The housing boom and bust, part 2

by Russ Roberts on April 13, 2011

in Government Intervention, Housing, Prices, Uncategorized

In this post, I suggested that the spike in housing prices starting in 1997

was due more to government housing policy and less to animal spirits or a self-fulfilling bubble that somehow got started out of the blue.

The picture is from Barry Ritholtz’s blog, The Big Picture.

Barry responds in the comments:

Be wary of squishy thinking.

While its easy to blame Uncle Sam, you need to show the data that supports that argument — so far, no one has successfully done that. NO ONE.

The much more persuasive case has been made that the combination of ultra low rates, shadow banking system, corrupt rating agencies, foolish lenders, irresponsible borrowers and dumb bond fund managers were the primary causes.

The DATA provides an overwhelming viewpoint of where the Housing boom and bust came from

Barry, I think you’re confusing the subprime crisis with the housing boom. They are related but they’re not the same thing. The Fed’s low interest rates between 2002 and 2004, for example, did have something to do with the subprime crisis. And artificially low interest rates did inflate the housing market generally. I don’t think they had much anything to do with housing prices in 1997. And yes, the shadow banking system had a lot to do with the run-up in prices after 2003 or s0. And yes, there were a lot of dumb, myopic lenders, borrowers and bond-fund managers. But why did they start getting dumb in 1997.

My other thought is that we don’t have particularly good models of bubbles, by definition. So when you say there no one has produced the data, I’m not sure what standard to use to evaluate it. What I think you really meant when you wrote that was that Fannie and Freddie and the CRA can’t explain why Bear Stearns and Lehman and a bunch of other cowboy waa-hoos went crazy on MBS. And you’re right. But that’s not all that I meant by government housing policy.

Here’s the outline of my narrative. Sure, it’s squishy in parts. All narratives are. Yours, too, I suspect, but I’ll let you make the call on that one.

The role of government in the housing market goes back decades to the deductibility of mortgage interest, FDIC insurance, and the creation of Fannie Mae. But those interventions were done a long time ago and they stayed in place with minor variations. They weren’t the cause of the crisis. You have to find a change in government policy. My narrative starts in the early 1990′s. Check out this article from 1992. (And don’t worry, even though I’m going to use the letters “CRA” in consecutive order in what follows, I don’t think the CRA is the main cause of the subprime crisis. I, like you, blame most of that on shadow banking. But the CRA has something to do with it…)

It’s about how ACORN and others used provisions of the CRA to get urban banks to make loans in neighborhoods that hadn’t been receiving loans:

The Philadelphia banks in the program, Mellon, Continental and Fidelity,, say their experience shows that a well-structured program can break even in the short run and promises intangible and financial gains over the long haul. The banks charge sufficient fees to cover costs and work hard to keep delinquencies and foreclosures low.

“These are not conventional loans and we make sure that we don’t lose money,” Mr. Desiderio said. “But they are totally beneficial to us because they improve our trade area. In the long run this will drop to the bottom line.”

Bankers believe that as poor neighborhoods stabilize, the entire region benefits, which affects a bank’s future profitability.

What is more, these mortgages help banks fulfill somewhat vague obligations of the Community Reinvestment Act of 1977, which requires banks to invest in communities that provide them with deposits.

It also talks about the role of Fannie and Freddie. Remember, this is 1992, right around the time HUD starts pushing Fannie and Freddie to buy more loans than they had bought before in poor neighborhoods.

But the mergers that have helped create the lending programs are also a cause of concern for some. LaVerne Butts, a Philadelphia Acorn official, fears that mega-mergers may leave the poor in the dust. “Where’s the accountability?” she asked. “We’re doing wonderful things, but we’re still swimming against the tide. Many of these banks still don’t view low- and moderate-income people as people. When they get so big, who do you lean on?” Aiming at Secondary Market

Yet at present, the three Philadelphia banks seem responsive. They have lobbied with Acorn in Washington to find ways to make it easier to package these mortgages and sell them in the secondary market. This would reduce the banks’ risk and free up more money to lend.

