Paul Krugman has an interesting OpEd in today’s NYT, one that I mostly agree with.

However, I take exception to his perspective on a few issues, one of which might ultimately prove to be crucial to understanding the crisis and putting the correct financial reform measures in place. Professor Krugman writes:

“A lot of the public debate has been about protecting borrowers. Indeed, a new Consumer Financial Protection Agency to help stop deceptive lending practices is a very good idea. And better consumer protection might have limited the overall size of the housing bubble.

But consumer protection, while it might have blocked many subprime loans, wouldn’t have prevented the sharply rising rate of delinquency on conventional, plain-vanilla mortgages. And it certainly wouldn’t have prevented the monstrous boom and bust in commercial real estate.

Reform, in other words, probably can’t prevent either bad loans or bubbles. But it can do a great deal to ensure that bubbles don’t collapse the financial system when they burst.” (emphasis added)

I disagree with many of my colleagues as to where the bubble actually was. I believe we did not have a national Housing bubble; rather, what we had was a national Credit bubble. (Understanding the difference becomes important, as you shall see shortly). And while much of the country had a housing boom, only a few areas — notably, SoCal, Las Vegas, Arizona and S. Florida — were full blown housing bubbles.

But that is a relatively minor quibble. The real disagreement is over the impact of sub-prime loans on the entire US Housing market, and whether lending standards can be adequately enforced. Had then Fed Chairman Alan Greenspan done his job properly, and prevented Zero Lending Standard loans from infecting the real estate market, we would have been looking at a very different housing situation — to the upside as well as to the down side.

Let’s look at the impact Sub-Prime had, then see what could have been done about it.

First, we need to consider that markets typically are in balance — there are a roughly equal number of buyers and sellers. Prices rise or fall as changes take place at the margins; If we were to add more supply (i.e., more sellers of houses) to what was a previously balanced market, prices fall; Add more demand (i.e., buyers), and prices rise.

What happens when you drop mortgage rates significantly? Monthly carrying costs become lower, and this attracts more marginal buyers (demand) — at least until prices rise to the point where the balance between buyers and sellers stabilizes prices once more.

Without the explosion of subprime, but with ultra low rates, we very likely would have seen a rise in housing prices, followed by a plateau. But it would not have been nearly as severe relative to historic price relationships (as an example, median income to median home price).

What the newfangled lend-to-securitize subprime model did, however, was to bring millions of previous non-buyers — people otherwise known as renters — into the housing market. On top of the rise in prices caused by 1% Fed Funds rates (~6% mortgages), this added an additional level of pricing destabilization to the Real Estate market.

This is evident in the charts I’ve shown again and again: Median income to median home price; cost of renting to ownership; Housing stock as a percentage of GDP — all of these showed a housing market several standard deviations above its historic pricing mean.

With that in your mind, consider how this sub-prime driven boom played into the securitization market, and eventually the Derivatives market (CDOs, CDSs, etc). Look at the 10 steps detailed here on Monday regarding the forming of the credit crisis.

The inevitable conclusion is that sub-prime was a major driver of not only the Housing boom and bust, but of the entire financial crisis and credit freeze, and the subsequent bailouts . . .

Could it have been prevented? Only if the Fed would have enforced traditional lending standards, i.e., the borrowers ability to service the mortgage. They should have regulated those non-bank lenders whose model was based not upon the borrowers ability to service these loans, but upon the lender’s ability to subseqeuntly sell the loan off top securitizers on Wall Street.

So, the answer is yes, appropriate regulation could have prevented the entire mess . . .


Bernanke Still Does Not Understand Credit Crisis).

Bubbles and the Banks
NYT, January 7, 2010

Category: Bailouts, Credit, Derivatives

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

57 Responses to “Bubbles & Banks & Zero Lending Standard Loans”

  1. An honest assessment of the crisis’ causation (and timeline) would look something like the following:

    1. Ultra low interest rates led to a scramble for yield by fund managers;

    2. Not coincidentally, there was a massive push into subprime lending by unregulated NONBANKS who existed solely to sell these mortgages to securitizers;

    3. Since they were writing mortgages for resale (and held them only briefly) these non-bank lenders collapsed their lending standards; this allowed them to write many more mortgages;

    4. These poorly underwritten loans — essentially junk paper — was sold to Wall Street for securitization in huge numbers.

    5. Massive ratings fraud of these securities by Fitch, Moody’s and S&P led to a rating of this junk as TripleAAA.

    6. That investment grade rating of junk paper allowed those scrambling bond managers (see #1) to purchase higher yield paper that they would not otherwise have been able to.

    7. Increased leverage of investment houses allowed a huge securitization manufacturing process; Some iBanks also purchased this paper in enormous numbers;

    8. More leverage took place in the shadow derivatives market. That allowed firms like AIG to write $3 trillion in derivative exposure, much of it in mortgage and credit related areas.

    9. Compensation packages in the financial sector were asymmetrical, where employees had huge upside but shareholders (and eventually taxpayers) had huge downside. This (logically) led to increasingly aggressive and risky activity.

    10. Once home prices began to fall, all of the above fell apart.

    I go into greater detail in Bailout Nation, but for now, play along with those 10 steps.

  2. Steve Barry says:

    “I believe we did not have a national Housing bubble; rather, what we had was a national Credit bubble.”

    I believe the same thing. I also believe that, while the bubble may have been pricked, it is still a bubble, with 370% credit to GDP and the gov’t desperately trying to keep it inflated. Therefore, much more pain to come. Seeing it as a credit bubble allows us to trace the root causes to easy money policies that started in the 1950′s and went totally insane, coincidentally ;), right about when Greenspan took over the Fed.

  3. hgordon says:

    As I recall, Bernanke tried to engineer a “soft landing” for housing prices in 2006. I did a quick web search and came up with this story –
    along with an interesting analysis from NYU Sterm –

    So what happened – did the subprime lending bypass the Fed’s efforts, leading to steps 2-10 ?

