Food Fight: the Role of the GSEs in the Financial Crisis

Hat tip to Arnold Kling for pointing out the return of Scott Sumner to the blogosphere in the form of his contribution to the ongoing food fight over the role of the GSEs (the public-private hybrids FNMA AKA “Fannie Mae” and the Federal Home Loan Mortgage Corporation AKA “Freddie Mac”) in creating the financial crisis. Why food fight? See this post from Tyler Cowen for a flavor of the argument, esp. see the appearance of prominent financial blogger Barry Ritholtz in the comments of Tyler’s post, chiding Tyler for having gone over to the Dark Side.

There’s lots of good insight in Dr. Sumner’s post and I commend it to your attention. See especially the first two graphs in the post, the first of housing starts per million population and the second of bank losses, real GDP, and CPI cost of living. Of the second Dr. Sumner writes:

I see three separate crises. A “misallocation of resources into housing crisis,” a “federal bailout of banks crisis,” and a high unemployment crisis. Who’s to blame for each?

followed by his interpretations.

I don’t have a great deal to add to this but I’ll supply a few minor observations. First, the market for housing has multiple different components and the components behave differently. Among these components are “buy and hold” (people who buy houses and live in them more than five years), hybrid owner/speculators (people who buy houses, live in them for a shorter period, and then move on), and speculators (those who buy houses to resell them for a profit). The long period, illustrated in the first chart, of housing start increases without a serious decline, undoubtedly encouraged a lot of people to go into the second two classifications. Some, maybe many, of those have been wrung out by the decline in housing prices and the increased difficulty in securing credit.

I think the most likely way to interpret that graph is that interest rates stayed too low for too long, a signal failure of policy on the part of the Fed.

I don’t really have a dog in the GSE fight. I think there are plenty of reasons to dislike the GSEs, corruption being the greatest. However, between the two warring camps (GSEs caused the financial crisis/no they didn’t) those who take the former position have yet to make the case that the GSEs were both necessary and sufficient for the financial crisis. IMO there’s a better case that Chinese trade policy coupled with Chinese monetary policy were both the necessary and sufficient for the crisis, given human nature.

At any rate I think that the problems with our economy go back much, much farther than the last ten years and the financial crisis, like an injury to the body, has revealed weaknesses that were there all along.

6 comments… add one
  • john personna Link

    The important thing to note is that Cowen made a much milder claim than the “caused” crowd usually does:

    It is wrong to suggest that the agencies caused the crisis in the sense that I will cause myself to eat breakfast cereal this morning. One can debate which weaker notion of cause might be appropriate, but I will just say that the mortgage agencies made the crisis much, much worse.

    I can actually walk away from Cowen’s weak connectivity … and only respond to any poor-reader that bends it back to him supporting “caused” in any meaningful sense.

    Essentially Cowen noted that the US has had a subsidized mortgage market for a long time. Film at 11.

  • john personna Link

    Or to put it more strongly, we had that subsidized mortgage system for decades, without an explosion.

    It took securitiazation, and an an abandonment of lending standards, to make both the steep upside of the bubble, and then the resulting pop.

    The GSEs, in all their decades, never did offer zero-down, interest-only, home loans to people without jobs.

  • I would align myself more with Cowen’s position than with either the “the GSEs caused it!” or “the GSEs were just standing there, minding their own business when…” camps.

  • john personna Link

    Well, to really understand it you need to understand the timeline, the various charters given the GSEs, and their own rouge actions, over the years.

    But if we are talking about “the crisis” as the crash in mortgage backed securities, it’s hard to make a case for them “leading” in any way. They followed, a bit, but most importantly were brought in as a “sin eater” after the fact.

    Sure, they ended up with a lot of bad paper on their books, but to understand why you have to know when they bought it, and to let whom off the hook.

  • john personna Link

    (Most of the “GSE/CRA cause it” folk either don’t have an idea of that history, or have been turning a steady blind eye to it.)

  • john personna Link

    (And arguably, the steady appreciation of home prices prior to the advent of mortgage backed securities was not a “problem” in any real sense. It a the pos-hoc argument that it would have gotten to a “pop” anyway, without the NINJA loans. But let’s remember that is conjecture, and just a motivated counterfactual.)

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