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Peter Wallison's Housing Bubble

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Monday, 06 January 2014 05:44

Peter Wallison, who was White House Counsel under President Reagan and has long been a fellow at the American Enterprise Institute, told NYT readers today that the housing bubble is back. Wallison is right to be concerned about the return of a bubble, as I have pointed out elsewhere, but his account of the last bubble and the risks of a new one are strangely off the mark.

Wallison wants to blame the bubble on government policy of promoting homeownership. There certainly has been a problem of a housing policy that is far too tilted toward homeownership, but this does not explain the bubble. Fannie Mae and Freddie Mac were bad actors in the bubble years, buying up trillions of dollars of loans issued on houses purchased at bubble inflated prices, as I said at the time.

However the worst loans were securitized by folks like Citigroup, Merrill Lynch, and Goldman Sachs. They weren't securitizing junk mortgages to meet government goals for low-income homeownership, they were doing it to make money. And they made lots of money in these years. In fact, the private securitizers were so successful in securitizing junk mortgages that they almost put the Federal Housing Authority (FHA) out of business. Since the FHA maintained its lending standards it couldn't compete with the zero down payment loans being securitized on Wall Street. It saw its market share fall to 2 percent at the peak of the bubble. Some of us warned about the problem posed by the bubble in low-income communities at the time.

Anyhow, Wallison's chronology of the last bubble is more than a bit off. He tells readers;

"In 1997, housing prices began to diverge substantially from rental costs. Between 1997 and 2002, the average compound rate of growth in housing prices was 6 percent, exceeding the average compound growth rate in rentals of 3.34 percent. This, incidentally, contradicts the widely held idea that the last housing bubble was caused by the Federal Reserve’s monetary policy. Between 1997 and 2000, the Fed raised interest rates, and they stayed relatively high until almost 2002 with no apparent effect on the bubble, which continued to maintain an average compound growth rate of 6 percent until 2007, when it collapsed."

I also date the bubble as beginning in the mid-1990s, but there was a qualitative difference in the price rises of the late 1990s and the 2000s. If prices had stopped rising in 2000, house sale prices would have been somewhat higher relative to rents, but there would have been no serious risk of a recession and financial collapse if they fell back to their historic levels. However house price growth accelerated in the 2000s, with prices rising at a 10 percent annual rate from the 4th quarter of 2000 to their peak in the 2nd quarter of 2006 (not 2007). [Doesn't the NYT do any fact checking? The interest rate story is wrong also, with the federal funds rate having been lowered to 3.0 percent by September of 2001.] And this more rapid price growth is from an already inflated level.

Levels are important also in assessing Wallison's claim that we have a new bubble because:

"Today, after the financial crisis, the recession and the slow recovery, the bubble is beginning to grow again. Between 2011 and the third quarter of 2013, housing prices grew by 5.83 percent, again exceeding the increase in rental costs, which was 2 percent."

This rate of growth is from a more normal level of house prices. As I have frequently noted, house prices were growing very rapidly in the first half of 2013 posing a real risk of a return to a bubble. However Bernanke's taper talk in June and the resulting rise in mortgage rates appears to have curbed the irrational exuberance, although it will be important to watch future price appreciation closely. In any case, it appears that the main culprits today are private equity funds and hedge funds who have been buying up large blocks of homes as investment properties, not low income buyers.

 

Addendum:

Through the Twitterverse I received a link to this Wallison piece from 2002 in which he critcized the GSEs for not doing enough to provide mortgage credit to moderate income households. Here's the key part:

"Any claim that they are discharging a public trust is an illusion. To the degree that they do anything less than maximizing profits it is to maintain their valuable franchise by reducing their political risk, not because they are voluntarily fulfilling some public trust. It can't be otherwise; they are legally bound to a duty only to the corporation and its shareholders.

"This is very clearly seen in Fannie and Freddie's activities in affordable and minority housing. Study after study has shown that they are doing less for those who are underserved in the housing market than banks and thrifts. Not only do they buy fewer mortgages than are originated in minority communities, the ones they buy tend to be seasoned and thus less risky. Despite Fannie's claims about trillion dollar commitments, they are meeting their affordable and minority housing obligations by slipping through loopholes in the loosely written and enforced HUD regulations in this area.

"In other words, two companies that are immensely profitable and claim to have a government mission, are doing as little as they can get away with for those who most need assistance--while swamping the airwaves with advertising that they are putting people in homes. This should be no surprise, since their incentives push them in this direction. As shareholder-owned companies, they are maximizing their profits--as they must--while doing just enough to avoid the criticism that might result in the loss of the government support that enables them to earn these profits."

 

 

Comments (14)Add Comment
...
written by Kat, January 06, 2014 7:58
The purpose of Wallison's op ed was not to warn of a bubble. The purpose was to keep the lie going.
Hurray! Let's Hear It for Those Rising Free Market Asset Prices! Oh Wait. The Government Caused It.
written by Last Mover, January 06, 2014 8:05

A key indicator of the (first) housing bubble emphasized by Dean Baker early on was the divergence between rental versus purchase price of housing.