  4. Yes, several Fed governors — most notably, Ed Gramlich — tried to bring the issue to Greenspan’s attention.

    He ignored them, and called subprime lending an innovation. . .

  5. Steve Barry says:

    Slightly off-topic:

    Just saw on CNBC a RE person saying he saw a bottom in CRE soon…yet his body language betrayed him, as his head was shaking NO.

  6. Steve Barry says:

    Per my first post above, consumer credit just came out…I think they said on CNBC “biggest drop ever”…this tends to happen in deflationary debt crashes.

  7. winstongator says:

    Regarding the geographic dependence, subprime loan foreclosure rate varies by state/county and losses on foreclosures also varies geographically. Out of 10 subprime loans in Lee Cty, FL, say 8 went delinquent, and losses were 75% of each (1 sorry buyer still making payments). 60% net loss. In Wake Cty, NC, maybe 4 went into foreclosure with only 50% losses – 20% net loss. Looked at another way, the FL loans retained were half as valuable, relative to face as the NC loans.

    I think the problem lies in the failed idea that rising prices made subprime loans (and other junk loans) SAFER. If home values keep rising, a deliquency is actually a good thing. Minus fees, the home appreciation will be a net gain. You could also substitute a refi for the DQ during the bubble, which nets new fees and the prepayment penalty! The worst loans sought out the frothiest markets, serving to make them frothier.

    It is the 50% price drop regions that have caused the real problems. A 10% price drop will not cause strategic default, or put many people far underwater. A national drop of 10% will cause less harm than having 20% of the nation have a 50% drop, and the rest stay level. It’s not a linear function but one with a threshold.

    How do you prevent fast money from seeking the worst loans? Outlaw mortgage payments increasing over the course of the loan (except perhaps tied to a non-teaser ARM, but maybe even those should go). Think about the 2-28 teasers. If someone is such a bad risk, shouldn’t you have them pay more up front to build a little cushion, and then lower the payment?

  8. Greg0658 says:

    but .. I think this is missing in this .. where would we be as an economy without all this housing activity … I’ll tell ya where .. right here but in a GOP POTUS and ramping up into MICs war

    “we need to consider that markets typically are for IN balance” when you can’t be that you invent .. if memory serves me BR – you called it “MEW”

  9. algernon says:

    The subprime ‘innovation’ could not have occurred without easy money. And as you point out, BR, it strongly motivated it’s developement as financial institutitons don’t make money unless they get their money lent out.

    I’m not really disagreeing with you except to say that central bank seeded money creation was fundamental, the sine qua non ot the whole crisis. The Fed & Asian central banks are the most culpable.

  10. maynardGkeynes says:

    “What the newfangled lend-to-securitize subprime model did, however, was bring in millions of marginal buyers — people who would otherwise have been renters — into the housing market.”

    Great post BR: Would you accept this slight gloss? The harm that lend-to-securitize/subprime did wasn’t so much to add these millions of “marginal” buyers (ie, risky/speculative buyers), but to substitute them for real money (ie, prudent) buyers. The latter were then, in effect, crowded out, by the absurdly high prices these marginal buyers were willing to pay. (Why not? They got a nice new house and a free option on the housing market.) We have a problem now because the government, in order to protect bankers, will not let home prices decline low enough to attract real money buyers, and there are not enough subprime buyers to close the bid-ask spread anymore.

  11. Europe says:

    The discussion is aiming at how bubbles could be stopped, and how to stop them from blowing up the financial system.

    I think it´s time to pick up a serious discussion regarding what will happen when the next inflated bubble will blow up. The markets are behaving like they did in 1999-2000. It just goes up and up, it can´t be stopped. Valuation, even on normalized earnings, is starting to look ridiculous.

    Not many are talking of this as a problem, a problem for the future. Is it a problem, and if can there be a soft correction?

    Are we inflating a new bubble, is s it going to blow up and what will the consequences be?

  12. Transor Z says:

    It’s a hybrid credit-asset bubble. Most people can’t buy the asset outright without credit. But no doubt the appeal of the asset was sweetened by the easy money.

    Remember that, not only was mortgage money made easier, so was HELOC money. Easy credit created the perception that the asset was actually fairly liquid because equity was so easy to tap, which is a real historical aberration. Think about it: the only time people ever thought of RE as liquid 30 years ago was when you could cash in your houses/hotels to pay somebody in Monopoly.

    Easy money also shifted national new construction patterns from multi- to single (i.e., incentivized the proliferation of the asset) and expanded square-footage designs to levels extravagant by historical standards.

    As Keynes at 4:29 pm points out, the price of the underlying asset is being artificially maintained (also to protect munipalities and capital gains taxes upon resale, I would add) which points up the uniquely sticky nature of this bubble and why I think it’s hybrid and not one or the other.

    BTW, if you look at today’s consumer credit deleveraging number, you see it was -$13B in revolving credit.

  13. Greg0658 says:

    “will not let home prices decline low enough to attract real money buyers” .. REAL real money .. you mean that money that was arrived at by pushing 40:1 paper piles around with a D12Cat-tractor*

    I’m starting to think the system must implode to the point paper pushers must get real jobs and the instruments of destruction are replaced with widget production … or War .. Civil would do … cause there are just to many people making to many problems** .. and not enough jobs to go around / what with robots doing half the work


    ** police’g / court action / punishment / is just to expensive – if even possible .. No Instruments for U

  14. Bokolis says:

    Leaving aside all the yahoos, the ripple effect was the ensnaring of many who were not sub-prime and would have otherwise- in the normal course of things- been able to buy at lower levels. Similarly, it dragged people into jumbos, Alt-A and sub-prime status.

    For me, one of the shocking takeaways of this was the (first-hand) realization that there are people in positions of leadership (business and otherwise) who really have NFC what they are doing. Call me naive; I expected conspiracies (I still wont rule out that this whole thing wasn’t engineered for some grand, yet-to-play-out sinister purpose) of The Man at the top, not incompetent Caring Understanding Nineties TypeS.

