Magnetar Did Not Give Us the Great Recession

Friday, 23 April 2010 12:03

ProPublica has a good piece on the dealings of Magnetar, one of the hedge funds that shorted the housing market, while at the same time taking a long position that it used to finance its short position. While the piece involves solid investigative reporting, it is more than a little oversold. The piece begins:

"In late 2005, the booming U.S. housing market seemed to be slowing. The Federal Reserve had begun raising interest rates. Subprime mortgage company shares were falling. Investors began to balk at buying complex mortgage securities. The housing bubble, which had propelled a historic growth in home prices, seemed poised to deflate. And if it had, the great financial crisis of 2008, which produced the Great Recession of 2008-09, might have come sooner and been less severe."

According to the article, Magnetar raised a total of $40 billion. This is equal to roughly 0.2 percent of the $20 trillion value of the housing market at the time. Did Magnetar's long investments help to prop up the market? Probably a bit, but it's hard to see it going too far. Furthermore, by last 2005 the bubble was already pretty close to its peak (that came in the summer of 2006), so it's unlikely that they could have pushed prices much higher than they would have otherwise gone, although it may have slowed the process of the air leaving the bubble. (Actually, a full assessment of its impact would have to factor in its short positions, which would have gone the other way.)

As a purely practical matter, business reporters like to focus on the financial crisis and blame it for the severity of the current downturn, but this really makes little sense. The financial crisis clearly sped things along, but is there any reason to believe that house prices would be higher today in the absence of the crisis. (I'm betting they will fall another 15-20 percent in real terms.) If house prices would be at current levels, is there any reason to believe that consumers would be spending more absent the crisis, that businesses would be investing more, that builders would be putting up more homes or malls? I see zero evidence on any of these fronts, hence I don't attribute the severity of the downturn to the financial crisis. But, I'm open to persuasion.