The biggest buyer of mortgages is the Federal National Mortgage Association, known as Fannie Mae, which resells them to investors. But Fannie Mae has been reluctant to buy such unconventional mortgages. Acorn hopes that large commitments like that of Nationsbank will help bring pressure on Fannie Mae. Already, Nationsbank is talking about joining with Acorn’s Washington lobby.

Fannie was reluctant, but they got over it. They made an enormous amount of money when they were “forced” to lower their standards. They weren’t really forced. They liked being thrown into the briar patch.

Remember, this is 1992. In 1995, the CRA got revised and was made tougher. Fannie and Freddie’s were required to buy more mortgages made to low-income buyers. In 1995, President Clinton announced the 1996 Home Ownership Strategy. Read about it here. Go to the end of the document. It details all the activities that would increase home ownership.

And it worked. Or something did. Correlation is not causation. The fact that home ownership rates started to rise in 1995 doesn’t mean the policy worked. But that was the goal of the policy and the stated activities related to that goal (Making Financing More Available, Affordable, and Flexible) would increase home ownership. Of course, you have to look at the data. You have to show that financing did become more available, affordable, and flexible. This 2001 paper by Josh Rosner makes the case pretty convincingly. But maybe I’m biased. You tell me where Rosner goes wrong. He does have a lot of data. Remember, this is 2001. Long before the important part of the subprime crisis.

I summarize the role of Fannie and Freddie’s increased willigness to buy mortgages they wouldn’t have bought before, here. I’m agnostic about their direct role in subprime. I don’t think they bought very much of it. They bought a lot of subprime MBS. But maybe someone else would have bought that anyway. It was awfully profitable for a while.

So my claim is that between 1995 (and maybe a little earlier) and 2001, there was a lot of government policy that pushed up the demand for housing. Increases in demand usually increase prices. There are exceptions. If supply is sufficiently elastic, the price increase can be minimal. But I think it’s pretty clear that in some cities, supply was quite inelastic, for both geographic reasons and zoning restrictions. So the push in demand helped create the rise in prices you see in the graph.

It probably didn’t create the subprime crisis directly. But it doesn’t have to in my story. In my story, the increase in demand (driven by housing policy, somewhat well-intended (getting people into homes who couldn’t afford them before), somewhat very nasty self-interested cronyism (NAR, NAHB, Fannie and Freddie) pushed up the price of housing between 1995 and 2001.

Once the price of housing started rising dramatically, it became profitable to bet on the rise continuing. So a lot of people, smart and stupid, tried to ride that meteor as it shot upward. And that’s where the shadow banking system and the low interest rates come in. The shadow bankers pumped trillions into that market via all those innovative new assets (CDO’s, CDO squared etc). They use borrowed money because they could. The lenders lent the money because the government had signaled that lenders would get made whole even when the bets their loans financed were worthless. I learned part of that story from a fine book called Bailout Nation. I think you’ve heard of it. So moral hazard had something and maybe a lot to do with the last part of the housing bubble and especially the subprime part. But why did the moral hazard spend itself in the housing market rather than somewhere else? That was because that market was rising nicely. But why was it rising nicely. Animal spirits or government policy that kicked off the madness? I think the government had a lot to do with it.

Here’s where my story is squishy. It’s not enough to say that demand went up, so prices went up. You have to show that the magnitudes are reasonable. You have to show the areas where Fannie and Freddie were most active between 1995 and 2001 were the areas where price rose. I’ve seen one paper that argues that Fannie and Freddie’s affordable housing goals had a limited impact on providing liquidity. Could be. But it is hard to tease out independent effects. I suspect this debate and empirical evidence will keep going for a while. But it’s a reasonable debate. It’s not silly.

And yes, I know other countries had housing bubbles but didn’t have a CRA or Fannie or Freddie. You can increase subsidies to home ownership without having the same named entities. Again, it’s an empirical question. And I certainly agree that monetary policy and the coddling of cronies in the shadow banking system made the whole thing many times worse than it otherwise would have been.

I responded to Brad DeLong’s claims that Fannie and Freddie had nothing to do with the crisis, here.

I responded to Erik Hurst’s claims about animal spirits, interest rates and foreign capital flows, here.