  15. LeeX says:

    I think that the greater Detroit area had an serious housing bubble in the 00′s. While not as outrageous as the sun belt housing situation, we did have much construction which was unnecessary, and home prices were incredible. I was in the real estate biz in ’05, which is exactly when the bubble burst here. Given the context of a deep recession (Detroit was in recession the entire decade) and extreme population loss, the flurry of construction just did not make sense. Now the Detroit area has a tremendous number of foreclosures, probably the worst place in the country.

  16. m111ark says:

    Housing bubble, credit bubble, who the fuck cares what you’re calling it, you’re still glossing over what really happened, no matter which one you favor.

    What happened was, a lot of unprincipled people, i.e. crooks, found a way to make a shit load of money while sticking someone else with the problem down the road, which anyone in the business could see coming. Congress was bought, the regulators were bought and, they’ve stayed bought. Does anyone really believe “reform” is going to stop the banksters?

    Anyone with half a brain or just a little experience simply has to see this must end badly. But “they’re” makin’ enough money to fly off to safe houses when everything goes boom!!! And to hell with everyone else.

    Yes, that’s happening in “the greatest nation on God’s green earth.” If we get out of this one alive, it will be by the grace of that the same God.


    BR: I discuss that in painstaking detail here (Ch 16)

  17. DeDude says:

    The only way to have someone purchase a house at price X is to have them qualify for a loan to purchase at price X. So if lending standards are more stringent, the same person now only qualifies for a loan of 0.9X – that reduces demand and, therefore, prices for ALL houses (whether purchased with subprime or prime mortgages). The bigger the boubble the more underwater everybody gets after it pops. So anything that helped blowing it bigger helped making the current underwater problems worse. But is was not only subprime that helped blow the boubble it was also free money. So even without subprime there would still have been a problem – just smaller. The creation of subprime was mainly due to the combination of securitization by private companies not enforcing any standards on what they securitized and rating companies giving that sh!t a fraudulent rating.

  18. DeDude says:

    Even if Greenspan had kept interest rates 200 bp higher (at least from 2002) that would not have prevented subprime. It would have reduced but not prevented the subprime scam, because it would have made the scam itself less profitable and/or increased mortgage rates (preventing house prices from increasing as much). Again the boubble would have been less so the damage from it poping would have been less.

  19. Thomas says:

    I understand Krugman as saying, implicitly, that deregulation gave you subprime. Not basically interest rates.

    I think he’s right. They needed not simply low rates, but the low standards to get the ridiculous numbers.

  20. Marshall says:

    I’m with Tom on this one. In fact, it’s Bernanke’s view as well and I think it’s largely correct (probably the first time in history I’ve agreed with the Fed Chairman). Of course, Bernanke’s newfound embrace of financial re-regulation is patently political. If he can convince Congress that the problem was lack of oversight and regulation he can shift at least some of the blame to Treasury and Congress—since it was Treasury Secretary Rubin, and his protégé Summers, as well as Barney Frank, Christopher Dodd, and many others (significantly, Democrats who will now decide the Fed’s fate) who pushed through the deregulation bills in 1999 and 2000. He figures that if the Fed now supports re-regulation, he will be forgiven and the Democrats will be too embarrassed to admit their own misdeeds.

    The financial deregulation, combined with tight fiscal policy (which forced people to go more into debt and use their homes as an ATM proxy, with these horribly toxic mortgages), was far more significant than low interest rates.

    We had 9% interest rates in the 1970s and housing starts were higher than now with a smaller population.

    I also think Randy Wray is right about this:

    While I do believe the Fed should be stripped of all such authority, I am sympathetic to his argument about monetary policy. Low interest rates do not cause bubbles. The Fed kept interest rates low after the NASDAQ crash because it feared deflation in the face of significant downward pressures on wages and prices globally (see here). The belief was that low interest rates would keep borrowing costs low for firms and households, helping to promote spending and recovery. In truth, spending is not very interest sensitive and the economy stumbled along in a “jobless recovery” in spite of the low rates. What was actually needed was a fiscal stimulus (if anything, low rates are counterproductive because they reduce government interest spending on its debt—as Japan’s experience taught us over the past couple of decades—but that is a point for another blog).

    Still, the Fed was following conventional wisdom, and only began to gradually raise rates when job growth picked up in 2004. Over the following years, the Fed kept raising rates, and economic growth improved. (So much for conventional wisdom!) The worst excesses in real estate markets began only after the Fed had started raising rates, and lending standards continued their downward spiral the higher the Fed pushed its target interest rate. In other words, contrary to what many are arguing, the Fed DID raise rates but this had no impact in real estate markets.

    Why not? Two main reasons. First, recall that Greenspan had promoted adjustable rate mortgages with teasers. No matter how high the Fed pushed rates, lenders could offer “option rate” deals in which borrowers would pay a rate of 1 or 2 percent for two to three years, after which there would be a huge reset. Lenders ensured the borrowers that there was no reason to worry about resets, since they would refinance into another option rate mortgage before the reset. That is the beauty of ARMs—they virtually eliminate the impact of monetary policy on real estate.

    Second, and this was the key, house prices would only go up. At the time of refinance, the borrower would have far more equity in the home, thus obtain a better mortgage. Further, the borrower could flip the house and walk away with cash. While I will not go into this now, public policy actually encouraged homeowners to look at their houses as assets, rather than as homes (see here) (And now that many are walking away from underwater mortgages—treating houses as assets that became bad deals—policy makers and banksters are shocked, shocked!, that borrowers are treating their homes as nothing but bad assets.)

