Root Causes
Some of those on the political Right are casting about for "market friendly" explanations of our Current Kerfuffle, because, of course, we know that the Giant Invisible Hand can never be wrong. The first such explanation, courtesy of Alanesq, is proferred by economics prof Stan Liebowitz, is that government regulation is the culprit--regulation of the late 1980s, culminating in a 1993 decision by the Boston Fed that banks must "Adopt "relaxed lending standards" or risk being labeled as racists, and face serious penalties under the federal Community Reinvestment Act. "

That's a bit oversimplified. First, Liebowitz himself conflates in the linked article disclosure requirements with substantive regulation:

The shift began in 1989, when Congress amended the Home Mortgage Disclosure Act to force banks to collect racial data on mortgage applicants. By 1991, critics were using that data to paint lenders as racist by showing that minority applicants were approved at far lower rates. Banks were "Shamed By Publicity," as one 1993 New York Times headline put it. </p>

In fact, they found a racial disparity only by ignoring relevant data on applicants' ability to make mortgage payments - such as their assets and credit history.

But the political pressure was intense - with few in politics or media eager to speak the truth. And then, in 1992, came a study from four researchers at the Boston Fed, which seemed to bear out the critics' contentions.

That study was, in fact, based on quite flawed data - but the authors' political, media and academic protectors stifled most serious criticism, smearing the reputation of one whistleblower and allowing the Boston authors to avoid answering serious academic challenges (mine included) to their work. Other studies with different conclusions were ignored.

The very next year, the Boston Fed announced new requirements for banks - rules that have now turned out to be monumentally catastrophic: Adopt "relaxed lending standards" or risk being labeled as racists, and face serious penalties under the federal Community Reinvestment Act.

First, while certain data flaws in the Boston Fed study have been found, the overall results--that minority applicants were declined where similarly situated, including objective measurements of creditworthiness, white applicants were granted loans, have been largely vindicated. (Anecdotally, I could give you some horror stories about this, too--I had some personal involvement with some redlining and discrimination in lending/housing cases, and some of what I saw, even post-2000, was startling).

So Professor Liebowitz's notion that "those pesky libruls" bollixed up a good situation by requiring statistics to be kept regarding discrimination in lending, which did not exist, well--no sale. Does the regulation require acceptance of poor credit risks, simply because of ethnicity? Well, no. Nor, even in the Clinton years, did the Community Reinvestment Act ("CRA") so loathed by Liebowitz, require any institution to take on credit risks as measured by objective standards; in fact an April 2000 Treasury Department Report om the CRA states unequivocally at pp. 18-19 that lending by CRA-covered institutions to lower and middle income borrowers ("LMI" loans) was finding a new competitor in the years since the amendment of the CRA: the "subprime lending" institutions, to which CRA covered entities were losing market share in the study period. In other words, subprime lending grew alongside, not as a result of, the CRA. (As Jed Bartlet might say, Professor Liebowitz falls into the fallacy of post hoc, ergo propter hoc).

What about law professor Richard Epstein's broadside against regulation, also referenced by Alan? Sadly, the piece is pure argument by assertion--from pure Libertarian principles. As a matter of logic, it's not wrong, per se--it just presumes a pure system of the market shaking out, and Pareto optimum being found--a society filled with rational, profit-maximizing individuals, free from emotions. Vulcans, in short. Who may in fact profit from Professor Epstein's scholastic logic, every bit as admirable as deducing the numbers of angels at a cotillion on the head of a pin, but remote to concerns here on earth. See how well it all works out:



So what is the root cause of of the Current Kerfuffle?

Well, I'm no economist, but, at the risk of looking foolish, I'll hazard a sketch, subject to correction. Here's my entirely amateur view:

1. A culture of debt, at all levels. Government as well as corporate, individual and family. We were all spending well beyond our means, and mortgaging the future for our present desires. This includes the US floating the Iraq War on debt, leaving its cost out of the budget and therefore not counting its expenses in the "deficit." Banks fostered it; consumers, for a wide variety of reasons, bought into it. I hate to agree with David Brooks, but I do. Eventually, the bill comes due. Just my luck, it happened on my watch.

2. Seven years of income stagnation for the middle class, during a period (2000-2007) which was, by other measures, considered an expansion--even a boom. (More details resulting in a slight downtick in real median family income numbers. As the Times notes, "[t]his has never happened before, at least not for as long as the government has been keeping records. In every other expansion since World War II, the buying power of most American families grew while the economy did. You can think of this as the most basic test of an economy’s health: does it produce ever-rising living standards for its citizens?" Not in the Bush years, it didn't. Moreover, as income stagnated, the risks posed by illness and the skyrocketing cost of maintaining insurance. Increasing demands on American workers without increasing participation or security may sound good to the corporate class--get more for less--but a successful parasite does not kill its host.

3. Securitization of mortgages, with the result that loan documents were lost, in many cases there is nobody to call or write to seek loss mitigation. The note holders often just don't think retail--and so a salvageable loan drifts to foreclosure, and maximization not of profit, but of loss, for all concerned.

4. Greed and risky investment. Here's where Fannie and Freddie and Bear and Lehman and AIG all had it coming.

Any other thoughts?