It Was the Housing Bubble: Not the Damn CDOs

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Saturday, 17 April 2010 07:10

The folks who got it wrong when the housing bubble was growing seem determined to prove to the world that they are incapable of learning anything. The latest tales of Goldman designing CDOs are fascinating in that they reveal the incredible level of corruption at Goldman and on Wall Street more generally, but it was not the CDOs that gave us 10 percent unemployment.

Unemployment soared because demand collapsed. And the reason that demand collapsed is because housing bubble wealth disappeared. And housing bubble wealth disappeared -- well, because it was a bubble that was not supported by the fundamentals.

For the 87,865th time, the collapse of the bubble led to a falloff in annual construction (residential and non-residential) spending of more than $600 billion. The loss of $6 trillion in housing wealth led, through the housing wealth effect (this isn't radical -- it is as old an economics doctrine as you'll find) to a loss of close to $400 billion in consumption demand. That gives a combined loss in demand of more than $1 trillion and hence a really bad recession.

This story has nothing directly to do with CDOs. Insofar as CDOs and other games helped to drive the bubble beyond the levels it would have otherwise attained then they made the crash worse than it otherwise would have been, but the CDOs were not directly the problem. It was the bubble.

The folks who played games on Wall Street should be put safely behind bars for long periods of time, but it is important to know that the real story of this crisis was not the complex shenanigans of the Goldman gang. The real story was a huge bubble that was easy to see and guaranteed to burst. The fact that those involved in making and reporting on economic policy somehow did not see the bubble was a failure of immense proportions that should cost many many people their jobs.

 

--Dean Baker