    In truth, when speculation comes to dominate an asset class, there is no interest rate hike that can kill a bubble. If one expects asset prices to rise by 20%, 30%, or more per year, an interest rate of 10% will not dampen enthusiasm. To kill the housing boom, the Fed would have had to engage in a Volcker-like double-digit rate hike (in the early 1980s, he raised short-term interest rates above 20%). There was no political will in Washington (either at the Fed or the White House) for such drastic measures. Nor was there any reason to do this. Bernanke is quite correct: the Fed could have and should have killed the real estate boom with much less pain by directly clamping down on lenders, prohibiting the dangerous practices that were rampant.

  21. Marshall

    We need to agree on some definitions:

    Low Rates: Understand we are not discussing “Low interest rates” — these were ULTRA-LOW, generatonal, lowest Fed Funds rates in 46 years low.

    That aberrational monetary policy was but one factor that surely contributed to an upward spiral in all items priced in Dollars 9which fell 41%), and anything priced in terms of credit. So the dollar collapses, oil, food, gold all rally strongly. And of course home prices rise when mortgages rates get slashed.

    That set the stage — but recognize that there is not a single factor causality here (i.e, Low interest rates cause bubbles). Instead, there were a series of factors, some conditions precedent, some that occurred in conjunction with others that led to the boom and bust. They are a function of a combination of factors — leverage, cheap money, a belief system that rationalizes otherwise irrational behavior (valuing clicks/eyeballs over revenue/profits) etc.

    Unfortunately for the FOMC and BB, the Fed was at the center of two of the biggest elements — the cheap money, and the nonfeasance when it came to overseeing the lenders (Banks and non-banks alike).

    I also have to disagree with the notion that “In truth, when speculation comes to dominate an asset class, there is no interest rate hike that can kill a bubble.”

    In 1998, a Reg T margin rule of 100% (as opposed to 50%) would have slowed the dot com bubble dramatically. And in 2003, if the Fed stopped at 2.5%, then reversed itself, bringing rates back to normal levels, we NEVER would have had this entire boom/bust in Housing. Add to that the fact that a 5.5% Fed funds rate popped the housing bubble . . .

  22. call me ahab says:

    “The Fed kept interest rates low after the NASDAQ crash because it feared deflation in the face of significant downward pressures on wages and prices globally ”

    no shit sherlock- all due to the mantra “no pain allowed for excesses”- if the Fed had not stepped in at that juncture- no housing boom-

    can you get that through your thick skull?

  23. km4 says:

    Analysis: Obama’s buck-stopping goes only so far

    Yes and enough with the Hopium bullshit !

    A Gallup Poll near the end of the year found 25 percent of people — just one in four — feeling satisfied with how things were going in the United States.

    “The president himself, not surprisingly, may feel quite satisfied with accomplishments in his first year,” said Frank Newport, editor in chief of the Gallup Poll. “But we don’t see signs that the American public is positive.”

    Obama made his bed with Vampire Squid from Hell so bye bye in 2012 !

  24. Joseph Martinez says:

    It is evident that the government wanted to get the low income folks into a house before the tech bubble burst. Uncle Sam knows that the housing industry can get the economy rolling. Without going into detail after the tech bubble a bigger push was made to get more people into homes. Also a boom in commercial restate when into high gear. I will blame the commercial boom on the premise that we needed to keep up with the Jones. But whatever the root cause may be the fact remains that in boom or burst times the majority of people will over look what is right or wrong.
    Now lets take an example in today’s economy as the TALF program. Look at the size of it 1.4 trillion and it is said the 1 trillion use been used up. Is the TALF program right or wrong? Base on free market principals I would have to say no. My point is that we will always put “innovations” in place to keep the economy going up or falling down. We are not a society that can live with the status quo. We are taught at an early age that being number one is where it’s at.

  25. Greg0658 says:

    when standard savings interest rates dropped to the point regular folks could not keep up and “speculation comes to dominate” creating all kinds of instruments or “financial weapons of mass destruction”
    switch gears …
    - corporations themselves probably have a dis-taste for the mechanisms of hitting numbers for the monster .. hit the mark or theres a run on the stock
    - regular folks would like to see a decent return with minimal effort so they can do things to juice the economy … switch gears … and the paper pushing industry where everything filters through their fingers .. I see the reason for regional banking sectors to regain importance with a mechanism of balancing the regions investment activities with the regions domestic product .. local credit cards
    Margarita episode – Poof it’s gone! – South Park

    we have a wacked out system .. both in money storage and politics
    “Control of the government is the best path to prosperity”

  26. Andy T says:

    “I believe we did not have a national Housing bubble; rather, what we had was a national Credit bubble.”

    Sounds like a man who has been listening to and reading Steve Keen. Well done.

  27. beaufou says:

    Derivatives will eat the World Economy eventually,
    it has become the only instrument of an under-educated elite to rule it all.

  28. farmera1 says:

    From way down on the farm we have a credit bubble. If the housing market hadn’t blown up first something else would have blown.

    Bubbles are always liquidity driven. (Who said that???) Despite Bernanke’a latest comments the FED made the housing bubble (or another equally painful bubble) not only possible but inevitable.

    To me the graphs of TOTAL US DEBT AS A PERCENT OF GDP says it all. Too much debt (as in too much liquidity) made the whole the whole god awful mess not only possible but inevitable. Yes I know that correlation doesn’t mean causation, but correlation can be evidence of causation.

    The DEBT AS A PERCENT OF GDP is now at some 300%. The previous high was in the early thirties at some 190%. So we have a situation of excessive debt (my definition is debt that can never be repaid). There are two options: Go through a Great Depression redo , or inflate your way out.

    The FED is attempting to ease its way around the excessive debt. No easy task. We had better all hope they are right, because the alternatives are really bad. Either choice will be long and painful. There is no free lunch, as some believe for example cutting taxes and starting two wars, makes no sense. The resulting debt is a huge contributing factor to where we are now.

  29. Susan says:

    I think the peak is generally considered to be 2Q 2006 rather than 3Q, might vary by index. I would need to look.

