Boom Goes the Dyn-O-Mite!

by Eric Martin

Barry Ritholtz tackles a question via email regarding a topic that has been discussed on this Site with some regularity (via):

“Can you support your position, in a fast, easy way, why the US housing boom was NOT caused by Fannie and Freddie, or the CRA? I understand all the factors you laid out in the book — but I would like to see more evidence to support your view.”

Well, its difficult to prove a negative — supporters of the “FNM/FRE/CRA caused it” should have to prove their case, as I did in Bailout Nation.

However, I have always found this chart to be quite compelling:

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Chart via BIS by way of NewObservations.net

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Pray tell what caused the same boom and bust in these other nations?

And how could Fannie/Freddie or the CRA be responsible — that only applies to the US — when you have the same, global, coordinated rise in prices?  (And you can add Korea and New Zealand to the chart above).

For those of you who still believe the political talking point that it was FNM/FRE/CRA’s fault, the question remains: What caused these other nations to boom the same time the USA did?

Poor minorities the world over?  Snark aside, Ritholtz posits a theory:

The US Federal Reserve’s monetary policy, on the other hand, did have a global impact. The US has the world’s reserve currency, the biggest economy and the most important central bank.  When the Fed took rates down to 1%, it had an ginormous impact on everything priced in debt, dollars or leverage. That includes housing, around the world.

But that doesn't really fit into a neat and tidy talking point with the racial overtones that the GOP is playing up via a number of dubious non-scandals these days.

Comments

[cleek]

yeah... but whatcha gonna do? wingnuts gotta spin. it's what they're made for doin.

[Sebastian]

You are illustrating half of a point I've been trying to make for a while. The recent crash should be causing everyone to be reevaluating their economic groundwork--in addition to the fact that most of the European countries didn't have the CRA, they also had much stricter banking laws, had the style of banking laws that liberals want in the US (less rules-based and more expert-based), and additionally didn't have nearly as much in the way of 'creative' house financing schemes.

So none of our tidy talking points fare very well in that graph. Yet we all cling to them.

[Eric Martin]

Are you sure Euro banks weren't heavily invested in credit default swaps and exotic mortgage derived securities? I thought they were.

[Snarki, child of Loki]

Good luck convincing wingnut true believers with those facty graphy things.

[Eric Martin]

Seb,

I'm not sure I follow. The housing crash would not have been as catastrophic had the banks not been so heavily leveraged with mortgage securities that, though comprised of junk, received "AAA" ratings from the ratings agencies. It was this leveraging that threatened, and still impacts, the financial sector in the US and Europe.

European banks also had big exposure on these securities. Candadian banks did not, due to stricter rules, and as a result, Canadian banks are much healthier.

What about Barry's post should call that account into question?

[hairshirthedonist]

But, Seb:

The US Federal Reserve’s monetary policy, on the other hand, did have a global impact. The US has the world’s reserve currency, the biggest economy and the most important central bank. When the Fed took rates down to 1%, it had an ginormous impact on everything priced in debt, dollars or leverage. That includes housing, around the world.

Considering the differences in the dynamics of the housing stock in Europe v the US, the effect of Fed policy would be magnified in countries that were more constrained. The extreme growth in our housing stock had to have mitigated the price increases caused by the in-flow of capital, so our bubble was a lot stretchier, resulting in less price pressure. That is, we could more easily increase supply to better match the artificial demand. If you weighted housing prices in proportion to housing stock, I have to think our bubble would look far worse.

The question is, how much worse could things have been for them if they had an American-style banking system? And how much better could things have gone here if we didn't do all the stupid things we all know we did?

I'm not sure that the recent financial reform was the best approach, after hearing it described as simply "more lifeguards" rather than real changes in the structure of our banking system, but...

[bobbyp]

Eric,

You don't follow? The point is clear. Despite the worldwide acceptance and/or imposition of Neoliberal dogma since 1980, the utter failure of this framework should inspire us to renew our fight against attempts at rational regulation of so-called free market economic systems. The ultimate outcome of this never ending "struggle" should be rather obvious.

Such an attack hardly constitutes "reevaluating" one's "economic groundwork" in any meaningful sense, and no evidence is presented by Seb that he is engaged in any such endeavor.

