Book Review, The Housing Boom and Bust

Book Review, The Housing Boom and Bust, by Thomas Sowell. Basic Books, 2009. 148pp plus references and index.

This book is an attempt to clear up the misinformation about the causes of our current economic problems. I believe that attempt will be successful if people will actually read the book and consider the information it contains. Unfortunately too many people have spent too much time blaming whoever they don't like for that problem. That only keeps the public ignorant of the real causes thus allowing the probability of a repeat.

“There was no single, dramatic event that set this off ... A whole series of very questionable decisions by many people, in many places, over a period of years, built up the pressures that led to a sudden collapse of the housing market and of financial institutions that began to fall like dominoes as a result of investing in securities based on housing prices.” (Preface to the book)

Before we can understand the bust we must understand why we had the boom and inflated prices which set the stage for that bust. Sowell points out that the boom (and subsequent bust) were essentially local phenomena, but that new means of financing housing set the stage for the problem to explode to national and even international scope. The boom in housing prices was limited to a few areas, especially coastal California. Those places have strict laws about how land can be used. Restrictions in the name of things like livability, green space, etc. drove up the price of land and of the buildings placed on that land. That drove prices up for everyone, but the poor were especially hard hit. Blacks and Hispanics suffered more than Whites (though Whites suffered more than Orientals). The result was a statistical imbalance that led to accusations of discrimination. Meanwhile cities like Houston and Dallas lacked such restrictions and therefore did not participate in the boom. They were also less affected by the subsequent bust.

These legally-driven price increases created pressure for government to do something, a government solution to a government-created problem. Of course the solution was to attack not the root of the problem but its symptoms. If Blacks were turned down for mortgages more often than Whites, government would force lenders to reduce standards. Credit requirements were lowered, interest only loans approved, balloon mortgages issued. That did allow more minorities to obtain mortgages though the numbers who subsequently defaulted make one wonder how helpful those mortgages really were.

In addition, once the flood gates are opened you can't control where the water goes. The lower standards facilitated speculators “flipping” houses as well as the purchase of million dollar homes with “liar loans.” In addition, with inflating prices, many people started to treat their homes as ATMs, taking out second and even third mortgages. The bubble was growing.

Freddie Mac and Fannie Mae (the organizations I call the FM twins) compounded that problem by encouraging risky mortgages. There were plenty of warnings but congress, especially Barney Frank and Christopher Dodd, made sure that those institutions were not hampered in their encouragement of marginal loans. They made soundness and security secondary to what they called affordable housing goals. The Office of Federal Housing Enterprise Oversight (OFHEO, the agency charged with overseeing the FM twins) found accounting irregularities in the books. Then Barney Frank took action. He excoriated ODHEO and demanded a leadership change there.

The private sector also contributed to the growing bubble as new securities based on those risky loans hit the market. Rating agencies had no experience with such securities and ignored the risky nature of the loans behind the securities. That set the stage for those securities to spread throughout the country and even abroad and eventually create a world-wide problem.

Political pressure to provide mortgages to minorities, bad accounting at the FM twins, risky securities and other factors inflated the bubble. Price increases attracted more people to buy and to take out second mortgages. Risky loans attracted more and more people who wanted houses but lacked the financial acumen to judge the risks to themselves. As the bubble continued to inflate, it was inevitable that it would burst.

Eventually, borrowers started getting behind on payments. Foreclosures led to price collapse. The price increase had fed on itself before, now the declining prices fed on themselves. Even many who could afford their payments found their homes “under water,” they owed more than the value of the property. Some of those gave in to the temptation to just let the bank have the house. Banks, not being in the business of renting or managing houses, sold them for what they could get. Prices dropped again and the bust was on.

All those defaults cost banks, the FM twins, and buyers of the securities. That made money for mortgages less available, driving prices down farther and harming other parts of the economy. Because the securities and lenders were widely dispersed, the entire country and much of the rest of the world was affected. Money to purchase other goods was in short supply and people lost their jobs. That further depressed the economy. Mostly (but not totally of course) because of the housing crisis we still face economic problems.

Sowell's last chapter starts with the quote, “Bad ages to live through are good ages to learn from.” He indicates that we should learn from this crisis and stop government meddling in the economy. In particular we should never pressure lenders to make risky mortgages for any reason. I'm not optimistic on that score.

This is a useful book. My only criticism, and it's a big one, is that it follows the modern abomination of not footnoting references. In fact it is worse than most in that regard. The references in the back are tied only to chapter and not to page number. That makes it difficult for the reader to follow up on those references.