    I’m not disagreeing with you as regards the overall pattern, but making a different one: that deregulation and low rates created a new turbo-charged effect.

    Normally, in any credit contraction, even in the early stages, it’s usually the riskier lending that starts seeing the falloff first. Here you saw a reversal of the normal pattern. That says interest rates, although important (as in they actually led to some of the crazier structures that made high subprime volumes possible in the first place), were not the sole drivers of the activities that were particularly damaging. And the Fed’s rate increases were slower to choke of credit than they “ought” to have been, again a function of deregulation.

    Maybe a better example than Reg T (but this also may explain reluctance to use more, ahem, effective and targeted measures): one of the two triggers of the 1987 Crash was a press release by the Treasury saying it was going to tax highly leveraged transactions at a higher rate than other transactions (I forget details, but I can find it in the Brady Commission report). I recall reading equity research in 1987 (pre-crash) that attributed 75% of the runup that year to takeover activity.

  30. ArmadaRisk says:


    It is mind boggling that there is continued denial that FNMA/FHLMC (coupled with the ultra-low Fed rate stance and shrinking bank reserve requirements) were the primary causes of the housing meltdown. Yes, there were an outrageously high number of subprime loans made by unscrupulous bankers and financiers who took advantage of the hot market that FNMA and FHLMC created. But is it laughable to continually attribute the entire financial crisis to private-sector subprime issuance. As those who actually have experience in the mortgage industry know that the GSEs had been buying/guaranteeing subprime loans for years (without calling them so) before the Wall Street really figured out what they were missing. FNMA only started labeling them sub-prime when it became hip to hock that kind of paper. Nearly 60% of the subprime and Alt-A loans outstanding in 2008 were held or guaranteed by the GSEs [1] and nearly 90% of all home mortgages are owned or backed by the GSEs [2].


    BR: You are conflating what came AFTER the crisis began with what CAUSED the crisis.

    Pre-2005, FNM/FRE purchased conforming mortgages. It was only after 2005 that they aggressively moved into that area – not because Congress ordered them to, but because Wall Street was “Eating their lunch.” It was a response to a market share grab, and an attempt to compete for profits.

    Further, by late 2007, the private sector demand for Sub-prime/Securitization had fallen off the cliff — the GSEs were the only game in town. (Remember Paulson’s Bazooka?)

    What they did post crisis, and the state of the Securitization market can hardly bve assumed to be the cause of the crisis.

  31. DeDude says:

    Very complicated problem with multiple interconnected enablers and multipliers. Sort of reminds you of climate change ;-) Has anybody tried to make a model of this housing boom and bust?

  32. DeDude says:

    I mean it is so hard to understand for out little human brains. We need simple linear paradigms with a single cause in one end, a few intermediate effects, and a final clear and understandable disaster in the end. Interconnected networks of networks, with brakes accelerators and feed-back loops, are for computers. Our brains crash whenever we try to think of such complicated things – and our primitive language is incapable of communicating them.

  33. m111ark says:

    I see I wasn’t forceful enough with my previous comment. So here goes:

    You people are picking at gnats. Trying to decipher the whats and wherefores of results rather than causes. With such blinders you’ll never get to the root of our present distress.

    I can’t agree with everything Chris Hedges says, but I can heartily endorse his agony at what we have become.

    Who has a solution? without understanding that the cause is what we have created. We think it’s a civilization. We are wrong. It is a barbarous, thuggish, bloodthirsty barbaric relic of fear. Fear has us in its grip, just as it has for the past thousands of years. We’ve prettied it up with doodads and gadgets and fancy material things, but it’s still the illusion of fear that has created an illusion of civilization.

    Each and every one of us is responsible for where we are. And the solution is within each of us as well. In the end it is not anything we will do… it is who we are.

  34. globaleyes says:

    No matter what people say, I still expect DOUBLE BUBBLE TROUBLE. Nothing’s changed. In fact it’s easier now because we’ve been through a whole cycle, right?

  35. hpinRaleigh says:

    I’m mostly in agreement with Marshall. Greenspan resurrected two semi-obscure terms: exuberance and conundrum, in his attempts to sound erudite. The media has forgotten about his “conundrum”. This was the fact that long-term rates stayed stubbornly low as the Fed was raising rates. People who I hold respect for, including (I think…) the late Peter Bernstein, were warning that the risk premium was evaporating on long-term debt, that investment houses and entities were “chasing” low returns on debt instruments. Greenspan even made a public quip about how reward seemed to have been disconnected from risk, in his concern for the investment community.
    In my estimation, the bedrock of this financial granfalloon was the securitization of loans. The reduction in loan standards were a direct result of the flood of money available to whomever would create one. It turned into a bonus-motivated gang-bang. The nerds at the rating agencies couldn’t resist the lure of lusty, bountiful, nubile and very moist bonus checks, among other incentives and were only too willing to open the ratings spigots – institutional reputations be damned.
    Living in San Diego during the run-up, I couldn’t believe what was happening. It was a farce. You could have asked a 12-year-old (I used to teach them) and they would have told you that the real estate loan industry was on a very wild ride.

  36. ArmadaRisk says:


    Yes, 2005 was the year that FNMA and FHLMC began purchasing subprime loans THAT WERE LABELED SUBPRIME, but as the articles you clipped from my previous post point out, FNMA began buying riskier loans as early as 1993 and had been steadily increasing the risk in their portfolio for years. Simply labeling a loan “Conforming” does not make it a low-risk loan, as loan originators did everything they could to find loopholes in the conforming standards. Ask any mortgage originator who did any significant volume pre-2005 and they will confirm this.

    [BR: I have researched this extensively, and I found no evidence that FNM/FRE purchased many non-confirming loans pre-2006 — certainly not in significant quantity or dollar volume, in 1993 or later. Do you have some data/evidence of this? Or is it just “I know a guy who knows a guy. . . ?” ]

    If FNMA’s conforming standards were so great, why are their “conforming” loans seeing such huge losses also? Granted, some of this is due to the collapse in home prices, but obviously the “conforming” standards were not good enough to withstand a home price stress test.

