The Housing Boom and BustThomas Sowell on how government policies made the
housing crisis possible
Thomas Sowell <http://www.tsowell.com/>, prolific public intellectual and
the Rose and Milton Friedman Senior Fellow at the Hoover Institution, is one
of America's greatest economic thinkers and educators. He's taught the
fundamentals through such books as *Economic Facts and
Fallacies<http://www.amazon.com/exec/obidos/ASIN/0465003494/ReasonMagazineA>
* and *Basic Economics<http://www.amazon.com/exec/obidos/ASIN/0465002609/ReasonMagazineA>
*and chronicled economic history through such scholarly works as *Marxism:
Philosophy and Economics<http://www.amazon.com/exec/obidos/ASIN/0688064264/ReasonMagazineA>
* and *On Classical
Economics<http://www.amazon.com/exec/obidos/ASIN/0300126069/ReasonMagazineA>.
*In his classic work *Knowledge and
Decisions*<http://www.amazon.com/Knowledge-Decisions-Thomas-Sowell/dp/0465037380/reasonmagazineA/>,
he espoused a sophisticated, largely Hayekian approach, revealing how the
efficient spread of relevant knowledge is shaped by our social institutions,
and often warped and misshapen by government.
Now, in *The Housing Boom and
Bust<http://www.amazon.com/Housing-Boom-Bust-Thomas-Sowell/dp/0465018807/reasonmagazineA/>
*(Basic Books), Sowell contemplates the greatest expansion of government
power in a generation, which was itself occasioned by the greatest economic
crisis in as long. A quick but thorough guide to the causes of the crises,
Sowell's book shows how government policies led to a huge increase in highly
risky housing loans. As he notes, the immense local variability in housing
prices and failed loans reveals that the government mistook a set of local
problems for a national one, and then imposed a single troublesome national
solution. Sowell argues that while foolish decisions to indulge in
complicated investment vehicles affected the specifics of how the financial
contagion spread, at its root the housing problem is one of bad mortgages.
And those came from bad decisions by government and by borrowers themselves.
Senior Editor Brian Doherty interviewed Sowell earlier this week about the
book, the crisis, and the government’s unfortunate response.
*reason: *Is the economic downturn caused by the housing boom and bust the
worst economic circumstance of your lifetime?
*Thomas Sowell: *Since I was born in 1930 the economic crisis with the most
impact of my lifetime was the Great Depression. As to whether this will
match that, it’s too early to tell. Right now it certainly is nothing
comparable to the Great Depression, but the *Great Depression *began as
nothing comparable to the Great Depression. For the first 12 months after
the stock market crash [of 1929], unemployment never reached double digits
but the solution turned out to create more disasters than the problem they
were trying to solve.
Whether that will happen again depends on how far and how long the current
administration will push policies to solve the present crisis and what their
repercussions will be. As mentioned in the book, parallel to the 1929 crash
was the stock market crash of 1987. That had the potential to create another
Great Depression had Reagan followed similar policies as Hoover and FDR did.
He didn’t, so we just about forgot about the stock market crash of ’87.
*reason: *Do you see or anticipate Obama’s reactions being sufficient to
turn this downturn into another lengthy depression?
*Sowell: *I hope not, but what we’ve seen in these past few months is an
exercise in unprecedented powers. I mean, to fire the chairman of General
Motors, to tell credit card companies how they should run their business,
tell GM what kind of cars it should be making, and there’s no sign of an end
in sight yet. Obama’s policies are a work in progress. So a lot depends on
how far he will push, but I see no signs of him turning back. I see no
substantial resistance in Congress. But you never know, as things start to
unfold voices of sanity may prevail.
*reason: *What is the most dangerous sign you’ve seen so far in terms of
policy reaction to the housing bust?
*Sowell: *The presumption that Obama knows how all these industries ought to
be operating better than people who have spent lives in those industries,
and a general cockiness going back till before he was president, and the
fact that he has no experience whatever in managing anything. Only someone
who has never had the responsibility for managing anything could believe he
could manage just about everything.
*reason: *You parcel out some share of responsibility for the specific way
the housing bust broke down to borrowers, lenders, financial markets, and
the government. What was the borrowers' share?
*Sowell: *There are those who borrowed to buy a place to live and
speculators who borrowed to speculate, and did enormously well for a number
of years. Then there were people who simply don’t understand complex
mortgages, particularly people who never owned a home before and whose
educations were limited. But the people I would blame the most in the sense
that without their interference other problems would have been within
manageable means are the politicians—people in Congress and the president
and regulators—who pushed the lenders and the banks and Fannie Mae and
Freddie Mac into lending and buying mortgages based on people who didn’t
meet standards that evolved in the marketplace and which had worked. Those
politicians, in addition to that initial mistake, ignored all sorts of
warnings from all sorts of sources. As I list in the book, the
*Economist*in London,
*Fortune,* *Barron’s*, people at the American Enterprise Institute, all over
the map, saw that this policy of encouraging homeownership at all costs was
leading to trouble.
But the politicians clearly had as their political goal homeownership as “a
good thing” and persisted—and for that matter persist to this moment in
pushing it. The Federal Housing Administration last I checked was promoting
supporting mortgages that have less than 4 percent down payment. We all make
mistakes, but politicians have persisted in their mistakes, and in the
pointing of fingers in other directions.
“Affordable housing” covers a number of things. There was this sense in
Washington that the cost of buying a house had become a nationwide major
problem which would require a federal answer as opposed to a local answer.
