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Brooks Wilson's Economics Blog: Sowell: Housing Boom and Bust

Tuesday, September 8, 2009

Sowell: Housing Boom and Bust

At the one year anniversary of the financial crisis of 2008, I am making an effort to learn more about its origins by reading several books with different perspectives.  I began by reading Posner's "A Failure of Capitalism."  Posner has extensive expertise in legal and economic aspects of regulation.  He took a Keynesian approach in his macroeconomic analysis of the crisis.  Keynesian economics is dated but anybody who studies modern macroeconomics will recognize his influence on those who followed, particularly New Keynesian economists.  As soon as it is available, I will order and read Chinn and Friden's forthcoming book.  Chinn is a careful modeler who pays close attention to empirical results.  I don't know much about Friden.  I suspect that they will use a real business cycle or New Keynesian approach.  I just ordered Thomas Sowell's "The Housing Boom and Bust."  Sowell is often described as a libertarian or sometimes a conservative.  Sowell believes that government policy designed to increase home ownership was an important cause of the financial crisis.  Chinn, Friden, and Posner dismiss this view.  Below I have included part of a book review by dostoyevsky76 that I found online.
The first half of Housing Boom and Bust is like the housing market in the first half of this decade--seemingly endless potential. While I disagree politically with some of what Sowell believes, he is a clear-thinking, thoughtful writer. His book "Basic Economics" is a five-star work. He has the ability to lucidly explain arcane subjects without talking down to readers.

But this book only begins to tell the story of the housing bust and ensuing financial crisis. It's the equivalent of watching a football game and the t.v. station only shows you the first half. It was a great two quarters, but I want to see the rest of the game.
This book does an excellent job of explaining the political origins of this crisis. The main thrust of Sowell's argument is that government action usually leads to the opposite of intended consequences. The mantra of "affordable housing" led to government interference into banking which weakened standards of due diligence for home buyers. The government's most significant act was the pressure put on Fannie Mae and Freddie Mac to buy mortgages from lenders who had lowered their standards in the pursuit of providing "affordable housing." Only banks that played along in the late 90s were allowed to offer more exotic securities, and thus increase their potential for profit.

What isn't here is the extent to which lenders and investors took every advantage of this system, flooding the market with new investment tools that didn't hold up to the light of day (mostly due to the unsoundness of many of the mortgages that provided their foundation). Just like any other market or opportunity that is offering unusually high rewards, huge numbers of lenders and investors were drawn to mortgage-backed securities at the beginning of this decade. It was the dangerous extent to which major creditors were heavily leveraged with these securities and their by-products, such as credit default swaps, that has led to the severity of this crisis.


  1. Brooks Wilson's posting addresses what Mr. Sowell's book does not address. However, if one understands the concept "people respond to incentives", then one would understand that the interference of the government (Community Reinvestment Act, Fannie May, Freddie Mac . . .) in the market in the first place, put the incentives there in the second place. Is Mr. Wilson trying to create some rationale for increased regulation?

  2. Thanks for the comment and question. Government is good at pointing fingers at others and not at itself when intervention goes bad. Social engineering to slow housing growth and encourage housing ownerships contributed to the housing boom and bust. I would eliminate any government policy to encourage expansion of home ownership. Although I believe that the Community Reinvestment Act is a small underlying cause of the bust, I would repeal it. Markets will deal with housing discrimination over time. I would cut Fannie and Freddie into pieces and sell the pieces. The moral hazard created by government deposit insurance and bailouts presents a thorny regulatory problem. Stern and Feldman offer some suggestions in "To Big to Fail."