    [BR: That’s a silly comment: Everyone’s loans are defaulting in higher than ususal numbers, and since the Federal bailout in September 2008, Fannie has been obligated to purchase just about EVERYTHING — post crash, in the absence of normal securitization, they have become the government sponsored buyer of last resorts of all manner of garbage loans.]

    As with all regulations, they created incentives for people to seek abnormally high profits in the loopholes and stick the government (ie, the taxpayer) with the losses, which is exactly what we have seen play out.

    As far as low rates go, teaser rates certainly played a role. But to deny that FNMA/FHLMC, with their implicit gov’t guarentees (which have, as everyone knew they would, become explicit) didn’t lower the cost of borrowing to an abnormally low level is to deny the very intent of the creation of Fannie and Freddie. They DID lower the cost of borrowing to such an extent that an unprecedented number of marginal borrowers entered the market place, creating the initial rise in prices that formed the base for what was to come with private-label “subprime”.

    Let us look at it from another perspective: if Fannie and Freddie were legislated out of existence in 1995, do you still believe that the subprime fiasco would have occured, independantly? Even if the subprime mortgage explosion had not occured, there is ample evidence to suggest that the mortgage market was well on its way to trouble.

    The truth is that FNMA and FHLMC were making SUBSIDIZED loans to borrowers on a scale that could never have been supported by the market left up to its own devices.


    BR: I hear lots of talking points from you, but no data evidence proof. Demonstrate to me that you are more than the typical ideological extremist and show me some evidence, or data or proof that Fannie Mae was a causal factor.

    Do far, you have produced nothing but misleading rhetoric and doscredited talking points.

    Give me something real.

  37. Greg0658 says:

    in the tone of m111ark .. I’m not sure what you all think a joe6pack can pull off .. in a world that he can’t take a hammer a saw a board and a nail and turn it into something bigger via sweat equity
    fyi .. here is this j6p’s entry into green energy .. not very big .. but big enough to blow a wad for the bottom double pyramid diamond :-)

    TBTF .. F = fail / fight .. whatever .. super corps rule and they don’t need to hire till something jump starts this “wacked out system”
    “Master Blaster runs Bartertown”
    “Resistance is futile”

    Rush – The Trees ( Exit Stage Left)

  38. Greg0658 says:

    ps – the Amish bread giz didn’t make it past day10 – I pulled an economist on the recipe $3.90/2loafs-loaves .. and folks were afraid of it’s safeyness

  39. elnino says:

    “newfangled lend-to-securitize subprime model” Lend to securitize was being done for years and years by FNM/FRE and others without such problems. The problems arise when the loans are made without a reasonable expection of being paid back. With the 100+ LTV nature of the loans coupled with the low/no doc requirements to verify DTI, there was no evidence to ensure payback. I agree that it doesn’t have much to do with rates. Lend to securitize still would have been fine with this model (bad loans could not be sold or sold at a discount or priced such that the borrower was paying usurious rates) had it not been for the rating agencies. The only way to unload these things was to slice and dice the cashflows and get the rating agencies to bless the top tranches, and they did.

    This whole subprime crisis happened on a very small scale in 1998 triggered by the Russian default/LTCM debt shock. For those not familiar, a bunch of companies issued 125 LTV home equity loans prior to that and it was the latest and greatest thing. I guess the thinking was that it was okay to loan someone more than their house was worth because values would rise and they were stable homeowners and good for the money. Well, all those highly leveraged low capitalized HE companies went under with the widening of credit spreads. It was a complete disaster. That 125 product went a way for a few years, but the ones that sprouted in its place (option ARMs, NINJA, etc.) were worse because they were bigger first liens.

    Take a look at this if you’re interested from 2002/3. Pages 6 and 7 show you who was around then and what happened to them:

  40. call me ahab says:


    thanks for that link

  41. KentWillard says:

    Just as in the housing bubbles in the Oil Patch in the early 80′s or in California in the late 80′s, mortgage credit standards become silly. Each time, you will see reduced documentation, non-amortizing products, and very low to no down payments. These bubbles happen with or without securitization, but securitization helped spread the housing bubble around the US, and spread the bad debt around the world.

    Bubbles don’t form for just a single reason, it is a multivariate model. Among the contributors: good fundamentals initially, easy credit, a natural or man made shortage, a lack of good alternative investments, and scarcity of good information. And most importantly, a lot of stupid money and stupid people – which is innate to mass human psychology. You don’t have to have all these inputs (except the last one), but the more you have, the more likely and larger the bubble. If the bubble is fed by credit, then of course it feeds much more of the economy on the way up, and destroys much more of the economy on the way down. In this case, the mass stupidity was that house prices couldn’t fall.

    Once the zeitgeist is running, it is hard for the government to stop it (witness the Fed in Summer 1929, or China today). Efficient market ideologues explain our latest bubble as purely due to a particular government interference (with which they already disagreed). The government did exacerbate the bubble due to low interest rates, raising I-bank leverage ratios, no mortgage credit regulation, no truth in lending or truth in securities disclosures, lots of housing subsidies through taxation and GSE’s, and even a little restrictive land use management. But remember that there was a bubble in high tech stocks only 10 years ago, to which most of these factors cannot be attributed. This is not to excuse government’s contributory mistakes – but the free market creates some pretty boneheaded bubbles on its own.