All the data say that was not true. People weren’t paying a higher percent
of their income nationwide for housing than they had a decade earlier. In
fact, it was a somewhat lower percentage in some areas. Now in some areas,
including California—coastal California—people were paying half their family
income to put a roof over their head. That in turn was a result of local
political people putting all sorts of restrictions on building.
Implicit in the idea of “affordable housing” is the notion that third
parties know what people can afford better than those people know
themselves. If you spell it out it sounds so absurd you wonder how anyone
could have believed it. But for politicians the question is not, is it
absurd? The question is whether or not the public will buy it.
*reason: *How much weight do you place on the notion that Federal Reserve
expansionary money and credit policies primed the bubble, and bust, in
housing?
*Sowell: *I find it hard to accept. I’m sure if the interest rates had been
at 8 percent the boom would not have gone as far and the bust would not have
been as big. I’m not saying monetary policy had no effect. But I am struck
by the fact that Federal Reserve policy is nationwide, and in places like
Dallas the increase in housing prices was in single digits and the decrease
has been in single digits. So while Fed policy undoubtedly aggravated
circumstances, it can’t be the fundamental cause because the defaults were
so heavily concentrated. 60 percent of all defaults nationwide were in five
states, and I suspect if you broke down the data even more you’d find
specific regions in those five states very heavily implicated in defaults.
*reason*: What do crisis like this, and public reaction, say about general
public understanding of economics?
*Sowell: *I think in the U.S. and in most of the world the public
understanding of economics is abysmal. But it’s one thing not to understand
something. I don’t understand brain surgery. It’s another to want to form
policies on things on which you are ignorant. I hear the wonderful phrase “I
want to make a difference” when it comes to policy. I would be horrified if
I wanted to make a difference in brain surgery. The only difference is more
people would die on the operating table.
The only encouraging thing about public reaction to the crisis is that going
by polls citizens seem to have more misgivings about some of these policies
than politicians or the media. Still, though there have been studies that
indicate the New Deal prolonged the Great Depression by years, what is also
clear is it was enormously popular. FDR was elected four straight times, and
more than once without ever having brought unemployment down to single
digits. An economic disaster does not necessarily mean a political disaster.
If we could raise the average level of understanding of economics to what
Alfred Marshall had in 1890, the vast majority of politicians would be voted
out of office.
*reason: *Do you think the policies we’ve seen Obama pursue so far threaten
another Great Depression-level downturn?
*Sowell: *I would hope not, but I certainly do think very serious
consequences are likely to follow from all this, and they aren’t really
discussed much. The ease with which we are now throwing the word
“trillion”—I remember when billion was a shock word. To talk about trillions
as though they are nickels and dimes, it’s a classic example of doing
something that sounds good at the moment whose repercussions are beyond the
horizon. When bad effects of his policies come, will people connect the
dots? Or will Obama be able to get away with it like FDR did, blaming it all
on his predecessor?
*reason: *What sort of reactions should the federal government have to the
current situation?
*Sowell: *First, the government should not try to artificially keep up
housing prices. The tremendous irony is that the very politicians who for
years talked of affordable housing are fighting to keep housing prices from
falling. How does housing become more affordable except by keeping prices
down? They really have no interest in having housing become affordable by
means other than their largesse.
*reason: *Do you think they need to be doing anything to ease the woes of
people in foreclosure?
*Sowell: *Not at all. Foreclosure is not something that happens to you like
being struck by lightning. Foreclosure is the end result of things people
have done that they need to stop doing in the future. And the market can
take care of that. California is one of those states where we’ve seen a
drastic reduction in fancy no-money-down mortgages and all kinds of creative
financing; we’ve seen those things drop sharply within just a couple of
years as housing prices fell and foreclosures rose, as long as the
government isn’t there to prop them up.
But though the market's reaction in California shows that borrowers and
lenders can learn with market discipline, one group has not learned:
politicians. Or rather they *have* learned a lesson, that they can get away
scot free simply pointing fingers at others and making pious statements. I
have no doubt Barney Frank will get reelected. But if people had any idea of
the damage he’s done [by promoting the “affordable housing at all costs”
policies] he’d be out of there. This stuff has happened before, though not
on this scale. Republicans in the 1920s were pushing homeownership which led
to increased foreclosures, and in the 1930s the Democrats did and that led
to increased foreclosures. This is all a cycle, though we’re in the worst of
the cycles. But politicians don’t stop doing this because they never pay any
price.
And I think we see politicians today repeating one of the features of New
Deal policies in that the policies seem not geared toward getting us out of
our current problem as quickly as possible, but to use the problem to create
enduring institutional changes to the very nature of the American economy.
*Discuss this article
online.<http://www.reason.com/blog/show/133594.html#comments>
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I recently finished reading Atlas Shrugged - great book, but depressing in the similarities between our current political/economic state and the situation described in the book. Nevertheless, I can't help fantasizing about escaping to Galt's Gulch (in case you haven't read the book, it's the libertarian, capitalist society created by the characters.) Upon further reflection, I realized that the US was once the Galt's Gulch of the world.
Which leads ne to ask the following question to the group: Assuming that Galt's Gulch could be successfully created, how would you insure that the principals on which it was founded continued? Is it inevitable that government power would grow with the population, and that as the society prospered, citizens would demand more benefits/protections and services at the expense of others?
If you can't - for any reasons - contain the government, doesn't that mean that either a revolution or tyranny are inevitable?
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