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jjoxman April 13, 2011 at 1:11 pm

Prof. Roberts,

It is also important to highlight the fixed rate mortgage, and its role in encouraging people to purchase houses. When interest rates are lowered below historical averages, people naturally want to lock in those rates so if there is a fixed rate mortgage (like in the U.S.) one should see a much greater impact on housing prices via demand channels than in countries where adjustable rate mortgages dominate (like Canada).

In essence, the FRM compounds the low-interest-rate problem. And mortgage rates are highly correlated with the fed funds rate:

carlsoane April 13, 2011 at 3:18 pm

The abstract for the linked article seems to indicate the contrary: “…in some credit markets associated with longer maturities, such as the mortgage market, common movements are less correlated with changes in the federal funds rate. “

jjoxman April 13, 2011 at 7:05 pm

Yeah, less than the short-term rates. Still correlation > 0.6 though.

carlsoane April 13, 2011 at 8:47 pm

Got it.

Dave April 13, 2011 at 1:41 pm

Part of Barry’s story is that investors who took profits during the stock market bubble of the late 1990s invested their capital in real estate. In fact he says he advised some of his clients to do this. That’s at least part of his narrative regarding why prices rose in 1997.

Just an FYI. The story I believe regarding the bubble is a combination of the Ritholtz/Kling narrative.

And I’m glad you mentioned the GSE purchases of subprime MBS. Most commentary that exonerates them leaves this out.

Mike April 13, 2011 at 1:42 pm

Here’s a data point that supports government interference in the housing market: capital gains from housing were treated substantially different than other capital gains.

See: Taxpayer Relief Act of 1997

vikingvista April 13, 2011 at 3:30 pm

Good point. The cumulative affect of perfectly timed political actions like this one make outright dismissal of government culpability absurd. Although one can make a claim that political actions in some manner follow market causes, it is ridiculous to attribute the same culpability to political decisions that you attribute to market actors who merely follow price signals. That’s like blaming the splash on the water instead of the stone that fell into it.

Russ Roberts April 13, 2011 at 4:58 pm

Yes. Meant to mention it and forgot.

John Hall April 13, 2011 at 1:54 pm

I thought this was a great post. I am a big fan of Barry Ritholtz, but he can be vehement on this issue.

If you haven’t done so already, I think you could do a great part 3 on the role of the shadow banking system on the subprime crisis. I tend to think that MBS and CMOs had been around for years. Granted the volumes of CDOs exploded over this period, but you seem to be blaming the products rather than the causes that led to the explosion in demand.

Pingry April 13, 2011 at 1:54 pm


The housing bubble was already taking off (some even point to data from the early 1990′s) before the whole ‘dotcom crash-9/11-recession’ to which the Fed responded with so-called “easy money”

And as a sidenote, if nobody can know what the interest rate should be (which is an Austrian criticism) then how can you claim that it was artificially low? Do you know what the interest rate should have been? The market certainly doesn’t know except in the longrun.

Anyway, the housing bubble was pumped to new heights in the early 2000′s not by monetary policy for which the evidence is pretty weak (faith-based economics and ex-post storytelling, as you like to say) but far more due to innovations in structured finance.

I’m sure that you’re aware of Mason and Rosner discussing how CDSs created the enormous demand for MBSs. The data suggest that CDOs purchased more junior MBSs than were issued in many years because while only a small part of MBS (say 10%) is junior tranche, it is these junior tranches which must be sold before any senior MBS tranches can be sold. CDOs were nothing more than deceptive securities whose only job was to provide enormous demand for worthless MBS.


vikingvista April 13, 2011 at 3:38 pm

“how can you claim that it was artificially low?”

Because that is the direction of Fed manipulation. The dollar decreases in value. Inflation is targeted. New money is almost continuously pumped out. There are very few, and very brief, times where it can be rationally argued that rates were artificially high.