    More tiresome is the argument that the bubble is due to Fannie, Freddie, and community reinvestment lending. As has already been pointed out, this doesn’t explain why there was a simultaneous bubble in commercial real estate (notably office buildings). The worst lending was typically done through Wall St. securities, only in 2007 (right after the bubble peaked & when Wall St got out) did the GSE’s idiotically capture most of the Alt-A mortgage originations. Fannie & Freddie did support a significant amount of Wall St. securities by buying some super senior tranches of subprime and Alt-A ABS, but their presence wasn’t required. What really empowered the subprime and Alt-A ABS was the way subordinate (junk) ABS tranches were repackaged as ‘AAA’ securities through CDO’s (which the GSE’s didn’t buy). This deceptive and lucrative transformation of risk created a huge demand for mortgages (no matter what the credit risk) by Wall St. I’m usually not a fan of Fannie and Freddie, but to blame them for so much of the problem is a white wash of much bigger contributors to the housing bubble.

  42. Greg0658 says:

    filled the tummy with sausage eggs toast waiting for me to get off this www via the MsGP+

    pss – if I could give a TBP bump to a supercorp I was investigating (wondered what they were .. paper or stuff) turns out a shooting over a pension (yea .. disas-cap bump)

    but I was impressed at this corp and they might have some stuff for my generator
    ABB Timeline (nice graphic as a 127yr tree)

  43. ArmadaRisk says:

    As the link(s) below show, FNMA’s own former credit officers admit that they ACTIVELY tried to lower lending standards long before 2005.

    Most of the run-up in low-down payment loans (NOT including Ginnie loans) occured between 1991 and 1995 and only increased marginally after that. [1]

    Barry, you continuously reiterate the fact that Fannie and Freddie only purchased Conforming loans prior to 2005. But YOU have yet to provide evidence that conforming loans are not actually subprime loans in disguise! Perhaps you have been decieved by the labeling as many have. Evidence is now emerging that the GSE’s mis-represented Conforming loans as prime even though they had many characteristics of subprime loans [2]. People in the mortgage industry (like myself, who worked as a analyst for a mortgage trading desk, which makes me the guy who is known by the guy who is known by the guy) have know this for years. It is only after the collapse that this has become general knowledge to all but a few who refuse to acknowledge the fact.

    Conforming is NOT the same thing as Prime!
    Non-Conforming is NOT the same thing as Sub-Prime!

    Please stop making red herring comments like this and address the issue. If you went into a room of mortgage lenders even before 2005 and stated “All conforming loans are prime!” you would have been laughed out of the place.

    And of course everone’s loans are experiencing higher default rates during the current economic crisis. But pointing this does not mean that Fannie and Freddie did not have lax lending standards. Part of quality lending standards is that your portfolio can withstand a full economic cycle, not just the bubble years, without tanking your company.

    Answer this question: If Fannie, Freddie, and Gennie were legislated out of existence in 1990, do you still believe the sub-prime crisis would have happened on its own?



    BR: In a very well researched and careful manner, I (laboriously) put together my 344 page explanation (with all sourcing and footnotes) for what caused the crisis, what were primary and secondary factors, what were minor or irrelevant. I named names — both Republican and Democrat (about a 57/43 split).

    I am willing to entertain other explanations. If you have an alternative theory, then prove it.

    But let me reiterate this: IT IS UP TO YOU TO PROVE YOUR EXPLANATION. It aint my job to fisk every harebrained explanation (Acorn caused the crisis?!)

    The burden of proof is on you, and the rest of the crowd that wants to blame the bust on the Fannie/Freddie, or the CRA or Acorn (like Ed Pinto who you linked to).

  44. Scott F says:

    Ritholtz, why do you bother wasting your time with trolls?

    If your little friend wants to believe that it was Fannie Mae — or CRA or Acorn — let him. You cannot convince someone who has already drank the Kool-aid — he is a moonie, a scientologist, a wing nut.

    As you noted, all he offers are talking points and bullshit rhetoric. If he was interested in serious intellectual debate, he would not have linked to a moron like Pinto. And he certainly would have offered some real data, as opposed to cryptic bullshit like “conforming was really subprime in disguise.”

    Its the weekend — go do something fun, and stop wasting your time on trolls.

  45. howard0339 says:

    Of the literally hundreds of factors, many of which are in play at various times, I think populous pressure from Congress to make more housing available to the “deserving” people who “cannot get a loan” is always in play and was a big factor in the “bubble.” Anybody who looked at lending standards and talked was kicked out. We were in a fantasy land created in large part by Congress and presidents who “gave us what we wanted” and just had to get reelected “next time.”

  46. Howard — that is the sort of nebulous, data free argument that sheds zero light on the situation. It is all supposition, zero evidence. And in my opinion, it only serves to take pressure off of the actual demonstrable causes.

    I detest it. Please find some actual evidence, data, proof.

    And yes, am going outside to play now.

  47. eurostoxx says:


    Great discussion about the marginal buyer/seller..I’m surprised analysts too often miss this point.

    For a good look of what the US housing situation would have looked like without subprime, just take the case of Canada (the clevland fed did a study on it recently).. we (canadians) have almost no subprime but yet had the same ultra low rates..and guess what, no housing bust because there were never any marginal sellers that were forced to sell …. though we now face home prices that are over-valued by traditional metrics.. but i’m sure most would consider that outcome to be better (aside from potential 1st time home buyers like myself)

  48. MayorQuimby says:

    Great critique BR. It was a credit bubble and not a housing bubble. By their logic you may well have called it a cell-phone or designer clothing bubble as well.

  49. ArmadaRisk says:

    Barry, you failed to answer my question (maybe because you don’t like the answer), so I’ll post it again:

    If Fannie, Freddie, and Gennie were legislated out of existence in 1990, do you still believe the sub-prime crisis would have happened on its own?

    As pointed out by Pinto, the percentage of mortgages that had a down payment of less that 5% (and not insured by FHA):
    1991 – 9%
    1995 – 27%
    2007 – 29%

    Barry: Can you dispute the above figures with other data sources? If not, you’ve got a pickle. You need to make the following case:

    1) High LTV loans are not riskier than lower LTV loans
    2) Lower down payments do not increase a borrower’s propensity to over-borrow or buy a larger home than they would otherwise
    3) People buying larger homes than they normally would have did not in any way create upward pressure on home prices
    4) The spike in the percentage of mortgages with low down-payments that occured between 1991 and 1995 was due to private-issuer subprime mortgages originated after 2005.

