Follow-Up: The Moral Panic, Its Perpetrators, and Its Victims

I’d like to add a few follow-up comments to yesterday’s post. It is popular to attribute the downsides of these issues to capitalists. Consider the popularity of claims against private equity investors and landlord algorithms relative to any reasonable estimate of their effect on the market.

As I mentioned in the previous post, builder consolidation is a common explanation for reduced construction. Were economists and policymakers demanding more production when the industry was consolidating? Absolutely not. Ben Bernanke wrote in his memoir: “Builders would start construction on only about 600,000 homes in 2011, compared to more than 2 million in 2005. To some extent, that drop represented the flip side of the pre-crisis boom. Too many houses had been built, and now the excess supply was being worked off.” Remember, as I wrote yesterday, by the time prices bottomed out, cumulative housing production was lower than at any time since World War II by any measure, by a long shot. And Bernanke thought that was just the way it needed to be. He reported it to Congress. He put it in his memoir. Did a single economist take issue with that?

Construction in 2011 should have been hundreds of thousands of units higher than it was. This was not the result of the homebuilders pushing back against public policy goals.

Most of the complaints about 2011 were and are fears about zero interest rates and quantitative easing causing overstimulus and inflation. Just about every day you can find an article somewhere that just presumes a “ZIRP” effect that created more activity than would have naturally occurred.

Public policy was biased toward stagnation, but it wasn’t biased enough toward stagnation to be popular.

The housing market in 2011 was where it was because that’s where we wanted it to be. That’s where we forced it to be. Bernanke was benchmarking to scorched earth.

How about the lenders? Did they get cold feet? Maybe they were too scared to originate mortgages with $200 payments for families with $35,000 incomes.

Figure 1

First, note, the tight lending came first. In 2006, the Fed issued the “Interagency Guidance on Nontraditional Mortgage Product Risks” and within months the the private securitization market was gone. That’s all well and good. Home prices in ZIP code 30344 hadn’t risen particularly much during the private subprime boom, and they didn’t decline much when it was killed. This is common across the country.

This is one reason why the extreme tightening of prime lending happened in 2008. The effects of the subprime boom were overestimated. When its demise didn’t lead to collapse (Bernanke had been right about that!), we pulled on other levels until a collapse happened.

It could be that we collectively insisted on collapse or it could be that we were benchmarking to scorched earth, so that collapse was bound to happen because there was no motivation to turn to the natural policy responses that would normally avoid a scorched earth. There’s a bit of both.

It’s sort of like if you try to play racquetball with one of the walls missing. Even if you try to keep the ball in play, eventually it’s going to leave the court. The fact that even today 2012 is so commonly treated as a benchmark, and is still defended as normal, natural, and unsurprising is evidence of that case. Scorched earth was inevitable because if and when it happened, the universal response was, “See! I knew it!”

Figure 2

Again, think back to Bernanke’s claim in 2007 that the subprime fallout was contained. Universally, the reaction to his statement isn’t to say that he could have or should have guided the economy to a better outcome. The reaction is that he was wrong in 2007 because the crisis was already inevitable by 2007.

On the racquetball court of our economy, we removed the wall labelled “scorched earth” and so scorched earth was inevitable.

The Truth in Lending Act was updated several times from late 2007 on. Do you think that those changes were meant to make mortgage lending easier or harder?

The average credit score on new mortgages, both broadly and at the federal agencies, tightened across 2008. Homes in ZIP code 30344 were still above $100,000 when the tightening happened. By 2008, the federal agencies were basically the market. By September they were under direct federal management. In 2009, the average price of homes that got Fannie Mae mortgages was 60% higher than the average price of homes that had received Fannie Mae mortgages in earlier years, before the tightening. Fannie Mae became a 30022 lender, and ceased being a 30344 lender. The losses in ZIP code 30344 followed that change.

In fact, coincidentally, the average value of homes that received Fannie Mae mortgages before 2008 was roughly the average home price in Atlanta in Figure 2. By 2009, the average value of homes getting Fannie Mae mortgages was roughly the average home price in the richer ZIP code 30022. Fannie Mae became a 30022 lender, and ceased being a 30344 lender - literally.

Lenders didn’t get cold feet because properties had lost value. Properties lost value after the lending stopped.

In 2010, Dodd-Frank was passed. Remind me. When Dodd-Frank was being debated, was Congress discussing how to encourage more lending so that home prices in ZIP codes like 30344 could recover from $75,000 back to $125,000? Then the Consumer Finance Protection Bureau was added to the list of overseers. Again, remind me, what was their position on lending standards? Were they trying to bring back mortgages to 30344? Were they trying to encourage a return of lending or were they trying to “protect” borrowers from those $200 mortgage payments?

In October 2011, “Occupy Wall Street” erupted. Surely they must have been angry about all that lost wealth in 30344. Surely with that movement’s concern for the working class, they were marching on Wall Street to open up the bank coffers again and increase mortgage lending to 30344. Right? Right?!

In 2014, Elizabeth Warren asked “Why aren’t any bankers in jail?” Was she mad about the great financial losses for the working class because the banks wouldn’t issue $200 mortgages on $700 rental homes?

Moral panics aren’t subtle and neither is the evidence. When you add the “bull” variable to your china shop model, it brings tremendous clarity to the questions at hand where nothing but confusion could have possibly reigned before.

As one of the coauthors of Dodd-Frank said, “Government is simply the name we give to the things we choose to do together.” Like decimating 30344.

To make the average home value in ZIP code 30344 $50,000, you need state capacity. You need police and jails. And, even then, they are only going to stay $50,000 temporarily, even if the Ptolemaists in finance and economics insist on benchmarking to it.