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Whose fault was it?

Paul Krugman and Robin Wells writing in the New York Review of Books (HT: Brad DeLong) criticize Raghuram Rajan for believing that government policy bears a lot of responsibility for the housing crisis:

In the world according to Rajan, a professor of finance at the University of Chicago business school, the roots of the financial crisis lie in rising income inequality in the United States, and the political reaction to that inequality: lawmakers, wanting to curry favor with voters and mitigate the consequences of rising inequality, funneled funds to low-income families who wanted to buy homes. Fannie Mae and Freddie Mac, the two government-sponsored lending facilities, made mortgage credit easy; the Community Reinvestment Act, which encouraged banks to meet the credit needs of the communities in which they operated, forced them to lend to low-income borrowers regardless of risk; and anyway, banks didn’t worry much about risk because they believed that the government would back them up if anything went wrong.

Rajan claims that the Troubled Asset Relief Program (TARP), signed into law by President Bush on October 3, 2008, validated the belief of banks that they wouldn’t have to pay any price for going wild.

Krugman and Wells continue and argue that Rajan has fallen for a “politically motivated myth”:

Roubini and Mihm, by contrast, get it right:

“The huge growth in the subprime market was primarily underwritten not by Fannie Mae and Freddie Mac but by private mortgage lenders like Countrywide. Moreover, the Community Reinvestment Act long predates the housing bubble…. Overblown claims that Fannie Mae and Freddie Mac single-handedly caused the subprime crisis are just plain wrong.”

As others have pointed out, Fannie and Freddie actually accounted for a sharply reduced share of the home lending market as a whole during the peak years of the bubble. To the extent that they did purchase dubious home loans, they were in pursuit of profit, not social objectives—in effect, they were trying to catch up with private lenders. Meanwhile, few of the institutions engaged in subprime lending—such as Countrywide Financial—were commercial banks subject to the Community Reinvestment Act.

Countrywide is the perfect scapegoat. They aren’t Fannie or Freddie. They were unregulated by the Community Reinvestment Bank. But there was a connection between Countrywide and Fannie and Freddie. I don’t know if Roubini and Mihm ignored it or if Krugman is simply unaware of it. Here is Gretchen Morgenson in the New York Times:

Outwardly, Fannie and Freddie wrapped themselves in the American flag and the dream of homeownership. But internally, they were relentless in their pursuit of profits from partners in the mortgage boom. One of their biggest and most steadfast collaborators was Countrywide, the subprime lending machine run by Angelo R. Mozilo.

Countrywide was the biggest supplier of loans to Fannie during the mania; in 2004, it sold 26 percent of the loans Fannie bought. Three years later, it was selling 28 percent. What Countrywide got out of the relationship was clear — a buyer for its dubious loans. Now the taxpayer is on the hook for those losses.

Krugman never gives an iota or quark of blame for the crisis on government policies. I guess this comforts the faithful. It does not help his reputation as a truth-seeker.