The Demand for Housing

Hello all, my name is Mike Konczal and I’ll be guest-blogging here this week. I want to start off with a request for comments. I think this page has one of the smarter comments sections (that statement is completely self-serving, as I am a commenter here too), and I want to get all of your opinion on a question that I’ve been thinking about lately: Where did the increase in demand for housing and subprime loans come from?

Think of our current story for the increase in subprime loans and the housing bubble: interest rates were kept too low following the attacks of 9/11 and/or there was a global savings glut. Financial deregulation allowed Wall Street to pour capital into mortgages while slicing and dicing them into investment vehicles, and politicians were happy to think the interests of Main Street (and its voters) and Wall Street (and its campaign donations) lined up perfectly. Fly-by-night unregulated subprime lenders steered borrowers into high-interest loans and/or community groups pressured banks to increase the amount of said loans, as well as restricted the increase in new houses in the most desirable areas through regulation and zoning. Alyssa Katz’s Our Lot is the best book I’ve read recently about the way deregulation and political goals worked together to get Wall Street to pour money into dubious loans.

Notice that almost all of these are changes are on the supply side: Someone now wants to offer you more of a mortgage than they did before. But why did we take these mortgages? We could say that supply creates its own demand, but I think that’s too much of a dodge when there are interesting phenomenon to investigate. Here are two standard ones:

Perfectly Rational Karl Smith points out that there may not be a conflict here at all. When it comes to no-money-down liars loans, or leveraged investments more generally, the effect for consumers might be a “heads-you-win, tails-nothing-happens” coin flip. If someone offers you a giant mortgage, and the upside that your new house may become worth a lot more than the fees and interest jumps, and the downside is that you got to live in a nicer house than normal for a year or two and lost your rent, that’s a perfectly rational bet.

That’s not the experience on the ground, where people hang onto their house, fighting, often desperately at times, to keep them. Houses aren’t dumped like underperforming stocks by the overwhelming majority of consumers.

Investments Gone Bad Interest paid on a mortgage is tax deductible. In 1997, President Clinton overhauled the tax code for selling real estates; consumers would no longer have to pay capital gains taxes on their houses. Between that, the collapse of the tech bubble and the worry that there were many more Enrons and Worldcoms waiting to be found, many households didn’t want to invest in the stock market. So people went nuts and invested too heavily in housing for their investment portfolio.

(Technically, if people want to spend more on houses because interest rates are lower, then the interest rate tax deduction may have slowed the housing bubble, since if people are buying more house because interest rates are lower then they must have less interest paid on their house, which is less to write off on their taxes.)

This depends on housing prices appreciating for a long time – here’s an example of economists discussing whether or not that is rational, and trying to fold it into a standard investment story. I often feel that when the story goes too quickly into “irrationality”, it is because we are missing some sociological explanations for why people are doing the things they do. I want to add three additional reasons why the demand for housing may have skyrocketed over the past 10 years, ones I don’t see discussed very often in the standard narrative.

Housing Equity as the new Social Contract As income has become more volatile, health care costs have skyrocketed, unemployment spells have increased, more household spending has gone to hard-to-decrease fixed costs, and all the while there has been a slow unwinding of the social contract, housing equity became a new form of social insurance to navigate the bad times.

A lot of housing equity was tapped to make large consumer purchases – televisions, remodeled kitchens, etc. But a lot of housing equity was tapped to pay medical bills, or as a form of unemployment insurance, as well. It is worth noting that 60% of subprime loan defaults in Massachusetts started off as prime loans, the previously stable households who put money down, paid their bills on time, etc. I’d be curious to see research focused on how much of each played a part in the housing bubbles and demand for subprime loans, and the rise in house prices more generally.

Education There’s a lot of focus on the interest rate deduction that is embedded inside a mortgage. I think the most obvious embedded option inside a mortgage that isn’t discussed is the option to educate your children at the local school district. If sending 3 kids to a private high school at your old houses costs $5,000/year, and if the new house’s public high school is free and equally good then taking a $60,000 bath on the house is break-even. Completely rational.

The value of this option has increased, both with the returns to education but also with a general worry about the robustness of our educational meritocracy. The amount of money and energy that goes into securing access to high-end education has skyrocketed over the past decade, and part of that budget, though it isn’t treated as such, is in your house. And though we often think of educational inequality as a function of a Kozol-narrative of the poorest against the richest, this bidding may be most driven by inequality between the middle and the highest parts of the inequality curve. I’d really like to see some hard research into how much our desire to educate our children in the best way possible has driven subprime and the housing bubble.

Gentrification The term gentrification may not apply anymore, as it usually is meant to describe a small neighborhood. What we’ve seen might be described as a demographic inversion, with the poor being moved from the city to the suburbs. That New Republic article focuses on Chicago, and as a resident of Logan Square during the time in question I can back up the statement: “The reality of demographic inversion strikes me every time I return to Chicago…But that hasn’t prevented Logan Square from changing dramatically again–not over the past generation, or the past decade, but in the past five years.” Even now, with the housing recession underway, it seems that we’ll continue to see a shift to a “new urbanity” over the next ten years.

Gentrification can increase the quality-of-life for people who remain in the area. There will be better services, safer streets, the kind of grocery stores where people with college degrees shop, etc. However the key point there is that people have to remain in the neighborhood. Taking a big bet on housing can be very rational in this case. The rollercoaster jumps in mortgage payments that come from a subprime loan might be less than the uncertainty in the jumps in apartment rents that occurred over the same period.

If you were an adult in the 2000s, you’ve probably spent at least one night thinking “am I making the right housing choices? Should I buy? Should I have bought more? Less?” Since this is the smartest comments section on the nets, I’d like to ask you – why was this?

110 responses to “The Demand for Housing

  1. Since this is the smartest comments section on the nets

    …and the least self-congratulatory, the most modest, the humblest, the most introspective, the most tactful, the least likely to flatter, always putting substance above form…

  2. Since this is the smartest comments section on the nets

    …and the least self-congratulatory, the most modest, the humblest, the most introspective, the least likely to flatter…

  3. That’s not the experience on the ground, where people hang onto their house, fighting, often desperately at times, to keep them. Houses aren’t dumped like underperforming stocks by the overwhelming majority of consumers.

    Just curious what your evidence is for this. I ask because there is this competing narrative about “ruthless default” and “walk-aways” and “jingle mail”… But I am unaware of any hard data to suggest which narrative I ought to believe.

  4. Lavrenti Beria

    And the most repetitive, it would seem. :-)

  5. Uh. . . what happened to the simplest (and I think most widely accepted) explanation of why demand increased – it’s because demand increased. Just your classic bubble. People saw housing prices rise and wanted to get in on the action. Same reason why people bought Amazon at $80/share in 1999: because they thought the price would continue to rise.

  6. First, I would say I am the most humble…as I have the most … ?least? ;) to be humble about.

    You know, humans are a strange bunch when they think they can make money. Take the Dutch tulip mania I was reading an article about sea shells in the Smithsonian – and shortly after the tulip mania, there was a sea shell mania.

    A lot of what we believe is a function of our upbringing. Born in some regions of Afghanistan, and what the Taliban says makes sense to you. Born in the USA, and you believe in progress, stocks for the long term, and that they’re not making any more real estate.

  7. winstongator

    At least in SoFL, where my family & in-laws are, you had a large amount of speculation through people buying investment properties, and people were OK putting a bigger percentage of their income towards housing because they viewed it as an investment. When I think of this, I get into a chicken-egg scenario. Demand increased because of increasing prices, which fueled increased prices. A key point is seeing homes as investments and not as more of a consumptive good.

  8. John Merryman

    I still think the primary factor is the supply side. Capitalism needs demand for capital to expand the supply of capital and greed overcame prudence for those regulating credit markets. After that, it really was a stampede on the demand side, as so many are willing to get in on whatever action is happening.
    As I mentioned in the weekend competition on admitting fault, the reason we have a central bank and let the bankers run the monetary system is because politicians will inevitably inflate the money supply, if they were in direct control. The problem is that bankers like to inflate the credit supply, so we have deflation when all the bad credit comes due. So the cause is on the supply side. The demand side is just details.

