BY mENCKEN'S GHOST | FEBRUARY 1, 2012
The root cause of the housing bubble and collapse
Once again, the libertarian narrative is proved right
In a continuation of a sorry tradition of badly biased thinking and superficial reporting, it appears that the narratives from the ideological media about the housing collapse and corresponding financial meltdown have been incomplete.
From the left we got the narrative that the causes were big bad banks, evil capitalism, and greed (but not the greed of common folk who bought houses they couldn’t afford because they thought they were going to make a killing in housing and didn’t bother doing ten minutes of Internet research on historic home prices before making the biggest purchase of their life).
From the right we got the narrative that the causes were the Federal Reserve’s easy money, the government’s housing policy of forcing banks to give mortgages to numbskulls, the government giving an oligopoly to three rating agencies that had identical views of the world, and the government-sponsored enterprise and poster child for crony capitalism, Fannie Mae, being the first to bundle mortgages into bonds that could be sold around the world to widows and pension funds.
All of these were contributing factors, so there is some truth in the left-right narratives. But a new book makes a compelling case that the root cause was none of the above. It confirms the longstanding libertarian narrative that when markets go haywire in a big way, the government is invariably the culprit.
The book is Engineering the Financial Crisis, by Jeffrey Friedman and Wladimir Kraus. It explains why a housing bubble had formed not just in the USA but also in Iceland, Ireland, Spain, and other countries.
The reason was the Basel banking regulations of 1988, named after the city in Switzerland where representatives of most developed countries meet to agree on conventions on a variety of worldwide issues. In an example of group hubris, the representatives set capital requirements for banks, as if a small group of know-nothing know-it-alls knew what was best for banks around the world.
The problem was that the geniuses set lower capital requirements if banks held highly rated mortgage-backed securities. Just like a gambler who bought a Las Vegas house on the assumption that housing was a sure bet, the Basel bunch gambled the world economy on the assumption that housing was a sure bet, despite the ample historic evidence that it was not.
Counter to the conventional wisdom that banks had been unregulated or had skirted regulations, they actually had complied with the Basel regulations in a big way. They bought a lot of mortgage “assets,” which in turn lowered their capital requirements and funneled a lot of money into housing, which in turn fueled the housing bubble. What might have been a small localized problem in the absence of the Basel regulations became a large international problem.
It was as if a Basel group had come up with a requirement that basil be used in all menu items in all restaurants, only to find out too late that basil was a carcinogen (it isn’t). A problem that would have been limited to eaters of Italian food would have become a problem for everyone.
There is a lesson in this that will be ignored by mostly everyone but libertarians, who, as another left-right narrative goes, are nothing but a bunch of anti-government crackpots.
Mencken’s Ghost is the nom de plume of an Arizona writer who can be reached at email@example.com or firstname.lastname@example.org.