    Point #4 I believe will cause you some real difficulty.

    Please not that I am not attributing the entire credit crisis to the GSE’s. But to deny that the GSE’s played a major role in the home price run up, which formed the base for the explosion in 2005 and later, IS to deny the facts.

  50. Pocket QQ says:

    Plain and simple, with no supporting data :)
    It was a Demand/Supply liquidity trap, The repackaging of loans and relative derivatives added and adjusted risk, lowered loan standards, increasing demand and leveraging of liquidity, that in turn caused prices to sky rocket. Leverage effectively distorted liquidity! Everyone involved got paid along the way, adding more fuel to the fire. Now the opposite is happening, tighter standards, over supply, less liquidity lowered Demand. The Bailout’s (although fraught with cronyism) were designed as a floor for forced liquidation. Considering, the enormity of this force of liquidation and our capitalistic structure, there is no question it was the correct thing to do. That doesn’t mean it was perfect. Some where in this decade we will find the happy medium and the American Dream will be back in vogue. In the mean time we need to take our deflationary and consumption lumps, as we fight the forces of a growing world demand for declining resources and advance our efficiencies, innovation in science, energy, engineering, and manufacturing. Low rates with high beneficial standards should help focus capital and liquidity where it belongs. Right now we appear to be in ‘Fake-it-til-you-make-it’ mode.

    Those who managed their life and business through the storm with out falling in the trap, and those with a solid business plan and fresh innovative idea’s don’t appear to be getting turned down for loans.

    If you don’t like my composition? 3M-TA3

  51. DeDude says:

    “If Fannie, Freddie, and Gennie were legislated out of existence in 1990, do you still believe the sub-prime crisis would have happened on its own?”

    Yes off course it would you moron. With those two privately owned mortgage securitising companies out of the picture a number of other privately owned mortgage securitizing companies would have taken over that business. That is what happened with substandard loans, initially F&F was to reluctant to take that sh!t because they could not ship the risk out to some Norwegian saps (F&F actually guarantee their papers). However, as they could see their market share slipping from 90% to below 70% their CEO got bonus angst and decided that housing never falls, so he could dip into that sh!t big time and try to win back the lost business. Any privately owned company that had picked up the business left after closure of those government sponsored entities would have done exactly the same as they did. And that is a proven fact because the other privately owned companies that got into the game and outcompeted F&F lend out with even worse standards. The race to the bottom would have been the same with or without some of those almost left behind entities.

  52. [...] Friday, we noted our disagreement professor Paul Krugman as to the multi-variate causes of the crisis and [...]

  53. engineerd1 says:

    I don’t call it an honest list…. I can only assume from past experience that the fact that it omits any mention of govt policy is because Barry is a pro-govt “progressive”. I do not understand…I apparently do not have the appropriate organ to understand, how anyone with an IQ over 100, or alternatively a functioning moral sense, could look at govt and business with all their failings, and cast their lot with and put their faith in the former….

  54. hawleyl says:

    Because we have a ten step process (beginning with ultra low
    interest rates) if we stop any one step none of the successor steps
    will occur. (Theoretically). Looking at the steps I would first attempt
    to inhibit/regulate step 5 because it has only three entities
    (Fitch, Moody’s and S&P). Theoretically that would inhibit steps
    5 – 10 from occuring and make steps 2 – 4 less profitable. I’m
    not concerned with fairness, only efficiency.

  55. cgb22 says:

    The last time I bought a house was in 2000. But it was a scary experience for this reason. We were moving from a moderately priced market to an expensive market. We made some money on our old house, but we couldn’t find a house we liked in the new market in the price range we wanted. So, that meant we needed to borrow more money.

    So, I called the lender who said not to worry, they’d already pre-qualified us for a loan some $160,000 larger than we were considering. That scared the bloody hell out of us, and we kept the size of the loan at a far more manageable scale.

    What caused this moment of insanity on the lender’s part was the use of FICO scores as the sole predictor of future behavior. There was no real underwriting to determine my faults; if everyone has them.

    That told me something odd was happening in the mortgage business. It had become very impersonal because securitization, once a smart idea, was totally driving the business. To me, that meant the mortgage market was becoming very vulnerable to trouble. And the decision to ignore the history of adjustable-rate and other wacky mortgages in the 1980s was going to lead to bigger trouble.

  56. ArmadaRisk says:

    “[BR: I have researched this extensively, and I found no evidence that FNM/FRE purchased many non-confirming loans pre-2006 -- certainly not in significant quantity or dollar volume, in 1993 or later. Do you have some data/evidence of this? Or is it just "I know a guy who knows a guy. . . ?" ]”

    Barry, apparently you did not research very hard.

    In 2002, FNMA/FHLCM purchased $38 billion of the total $213 billion subprime originated that year.

    In 2003, FNMA/FHLCM purchased $81 billion of the total $332 billion subprime originated that year, and 49% of the subprime volume from the top 20 subprime issuers.

    In 2004, FNMA/FHLCM purchased $175 billion of the total $530 billion subprime originated that year, and accounted for 44% of the subprime securities issued.

    In 2005, FNMA/FHLCM purchased $169 billion of the total $625 billion subprime originated that year, and accounted for 33% of the subprime securities issued.

    Even as their share of the subprime market slipped in 2005, they still bought 27% of the subprime loans originated and issued 33% of the subprime securities issued that year. Does this sound like “no evidence that FNM/FRE purchased many non-confirming loans pre-2006″? I don’t know about you, but I consider 27% market share to be a “Major Player.”

    Where do these numbers come from? None other that the Federal Housing Finance Agency’s “Mortgage Market and The Enterprises” reports, various years.