  9. Demand increased due to the lowering of the barriers to entry of real estate ownership.

    When you had to put 20% down, it was hard for a first time buyer to save $80k to buy a $400k house. Change that to nothing down, and lots of people could now buy that $400k house.

    I still think the relaxation of down payment requirements was a large part of the bubble which has not been examined by many people.

    Of course this was only one part of the “perfect storm” of events that caused the real estate bubble.

  10. One reason I don’t see discussed so much is that many people had an intense desire to ‘privatize their pension plans’ – i.e. both to decrease their reliance on government pension provision and to cut out finance industry middlemen charging fees and in various ways (legal and not) skimming their accounts (e.g. ‘churning’, but that list is long). Real estate was seen by many as the way they might do this.

    This desire was even more visible in the UK than in the US, but in my view it was a strong factor in both those two and many other countries. People felt that real estate was the one pension asset via which they could manage themselves to a real financial independence, and which they could continue managing themselves in retirement.

    ‘Enron’ probably did play a role in the emergence of this asset allocation preference, but I believe a more important driver was the general decline in trust in governments, in financial assets, and in the relationship between politicians and bankers which has been reflected for a number of years in opinion surveys about trust in various institutions and professions, and which has so recently turned out to be a central factor in the current debates over both the recession and health care.

    This is the factor I personally saw people getting most fired up about during the upside phase of the boom.

    We could argue about how rational it was to give so much weight to the desire to chase a perceived opportunity to secede from both state pension provision and state-regulated pension asset management. I think it was pretty rational, given a certain amount of naivete about whether real estate markets either did function free of government income reallocation schemes, or would be allowed to do so as trillions in assets were directed in that direction.

    One distinguishing attribute of this factor (declining trust in politicians and finance industry professionals) is that it’s always going to be right at the bottom of the list of boom-generating factors our politicians and finance industry professionals want to talk about publicly.

  11. What I remember very clearly from early 2000 and well into 2001, after everybody’s dot-com stocks had tanked hard, was that there were a lot of people who had (I swear by the gods) written their household budgets around the assumption that their investments would always return at least 10% per year. I remember dozens of otherwise smart people, just counting ones that I knew personally, who were living so far beyond their means that they were all running around asking each other where they were going to put what was left of their money where it would return high enough rate of return that they wouldn’t end up having to put their kids in private schools, wouldn’t end up having to buy clothes at WalMart, wouldn’t end up having to give up their vacation. In short, just like a lot of people now, they (a) had come to think of bubbles as normal, as how the economy is supposed to work, and (b) were begging, openly begging, for there to be another bubble, another pyramid scheme, that they could get in on.

    Anyone who knows enough history to remember how, in the 1970s and 1980s, the banks stumbled en masse from one bad investment to the next until thousands of them went bankrupt, should be seeing the parallels now, only thanks to “the investment society” private individuals are following the banks into the same bubbles and going bankrupt with them, so this time there won’t be a well-off middle class to save the banking industry when the “green bubble” bursts.

    There are such things as the “rational investors” that Chicago-school economists talk about. When investors who care about what an investment is actually worth dominate a market, you get a fairly rational market. When a market gets entirely taken over by speculators, none of whom is willing to accept a rate of return of less than double or triple the inflation rate but who insist on no risk, and who think that the way to get there is to price investments based on the Greater Fool Theory (“it doesn’t matter how much of a fool I am to pay this much for something if I can count on finding a greater fool to sell it to”), rational investors get swamped.

  12. Anytime someone mentions ‘demographic inversion’ (not a term I had heard before, but it is as good as any to describe the phenomenon), I must comment. I definitely see this housing crisis as a tipping point in said demographic inversion. Most people moved to the X-urbs from 1970-2005 for safe affordable housing for their school aged children. A significant percentage (my estimate is 25%, this is based upon my first hand experience purchasing foreclosure properties and hiring contractors), of households living in the x-urbs (the fringe communities roughly 25+ miles from the edges of metro areas), were reliant upon construction and real estate sales to the steady stream of people moving out to the x-urbs. The rapid evaporation of these construction related jobs has pulled the carpet out from under these communities and exposed the raw reality of 1. demographic shifts taking place (aging population that needs to live closer cities). 2. The factory and service jobs that were hoped to move to remote areas never happened. 3. People just don’t want to spend an hour a day commuting to work, and when you factor in the cost of $3+/gallon gasoline, it actually costs more today to live in the x-urbs given that inner city housing has now become much more affordable. Thus even though I see the broader housing market improving significantly this year, I do not expect the X-urbs to bounce back for many years.

  13. Suggesting that there was a thought process on the demand side is probably much too generous. The people I know who got screwed did seem to believe increasing house prices were some kind of new social contract, but they didn’t think about it in any meaningful sense. It was just a very powerful monkey-see, monkey-do situation the first time somebody’s semi-literate brother in law made $100,000 on flipping a house.

    Banks have to be regulated, period. Otherwise people will always borrow more money than is good for them if it is available on “easy” terms.

  14. Hard to say. We looked at buying in 2001-04, before and right after our son was born. We decided there was no way to buy in a neighborhood we could tolerate (i.e., good schools, low noise, low crime) without my wife working full-time to cover mortgage costs and the secondary mortgage cost of child care. (She wanted to stay home and teach dance part-time.) So, we decided we’d rather rent in a neighborhood we like than own in one we don’t. (At the height of the boom, people were sprinting out of open houses to have their agents or whomever fax offers into the homeowner!) I’m not saying our way is THE WAY, but Americans do need to consider what I call “TQL”–that is, total quality of life–when it comes to homedebtorship. Also, IMHO you factor in what you can afford for housing AFTER you put away for life/disability/health insurance, retirement, education, and reliable transportation. Housing is not a subsidy for these things.

  15. I have a very hard time believing the education or gentrification arguments, for the simple reason that this does not explain the CHANGE in real estate values. Plenty of places that had enormous property appreciation were already nice spots before the runup; nothing about them changed.

    Actually, that’s not true. One major thing did change: zoning. The California Coastal Commission, for example, was founded in 1972 and has essentially blocked the development of property along the coastline even as the population has increased from 20.5mm to 36.8mm. This artificial scarcity created a situation where segments of the population took it as received wisdom that property could only increase in value.
    http://tauntermedia.com/2009/04/22/texas-real-estate/

    If you look at areas without significant zoning constraints, you will find dramatically lower price appreciation (the exception being areas where population growth was so explosive that infrastructure capacity functioned as de facto zoning).

    I think the house equity as social contract argument is an effect, not a cause. Plenty of people who had no real increase in income looked at their houses and were told the house had several times the equity they had put in. It was the easiest place to fund increased consumption.

  16. My girlfriend of many years and I (both divorced over 10 years ago, both sold small, cheap houses a few years ago and have been renting since then) were looking in 2007. The offers and buying seemed increasingly frenzied and we right on the verge of making an offer on one house – very nice but priced well above what we had started looking for – when she got cold feet. We did not buy and are extremely happy today that we did not. However, it was not rationality on my part that made the decision; it was her emotions. It was the feeling that something was wrong, something was too pushing, too pressuring. There was too much of the feeling that you had to buy something now or lose out forever.
    But that is the essence of a mania. Today, I think, is just an echo or bounce of the big bubble.

  17. Well, here in San Diego, I had the feeling of wondering why we should stay in our little 1344 sq ft house when our friends were buying McMansions — until I saw their monthly payments and realized I would probably have to go back to full-time work to pay that kind of mortgage. I like consulting and my free time… and my nice low mortgage payments. And I don’t like cleaning 3000 or 4000 sq ft since I can barely manage 1344…

    I feel for the kids who bought more house than they can afford, but I just shake my head at them trying to hold onto them now that they are worth half of that. And now am glad we stayed put, which really in the end seems to have been the smarter choice.

