I understand how the Federal Reserve causes recessions. What I don’t understand is why this recession manifested itself in the housing market specifically, as opposed to any other sector of the economy.
What sectors have been hit first in previous recessions?
Before someone replies with Fannie and Freddie and the CRA, I found this
interesting article. Particularly:
"
From the supply-side Republican establishment who until 2007 and in some cases well into 2008 denied the existence of any serious problems the blame is cast on Fannie Mae and Freddie Mac and the Community Reinvestment Act (CRA). Despite having been so wrong, they are closer to the truth than other deniers. Surely the fear of being accused of violating the CRA made some lenders more willing to lend to some low-income and minority households that really weren’t credit worthy. And surely, the role of Fannie and Freddie in buying up many of the mortgage-backed securities and then passing them on with their guarantees helped increase such lending.
But there is little reason to believe that either of those factors contributed significantly to the crisis. After all, both Fannie and Freddie and the CRA have existed for decades without causing anything similar. And most subprime loans were issued by institutions not covered by the CRA, and the act itself isn’t really that draconian since it says that lenders aren’t compelled to make loans that are likely to be unprofitable. Similarly, lending not covered by Fannie or Freddie also expanded rapidly during the bubble."
The idea that the CRA “isn’t really that draconian” is kind of laughable. How about I make you collect data on the number of ethnic minorities who are vendors, customers and employees of yours and then publish it and let me know what your performance matrices start to capture.
One of the problems was all these bad loans in the Sand States (California, Arizona, Nevada, Florida) got bundled in with all the other mortgages as that was the only way to create an after-market for them. Since the various tranches of bundled loans became unbelievably complex, nobody really knows how much “bad” is mixed in with the “good.” Another problem was that when Maria the hotel maid in LA got a $200K loan, then John the insurance agent in Atlanta wanted a $400K loan, and a dozen mortgage brokers sprang up all around them to satisfy the need. After all, there’s big, fat Fannie and Freddie waiting around to soak up all this crap, forcing everybody else to loosen their standards as well to avoid losing market share.
To answer your particular question, the new money went, like all capital, to the sector that seemingly offered the greatest ROI.
The housing boom correlated with a huge push by Congress and the Bush administration to increase rates of minority home-ownership. Houses were being listed at $300K in Compton, of all places. Prior to this big push by government, stocks looked like a better place for the new money to go.
The CRA was pretty old, but it DID contribute. Fannie and Freddie I cast less blame upon, because they really replaced the government-backed S&L’s as the primary mortgage buyers. Of course, the S&L bailout had clear moral hazard implications on Fannie and Freddie, who was in the same market and same position to privitize gains and socialize losses. These things alone, however, could not cause the bubble we got.
I believe the housing bubble started in 1997, when capital gains taxes were excluded up to $250,000 on owner-occupied housing. This occurred around the same time as the upward movement in house prices. Of course, the NASDAQ bubble appeared more profitable at the time…until it popped. Then the FED put things in overdrive, and we know the rest.
So I blame the initial cap gains tax exclusion as the initial event that pushed prices up, and the easy credit from the FED that kept inflating the bubble.
Actually, Fannie increased the loan-to-value ratio on low-income loans to 103% in early 2003. I was told by a lender at a holiday party that they eventually raised it to 110%, although I haven’t verified this. The combination of the CRA and the fact that, not only could buyers now get a home for no money down, but they were actually paid at the closing table, contributed to crisis.