to bail us out blah blah. I suspect the government seeing the prospect of DEFLATION will inflate and spread this bubble to all who work for dollars and save dollars. Except retired folks for them there really is no inflation so your SS checks don’t go up.
I really don’t think the FED can inflate us out of this mess and I expect Deflation in the end, but to pass the time I buy commodity stocks figuring I can get out before the Recession finally sinks in as the FED runs out of rate cuts al la Japan.

“a fragmented, poor society with no jobs, no ability to save, dismal living conditions, and no hope is easier to control.”

I think you are right on target with your comment. Where the elitists are wrong of course is in their thinking that THEY will be the ones doing the controlling….

How many guns are owned by the American public? Hey, it’s at least one category where we’re indisputedly numero uno.

A similar problem comes up when the Fed protects investors from downside risk. Soon stock prices are way out of wack, as they reflect a temporarily-correct belief that stock prices always go up.

Right and I seriously doubt that inflation will show up in wages.

“Right and I seriously doubt that inflation will show up in wages.”

Which leads me to conclude that you are probably right that home prices will keep falling for the foreseeable future, as lenders are no longer in the mood for making home mortgage loans that are unlikely to ever be repaid, and loan repayment potential is heavily dependent on future wage inflation for all but the very upper-most tail of the wealth distribution.

And this is the only thing that has me concerned about renting. At one point my landlord admitted to me at least on a month to month basis he can’t charge enough in rent to cover all expenses of the condo unit I rent. I can’t remember where I read this (it might have been on this blog) that some guy had to move 3 or 4 times in the last 2 years because of landlords going under. Renting is clearly the correct choice right now, but I do think I might buy if I meet my criteria for buying sooner rather than later since even if it isn’t the bottom at least I won’t be dealing with the hassle of moving and finding a new place to live multiple times a year.