  18. Without having any numbers on hand, it would seem the answer to this question is to compare forclosure rates to the size and degree at which people are underwater on their loans, keeping in mind also that many of the forclosures are people unable rather than unwilling to pay. There seem to be a lot more people deeply underwater than going into forclosure.

    I vaguely recall reading one analysis of this type that attempted to calculate the “price” people put on their good credit and staying in their home, came up with an estimate of $100k, which suggests people really do not like to default.

  19. Taunter, you really should take a look at Phoenix. The huge increases can’t be explained by zoning, infrastructure capacity, or anything else halfway rational. The price increases were actually larger as a percentage in a lot of areas were development was completely unconstrained. There were empty houses as far as the eye could see, but local people were bidding against busloads of California speculators. People had access to unlimited credit that they never thought they’d have to pay back, and they just bid up the houses as fast as they could.

  20. I second that Ben. I recall having the same repeated conversations around 05-06, with people considering buying homes. Most readily acknowledged that we were possibly in a bubble, but insisted that housing was still a good bet since housing prices always go up…

    There’s your demand. Add the cheap money supply component, and it’s a pretty clear and simple recipe for disaster.

  21. The entire story is complex and many sided. But if I was to invent a new explanation for the increase on the demand side, I’d say it was the incentive to gamble by people who were aging, had stagnant real income and little or no assets.

    Neville above seems to be saying the something similar.

    A majority of the Boomers are probably financial basket cases and have no real ability to retire. The housing bubble offered them salvation.

  22. Not the Mike You're Looking For

    Do we even know there was an increase in demand (for loans, that is)?

    The price of many subprime mortgages went from infinite (not available) to a specific interest rate, which is a decrease. So it seems like you can get to the current situation with only a supply-side shift. (Of course, a decrease in price does not eliminate the possibility of simultaneous shifts in supply and demand, but whatever.)

    Is there a way to get an apples-to-apples comparison of pre- and post-bubble prices, that is, mortgage interest rates with controls for credit rating and the risk-free rate?

  23. The current anti-government riposte lays much of the blame at Barney Frank (and he’s such an easy target, too). The line of attack is that Frank compelled lenders to extend financing to segments of the population (e.g. minorities) that had insufficient accumulated wealth to muster down payments. This expanded the set of individuals who thought they could afford homes, and (via Fannie and Freddie) ensured they could obtain financing.

    The argument is apparently popular enough to force Frank to defend himself:

    http://www.businessinsider.com/henry-blodget-barney-frank-i-didnt-cause-the-housing-bubble-2009-7

    While the argument against Frank seems to hold some water, Frank is correct that his counterparts across the aisle and in the administration share plenty of blame, particularly given that “increasing home ownership” among minorities was trumpeted as one of the major “free market” successes in the 2004 presidential election.

    For example:

    http://www.foxnews.com/story/0,2933,115279,00.html

    “”We want more people owning their own home in America,” Bush said. His goal is to have 5.5 million minority homeowners in the country by the end of the decade.”

    ————————–

    And now, on to another alternative hypothesis: Fear.

    Warren Buffett’s now classic statement that all investors are motivated by two emotions – Greed and Fear – receives a lot of play. In bubbles we get greedy, and in downturns we get fearful.

    But I believe there are three emotions in play:

    Fear, Greed, and Fear.

    And the reason I offer Fear up twice is that many people who bought houses in 2005/2006 had held off purchasing for a long time. A LONG time… as in, 5-10 years, and finally capitulated (either because they had reached a life stage where they had no choice – e.g. kids going to school, or they feared they would lose the opportunity to buy forever). This fear accelerated when the Fed moved to a tight monetary policy (after leaving the rate low for too long), leaving people with the thought “Prices keep going up, and now rates are going up… if I don’t buy now, I’ll never buy.”

    It seems likely that in certain markets (Arizona, Florida, Las Vegas, parts of California) prices were driven by speculators… And that’s Greed.

    But in other markets, where people actually had real incomes and needed to settle down, I suspect prices were driven by Fear.

  24. Real estate markets are often quite local. Even though we talk of a national “bubble,” the price increases were very different in different localities. It seems to me that the supply-side factors (supply/cost of capital) were more national in nature, while the demand-side factors were often more local. All of the demand-side factors cited in the article had roles somewhere. Where I live, some wealthy suburbs with excellent schools and restrictive zoning were strongly influenced by those two factors. In other “faster growth” locations, speculation played a big role.
    It seems to me that there also was an increase in what ordinary families considered the “acceptable” level of housing. I don’t know whether this was driven by the media, a “keeping up with the Joneses” attitude, or the big increase in wealth among the upper middle or just plain upper class, but houses which seemed perfectly acceptable in 1999 just were not good enough a few years later. In my town of older houses there was a huge surge in renovation/expansion of what seemed to be perfectly acceptable homes. When an administrative assistant in my office, a mid-50’s woman with a now empty nest, was home shopping in 2003 she told me that she loved a 2500 sq ft house she had seen, but it was “just too small.” I knew then that something was seriously out of whack.

  25. Fear and greed most definitely ruled the housing market, but Rorty’s hypothesis is that rationality also drove the market. I assume he means in the rational choice theory definition, that people weighed the pro and con reasons before making a choice, no matter how insane.

    That stretches “rationality” to the breaking point. Perhaps people chose the only avenue seemingly left to secure their future, and the future of their families. It was an avenue incentivized by policymakers, who might have been giving with one hand (Greenspan, et al.) and taking away with the other (stagnant wages, etc.)

  26. I don’t know how anyone could assign relative weights to all the various factors that fed the demand side of the housing market for the last half century–fear at being left behind beside an escalator forever going up, greed at getting a ‘free’ place to live (and funding your retirement, to boot) just for getting on the escalator, desires for security, stability, conformity–different decades, different answers.

    One thing I do know–nobody knows what the ‘value’ of housing is once you strip the post WWII assumptions out of the picture. Maybe value is a poor word choice. It might be better to say nobody knows where the pricing equilibrium will be, or how stable it will be if there is one.

    For years, I thought ‘affordable housing’ was a national policy objective. Now, it looks like we are going to get it, despite a concerted bipartisan effort to delay it.

  27. Likewise Inland Empire, Florida, Nevada, Dubai.

  28. Likewise Florida, Nevada, Inland Empire, CA, Dubai.

  29. Econ 101. If the supply of money increases, the price of money has to decrease given constant demand. It will look like demand increased, but even if the demand curve doesn’t change, you have more RE transactions because there is more money at a cheaper price. Add speculative mania, momentum and bubble mentality to that and you get, well, the last 9 years. I suspect the truth will be that supply increased, then demand followed, and supply flowed in, etc. Perhaps the basis for a paper on bubble mechanics?

  30. LarryKudlowIsGiddy

    Question: Where did the increase in demand for housing and subprime loans come from?

    Answer: Mexicans.

    This is not a frivilous answer either Mike. Our illegal immigration fiasco has ruined housing, education, health care and employment. But has had no effect on the overall economy, so don’t worry about it.

  31. But is that a change in demand or simply the supply increasing and the price decreasing (resulting in more demand)? I don’t dispute that the barriers came down, and perhpas this helped shift the demand curve a bit, but you could argue that was really only a drop in the cost of the funds, resulting again from a fundamental shift in the supply curve.

    My guess is the relaxation of the barriers would be a second-order result of too much money sloshing around in the mortgage market.

  32. The simplest explanation (and as such probably correct) is that bubbles are simply self reinforcing (and individually rational to participate in). Rising prices lead to the expectation for rising prices, just as in Friedman’s wage price spiral except for assets. The expectation for higher prices leads to a greater mass of entrants who lever up in order to enter. Sub-prime loans allow these investors to lever up more aggressively.

