Campbell and Hercowitz, which I found from a Krugman link, write:
The Monetary Control and the Garn-St.Germain Acts of 1980 and 1982 allowed market innovations that dramatically reduced these equity requirements: Greater access to sub-prime mortgages, mortgage refinancing, and home equity loans, reduced effective down payments and increased effective repayment periods. More important for the short run, it enabled households to cash-out previously accumulated home equity, which in 1982 amounted to 71 percent of GDP. This was followed by a huge wave of household borrowing.
Maybe I’ll deal with the 1980 Act another time. but on Garn-St. Germain those claims are not easy for me to verify. (Their paper is a theory paper and offers no further evidence or narrative. Here is also an earlier Krugman piece of relevance.)
Here is one summary of what the Garn-St. Germain Act did. Maybe this summary is incomplete but it is hard to see how Garn-St. Germain is responsible for either the current crisis or for the more general decline in national savings rates. The closest I come to finding a relevant passage is:
(7) the act preempted state restrictions on enforcement by lenders of
due-on-sale clauses in most mortgages for a three year period ending
October 15, 1985, and authorized state chartered lenders to offer the
same kinds of alternative mortgages permitted nationally chartered
financial institutions.
Over time most institutions moved away from the state charter and those mortgages already were legal at the national level.
Or try this summary of the Act, from a book. Again, the connection is hard to see. In fact Garn-St. Germain freed up S&Ls from investing so much in home mortgages. You can blame that (partially) for the S&L crisis, but the current real estate bubble? Or the general rise in indebtedness which started in the 1980s?
Here’s a recent empirical paper on the rise in U.S. household indebtedness. Not surprisingly, it emphasizes demographic factors as the main causes. pp.18-19 discuss financial innovation as a contributing cause but there is not a peep about Garn-St. Germain. The authors do cite a paper by Wendy Edelberg, who pinpoints some of these innovations as coming in the mid-1990s and resulting from greater risk-based pricing of loans.
On mortgages, a lot of the relevant deregulation occurred at the state level or the problem was the simple lack of enforcement of anti-fraud laws. Government-promoted low or zero down payment mortgages date back at least to Section 235 of HUD, from 1968 (a disaster, by the way) and Garn-St. Germain is hardly a turning point in that history.
Maybe I’m wrong about Garn-St. Germain. If so, I’d like to learn how and I am asking you, readers, to set me straight.
Like most of the commenters on this site, i have spent a significant amount of time over the last 18 months pondering and researching the causes of the housing boom & bust, and the ensuing financial crisis. Always from the point of view – was it mainly the government or instead the financial system & deregulation that was to blame?
In this latest post from Tyler, we have yet another lead to potentially follow (Monetary Control and the Garn-St.Germain Acts). Are we any closer to solving the mystery of the crisis than we were 12 months ago?
I’m starting to wonder if the whole government versus free markets thing is a false dichotomy. Maybe the housing boom was really just a cultural fad, or a meme that simply fed on itself until disaster struck. Given the context of a quarter-century decline in savings rates that is little understood, and certainly contradicts the accepted consumption function theories, the idea that the housing boom was mainly caused by sociological factors would make some sense.
Maybe the whole episode was exacerbated by economic factors, but wasn’t primarily due to economic factors at all. To solve the mystery, we may have to search wider than has so far been the case.
The issue is that the toxic combination of rapidly increasing financial innovation in the context of deregulation (Garn St. Germain, TRA of 86, capital gains repeal of 1997, etc.) and a regulatory posture of preemption and one that could not keep up with innovation that made homes much more liquid. Combine that with progressively lower rates and it made real estate assets more valuable and a positive feedback loop ensued.
Sam gets pretty close to the proximate cause. Maybe even as close as one can get with our limited knowledge.
In the last 40 years we have seen a process where home ownership has evolved from the satisfaction of a basic need (and need I say an emblem of being a member of the middle class) to an “asset” not much different from shares or bonds. IE, houses became an investment with the potential of a large upside return. This evolution has been driven by two complementary changes in the economy. First, inflation that provides “gains” in value and second, a reduction in the friction of housing transactions.
In the past, buying and selling homes was constrained by complications in the sale and financing. It was a sticky process and people only undertook it when they had a need. Work transfers, new additions to the family, changing circumstances, all these generated a perceived requirement for newer, bigger or even just different houses. In general, people did not sell their house and buy a different house because of an increase in the value of the home. The friction made capturing potential gains costly and inconvenient. Even at a minimum you do have to physically move out of one house and into another at some cost in time and money.
Government and the financial markets have cooperated to reduce the friction to very low levels. In some respects houses have become nothing more than a financial asset to be bought and sold for a profit. Not surprisingly, a whole industry has grown up around the trading of this asset. When stocks could be bought under 10% margin rules in the 1920s, stock trading became a bubble. When houses can be bought and sold for little or no money down, and inflation + demand drives house prices to a bubble, the result is not surprising.
