I'd like to add an 8th variable; policies and regulations that has skewed the public's incentives towards the bubble.
As Tyler Cowen wrote in the New York Times, ``And legislation that has been on the books for years — like the Home Mortgage Disclosure Act and the Community Reinvestment Act — helped to encourage the proliferation of high-risk mortgage loans. Perhaps the biggest long-term distortion in the housing market came from the tax code: the longstanding deduction for mortgage interest, which encouraged overinvestment in real estate.
``In short, there was plenty of regulation — yet much of it made the problem worse. These laws and institutions should have reined in bank risk while encouraging financial transparency, but did not. This deficiency — not a conscientious laissez-faire policy — is where the Bush administration went wrong."To add, this from Arnold Kling of Econlib, ``Our high corporate tax rate, along with the deductibility of interest for corporations, encourages corporations to look for ways to minimize equity financing. For individuals, government-subsidized mortgages and the tax deductibility of mortgage interest help to encourage over-leveraging."
The CRA is a thoroughly debunked political talking point.
ReplyDeleteThe facts as to who wrote most of the bad mortgages (Non CRA institutions) where the biggest housing bubble was (Non CRA regions, ie, Sand States) and other non CRA nations that had similar boom busts in Housing show the CRA argument is not reality based.
It is a provable false thesis by people who still want to believe that Radical Deregulation was not a key cause
Hi Barry,
ReplyDeleteThanks for your comments. I find it a privilege to have one of the most prestigious financial blogger grace my blog with a valued comment.
Nonetheless, in my view, regardless of the disputed contributory role of the CRA, the premise that policies and government actions, which shaped the last bubble or the 8th variable, remains.
Next, I see this bubble cycle as being primarily caused by two factors: one cheap money and second psychological or behavioral.
The first factor has been widely discussed. While the second factor, in my view, had been instrumental in shaping the interactive feedback loops between regulators and market participants.
This had been seen in the consequent role of Moral Hazard (implicit subsidies, role of GSEs, Greenspan Put, and President’s Bush’s American Dream housing policies), the gaming of the system via Regulatory Arbitrage (the Shadow Banking System emerged from evading bank capital regulations and tax policies that encouraged debt relative to equity) and finally Regulatory Capture (sleeping on the wheels, blind to bubbles, accommodation of Wall Street, corruption etc.).
Of course, we also have the influential role of cognitive biases (as herding behavior, rationalization etc.) where the general public responded to these underlying incentives.
Regulations will always be gamed with as it had be so historically, as market participants will always be ahead of the curve and exploit unregulated opportunities.
Best,
Benson