  33. There are more and more people in this country in the low income group. This (I would guess, but honestly haven’t seen the numbers in awhile) is probably obvious when you compare median incomes to average incomes. More and more low income people (who are generally people with little financial education/knowledge) have to make the biggest financial decision they will ever make in their lives: Should I take my income and use it to get EQUITY in my home, make huge payments and maybe overextend myself and end up with nothing??? Or pay for an apartment and have less commitment (risk of ruining my credit), but ZERO equity.

    Now take that common situation with individuals across America and combine it with these 4 huge systemic problems.

    1. The Gramm-Leach-Bliley Act of 1999. Which combined commercial banks with investment banks and therefor allowed big SPECULATORS to play with small depositors money.

    2. Being able to take little pieces of garbage and mash it together into a big piece of garbage and sell it with a triple A stamp. (I DO KNOW the financial terms for these. Garbage is garbage.)

    3. Low interest rates

    4. The SEC and other major regulators taking the Bush administration’s cue and fornicating wildly with the banks.

    Of course there are other things but those are the big ones. The problem with a country losing its morals and sense of what is right and wrong (feeling it’s ok to lie and cheat your neighbors as long as YOU end up on the winning side) is that as the country goes down the toilet it becomes more difficult to present the problems without putting 5,000 bullet points in your presentation.

  34. “25+ miles from the edges of metro areas . . . an hour a day commuting to work . . . $3 / gallon gasoline”

    X-urban dwellers working in big Australian cities (to say nothing of the UK) would KILL for that combination.

    My UK cousin’s husband spends 3 hours a day commuting (90 minutes each way), and his gasoline costs about $US7 / US Gallon.

  35. Mr. Mike Konczal, let me explain it all in just 4 brief paragraphs!

    If you have been able to convince Joe to take a 300.000 dollar mortgage at 11 percent for 30 years and if then, with a little help from the credit rating agencies, you can convince Fred that the risk structure of this mortgage is such that it merits an investment at a rate of only six percent, then you can sell Fred the mortgage for 510.000 dollar, and pocket a tidy profit of 210.000 dollar.

    We then have Joe, with a real liability of a mortgage of 300.000 dollar guaranteed with a house that might o might not be worth it, and Fred, with a 510.000 dollar investment in the willingness of Joe to service his original mortgage at 11 percent for 30 year.

    And so, when all is sliced and diced, 210.000 dollar of this 510.000 dollar toxic asset has little to do with easy money or a house bubble, and all to do with the wizardry of an immense structured-finance-endorsed-by-the-credit-rating-agencies bubble.

    According to Basel regulations if a bank lends to a non-rated borrower the bank needs to put up 8 percent in equity (a leverage of 12.5 to 1) but if the borrower has a AAA rating then 1.6 percent suffices (a leverage of 62.5 to 1). When the regulators decided that the capital requirements of the banks was to depend so much on the credit ratings the rewards for being able to dress up as AAA increased dramatically… and so they did.

    If you just can get down to understand that not one of those securities collateralized with lousily awarded mortgages to the subprime sector would have found one single investor were it not for the AAA ratings… you should be able to understand what happened.

  36. “there was a global savings glut”. I think a better way to look at it is that there was a dollar glut caused by too easy access to credit and the U.S. government’s deficit spending, which was necessary by the way.

    “Alyssa Katz’s Our Lot is the best book I’ve read recently about the way deregulation and political goals worked together to get Wall Street to pour money into dubious loans.” Actually deregulation was not the problem at all. The convention wisdom of most the economists, especially Alan Greenspan, who spread the truth of the “Efficient Market Hypothesis” actually amplified the bubble in the housing market. Asset markets become unstable when investors believe that prices will only go in one direction and thus bid them up or down. The financial system then abets the situation by extending more credit on the inflated asset price or restricting credit on deflated asset price creating a positive feedback loop that sends prices ever higher or lower.

    I would recommend reading “The Origin of Financial Crises” by George Cooper for a contrarian view of the “Efficient Market Fallacy”: The “Financial Instability Hypothesis” developed by Hyman Minsky better explains the data.

  37. Per, are you saying:

    (1) that a Shadow bank held $1 billion in reserve and acted as the “middle man” to lend $62.2 billion in AAA rated financial products?

    (2) if so, who provided the $62.2 billion to lend out? Can you give some examples of who these lenders might be?

    Thanks

  38. When in doubt, blame the Mexicans.

  39. Here is video from an important meeting between Conan the Barbarian and the Mortgage Bankers Association.

  40. You know you’re in a bubble when…


    295: They publish the dummies book: http://www.dummies.com/store/product/Flipping-Houses-For-Dummies.productCd-0470043458.html
    ..

  41. Manicotti Pavarotti

    Some people were induced to buy before housing prices became hopelessly unaffordable in their city, by the presence of other people who could no longer afford to buy in their city even with dual incomes and good jobs.

  42. No! You needed shadow banks when the capital requirements were high and you wanted to avoid these, but if your own regulator only required 1.6 percent in capital for AAA loans or securities, then you could easily carry them on your own books.

    Monet to do the operations were abundant and cheap as many have told you so where to get it was no problem but let me go back to the main point had these instruments not carried a AAA rating no one would have touched them with a ten feet pole… for a starter few even understood them

  43. Nicely told, but this mostly covers the “supply of credit” issue, not the Demand to use that credit to buy houses.

  44. Having said that, I should note that this blog has hardly covered the issue of cap/asset ratios and Basel. It’s touched upon the lousy performance of ratings agencies, but not on the quasi-official role of these agencies vis-a-vis the Basel Accords. Nor the role of (non-collateralized) CDS in improving risk ratios by neutralizing low risk assets in cap/asset calculations.

    Not long ago, we had a discussion in comments about whether ratings agencies should be held culpable, since their rating is only a “recommendation”. But due to Basel, which as a treaty has the force of US constitutional law, these “recommendations” have direct regulatory impact. I’ve been hoping SJ would cover this issue – if anyone has visibility on the IMF, Basel Accords, ratings agencies, and the BIS (bank of international settlements), it’s him.

  45. My you are a stubborn crowd indeed. You could have as much liquidity you wanted but no one, and I repeat no one, would have put one cent in any of those securities packed with badly awarded mortgages had it not been for the AAAs. But given the AAAs then everyone wanted a piece of that action because it paid some basis points more for the same non-existent risk.

    As for the supply have you seen a speculator or a wife say no to a house which someone with the incentive of making 15 to 20 grand were selling as a great investment?

  46. What do you mean? If there is anything I do it is precisely that, I invite you to have a look at

    http://www.theaaa-bomb.blogspot.com/

    http://www.subprimeregulations.blogspot.com/

    and then also 302 letters to the Financial Times on precisely that issue
    http://teawithft.blogspot.com/search/label/subprime%20banking%20regulations

    And yes I hold it against SJ and others in similar positions not having said a word about this the most gullible and naïve regulatory paradigm in mankind´s history.

  47. Thanks Per,

    Were commercial banks lending out $1 billion in demand deposits while holding $16 million in reserve?

  48. Yes, if they were lending out $1 billion in demand deposits to clients rated AAA they would only need 16 million in equity.

    Actually it really works the following way. $1 Billion in loans to AAA rated clients are risk weighted at 20 percent and then only supposedly represent$ 200 million in risk… and since Basel requires the banks to keep 8 percent in equity 8 percent of $200 million is $16 million.

    Then, also the financial reports will inform the world that the risk weighted assets of that bank are $200 million and since it has a capital of $16 million the leverage is only 12.5 to 1, while in reality it is 62.5 to 1.

    And I can show you full of reports, even from this year, signed by a lot of experts from important think tanks that do not have the faintest idea of this. It is almost embarrassing having to inform them… fact is think tanks are not what they used to be… they have been taken over by operators.

