Bubble Riders Got Richer

Poverty and Policy Problems for the Rest of US

My friend Alex Kotlowitz is nearly done with a magazine piece outlining the many ways the city of Cleveland has been devastated by the collapse of the housing market. Cleveland’s problems are on the devastating side of bad; a rust-belt city built around good union manufacturing jobs, suffering from hundreds of millions of dollars worth of lost wealth, eroding tax base and unmet needs.

The other day, Alex and I vigorously debated the proposition that sub-prime housing problems caused the collapse of the larger housing market. Though it wasn't really Alex's position, I have a hard time with even the suggestion that sub-prime mortgage holders somehow caused anything. But we were engaged in a discussion that could have continued indefinitely.

After all, Cleveland homeowner households had a much higher percentage of sub-prime mortgages than did most urban markets. At ground level in Cleveland the flood of mortgage defaults, abandoned housing, personal bankruptcies and business closings must look like a cataract unleashed when the tailings damn of sub-prime mortgages washed out. Alex ended the discussion, graciously suggesting that it might be fair to say that the housing bubble burst and the sub-prime mortgage market collapsed in some places almost simultaneously.

I pushed hard against the notion that defaults on sub-prime mortgages were a first cause of our current financial problems for a couple of reasons. One, I really do believe I’m correct here. And two, it freaks me out that some conservatives (and large numbers of ordinary folks traumatized by their own growing financial problems) think that the nasty habits of sub-prime mortgage holders are to blame for everything.

If such a perspective were to prevail, it could lead to all sorts of scary policy outcomes. Like bailout programs kinder to bankers than homeowners. Like scapegoating low-income folks because they wanted to be homeowners, too, and because they were innocent grist for the commercial and investment banking mills grinding out securitized mortgages at great profit. Like policies that abandon rather than bail out and invest in hard-hit urban communities.

Anticipating the possibility of bad policy outcomes is time well spent, but not if it molds an argument about facts, however elusive those facts might be. That night I hit the books, scanning Dean Baker’s new book, Plunder and Blunder, The Rise and Fall of the Bubble Economy, and coming to the conclusion that I had better clarify a few things, particularly as I have no wish to be regarded as a dogmatic idiot.

A decent understanding of Baker’s work (you can see lots of it at www.cepr.net/) might be to say that the collapse of the housing bubble and the subsequent loss of more than $1 trillion in wealth were caused by the inevitable collision of the forces that fueled the bubble in the first place with the forces that would pop it. Those forces included:

• Sustained and artificially low interest rates, primarily the work of the Fed under Greenspan;
• An artificially high dollar, primarily the result of export economies like China investing their cash in US Treasury Bonds in order to maintain American purchasing power and appetite for imported goods;
• Deregulation and bad regulation that allowed major financial actors driven by greed to develop, sell, swap, trade and insure a myriad of dubious services and securities;
• And job loss, especially high-paying manufacturing jobs, in the United States, caused by competition from cheaper imported goods and resulting in significant losses in household income concentrated in urban economies most dependent on manufacturing.

Though these essentially contradictory economic forces could co-exist for a period of time, they could not do so indefinitely. As the deflating of the bubble proceeded, the effects showed first in housing markets with a high percentage of sub-prime mortgages and adjustable rate mortgages (sub-prime or otherwise).

In not a few instances, households with sub-prime mortgages and ARMs had actually been steered into them in spite of the fact that they were qualified for cheaper and more stable conventional mortgages. Some qualified homebuyers simply received mortgages with disastrous terms lurking in escalating interest rates and onerous payoff conditions.

In other instances, borrowers sought and obtained ARMs that deferred principle and, even, interest payments, and created only temporarily affordable monthly mortgage payments. In the rush to securitize and sell mortgages, and collect the fees associated with midwifeing the securitized mortgage packages, lenders barely scrutinized borrowers.

In some cases, refinancing deadlines arrived for households with ARMs at the same time that job losses began increasing and home values in their communities began stagnating. With little or no equity in their homes, these households found new low-interest mortgages increasingly unavailable.

An honest reading of Plunder and Blunder wouldn’t likely lead anyone to the notion that a single first cause for our economic depression is identifiable. But Baker’s last chapter, “Learning from the Bubbles,” is full of quotable indictments of some of the villains, and they aren’t sub-prime mortgage holders.

“The financial industry’s conduct in the housing bubble was even worse,” Baker writes (pg. 141). “housing prices had sharply diverged from a 100-year trend…vacancy rates were at record highs…inflation-adjusted rents were not rising through most of the period of the housing bubble…some owners of rental units [converted] them to ownership units…Decreasing demand and increased supply lowers the price; what part of that reality did the highly compensated analysts fail to understand?”

Elsewhere, Baker neatly excoriates former Fed Board Chair Alan Greenspan. He also takes a swipe at the media, which he amply substantiates elsewhere.

“The leading villain in this story is Alan Greenspan. Greenspan mastered the art of currying the favor of the rich and powerful and held top economic positions under five presidents of both political parties. He also managed to gain a near cult-like following among the media. As a result, most of the public is largely unaware of how disastrous the Fed’s policies under his tenure were for the economy and the country (pg. 140).”

The cascade of terrible economic news that has characterized most of the last two years was almost inevitable. Except, of course, for the mega- and quasi-collapses of so many banking, insurance and brokerage giants that promoted the bubble in the first place.

The much ignored original sin here is the amount of wealth that was privatized in the form of dividends, salaries and bonuses during the bonanza years, leaving the now shaky financial giants without the resources to cover their losses. Almost to a man, or woman, the nouveau rich and richer of the last 15 years will get to keep what they took.

The rest of us will be left with the responsibility for developing, advocating and supporting fair, just and restorative polices, based on a clear understanding of what happened, and focused on communities where people live and work and engage the future.