I agree with many of Brad’s specific points, but he is underestimating how simple and direct my initial argument was. I explicitly wrote that the agencies did not cause the crisis. The agencies, along with several other government policies, did increase the size and leverage of the real estate sector, as well as parts of the financial sector, namely those dealing with securitization. That made the blow-up — as caused by other factors — worse than it otherwise would have been. And that’s the fourth flavor of the crisis. Here is a simple parallel argument to my case on the agencies:
1. The U.S. government put a lot of additional people into its Embassy in Ruritania.
2. Terrorists blew up the Embassy with a really big bomb.
3. Because of the U.S. government’s previous staffing policy, the tragedy was worse than it otherwise would have been.
4. The U.S. government did not cause those deaths, but #3 is still true. And since Ruritania was a dangerous country with lax security (analogous to the financial sector! analogous to the poor decisions of low income borrowers!), #1 was a very unwise policy.
The early part of Brad’s post doesn’t counter that argument. Both Brad and Matt are trying to semantically rope off some pre-2008 events and call them “not part of the crisis,” or rather only a part of Brad’s Crisis1. They are neglecting Fischer Black’s point that the longer-run causes of underlying economic vulnerability are important and it is not just about the shocks themselves.
Brad’s fifth point is more directly on my thesis:
Fannie and Freddie did not make the crisis worse but rather made it better. The really bad parts of the crisis–crisis2 and then the subsequent failures of political economy that have given us crisis3 started with the uncontrolled bankruptcy of Lehmann Brothers, in which it was all of a sudden no longer clear where the government stood and which financial assets had value. But people knew one thing at least: they knew that the government stood behind Fannie and Freddie. If every Fannie and Freddie bond and mortgage guarantee had suddenly dropped to the quality of Lehmann Brothers’ liabilities–as would have happened if they had not been GSE’s–things would have been much much worse. Crisis1 phenomena encourage overleverage during the boom, but they are a fountain of confidence and stability and make crisis2 much less severe when the crunch comes.
I agree with the specific claims but not with the general conclusion as embodied in the first sentence. Had we abolished the agencies in, say 2008, matters would have been much worse, as Brad is suggesting. It does not rebut my claim that never having created the agencies would have led to a smaller blow-up in the first place. Imagine that 2006 rolls around, full of financial shenanigans and bad derivatives trading, but homeownership rates had been lower, credit had been tighter, and a lot more people had had twenty percent down. 2008 would not have been nearly so bad. Work-outs would have been easier too. On this entire question, the time horizon really matters.
In similar fashion the mortgage interest deduction made matters worse, though again without causing the crisis in any active or temporally-specific sense.
Here is Arnold Kling and his reply. To pursue the Embassy analogy, I would say that Brad is simply claiming that the “added employees” had a lower than average fatality rate. Maybe so, but it was still a mistake to stick them where we did, when we did. Furthermore a crisis is not just about loan default. What about the wealthy family that bought extra homes and flipped them, ended up getting caught by the price crunch, never defaulted but now has to cut back significantly on consumption? Default rates won’t give you the true measure of the malinvestments and AD problems caused by the mortgage agencies. These days, household leverage is a problem per se.