  49. As someone who made his livelihood in the real estate closing business for decades, and had the opportunity to discuss motivations with many consumers, I may have a different perspective. I think it’s extremely simple: The market place in the era of no-doc subprimes simply fed the American dream that had been carefully nurtured by our society (from top to bottom, and from one side to the other, unequivocally). Put that within the reach of far more people, and a bubble the size of a super nova is inevitable. My firm did work for several builders, and I can’t tell you how many times, even on full doc loans, that I saw people buying homes that I knew they could not afford. Prudence was the exception. Everyone wanted to maximize the upside equity. This is all just human nature at it’s greediest. Don’t get me wrong, this is just an observation, not a criticism of who Americans/humans are. It’s not so amazing that it went so far beyond the pale either, because the “big lie” was bought by everyone in the end. After all, if you tell a lie long enough, even you believe it if contrary evidence doesn’t show up to devalue/disprove it. The bubble had to happen, it was just plain inevitable by the time it burst. And now, life goes on, miserably for many, not so miserable for those that our government has so scrupulessly protected. I can’t help feeling that good governance would mean letting everyone share the pain, so that everyone can work to make it go away.

  50. in 1954 I had a geography teacher who had lived for 13 years in South America (we weren’t told the reasons for such biographies at the time, but now I think he probably was a jew having managed to get out in time – so if it was anti-Americanism it was different from the common one)

    So this teacher drilled it into our heads incessantly that the downfall of the US was imminent because it was just like Rome right before it crumbled – he never hinted that it could possibly survive for decades on its “self-destructive” path – I wonder what he thinks in paradise, where I hope he resides now, about the subject.

  51. what about the demand for the financial papers
    – I read somewhere that once this AAA mortgage stuff had been invented demand exploded so the mortgage providers had to come up with evermore adventurous ideas to enlarge their demand and thus keep feeding the AAA-creators.

    around 2000 the two of my colleagues into the stock market kept forever wondering what would happen to the huge and not so huge war chests corporate Germany had sitting ready not knowing what to do with it after the merger mania had subsided. Where did it all end up? Buying fake-AAA-stuff thereby forcing the poor banks to increase demand for mortgages by getting creative about the definition of exposure to risk?

  52. maybe they came from the “war chests” I have heard so much about …

  53. thank God I’m different
    (said a cartoon from Woody Allen showing a long row of people standing in a subway train each with the above bubble over his head)

  54. Bayard you say “The bubble had to happen, it was just plain inevitable by the time it burst”.

    You are right but never ever did the bubble have to get so big. What connected the American illusions with the pockets of the investors was a faulty AAA bridge. The particularity of that bridge was also that the further away the investor lived, like in Germany and Norway, the more he had to rely on the AAAs. Or was he supposed to go down to California to check up on the quality of the mortgages?

    If I was a European investor who had lost money there, I would be suing the regulator who had more than told me these credit rating agencies were absolutely trustworthy… they had even signed them up as their very own risk sentries

  55. This knowledge has been around for almost 3 years. Ever since Mason-Rosner pricked our bubble with their delightful presentation at the Hudson Institute (note carefully the venue).

    The general mechanism is “making money without risk.” Get some rocket scientists to develop “exotics” at Oxbridge/LSE. As Milken found out, there actually *is* a little risk, but not enough to prevent him , for example, from becoming a “respected philanthropist.”

    The people who broke the world should not be given the task of fixing it. You sound just outsider enough to be credible, Per. Call some friends and write a manifesto.

  56. Per, according to Wikipedia (last I looked), Basel II has been adopted and is being implemented, or has been implemented, by nearly every country in the world. But then there were some comments on this blog Basel II is being — revisited. — Any news on this front? Or is it the AAA-bomb madness unmitigated by recent events. (Although it is hard to imagine the Basel regulators would be so wrecklessly blind to recent events.)

    Thanks

  57. Uncle Billy Cunctator “You sound just outsider enough to be credible, Per. Call some friends and write a manifesto.”

    Thanks but I guess I am an outsider because I am sort of lousy at being an insider. Even with a strong cv and loads of experience under the belt, I have not even been able to get on a short list at the World Bank

    …. where I want to get in to remind the developers there about that risk-taking is the oxygen of development and not something that should be taxed as the wimps of Basel are doing placing higher capital requirements on operations perceived as risky than on those perceived as less risky

    … and this as even though the wimps should know that most do anyhow behave more carefully when confronted with something perceived as risky and with less care when dealing with something they do not believe to be risky … and so that in fact you could even make a case that anything with AAAs should have higher capital requirements… because there is a risk of more investors or lenders running simultaneously over the same cliff… exactly like what happened with the sub-primes. Face it, the real accumulated losses in what was originally rated as risky are minuscule when compared to the real accumulated losses in what was originally rated as no risk.

    And I also guess the managers at the World Bank might find it more comfortable to think more of their work in terms of helping along risk-free development. Or perhaps they just do not want to have someone that messes around with the Basel guys… who are so good friends with their neighbor the IMF and with whom they have been instructed to “harmonize with”… instead of fighting it out in the OK Corral, with risk-takers dueling continuously the more risk-adverse, as is done daily out there, in the real world.

  58. Per, according to Wikipedia (last I looked), Basel II has been adopted and is being implemented, or has been implemented, by nearly every country in the world. But then there were some comments on this blog Basel II is being revisited. Any news on this front? Or is it the AAA-bomb madness unmitigated by recent events.(Although it is hard to imagine the Basel regulators would be so wrecklessly blind to recent events.)

    Thanks

  59. I am not privy to any of the internal workings of Basel but yet I am absolutely sure they have painted themselves into a corner and are trapped by their own regulatory paradigms and find no way out.

    I guess that one would have to change them completely and from what I read I have a feeling that getting professional from other areas into these regulatory issues could be very useful. For instance I believe there is a lot of advanced know-how in the prevention of infectious diseases that could be extremely useful to understand what happens

    … having said that the principle of banking regulations should be real transparency so that any bank teller is perfectly capable of fully understanding how the bank he works in is regulated… without having to take a PhD during the nights.

  60. In Southern California, over the last twenty years two things relative to housing happened: there was a huge influx of millions of illegals and at the same time, local governments severely restricted the construction of new housing units. The end result was skyrocketing housing prices, and a totally dysfunctional housing market where supply no longer met demand. Living standards fall hard and illegal alien ghettos sprang up all over the place. In is very common for two or more family units to be living in the same unit now in LA.

    Not surprisingly, LA became the center of the subprime mortgage abuse and eventually bust. I believe there are now more foreclosures in the greater LA area than in any other state,- that’s right, state. Credit should clearly be awarded to our Socialist housing policies at their finest.

    Also as an answer to “when in doubt blame the mexicans”, California’s welfare caseload is now 32% of the total caseload in America; more than 2 1/2 times it’s percentage of population. That caseload can only be blamed on the Illegals, which comprise the vast majority by far of California’s poor. That is not to say all illegals are bad people, many are skilled upstanding people. However, many of the recent arrivals have only a grade school education at best, no interest in learning english and increasingly a very bad attitude. There is also burgeoning brown on black crime and murder, intentionally pushing blacks out of formerly all black ghettos.

  61. Illegal immigrants are not eligible for welfare. In fact, they are not eligible to receive welfare benefits ever. Even legal immigrants must wait for ten years before being eligible.

    Source: Congressional Research Service, Houston Chronicle.

  62. Rortybomb,

    There is the supply side to the housing bubble and there is the demand side. Then there are allegations of outright fraud by the mortgage dealers working both sides (suppliers fueling demand). So perhaps “social science” is also in order here to understand what the mortgage dealers were up to.

  63. You have one of the best macro/global perspectives. I think very few can pretend to know much at all about the behind the scenes politics at the international level.

    Do you see any value in the World Bank / IMF as they are now? Would we be better off without them, creating something to replace them that has more genuine, transparent goals? (I think I remember reading that Bush Jr. is running around at one of them these days. The mind boggles)

  64. Given that I am proposing that the global migrant workers that nowadays represent an economy the size of somewhere between India and China should have a chair at the Executive Board of the World Bank… among other so as to get some more World representation in there I might have some bias when it comes to discussing the subprime mortgage to the migrants in California.

