Did the government cause the bubble? Not according to Austan Goolsbee

December 1, 1:29 PMEconomic Policy ExaminerJoseph Hight

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Austan Goolsbee (U. of Chicago)

By now it is a foregone conclusion that the root of the financial crisis of 2008 is the housing bubble, the incredible run up in housing prices that began during the last half of the 1990s and lasted until about 2006. During the run up in housing prices it was not uncommon for the price of a home to increase some 30 percent in a single year.

Some have argued that it was government policies of low interest rates, easy money and lower lending standards forced on lenders that caused the bubble.  For example, Stan Liebowitz in a New York Post opinion piece, “The Real Scandal,” wrote that the bubble was the

“… direct result of an intentional loosening of underwriting standards - done in the name of ending discrimination, despite warnings that it could lead to wide-scale defaults.  At the crisis' core are loans that were made with virtually nonexistent underwriting standards - no verification of income or assets; little consideration of the applicant's ability to make payments; no down payment.”

And Randal O'Toole of the Cato Institute agrees. Writing in an article entitled, "Blame Urban Planning," O’Toole said,

”… Congress gave the Department of Housing and Urban Development (HUD) oversight authority over Fannie Mae and Freddie Mac. While this was supposedly aimed at protecting taxpayers, Congress knew that HUD’s main mission is to increase homeownership rates, and Congress specifically pressured HUD to increase homeownership among low income families. So HUD responded to the housing bubble by directing Fannie and Freddie to buy increasingly high percentages of mortgages made to low income families, eventually setting a floor of 56 percent. This led Fannie and Freddie to significantly increase their purchases of subprime mortgages, which legitimized the secondary market for such mortgages.”

Ditto the opinion of Yaron Brook, who said on Forbes.com,

“It is popular to take low lending standards as proof that the free market has failed, that the system that is supposed to reward productive behavior and punish unproductive behavior has failed to do so. Yet this claim ignores that for years irrational lending standards have been forced on lenders by the federal Community Reinvestment Act (CRA) and rewarded (at taxpayers' expense) by multiple government bodies.”

But in an opposing view in The American Prospect in April 2008, Robert Gordon said,

“First, consider timing. CRA was enacted in 1977. The sub-prime lending at the heart of the current crisis exploded a full quarter century later. In the mid-1990s, new CRA regulations and a wave of mergers led to a flurry of CRA activity, but, as noted by the New America Foundation's Ellen Seidman (and by Harvard's Joint Center), that activity "largely came to an end by 2001. In late 2004, the Bush administration announced plans to sharply weaken CRA regulations, pulling small and mid-sized banks out from under the law's toughest standards. Yet sub-prime lending continued, and even intensified -- at the very time when activity under CRA had slowed and the law had weakened."

And even more important, considering his appointment by Barack Obama as Staff Director of the Economic Recovery Board under the leadership of Paul Volcker, is Austan Goolsbee’s view that subprime lending and loosening of mortgage standards under the CRA did not cause the housing price bubble and subsequent bust.  In defending the CRA as an instrument that served to give people power to make their own decisions about housing, Goolsbee said in March 2007 in the New York Times,

“The traditional causes of foreclosure, even before there was subprime lending, were job loss, divorce and major medical expenses. And the national foreclosure data seem to suggest that these issues remain paramount. The latest numbers show that foreclosures have been concentrated not in places where real estate bubbles have supposedly been popping, but rather in places whose economies have stagnated — the hurricane-torn communities on the Gulf of Mexico and the industrial Midwest states like Ohio, Michigan and Indiana, where the domestic auto industry has suffered. These do not automatically point to subprime lending as the leading cause of foreclosure problems.”

In defending the CRA and arguing for its extension and strengthening, Goolsbee goes on to say in the New York Times piece,
”When contemplating ways to prevent excessive mortgages for the 13 percent of subprime borrowers whose loans go sour, regulators must be careful that they do not wreck the ability of the other 87 percent to obtain mortgages," and adding

"For be it ever so humble, there really is no place like home, even if it does come with a balloon payment mortgage.”
So, did the government do it?  What do you think?

For more info: 

Home prices plummet, foreclosure sales rise

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