walkitout (walkitout) wrote,

A Simple Explanation of the Housing Boom

A friend really liked my Discounting entry because he saw in it a simple explanation of why we aren't on the gold standard. Which is funny, because I _was_ talking about the gold standard, but mostly by way of pointing out some things about banking history in the US that I thought was a relevant metric for understanding the decision making being displayed by the troika. He wanted to know if I could explain the housing boom. I will try.

Once upon a time, in order to borrow money, you had to show that you satisfied a lot of criteria: good _C_haracter, _C_ollateral, _C_apacity to repay, maybe some other stuff, too. If you wanted to buy a house, they wanted you to have some "skin in the game", that is, they wanted you to put up a significant fraction of the value of the house, they wanted you to demonstrate income (to prove capacity to repay) that was enough to pay the bill and live a decent life, and they wanted to know you were the kind of person who paid your bills (you've been paying them for a while, type of thing).

Then, in a fit of efficiency, we decided since "credit scores" were almost as good at predicting who would repay as the 3, 4 or 5 or whatever Cs, then we only needed to look at the credit score, maybe _ask_ you what your income was (but you didn't have to prove it). And as long as the house was worth enough, we wouldn't even make you put up a down payment. Etc.

This was okay. It was a lot more fragile than the previous system, but it also let a lot of people borrow who _would_ repay, but had trouble convincing borrowers of that under the previous regime. It worked well, it was a lot cheaper.

Ordinarily, when a lot of money is being loaned out, it becomes harder to get: either interest rates rise, reducing the desire for it and/or other restrictions are placed on credit. Interest rates rise when the Federal Reserve says they rise. Other restrictions are placed on credit when regulators insist on that happening. Neither one of those things happened as we were coming out of the recession of the early 2000s, and we went from a time period of easy money designed to help us recover from the recession to an inflationary boom. But it didn't _feel_ inflationary, because the inflation occurred in "assets": that is, house prices went up, but other things not so much, and people weren't concerned, _because they could just keep borrowing more money_.

So, you have to ask yourself: who were the suckers loaning the money? I get that the regulators (at the Fed, which should have raised interest rates, and at the various banking regulators, where they should have insisted on raising lending standards and stopped the ratcheting up of housing appraisals) didn't stop it, but shouldn't the suckers have wised up? Rather than the money coming from Savings & Loan deposits (you put your money into a savings account and the bank loans it out to your new neighbor to build a house on the vacant lot, type of thing), the money was coming from investors who were searching for a marginally higher return (rate of interest) in an extremely low interest rate environment (see how that very low interest rate policy has all kinds of nasty effects in the wrong environment?). The investors bought packages of pieces of mortgages that insurers and/or ratings agencies promised would NOT go bad not ever never could not happen. The investors believed the guarantor, in other words (sort of like people who put their money in banks that are known to be in trouble, but offering a higher rate of interest on CDs, because they figure they'll get bailed out no trouble).

The investors actually did start wising up. They really did. But the brokers who created the packages made so much fucking money in commissions on these things that they worked long hours and swore to all kinds of false things to convince people to buy variations on the scheme, scam, etc. -- and then they had to find people who were willing to build houses/take out mortgages on (commit to making the payments, in other words) for the other side of the deal. They beat the bushes to find new suckers to invest and new suckers (or fraudulent straw buyers) to sign up for mortgages.

Want to know who to blame? Think of this as Agatha Christie's _Orient Express_: there's a whole cast of bad guys. People who knowingly paid too much for a house believing they could make money selling it quickly. People who signed up for mortgages they couldn't afford, believing they could somehow make it work with another mortgage (a home equity loan, etc.). People who bought securities that packaged up all that future heartache. The brokers who figured out how to make the machine spew out ever bigger chunks of money for them to buy drinks for hot chicks in NYC bars. Greenspan for being old and stupid and fundamentally cowardly. Bush for being a cynical blowhard who didn't care what happened to the Republican party after he finished his second term. A whole bunch of regulators appointed by Bush who sat around and looked at porn on the internet, rather than go after criminal behavior at the banks (but don't blame the career people under those guys, because the staff was cut to the bone and then discouraged from taking the obviously correct actions).

The houses got built as a _side effect_.

Think about that for a while. What else could we do as a _side effect_ if we could only get the right kind of delusional thinking going at a high level? Or for that matter, as an _intended_ effect, if only we were really prepared to do Big Things like, well, insert favorite infrastructure project here.
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