A better question would be “How can you claim interest rates were *unusually* artificially low?”

carlsoane April 13, 2011 at 5:36 pm

I’ll concede that I don’t know what interest rates should be. I would think that you’ll have to concede that the Fed doesn’t know either as evidenced by its clear failure to fulfill its mission of maintaining financial stability.

dan April 13, 2011 at 5:54 pm

I wouldnt assume fed was acting on interest maintain financial stability. Fed may have been complicit in the overall Govt Push to increase Housing ownership in the US. Key word is ‘may’.

dan April 13, 2011 at 2:01 pm

The problem with all of this…………… is the truth.
See how much work is required to get the heart of the matter.
Quick 30 sec quips rule the day. Explaining this matter requires time and energy. News stations and printed media will not use their precious on-air time and printed space to dedicate to this information. They can’t. Few will read it.
The whole story has to be in a 10 word sentence or less. And, that will capture enough to read further. But, still the reader is ADD.
Liberals and progressives had the edge in simply stating “The banks did it”…………done, they got the attention and is simple enough.

Slappy McPhee April 13, 2011 at 2:41 pm

This is why I come to CafeHayek everyday and have spent the last couple of months listening to the last two years of podcasts by Russ.

SheetWise April 14, 2011 at 2:07 am

Ditto. I try to contribute at the Cafe with narrative when I find a significant chasm in experience, but that’s rare. Would like more podcasts with Teleb and Epstein — just a suggestion. I have listened to these at least twenty times or more, and still nuances that are enlightening. That’s rare, and I want more.

Barry Ritholtz April 13, 2011 at 2:58 pm

One should also adjust home prices for size — homes square footage shot up tremendously from 1995 to 2007, for Inflation (we had a huge inflationary surge from 2001-07, as the dollar collapsed 41%) and for Quality (high end materials and appliances migrated from the most expensive homes through to the top 30%.

Keep in mind as well that the the mid 1990s were well into the 2nd decade of the world’s greatest bull market. Many investors pulled winnings off the table in the 1990s and rotated some assets in to Residential Real Estate — i.e., buying bigger homes (this is a anecdotal, but well known amongst RE agents and others).

Pingry April 13, 2011 at 3:47 pm

“we had a huge inflationary surge from 2001-07, as the dollar collapsed 41%”

I’m sorry, what? A huge inflationary surge?

The data shows that inflation looks pretty low and stable. Why can nobody recall inflation expectations becoming unhinged given this “huge surge”?

We were under an implicit-form inflation targeting strategy, and there was no inflationary surge.

And no, the dollar didn’t “collapse”. It would be better to say that the value of money, the reciprocal of the price level (whose rate changed at a low and stable rate, as I mentioned above), decreased at a low and stable rate.

Truly bizarre how you messed this up.


Ken April 13, 2011 at 4:10 pm

Inflation is near 10%:

vikingvista April 13, 2011 at 5:12 pm

“The data shows that inflation looks pretty low and stable.”

Inflation is not uniform. It follows a wave of transactions of new money. Are bank share prices and expenditures much larger than they would’ve been without the Federal Reserve buying their assets and pumping their reserves with new money? Are Treasury coupons as high as they would’ve been without the Fed Reserve buying them up with new money?

The leading edge of inflation is in Treasury rates and in share prices of bailed out financial institutions. As that new money is spent, that inflation will (and has) spread.

Inflation is inflation of the money supply. Affected absolute prices may increase or decrease, but always increase relative to what they otherwise would’ve been. And that new money always trickles out into the economy. The only questions are where will you see it and when, and how bad will it be.

And inflation is never free. When the Fed creates new money, that money has real purchasing power. All of that purchasing power comes from somewhere. It comes mostly from those latest hit by the inflation wave–those furthest from government.

Pingry April 13, 2011 at 7:09 pm

Do you just invent things on the fly? Or have you believed this nonsense for a long time?

As I always say about Austrian Business Cycle Theory, it’s a coherent theory of nonsense.


vikingvista April 13, 2011 at 7:23 pm

Care to present an argument, fool?

vikingvista April 14, 2011 at 2:26 pm

I didn’t think so. Take some advice–when you are totally clueless about something, don’t post at all.

Barry Ritholtz April 13, 2011 at 3:01 pm


The GSEs petitioned OFHEO to purchase subprime because they were losing so much market share to Wall Street, who was minting money securitizing ALt-A and Subprime.