    Nonetheless, let me say the following… follow the money! Who made money out of these mortgages? The debtors? Of course not, they paid for a couple of months to hold on to a dream or a fraud, only to lose out at the end. The investors? Try to tell that to any investor! No the profits were made by a crowd of intermediaries where some were guilty of outright fraud and others were just innocently following the examples of their times or the how to make it rich courses sold on TV.

    I think the best is to keep the issues of subprime mortgages and illegal immigration quite apart less we want to confuse ourselves.

  65. all you have to do is listen to Roger Lowenstein http://www.uctv.tv/search-details.aspx?showID=14382
    to realize the mess doesn’t need the help of immigrants – it is the result of hubris in affluent times

  66. Do you see any value in the World Bank / IMF as they are now?

    Iceland would have a Russian air base by now without them?

    institutions once they are there have a life of their own – maybe the League of Nation would have gone on to dysfunction into eternity with a World War making it vanish – noah Feldman claims that creating institutions any institution is extremely hard but once they are there they are there

  67. Per, regarding 20% risk weighted.

    It means for $1 trillion in borrowed money there was an AAA-rated guarantee that $800 billion (in other words, 800,000 million dollars) had nil chance of default! With — scores of such trillions — of dollars in debt hidden in the books of Zombie Banks.

    One can only wonder how history will look back at this madness.

  68. or what history will do to us all when and if it should blow up after all
    slowly I am getting to the point where I believe that the wreckless gamblers are the ones who are pillars who keep sustaining it and without them everything would crumble in a never before experienced worldwide madness ending up in a revival of the most basic tribal and feudal society

  69. You might ask yourself why the state of California doesn’t crack down. Could it be because of the enormous exploitation of the illegals’ labor that businesses in California have come to rely on?

  70. when my lawyer bosses at the time got all enthusiastic over what Reagan did I kept saying to myself “but we can’t copy that, we are not a huge state which can sustain pockets of the Third World in its midst”
    as I get told today they have, all said and done, a better life in the US than they could have at home – I sincerely hope that has at least some truth to it.

  71. Close but not exact. The AAA rating implied that all the $1 trillion in borrowed money had been invested all in $1 trillion AAA rated loans and that were all basically so risk free that the banks should hold only $16 billion in capital (8 percent on $200 billion) This means that the accuracy of the AAA ratings guaranteed the safeness of the other $984 billion… since no one ever asked the credit rating agencies to come up with some equity to back their opinions with… not even a token $1 dollar to show good faith!

    If you find this crazy I can sort of understand you!!! I just knew that sooner or later the rating agencies would mess it up that´s just human nature… but no, the ones in Basel were so sure this was not going to happen… so they went to sleep fully trusting the sentries they sent out to watch for risks… completely ignoring the fact that they had thereby set up the sentries to be the juiciest target of capture in the whole financial system… ever.

  72. Silke: They used to have a large American air base there. Not quite as troubling as a Russian air base. Or maybe so.

    Either way, this is interesting:

    http://www.barentsobserver.com/russia-invited-to-icelands-airbase.4525408-58932.html

    (Trivia: Grimmson is my cousin, but I’ve never met him)

    Especially interesting in light of the relationship that Iceland’s first billionaires are reputed to have had with Russian organized crime.

  73. Do you see any value in the World Bank / IMF as they are now?

    Do you see any value in the World Bank / IMF? YES, YES, YES!

    As they are now? yes, no, yes!

    As I see it these institutions should be part of a Global Constitution and that global constitution should have mechanisms that make it harder for individuals to take over these institutions.

    Some parts of these organizations are like private kingdoms and in these cases you are therefore in the hands of the king in turn… if he is good, good and if not bad luck. Also these institutions themselves slowly evolve into caring more about their own survival than about what they were created to do.

    There are many ways of bettering this but you need to have the will to tackle it against the strong will of those not interested at all in having it tackled.

    In the link below some of my ramblings on World Bank Governance while an Executive Director there for a brief passing moment, November 2002 – October 2004.

    http://perkurowski.blogspot.com/2005_01_01_archive.html

  74. never say anything bad about American Air Bases to me!!!

    Wiesbaden had Rhein-Main-Air-Base in Erbenheim and they were responsible for a lot of what is a teeanager’s and young adults delight – I lived there on and off from 1953 to 1984 – also Hanau had a great American base and a lot of other towns – all suffered quite a bit when the Americans left not just in money and in jobs also in atmosphere a certain lightness of being, only the car drivers remained as polite as the Americans had taught them to be (in that respect there’s a lot getting used to if you move to the ex-British-zone) – of course the Americans of my youth with the Dollar at DM 4,20 were the best because they could afford to be most visible off-base

    re Grimsson
    that must have taken place after those perfidious British had dared to clamp down on Iceland’s money in their country by the only legal means they had declaring it terrorist money – wonder if the British had to give up that money to get the Russian “option” of the table.

  75. 1. demographic shifts taking place (aging population that needs to live closer cities). 2. The factory and service jobs that were hoped to move to remote areas never happened. 3. People just don’t want to spend an hour a day commuting to work, and when you factor in the cost of $3+/gallon gasoline, it actually costs more today to live in the x-urbs given that inner city housing has now become much more affordable.

    1. That aging population tends to want to retire away from the city, strangely enough. It does need access to services, all of which are abundantly available in sub- and ex-urbs, in most cases more conveniently.

    2. A mixed bag, I would guess. Certainly service jobs have moved out (in my area, they have clustered around a ring highway making them convenient to the city and to the ex-urbs.

    3. We’ve now been through a couple of sever oil shocks and it is clearly evident that people living in ex- and sub-urbs can very dramatically cut their gas usage. They can swap cars (and around here, a lot have), they can carpool, they can batch errands. I would guess that with minimal effort, they can swing their gas usage to half where it generally is. That sucks, really, because it implies way too heavy usage today.

    Note that people living in the city will pick up the additional cost for all goods caused by an oil shock. Note that they *cannot* swing their usage at all. They are already very efficient, which is good, but add in an oil shock to, say, twice current prices and the people in the ex-urbs are not terribly effected. The people in the city are.

  76. You’ve way underestimated the education costs. You need to figure private education at closer to $20K a year/child. Now figure two kids, $40K a year, 12 years, $480K – but you need to be in a good enough school system. In states doing testing (take Massachusetts and MCAS), you should see a dramatic swing in the top districts.

    I live in one of those top MCAS districts and my experience, FWIW, was that our propoerty values immediately and dramatically shot up after we were scored by MCAS. Most people are underwater on their loans. Foreclosures and short sales are essentially non-existent.

  77. Here’s what I recall about the demand side in DC from 2001-2008.

    2001-2002: “Interest rates will never be lower than this!”

    2003-2004: “I’m buying now before I get priced out of the market forever”.

    2005-2006: “I can’t afford the mortgage payments, but I don’t intend to still be there when the payments adjust so I’ll make a tidy profit then when I sell and use that as a downpayment on the next place”.

    2007-2008: “Housing prices fell 3%! Buy now – it’s a bargain!”

  78. What you need to understand is that the housing bubble has nothing to do with building costs – it is the land element which is subject to speculation. You know, that stuff which Mark Twain recommended you buy ‘because they’re not making any more of it’. It’s the combination of uncontrolled credit, and the inelastic supply of land, eventually crowding out productive investment. Go and research the dysfunctional land market and the solution: annual land value taxation.

  79. I don’t buy the education argument. If education is bundled with the house, then there is no bubble – there is a real growth in value as the returns to education grow.

    Unless the argument is that that growth in value is what set off a Minsky-type dynamic that made the bubble. I’m not so sure about that.