[ajay]

in addition to the fact that most of the European countries didn't have the CRA, they also had much stricter banking laws, had the style of banking laws that liberals want in the US (less rules-based and more expert-based), and additionally didn't have nearly as much in the way of 'creative' house financing schemes.

Little if any of this is true. Particularly impressive is the assumption that 'Europe' is all the same place.

[elm]

Little if any of this is true. Particularly impressive is the assumption that 'Europe' is all the same place.

To address this very specifically, Ireland had the biggest peak on Eric's graph and also had a weak financial regulator and permitted many types of creative mortgages (100% mortgages, jumbo mortgages, 35-year mortgages, and skip-payment-option mortgages to name three).

[elm]

European banks also had big exposure on these securities. Candadian banks did not, due to stricter rules, and as a result, Canadian banks are much healthier.

I'd go even further than that. Some European banks created and used the same sorts of securities as U.S. banks. The linked article describes how the Bank of Scotland (Ireland) sold mortgage-backed securities composed of dubious-quality mortgages which received good ratings from ratings agencies.

[skeptonomist]

The fact that other countries had the same sort of bubble should tell you that they were doing something similar. Was it programs for low-income people, or Randian Maestros who encouraged trick mortgages and credit default swaps? Spain, for example, definitely had policies to encourage home ownership; and Maestros in different countries have in the past usually operated out of the same playbook. The similarity of countries does not prove anything by itself, you must definitely identify what was responsible for the bubbles.

[Sebastian]

Hey bobby. Why don't you cool it a bit huh? Stick to substantive comments and we'll all be much happier. Thanks.

Eric, "The housing crash would not have been as catastrophic had the banks not been so heavily leveraged with mortgage securities that, though comprised of junk, received "AAA" ratings from the ratings agencies. It was this leveraging that threatened, and still impacts, the financial sector in the US and Europe."

Yes, the leveraging was it. The graph suggests it was not the different bank regulation styles, bank regulations, rating agency differences, the deregulation of the Bush administration, differing tax policies etc. All of those varied wildly across the US and different European nations, but the bubble still occurred. And actually the lose monetary policy of the US government probably wasn't it either, as the EU policy was much tighter, enough to largely offset the US policy.

My point about the graph is that you are only getting about half of it if you only recognize the shibboleths that it hits on the people whose policies you oppose. That graph strongly suggests that a lot of the stories being told about the bubble are wrong. And not all of the stories proven wrong are on the right.

For example, tricky mortgages. They weren't as available anywhere as much as they were in the US, yet the US is in the middle of that graph. To the extent that graph suggests the silliness of conservative ideas about the crash, it also calls into question a number of popular liberal ideas about the crash.

(The most interesting idea I see in the graph is either that there really wasn't a housing bubble at all--since the US isn't anywhere near the top of that graph, or that much of Europe is *still in it*). I suspect the latter, which should be really really scary.

[Sebastian]

"I'm not sure that the recent financial reform was the best approach, after hearing it described as simply "more lifeguards" rather than real changes in the structure of our banking system, but..."

I agree with this part of this comment.

We have been trying to make failure impossible, which I suspect just ends up putting off failure until it is radically destructive. It might be better to design a system where we focus on making failure easier and non-catastrophic.

[Eric Martin]

The graph suggests it was not the different bank regulation styles, bank regulations, rating agency differences, the deregulation of the Bush administration, differing tax policies etc. All of those varied wildly across the US and different European nations, but the bubble still occurred. And actually the lose monetary policy of the US government probably wasn't it either, as the EU policy was much tighter, enough to largely offset the US policy.

I'm not sure I follow.

The graph shows one thing: each country had a housing bubble.

The graph DOES NOT show that the heavy leveraging that caused the massive financial meltdown was not caused by lax regualations, creative derivatives born out of the repeal of Glass Steagall and ratings agency malfeasance.

That theory is entirely unaffected by the graph.

Again, many European banks got into trouble because of their own lax regulations, and willingness to trust our ratings agencies.

Canadian banks, with stronger regulations about leverage, did NOT get into trouble.

So, again, the "bubble" was not caused by lax regulations and exotic mortgage securities which were repackaged junk sold as AAA because of ratings agency complicity.