This was requested by FNM/FRE not to fulfill some government mandate, but in pursuit of profits.

Approval was given in 2005 — about the time that home sales were peaking (prices peaked 12 months later). By then, it was all over but the crying.

dan April 13, 2011 at 3:07 pm

And who was at the helm of FNM/FRE during much of this time in the 90′s? Are there elected officials in D.C. or states, today, that were employed by FNM/FRE in 90′s or later? Are there players in the White House, today, who were employed by FNM/FRE in the 90′s or later?

Dave April 13, 2011 at 5:50 pm


You may have misread my comment above. I wasn’t talking about GSEs purchasing subprime mortgages to securitize, I was talking about GSE purchases of the subprime securities themselves.

This link, from 2006, covers some of the history:

“Fannie also invests in bits of MBS that have been put together and sold by other mortgage companies like Countrywide Financial and Washington Mutual. It held a little more than $730 billion in mortgage-related securities on its balance sheet at the end of June.

In 2005, Fannie and Freddie purchased 35.3% of all subprime MBS, the publication estimated. The year before, the two purchased almost 44% of all subprime MBS sold.”

Unfortunately, it doesn’t discuss their share before that, but it’s clear that they had purchased 44% of all subprime MBS sold in 2004. In other words, they were arguably worse than the securitizers; they were the ultimate investors propping up demand for the subprime securities.

dan April 13, 2011 at 5:56 pm


Troy Camplin April 13, 2011 at 3:07 pm

When did Greenspan start artificially holding down interest rates as a way of controlling the growth rate of the economy? 1996-7?

JG April 13, 2011 at 3:10 pm

Barry Ritholtz replies:

BR: When one considers home prices, there are many other factors that need to be looked at.

One should also adjust home prices for size — homes square footage shot up tremendously from 1995 to 2007, for Inflation (we had a huge inflationary surge from 2001-07, as the dollar collapsed 41%) and for Quality (high end materials and appliances migrated from the most expensive homes through to the top 30%.

Keep in mind as well that the the mid 1990s were well into the 2nd decade of the world’s greatest bull market. Many investors pulled winnings off the table in the 1990s and rotated some assets in to Residential Real Estate — i.e., buying bigger homes (this is a anecdotal, but well known amongst RE agents and others).

dan April 13, 2011 at 3:31 pm

1995- new rules were created to determine the if a bank was meeting CRA standards

Rather than examiners using discretion on banks attempting to prove that they were looking for LMI borrowers, the rules required a minimum amount of loans processed.

And, the new regulations pushed for innovative or flexible lending practices to qualify more LMI borrowers.

Greg Ransom April 13, 2011 at 3:46 pm

Russ, you’re missing the 2nd mortgage part of the story, and the malinvestment boom-bust employment side of the story. I live in the #1 forclosure zip in Orange County, CA where these things mattered.

People had boom time jobs in construction, finance, real estate, etc., lived the high life , then lost it all.

Russ Roberts April 13, 2011 at 4:57 pm

Agree. The post was too long already. I discuss it here:

Dave Cribbin April 14, 2011 at 3:03 pm

I read through the article and the comments and no one has mentioned the practical elimination of the capital gains tax on homes as part of the reason. The elimination of the tax came at the end of 1996 along with the cut in the capital gains tax rate. I believe that the strength of the dollar( the deflation of 1007 -2001) kept the lid on nominal home prices and until the great reflation of 2003 broke the dam wide open. The weakening dollar and all the rest were contributors but it was tax and monetary policy that made the big mess.

Darren April 13, 2011 at 3:53 pm

Even if you took away all the perverse incentives (public and private) for subprime you would still be left with a large pool of un-utilized capital in the developing world chasing a limited amount of safe high yielding assets. Even now, we still see speculative fervor in commodities and Chinese real estate and I question if that’s any less dangerous than subprime was.

dan April 13, 2011 at 4:07 pm

How does speculative fervor in commodities compare to housing boom/bust?
I don’t think any bust in commodities will have nearly the effect that housing did on individuals. You could make a long argument, but still would not have the same kind of direct effect as the housing boondoggle did most Americans. My T-shirt won’t be confiscated, nor will the cans of corn in my cupboard be repossesed.