  80. Anecdotal evidence suggest that a number of forces contributed to the housing bubble and the current rash of foreclosures in the DC area. First, as noted by Bayard, the classic American dream drove many to buy houses they could just barely afford, if at all. Steadily rising prices gave rise to fear that they would be priced out of the market if they didn’t act fast. The availability of mortgages–conventional and toxic–allowed folks to pursue their dreams of home ownership (together with better schools,services, shopping and other opportunities), often with the misleading encouragement of mortgage brokers who did not care whether the loan could be paid so long as the broker was. I’ve scanned the published foreclosure notices in the DC area over the past several months and I can tell you that a majority of foreclosures are against those with Latin and other surnames associated with relatively recent arrivals on our shores. They also involve homes of modest value which do not appear to have been over-priced at the time of purchase or to have declined substantially in value since the home was mortgaged. Now I have not done any polling or other research to determine whether these are owner-occupied homes but my hunch is that the vast majority of them are for the simple that the majority of them are in the suburban and ex-urban locations associated with modest home prices and there is virtually no repetition of names in the notices. That suggests that they are owned and occupied by those seeking to move out of neighborhood more closely associated with recent arrivals and move toward better schools, services and shopping.

    There is also anecdotal evidence of efforts to buy and flip houses to take advantage of expanding price bubble and a scattering of folks who bought million dollar plus abodes before the economy (and their fortunes in particular) tanked.

    But the vast majority of foreclosures in this area (as distinguuished from Phoenix, for example, where much of the run-up resulted from investors with liar and no-doc loans) appear to involve owner-occupied dwellings. This suggests that lenders abandoned due dilligence and traditional risk management (because they were passing on the risk, earning fees and cynically satisfying social critics who pushed for more low-income lending) to provide loans to many who were ill-equipped to fully understand the risks they were undertaking. Many of the foreclosures we now are seeing result not so much from the bubble bursting but from the consequences including the job losses that followed.

    As I said, these opinions are the result of anecdotal observations colored by pre-existing bias, not rigorous empirical research. But I believe they are more accurate than not and help explain a part of the inflation of the housing bubble here in the DC area and the social consequences of the collapse

  81. That’s right, the nationwide growth of the finance industry to 45% of coroporate profits and the explosion of credit/debt (at all levels, including government and international trade) to 350% of GDP had nothing to do with the financial/credit crisis and the current debt deflation recession. It’s all about those subprime Mexicans.

  82. From a small town perspective, here’s a stab at answering where the demand for subprime lending came from.

    I live in an atractive mountain town where housing costs are up, but not astronomical. The size of the rental market has been shrinking.

    What renters can or will pay in rent does not cover a landlord’s mortgage if the landlord is a more recent purchaser, unless you put down quite a bit more than 20%.

    So additional units to accommodate both population growth and new arrivals are sale units, not rental. I’m on the planning commission, and multi-family units are built to go condo immediately. We have enough external demand (amenity migration) to keep the construction industry busy. (That is, we did until last fall!)

    If you are part of the local workforce, there is little to rent. You HAVE to buy, or commute long distances and sacrifice quite a bit of family time.

    In the old days, you’d need to qualify for your mortgage with a 28/41% front/back end ratio. But not during the EZ finance years. If you can’t find a decent rental and you can get EZ finance, you go for it, especially if you expect your income to rise over time and you figure you’ll refinance alter if it matters.

    Thus the increase in demand for sub-prime loans. Shoot, they practically shoved one down my 23-year-old son’s throat.

  83. “Banks have to be regulated, period.” You can say, that’s already the case, they are regulated; or, That’s never going to happen in a meaningful way (Dear God, it would be Socialist!). Same thing. The part that’s still hard for me to accept is that they are not going to be meaningfully regulated, but your and my money will be spent to maintain their lifestyle when their unregulated partying threatens to destroy them.

  84. Leverage, leverage, leverage. As Professor Minsky pointed out (to an apparently deaf audience) in 1986, during any period of economic stability everyone begins taking more risks to increase their wealth, by any means possible. He goes into great detail, but even he did not imagine that trillions of dollars would be offered to people with with no assets and no income so they could join the “ownership society” and dream of sudden wealth. How much leverage are you accessing when you put no money of your own in? (Clue: it’s the same answer no matter how much the asset costs and whether you’re a Mexican or naked derivative trader).

  85. Is this disgusting enough? I was foolish enough to buy a shitload of Countrywide mortagage-backed securities (AAA of course) before the bust. Not that I was greedy (6% return for 30 years is not inherently exciting), just stupid – I thought I was diversifying my portfolio. I should have lost my shirt. Instead, BofA bailed me out by buying Countrywide and honoring its garbage MBS. Then the government bailed out BofA, so the garbage MBS could continue to pay rich schmucks like me. Everyone who pays taxes is now sending me a big Countrywide check four times a year. I’m investing the returns in tax-free municiple bonds. When are the American people going to get the picture that “supply-side” economics is legalized theft? My guess in never.

  86. I bought a house in 2002 for the first time. It was the first time in my life I felt I could put enough money down to avoid payig PMI. I still wanted as much maintenance provided as I could get, so I bought in a maintenance provided community and have carried the extra home warranty insurance. The reason to give up renting and deciding to buy (which did cause sleepless nights) of course there was the tax deduction on interest as an incentive. I also wanted to be able to make improvements to my living space. As a renter, improvements just didn’t happen. I wanted some neighborhood stability. As a renter, I knew very few neighbors, because they moved in and out pretty quickly. As a homeowner, for the most part I’ve found my neighbors to stay for years in their houses.

    Now, in my neighborhood there are a half a dozen or more houses for sale that aren’t moving. They used to turnover in weeks if not days. These are houses where the owner either died, moved to assisted living or something else beyond their control. It’s a desirable neighborhood. The houses aren’t selling, because the people who would buy can’t sell the house they have now and are stuck. My neighborhood is one where people want to move when they become empty nesters and want to downsize. The squeeze seems to be on people not being able to sell the larger houses.

  87. Michael, how do you suggest poor schmucks like me get a piece of this legalized theft action if we haven’t already stupidly invested in Countrywide?

  88. Incredulous. And more AAA bombs could be set to detonate with ARM mortgages up for reset. Correct?

  89. Follow the $$Money$$! The BIG money!

    The investment banks were at the center of this disaster, including the demand for housing. The investment banks created the MBS and CDO and learned how to use the CDS to hedge. The investment banks owned mortgage originators. The investment banks bribed the credit rating agencies. The investment bankers knew the bubble existed, but, hey, there was money to be made! It was a wild, wild gambling game, take no prisoners game. Some of the investment bankers went down. The investment banker who understood the game, with all of its treachery, just a bit better than the rest was left standing. Of the five, three are no more. One really did not participate. And one investment bank did very, very well. What created the demand for housing? The intention by the investment banking industry to transfer as much wealth as possible from the poorest segment of our society, that is what created the bubble, that is what created the irrational demand for housing. It wasn’t suppose to end this way though. The four investment banks, and their investors, hoped to just continue transferring wealth from the poorest part of society. Certainly its not this simple. There were flippers and those taking equity out of their homes. But without the intent of the investment banking industry it never would have happened.

    Follow the Money!

  90. Yes, but it would be part of the same explosion.

    Where the new AAA-Bombs will detonate, since they seem intent keep on using them, is anyone´s guess but clearly public debt to AAA countries supported by zero capital requirements, sure looks like a possible venue.

  91. Yes you follow the money… and you find a lot of brokers… and then you get to some investment banks. Hip Hip Hurrah! Found them!

    But then you realize that the investment banks would never have been able to pull this off without the credit rating agencies… but then you realize that the credit rating agencies would not have had so much to add had they not been so tremendously empowered by the regulators… and here the search by the radical extremes stops.

    Because the pro-market forces cannot find where to hide in their shame for not having detected this monstrosity of market intervention earlier, and the pro-regulation forces, besides being geared to attack the bank oligarchs, find it so difficult to begin their work correcting a regulatory monstrosity

    And so the issue is hushed up and the world will suffer more, because the middle that could do something rational about it is too boring for the media that for their ratings prefers the fighting between the two extremes. And of course we also have the money… Who owns the credit rating agencies? How are the regulatory AAA super-agents governed? What are they licensed to do?

