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.

Blaming the sub-prime mortgagees for the sins of bankers

I keep trying to explain the current financial crisis to myself for two reasons. One, I believe there must be simpler explanations than the ones that seem to prevail in media reports and on op-ed pages. And two, I'm discovering that far too many people believe that one of the major causes of our current problems lays with homeowners who took mortgages that they couldn't afford.

There is of course, still a class of pundits who believe that too much regulation is a significant cause of the collapse of the financial markets, the freezing of credit, and the abysmal performance of American auto companies. We are going to have to agree to leave such people out of the conversation--they are market fundamentalists whose cultish practices are no doubt constitutionally protected however much they might frighten children and the simple-minded.

But to apply, at least minimally, the notion that it is markets that decide (rationally or otherwise) who gets what, when, where and why, it seems both wrong-headed and unkind to blame individual homeowners who have fallen behind or defaulted on their mortgages for our current financial difficulties. These homeowners must live with the decisions of markets. They are not the deciders, as our soon to be ex-president might say.

After all, a good many people who received sub-prime mortgages actually qualified for conventional mortgages at more favorable rates. They were channelled into the sub-prime market, which created huge difficulties for them when affordable adjustable rate mortgages suddenly climbed to much higher rates after the housing bubble popped. It is shoeing the wrong horse to ask such people to predict the end of the bubble when bankers themselves believed (or pretended to believe) that we were all going to profit from an endlessly inflating housing market.

Mortgage applicants are consumers, not financial experts. They rely, mistakenly as it happens, on the expertise of others.

It is arguable, of course, that it is the buyer who ought to beware. But historically, it is banks and mortgage companies who have decided who is eligible for their services and who is not. If we are to take reasonable steps toward resurrecting the housing market, it makes far more sense to examine the practices of bankers, mortgage brokers and the buyers and sellers of bundled mortgages than it does to swing away at people who are losing their homes.