For the last few days I have been perusing Housing, Housing Finance, and Monetary Policy, a symposium held by the Federal Reserve Bank of Kansas City in the summer of 2007, and published earlier this year. It makes for fascinating reading. By last August, when the conference was held, there already was considerable worry about sub-prime mortgages. Ben Bernanke, chairman of the Fed, had just lowered the discount rate in response to the gathering crisis. Bernanke has an excellent article in the collection on the history of mortgage financing in 20th century America, and shows how the finance of mortgages was transformed in the 1930s by the federal government. (Bernake is perhaps the acutest student of history of an American on the highest echelons of government since Woodrow Wilson or perhaps Henry Kissinger.) Another article in the collection on the “Housing Finance Revolution” shows how mortgage-loaning was again transformed in the 1970s and 1980s, this time by removing the essential mortgage process as much as possible from the regulatory control of the government. It is surprising how world wide this process was—the article discusses similar transformations of mortgage lending in Bangladesh and South Korea, as well as the United States, among other places. An excellent article by Robert Schiller discusses the boom in housing prices in the 1990s and early 21st century and argues that if low interest rates provided a warm soup in which sub-prime lending thrived, it was essentially an irrational phenomena—labor costs were not increasing, material costs were declining, the main reason why housing prices were soaring was because many people thought they would even rise further.
But what mainly comes across from reading about the symposium is a sense that most of the participants were both aware of what was going on and more or less clueless as to its ultimate consequences. There was a sense of unease, of worry, but not one of dread, or to use the proper economic term, panic. I guess this is to be expected. If there is one thing that is clear about the history of stock trading, from the early 17th to the present, is that no one has any foolproof way of knowing the future, and there will always be voices prophesying doom, like the legendary bear investor who predicted the last market crash ten times.
To be sure, hindsight is powerful. Almost all of the participants in the symposium, liberal or conservative, convey a sense that something had gone fundamentally wrong with how risk was accesses in mortgage lending and securitization, and that in many ways the greatest “moral hazard” was provided by the market itself—if you think you have eliminated risk, the natural thing to do is to make riskier and riskier investments, until you hedge yourself to your doom. But what is so frustrating about the symposium is that it is clear that everyone who needed to know about the sub-prime crisis knew precisely what was going on no later than last August, but a variety of motives; political caution, ideological blinders, a stubborn commitment to an unfettered free market in a situation when it clearly wasn’t working, led them to suggest weal palliatives that I suspect, they knew in their heart of hearts probably wouldn’t work. If only they had suggested some of the things we have trotted out in the last few weeks last August. But whatever they did or did not do then, we now know better.
I suppose it is human nature not to wait until something is in catastrophic failure until you try to fix it, hoping that somehow you can avoid the unpleasant task. And failure, as devastating as it often is, whether on an individual, collective, or national level, can be liberating. It forces us to start anew. My friends, my fellow Americans, let us begin.