Housing asset prices were rising even as rental prices held steady to trend. It didn't make sense to most because it wasn't suppose to happen. It was an accepted axiom of economics that if asset value increased on behalf of the owner, then present rental value should track that value, but it didn't because the glut of housing acted to keep rental price down as asset price kept rising.

This measure of evidence, more than any other, clearly proved the existence of an asset bubble, regardless of how it originated or was encouraged through the private or public sector.

Yet it was willfully ignored on all sides because there was nothing but economic and political downside to stopping it in the form of enormous lost gains, especially to the heavily leveraged shadow financial sector behind it.

When Dean Baker says Alan Greenspan was the one individual most responsible for the bubble, he means Greenspan enabled it through silence while no private market force was powerful enough stop it on its own through the usual negative feedback that "prices can't rise forever".

Specifically, it was the failed private market sector that crowded out the government in pushing the bubble to a bursting point, not the other way around as right wing ideologues rant to this day via government pushing home ownership and such ... the same ones who could never explain how asset versus rental prices diverged from trend so sharply, cheering it on instead as a "natural" result of "free markets".
...
written by Matt, January 06, 2014 8:46
Wallison wants to blame the bubble on government policy of promoting homeownership


Ah yes, the Southern Strategy for the 21st century. Lee Atwater would be so proud.
The ad
written by Squeezed Turnip, January 06, 2014 8:50
It's like those ads for pain killers, where the narrator wears a white lab coat in order to impart an aura of medical competence. Wallison is not an economic historian, but plays one in the infotainment sector. How can you tell something is the government's fault according to the AEI? When it's still breathing.
Why woul anyone pay attention to Wallison?
written by EMichael, January 06, 2014 9:15
During the bubble he blamed the GSEs for not doing enough for low income people, then he turned around and blamed the bubble on the GSEs lending to low income people.

On the other hand, I believe the run up in real estate prices had more to do with foreclosure resales than mortgage rates. If you take a look at Shiller, most of the gains were in the main bubble areas which also were the areas that contained most of the foreclosures. And the slowdown in prices is related to running out of foreclosed properties.

...
written by JDM, January 06, 2014 10:01
I think you're only partly right, Kat. I suspect he really is concerned - inaccurately - that there's a bubble. He's concerned now and not when there really was one because then the damage was largely to low and middle income people. Now it's rich hedge fund investors.
mortgage interest deduction, the middle class tax cut
written by djb, January 06, 2014 10:42

"In any case, it appears that the main culprits today are private equity funds and hedge funds who have been buying up large blocks of homes as investment properties, not low income buyers. "

and these investors GET TO DEDUCT THE INTEREST

but the billionaires in order for them not be taxed more like eliminating the 15% tax rate for carried interest,

they instead call the mortgage interest deduction a "loophole" and have an all out campaign to get rid of this middle class tax cut

so that home owners wont even get the same break that these investors get,

the ones who are buying foreclosed houses for far below market value, driving up the cost of housing for middle class


One Day
written by EMichael, January 06, 2014 11:39
people will stop calling the mortgage interest deduction a middle class tax cut.

But Not Today.

http://voices.washingtonpost.com/ezra-klein/2010/11/who_does_the_mortgage-interest.html
The housing bubble was driven by major banks changing the banking multiplier using AIG
written by Brian, January 06, 2014 1:09
The paper, Release of the Kraken, explains precisely how the banking multiplier was modified by the purchase of CDS contracts to insure loans, and how that allowed the major banks to then move the insured loan back into their capital account, where it could be used again to make a loan. Being able to do so changed the classical banking multiplier asymptotic limit from 1/r to a complex equation that for most practical purposes has no limit.

Given that such loan insurance was only available within the housing sector, it was inevitable that the temptation to make use of this mechanism would pump up the housing sector.

Furthermore, the major banks realized that not only could a loan be made, then insured, and the money loaned out again. (And then that second loan insured and loaned out again, etc.) But each loan made could be bundled up in a security, and sold off, thereby retrieving the capital once more.

If you think it through, you realize that this algorithm allows a bank to create money through loan activity limited only by borrower activity within the sector, and then realize the created money as real capital on its books.

The capstone on that strategy was when some bright boys realized that the most profitable loan sale was a loan that went bad. Because then, not only would the bank realize all the money created through loan activity, but each time a loan went bad (after being sold) the bank would be paid off. (And, if the bank for some reason couldn't sell off the bad loan, they would be covered.)

The paper is titled, "Release of the Kraken: A Novel Money Multiplier Equation’s Debut in 21st Century Banking" Hanley, 2012
http://www.economics-ejournal.org/economics/journalarticles/2012-3

There are a few more ramifications, but I think that should be enough to spark interest.
Re Fannie & Freddie, Wallison has forgotten everything he knew
written by Richard Genz, January 06, 2014 2:08
As EMichael notes above, Wallison's analysis of what drove Fannie and Freddie into subprime certainly has "evolved." He used to believe they entered subprime purely for business reasons, not because of regulatory pressure as stated here.