Greg Ransom April 13, 2011 at 3:55 pm

When the 2nd mortgages stopped and the boom time jobs in finance, construction, home decor, and real estate were lost, people stopped being able to pay their mortgags and their bills, and continue spending in the local economy.

The end of the arificial boom supercharged the size of the bust.

Greg Ransom April 13, 2011 at 3:58 pm

To tell this story, economists need to be scientists like field research biologists — and tell the on the ground story in detail out in particular parts of the economy — such as a ZIP code, with details about every member of the population the causal story presumes to cover.

Chuck April 13, 2011 at 4:17 pm

There were others that were aware of what was going on between 1995 and 2001, even at the NY Times. This 1999 articles there is a discussion about the Clinton administration putting pressure on Fannie and Freddie, and HUD suggesting that they [Fannie+Freddie] should have half their portfolio in low-moderate income borrowers, under threats of discrimination. This was simply a doubling down of the Clinton-Reno lawsuits in the other NY Times article you posted about Redlining.

Chuck April 13, 2011 at 4:19 pm

Try posting my link again. Maybe you’ve got them disabled. If so, just go to NY Times website and search for the article: Fannie Mae Eases Credit To Aid Mortgage Lending, By STEVEN A. HOLMES, Published: September 30, 1999

dan April 13, 2011 at 4:19 pm

And ACORN was organized to be front and center at BofA for the media to cover the scorn of ‘outraged citizenry’ over the racist bankers.

Gnatman April 13, 2011 at 4:41 pm

I can’t remember if I found Hayek or Ritholtz first. No matter, it is a joy to read both regularly.

Michael Meyers April 13, 2011 at 7:00 pm

Hi Russ,

Sure the run on the shadow banking system was the proximate cause of the meltdown. But why the run? Obviously fear about the actual value of sub-prime mortgages. While one can find blame through out the system, this is at its heart a story about government affordable housing programs [CRA/Fannie/Freddie] gone awry.


Mesa Econoguy April 13, 2011 at 10:05 pm

Lost in all of this discussion is the price elasticity of demand for housing, and fixed rate vs. ARMs. Much of the “speculative” “investors” and flippers around the 2002-2007 time frame were almost completely oblivious to interest rates – they just bought & sold 6 mos later (or so they hoped), and didn’t really care what interest rates were.

And Russ, government intervention in housing goes back almost a century:

Obsessive Housing Disorder

dan April 14, 2011 at 2:39 am

For 100 years? Then, why the CRA? Then why distort statistical information for purpose of coercing banks into making highrisk loans? Why have FNM/FRM incentivize sub-prime by buying those loans en masse?

Mesa Econoguy April 14, 2011 at 7:18 pm

Because government has never met a government program/homeowners incentive it didn’t like.

This latest version was just that – the latest version.

Dan April 17, 2011 at 5:02 am

This latest has been very destructive. What was the last destructive intervention into the housing market?

Designer Wholesale Handbags April 13, 2011 at 11:54 pm

do with the run-up in prices after 2003 or s0. And yes, there were a lot of dumb, myopic lenders, borrowers and bond-fund managers. But why did they start getting dumb in 1997.

Argosy Jones April 14, 2011 at 9:34 am

^^ the magic of capitalism at work.

richard April 14, 2011 at 11:49 am


Hold on: the picture is from the NYT, data from Shiller. Ritholtz just edited it a bit. (I think Paul K used the original some time ago in an op-ed)

Pingry April 16, 2011 at 10:55 am

Hey VikingQuest,

Go look at FRED data, it’s pretty clear to see that there hasn’t been any inflationary surge.


vikingvista April 16, 2011 at 11:49 am


I’m so glad you managed to spot the word “inflation” in my post. Now go back and read some of the other words. Then perhaps, if you are intellectually capable, you can post a contextually relevant comment. Posting a non sequitur makes you appear to be a dimwit or troll.

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