  92. Per,
    thanks for supporting my gut feeling with words
    – if we do not buy it ourselves than surely the money/credit we still may have will feed the AAA-buying somewhere/somehow
    – as a kid I was warned from swimming in the Rhine River because there were whirlpools which might drag you irresistably down

  93. Risk of whirlpools!

    We might institutionalize it better creating Risk of Whirlpools Rating Agencies and that way, little by little, we might end up solving the growing unemployment problem in the world creating legions after legions of risk-sentries that help us towards a safer future… “Ma’am watch out for that banana peel… in your closet!”

  94. Rick- you obviously haven’t heard of Sanctuary cities. It is illegal for a city employee in LA, and other cities in California to inquire as to immigration status of a individual.

    I know a Ventura county school principal who has a health clinic at her school, to serve the needs of its students. The school is nearly all latino, and mostly illegal. Once a month, the school opens its health clinic to everyone in it’s community for free. We American citizens don’t get that kind of healthcare service.

  95. I thought being born on US-soil made you automatically a citizen – if that’s correct all the children at that school must have been born outside
    – I can see how adults enter a foreign country illegally but with their little ones in any amount of significant numbers?

    could you explain?

    by the way I would feel deeply sorry if the English language lost it’s predominance so I hope English manages to “swallow” the Spanish of the immigrants just as elegantly as it has a long time ago managed to integrate French and since then a lot of other foreign born stuff

  96. Declining interest rates increase house prices, which increases demand for said houses.

    Greenspan became concerned and started raising interest rates leading up to the bubble being burst.

    Doesn’t matter who, or what cohort, of even why. Declining interest rates increase house prices.

    Rising property prices also increase local government income, which results in too ambitious union contracts and other spending. California’s a good subprime example. Liar loan union contracts.

    Of course increasing health insurance bills (mentioned in the post) and rising oil prices amounting to a $500 billion annual tax increase didn’t help either.

    The only reason we are not now in another Depression is that there were massive amounts of stimulus pumped out, and there was a 70% decline in the price of oil.

  97. I can testify to the education part of housing demand. In 2006, I researched the local school districts which were good enough that I wouldn’t need to consider private schools. I did some rough calculations to consider what public schools that met my expectations were worth. I came up with at least $500K in home value. It just did a back of the envelope type calculation — 13 years X 2 kids X 20k per year. Without even considering that my mortgage interest would be discounted by the government, it was a no-brainer where to buy.

    When it came to actually buying a house, I found myself outbid on several houses with people following a specific plan. People whose kids were already in school would max out an interest-only or even negative amortization loan with the plan of selling as soon as the kids graduated. This pushed prices up at least $200k on houses zoned for the best high school. We toured several houses in the spring where we saw high school senior year paraphernalia. I also saw things that indicated the sellers’ occupation — many didn’t have professions that would typically allow one to actually afford the houses we were looking at. It didn’t take a PhD to notice people were increasing their leverage to secure better education for their kids.

  98. Having taken the time to study (and approve the exams) for a license as a real estate salesman and as a mortgage officer in the US (Maryland) (among other so that I with knowledge of banking and regulation could be more certain of of what I was arguing) I can certainly attest to that this school consideration was one of the prime drivers of location-location-location value though it bears no mayor relevance as to why the crisis developed.

  99. Yakkis,

    First Principle: The function of government in a capitalist society is to guarantee the security of the capitalists. Therefore, you have to be a capitalist. That means you have to have capital, which you can 1)inherit 2)earn and save 3)borrow. If you didn’t inherit your capital, and you’re not patient and self-controlled enough to earn and save it, you are in the vast majority of Americans. I’m not, and never having any debt of any kind has meant it took me longer during boom times to accumulate, but I kept going upward during busts, unlike the borrowers. I guess I’m a freak.

    That said, here’s All The Other Principles:

    1) Never borrow for consumption – that’s for suckers and idiots. It’s like the lottery: a tax on stupidity.
    2) When you borrow to invest, make sure there’s a government guarantee somewhere to bail you out in case your investment doesn’t work out. If you can get such a guarantee (e.g., SBA loan) then leverage to the max, and if you can’t don’t leverage at all.
    3) Diversify. Don’t run with the herd after the latest hot investment, and don’t try to “beat the market” (or anyone else). Think for yourself, do your own research, or don’t invest.
    4) Once you have a safe, diversity-based strategy, don’t suddenly get wild because you feel you’re “missing out” on some bubble or market cycles have reduced your real return (as long as it is overall positive). Kindleberger pointed out that people get a certain lifestyle goal into their head and then feel pressured to take unsafe risks when safe investments just won’t produce the return they feel they “must have” to meet their goal. The goal is accumulation over time, not instant wealth.
    5) Clean out your brain from the fantasy of capital gains and invest in steady income producing assets. Dividends are not a steady form of income, and the stock market is somewhere between a casino and a racetrack. Re-invest all returns until you have hit “critical mass” and can live happily ever after on the income.
    6) To get in on the theft racket, only invest in sectors and companies with a strong government connection (the most obvious include military, health care, finance, etc.)

  100. There are many sides to what really caused the collapse. But clearly at the Wall Street investment houses, once the rating agencies started slapping AAA on toxic crap subprime deriviatives, while at the same time Fan and Fred were talking guarantees on similar crap, an incendiary situation developed which quickly spread like a forest fire out of control.

    The allure of big return with no perceived risk is key to understanding much of Wall Street’s behavior, which is not to say that behavior should be condoned or forgiven. Wiser heads should have known better.

  101. Of course it spread like fire! In January 2003, before I was blacklisted, who knows why, the Financial Times published a letter I sent to them which ended with “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

  102. LarryKudlowIsGiddy

    ……… if you don’t believe me ask Lou Dobbs.

    “When in doubt”…. excuse me, the doubt is yours not mine.

  103. Per,
    why is it so important that the Financial Times didn’t want your letters ?
    – I mean what is so special about the Financial Times that you didn’t just go to another one ?
    to me the FT is just another one

  104. OK, now you’ve convinced me. Lou Dobbs. Can’t be wrong.

  105. Oh there is no other particular reason for having picked FT except that I read it and find it to be a good paper… and that it gives me somewhat of another perspective.

    And they did publish 15 letters of my letters over quite a brief time (all of which are still valid today) so they must have felt I had something to say… why they then cut me off I do not know they said I wrote too much which seems silly for a newspaper.

    That said I am approaching or I might have passed 1000 letters in my TeaWithFT blog and I hope that one day I can look back at these letters and make some sense or some less sense about these period of time when frankly the world has been behaving quite nutty… to use a British understatement.

  106. Per,
    provide them with letters under different pseudonyms so they can keep up their diversity …
    – German media seem always terribly afraid of being one-sided and being caught at adhering to some basic rules of decency
    the British seem to be wild at constant self-accusal for their imperial sins
    – the result quite often is excessive even scatter-brained open-mindedness as still the fashion of the day – hopefully the burst of that bubble doesn’t come in the shape of a revival of excessively strict rules

  107. Silke
    I have never written something under a pseudonym (not even in Venezuela) because I am frightened to death having to start thinking which me wrote what?
    And frankly, the problem of FT not publishing me might be more theirs than mine. There are my letters for anyone to see.

  108. isn’t it remarkable that in society in general the battle cry is for diversity while for corporations it still seems to be “focus on your core business”
    (exception the BASF-boss very recently said he would rather cut his ties to the providers of outsourced stuff than fire his own people – a phrase which would last year have earned him hoots of derisive laughter)

  109. “If sending 3 kids to a private high school at your old houses costs $5,000/year, and if the new house’s public high school is free and equally good then taking a $60,000 bath on the house is break-even. Completely rational.”

    I don’t think there are too many actual families that fit this paradigm. If someone is using private school for 3 kids, it’s unlikely they’d conclude the public one is equally good. This also assumes property taxes are equal in both locations which is unlikely if the new school is sufficiently better than the old one to induce the change. And I don’t know how many private high schools charge just $5000 per pupil.

  110. And I don’t know how many private high schools charge just $5000 per pupil.

    The ones that are equivalent to public schools?