Monthly Archives: April 2015

Housing Bubble Redux

The root cause of the financial crisis was the housing bubble, going back to Clinton’s repeal of Glass Steagall and looting at FNMA, but – what was the trigger? Understanding the chain of events helps us to evaluate the policy response, and also suggests what to look for the next time.

The nadir, as everyone knows, was the S&P 500 touching 666 in March 2009, before its rescue by Chairman Bernanke. Lehman Brothers had failed in September 2008, precipitating the crash in October, but the market had peaked a full year earlier.

Crash Chart

The NBER identified December 2007 as the recession’s start, and it’s not surprising that the market peaked a few months ahead. It is generally a leading indicator for the economy. Mortgage lending, with its new ecosystem of boiler rooms and dodgy paper, had been shaking out all year. This is variously attributed to a dip in housing prices, declining demand for mortgage backed securities, and rising mortgage interest rates.

… the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not – FCIC

So, among the proximate causes, which was the trigger? Did the Fed pop the bubble by raising rates? Probably not. Fed funds had ramped steadily throughout the bubble, but had been flat at 5.25% since July 2006. That’s an indication the Fed was trying not to spoil the party.

Housing Bubble

Mortgage rates peaked in July 2006 and so, roughly, did the Case-Shiller home price index. The chart shows rates following the price trend up, and then following it back down.

It’s reasonable to suppose that the recession started and then people couldn’t make their mortgage payments, but the timing doesn’t support that. The recession was not a cause of the bust, nor was it obviously an effect. Delinquent mortgage payments, especially for Miami condos, had been on the rise throughout 2006. This chart is from the Financial Crisis Inquiry Commission.


These were flippers running out of people to flip to, like punters at the end of a chain letter, plus some poor fools actually occupying the homes and trying to make the payments. The trough of the rate trend was around 2003. If you had signed an ARM then, your interest rate had just about doubled by 2006.

  • Delinquencies start to rise in 2006.
  • Home prices peak, June 2006.
  • Mortgage rates peak, July 2006.
  • Mortgage bonds downgraded, July 2007.
  • Stock market peaks, October 2007.
  • Recession starts, December 2007.
  • Stock market crashes, October 2008.

Right up until the crash, this reads like a normal business cycle recession. David Stockman argues that main street banks were never in danger from the housing market, because they had been run out of it by big investment banks. On this reasoning, policies like TARP, ARRA, and QE were a response to Wall Street, not the recession.

If you had been alert, you could have predicted when the housing bubble would burst simply by looking at the timing of the 5-year ARMs. Stanley Druckenmiller knew that risk premiums were too low in 2004, but it took him another a year to identify the housing bubble.

When you have zero money for so long, the marginal benefits you get through consumption greatly diminish, but there’s one thing that doesn’t diminish, which is unintended consequences.

We are in a similar phase now. Everyone knows that six years of ZIRP have planted a bomb somewhere in the economy, but no one knows for sure where it is.


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Zhiguo Pingtianxia

Lee Kuan Yew, the father of Singapore, was cremated on Sunday. What Americans know of Mr. Lee from the news is that he took a small Asian country from kampong to skyscrapers in one generation – with an asterisk for being a dictator.

Mr. Lee was a master of so-called “Asian values,” in which the good of society takes precedence over the rights of the individual and citizens cede some autonomy in return for paternalistic rule.

Jeremiah, who has been to Singapore, was amused by the sour grapes subtext. Singapore’s GDP per capita is higher than ours, the streets are totally safe, and their subway stations are cleaner than our hospitals. In this post, however, we’ll try to be objective. We do this using two archived articles from Foreign Affairs, one for and one against Lee’s ideas.


The ever quotable Mr. Lee makes his case in this interview, despite skeptical framing from the interviewer. If you want to know where America went wrong, this is a good place to start. Here is Lee’s description of Asian values:

We were fortunate we had this cultural backdrop, the belief in thrift, hard work, filial piety and loyalty in the extended family, and, most of all, the respect for scholarship and learning.

The rebuttal from Kim Dae Jung argues that democracy, not culture, is a more reliable source of good government. Alas, the intervening twenty years have not been kind to Western democracy. We have seen our economy looted by various special interests, each having captured the agency that was supposed to be its supervisor, from the SEC to the FDA.

Kim writes that “Asian values” are self-serving, a smokescreen for authoritarianism. Today, the con job seems to be on other side. We hear about how exceptional our freedoms are, while the NSA reads our email and the IRS persecutes political opponents.

We no longer have the moral authority – as Kim did, writing in 1994 – to hold other governments up to our standard of democracy. We should be pondering how to remove the mote from our own eye, as Jeremiah does here. Therefore, we were intrigued by Lee’s idea that “one man, one vote,” might not be the answer.

We would have a better system if we gave every man over the age of 40 who has a family two votes because he’s likely to be more careful, voting also for his children.

This is a perfect example of Lee’s pragmatism – his willingness to consider how an idea will work in practice, whether or not it’s defensible in theory. Half a million people visited Lee’s coffin, waiting up to ten hours in line. That’s about ten percent of the population. He must have done something right.

See also: Asian Values

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