In his 2000 book with Bert Ely, Nationalizing Mortgage Risk, he analyzed Fannie CEO Franklin Raines' business plan to double earnings per share by 2003, beginning in 1999. That plan had nothing to do with government regulations or "affordable homeownership" per se. It was all about profit, growth, and market share. Wallison wrote then:

"We [Wallison and Ely] project that by 2003 they [Fannie and Freddie] will have assumed the risk of virtually all these [prime, conforming] mortgages—91.5 percent. It is no wonder, then, that Fannie and Freddie are advertising their efforts to acquire loans in the subprime categories. They are making a virtue of necessity, since their growth requirements leave them no choice...."

"As they grow beyond their traditional market segment, Fannie and Freddie will have to purchase increasing amounts of lower-quality loans and hold more of those loans in portfolio, increasing their risks. If they fully hedge those risks, their extraordinary profitability will decline."

In this article and others he's written since the 2007-08 crash, he criticizes government "mandates" re: homeownership as the root cause of Fannie and Freddie's failure. His earlier work shows his recent critique to be a transparent attempt to blame and discredit government, regardless of the facts.

In reality the homeownership campaign failed precisely because the Feds outsourced the job to profit-seeking entities like Fannie, Freddie, and the rest of the mortage industry.

Fannie and Freddie did not HAVE to keep growing. It was business logic, not government pressure, that made growth an imperative. In the reckless world of mortgage lending circa 2000, growing market share meant assuming risks that were too dangerous--and dangerous to homebuyers above all. For Fannie, Freddie, and the entire private mortgage industry, "extraordinary profitability" came first. If the government's "partners" had been genuine, policy goals might have been realized, not sabotaged.
...
written by ReturnFreeRisk, January 06, 2014 4:11
Well, I would not be so quick to dismiss low interest rates. They formed the basis for ARMs and other high risk mortgages. Greenspan was telling people to take out ARMs and Bernanke was telling the world that house prices have never gone down post WWII so it was unlikely they ever will.
And how do you reconcile the Fed taking credit for stock price gains in this cycle? Asset prices are asset prices. If loose money makes stock prices go up, they also make house prices go up. And the Fed is too happy to take credit in this cycle but does not want any part of the last cycle. Revisionist history, brought to you by your friendly neighborhood Fed.
...
written by fuller schmidt, January 06, 2014 4:58
Sometimes you just have to do the reading and Fox News just won't do.
...
written by Benedict@Large, January 07, 2014 1:18
Peter Wallison is blaming the government for the crash. Oops, must mean another 6 months has gone by. No doubt the ancients would have created a calendar using Wallison's rants by now.
Why do economists ignore the role of counterfeit fraud? What disaster is being avoided by the concealment?
written by Perplexed, January 08, 2014 3:10
-"However the worst loans were securitized by folks like Citigroup, Merrill Lynch, and Goldman Sachs. They weren't securitizing junk mortgages to meet government goals for low-income homeownership, they were doing it to make money. And they made lots of money in these years. In fact, the private securitizers were so successful in securitizing junk mortgages that they almost put the Federal Housing Authority (FHA) out of business. Since the FHA maintained its lending standards it couldn't compete with the zero down payment loans being securitized on Wall Street. It saw its market share fall to 2 percent at the peak of the bubble."

By describing the crisis using terms with no precise "scientific" definition i.e. "bubble" economists make themselves knowing participants in covering up the role of fraud and lack of enforcement of existing laws against it that have existed the entire time. While all kinds of complicated explanations are offered (i.e. derivatives, CDS's, CDO's, CMO's, etc.,etc.,etc.) to obscure the fact that the underlying crime that drove the "bubble" to "expand" to a size that threatened the entire world economy is called "counterfeit fraud." It has existed for centuries and appeared in almost all industries that produce anything that can be "counterfeited." Mortgages that do not meet underwriting standards are simply a counterfeit of mortgages that do. Selling them as fully underwritten mortgages is just another form of counterfeit fraud. The rest of the story is obfuscation of counterfeit fraud. It should be a relatively simple exercise to determine the extent of funding that the counterfeit mortgages brought into the system, its impact on the size of the "bubble," and the limits on the size of the "bubble" that would have existed absent the funds drawn in by fraud. With all that has been written about the crisis, why do economists refuse to address this rather obvious question? Not all "bubbles," (whatever they really are), are created equal. Are you (and Wallison for that matter)claiming that the current "bubble" is somehow equivalent in risk to a "bubble" driven by counterfeit mortgages? Is the risk to the financial system equivalent? We need to know the extent of addition investment that was generated through counterfeit fraud to answer these questions. Why would we think we can fully describe this crisis without producing estimates of these numbers? Surely there must be mathematicians that can help out if economists lack the math skills. As you point out: "And they made lots of money in these years. In fact, the private securitizers were so successful in securitizing junk mortgages that they almost put the Federal Housing Authority (FHA) out of business." None of these ill-gotten gains were "clawed back" due to the lack of enforcement of our criminal laws. This "insured" that all of the losses were imposed on the victims of the crimes rather than perpetrators. Economists played a huge role in that by obfuscating the role and impact of criminal fraud. Yet they still wish to be thought of "scientists"? Are they even learning that this is a distinction that needs to be "earned"? That doesn't appear to be the case based on much of what has been written to date.

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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