What I find odd is that so many people could have thought that house prices will never go down. Is my personal experience unique? I remember my parents being forced to eat a $5000 loss on a home sale in 1974. I also lived in Dallas during the S&L debacle of the 1980s. I’ve seen home prices go up and down. I can’t be the only one.
If you want to blame a politician blame President Carter. His stagflation led to financial firms seeking ways to avoid the risk in long term loans when extreme events occur.
The Reagan path was to encourage markets to find ways to manage risks.
I suggest Mr Krugman talk to President Clinton and Mr Robert Rubin about federal oversight of derivatives.
I’m tempted to write a long post about this, but I’ll be brief and hope that I still make some sense. Between 1985 and 1990, in CA, there was a housing bubble. It does track with the S & L Crisis to some extent. It also could have been caused by the cap on prop taxes, etc. I bought my house 2 years after it burst. Unfortunately, prices declined for 3 more years. In any case, I wasn’t bothered, because it was a long-term investment. Indeed, the conversation was about demographics. Many people were coming to my area, and my house would do well because it was in a good location in which it was very hard to build.
During this crisis, all I heard was talk about retirement, not demographics. The young people buying around me did not want to pay rent. Period. It was mug’s game. In other words, the fear of being priced out of a home as an asset for retirement was the big draw. All that anyone had to do to understand how correct this view had turned out to be was to see who they were buying their houses from. Retirees moving elsewhere being a main source of sellers.
I do believe that govt guarantees were the main cause of this crisis. In that sense, I believe that the S & L Crisis was very important. But the current bubble was caused by a panic about retirement. People were terrified of being left out and left behind. It was worth any gamble.
If you look at the two bubbles, the last one looks pretty normal. If you compare it with this one, the difference is shocking. It’s true that we made great strides towards this current crises in the 1980s. But we made a very large number of mistakes since then that have made this crisis the beast that it is.
How anyone could miss the fact that we were deregulating while increasing the amount and strength of govt guarantees is truly frightening. That was our system. It still is.
I agree with mulp, I think. The introduction of things like Money Market accounts were having a substantial drain on firms (S&L’s) restricted from paying market rates of returns on interest bearing accounts.
It is hard to imagine that Krugman does not accept the market reality that many financial firms could no longer compete with innovations in the market place given the regulatory restraints they were facing. The marketplace, the rules of the game, had already changed by the time the above mentioned bills were passed.
The choice was to stop market innovations and allow regulated firms some monopoly profits and protection. Reagan encouraged market innovations and competition. Krugman seems to prefer government monopolies, without regard to the deadweight losses of such a system
A good book on the causes of the recent Housing Bubble is “Our Lot” by Alyssa Katz, a liberal journalist. She’s especially good on mistakes made by the Clinton Administration. I think she should have been much harder on the Bush Administration, but, she appears to have had better sources on the left than on the right. My review summarizes her indictment of the left’s role:
http://www.vdare.com/Sailer/090830_homeownership.htm
Steve, the review and the quoted passages it contains do not inspire confidence. To give a few examples:
It quotes this passage: “By 1993, [Fannie Mae] made a deal with [Mozilo’s] Countrywide to buy $2.5 billion in loans for lower-income and minority borrowers.” Yet in 1990, Fannie Mae’s retained portfolio of mortgages was already about $200 billion according to the OFHEO. The $2.5 billion number is quoted as if it is significant but it is less than 2% of the agency’s loan portfolio.
Additionally, the Countrywide reference misses the fact that while Fannie Mae did good business with Countrywide for a long time, its purchasing of Countrywide loans (primarily prime mortgages) peaked in 2002 and then declined so that by 2005 it was only buying 30% of prime mortgages and less than 25% of overall loans originated by Countrywide. The market was sucking up the great majority of Countrywide loans.
Finally, it has a clear factual error in claiming Lewis Ranieri invented mortgage-backed securities in 1983. This is false as the first private MBSs were developed in 1977. GSE-issued MBSs started even earlier.
These were problems I noticed just at first glance but it inclines me to not bump this book up on my reading list.
The S&L’s business was based on fractional reserve money market deposit accounts, guaranteed by the FSLIC. They were not borrowing short and lending long in the way an investment bank does. They were creating money out of thin air in the form of loans, by lending out deposits. Such a scheme is inherently unstable, especially when backed by a public guarantee, and many would say it is fraudulent. Why then do so many free marketeers call it “deregulation”? As if encouraging Ponzi schemes with taxpayers’ backing had anything to do with free markets… Krugman rightly makes fun of the advocates of free markets who are allergic to the R word, but don’t realize that there is no such thing as a free market in privileges and special guarantees.
I have been researching this topic heavily for some time and I feel that if we are to point fingers at any “deregualtion” in the banking industry it should be at Gramm-Leach-Bliley Act. this effectively demolished the Glass-Steagall Act of 1933,Gramm-Leach-Bliley Act was also signed into law by Krugman’s most loved Clinton. Carter, and Reagan opened the flood gates, but clinton put the nail in the coffin
Comments on this entry are closed.