But the financial meltdown that required the enormous bailout of Wall St was caused by the latter, and foreign banks' willingness to go along for the ride (at least, those banks that did not operate under a strong enough regulatory environment such as Canada).

[Sebastian]

"The graph shows one thing: each country had a housing bubble."

Actually it doesn't show that unless you think Europe is still in the housing bubble. The slope of the US graph is much milder than that of many of the EU countries.

"The graph DOES NOT show that the heavy leveraging that caused the massive financial meltdown was not caused by lax regualations, creative derivatives born out of the repeal of Glass Steagall and ratings agency malfeasance."

Actually it kind of does. The EU never had Glass Steagall. So its repeal is well beside the point. The crash has been used by many, even around here, to suggest that we need a less legalistic, more toothy bank regulation system like Europe. But in my view, what the graph shows is that the style and overall attentiveness doesn't differentiate much, only the overall leverage restrictions matter (which is why Canada wins).

"Again, many European banks got into trouble because of their own lax regulations, and willingness to trust our ratings agencies."

I would say this is a wild over-interpretation. The fact of the matter is that banking regulations laxity varied wildly across the countries in question, but that it didn't seem to have much effect on the crash except when they were tightly focused on leverage (Canada). So overall tightness of the oversight wasn't the differentiating factor.

"But the financial meltdown that required the enormous bailout of Wall St was caused by the latter, and foreign banks' willingness to go along for the ride (at least, those banks that did not operate under a strong enough regulatory environment such as Canada)."

I'm having trouble following you here. To the extent that this graph purports to show anything, it is about the bubbly nature of the housing market (which again I will note does not appear to have popped in Europe, and which could not have been caused by exotic mortgages in Europe). The graph doesn't appear to say anything whatsoever about mortgage securities, AAA bonds, rating agency complicity, or whatever.

You were right to suggest that it showed that the bubble was beyond CRA and Fannie/Freddie. But it *also* shows that all of the US specific mortgage things that liberals complain caused the bubble, didn't cause it. Because those things pretty much didn't exist in the much more regulated European housing loan market.

Now I think we both agree that the bubble was one bad thing, and the bank leverage/securitization response to the bubble popping was another thing. But you can't use that graph for any argument about that issue, because it is completely silent on that.

[Eric Martin]

Actually it kind of does. The EU never had Glass Steagall. So its repeal is well beside the point.

And the EU didn't have massive bank bailouts ala TARP.

You seem to view the housing bubble as the primary economic calamity. It was not. It was the meltdown on Wall Street, which was caused by overleveraging.

The crash has been used by many, even around here, to suggest that we need a less legalistic, more toothy bank regulation system like Europe. But in my view, what the graph shows is that the style and overall attentiveness doesn't differentiate much, only the overall leverage restrictions matter (which is why Canada wins).

Well, speaking for myself only, I never mentioned the EU. But I did mention Canada. And I did mention Glass Steagall, as well as tighter regulation of the ratings agencies.

The graph doesn't appear to say anything whatsoever about mortgage securities, AAA bonds, rating agency complicity, or whatever.

Exactly! That's my point. The graph is only addressing one side of the story: that CRA and the Macs caused the housing bubble and, in turn, the bubble was responsible for the massive meltdown on Wall St.

1. The CRA/Mac story is thin gruel, as the graph shows.

2. Regardless, the focus on the bubble (and CRA/Mac's alleged role in it) misses the point. The much larger, more impactful damage was caused by exotic mortgage securities repackaged as AAA with a complicit ratings community that were gobbled up freely.

But it *also* shows that all of the US specific mortgage things that liberals complain caused the bubble, didn't cause it. Because those things pretty much didn't exist in the much more regulated European housing loan market

I can't answer for nebulus "liberals" - only myself. I didn't make those arguments, so I won't defend them.

Now I think we both agree that the bubble was one bad thing, and the bank leverage/securitization response to the bubble popping was another thing. But you can't use that graph for any argument about that issue, because it is completely silent on that.

True, but I didn't actually try to use the graph as an argument about those things.

I merely said that the graph did not refute those theories. And in that, I think, we agree.