That makes very good sense! That pretty well expresses how I was feeling about it. I kept thinking when is someone going to step in, you could almost feel the tension in the air.
This pretty much describes my experience as well. I can recall people ‘feeling’ in 2005-2006 that things weren’t as stable as they could be and that something was going to break. Real Estate was the obvious target since the pressure to buybuybuy! was always out there (I recall a tiny online animated gif ad that had some crazy woman dancing in a panic while it mentioned low lending rates - I never could figure it out and it was EVERYWHERE!).
But as pointed out, it turns out that the banks hadn’t just been lying to lendees, they had been lying to themselves.
There was certainly talk among policy makers at least as early as 2005 about a possible housing bubble. Thing is, asset bubbles don’t always result in steep economic downturns. For example: lots of people lost money when the dot.com bubble burst, but the US economy itself was fine, in general. And despite discussion of a possible bubble, the Fed saw this information, and did pretty much what the general public did - shrug and go back to business as usual.
In addition to essentially missing the bubble, what ‘they’ actually missed was how massively over-leveraged the financial sector had become during (and because of) the housing boom, and the impact any shock to the system would have on liquidity for a whole new class of financial assets that were both (relatively) new, poorly understood (including often by the people selling them) and almost completely unregulated.
The financial crisis was far more than a housing bubble.
In Northern California there were many people in the mid-2000s who did the right thing by saving for a down payment - only to see housing prices increase far faster than they could save. And prices were seen as high years before their peak. Some who bought near at the top could be excused for thinking there was time left.
IIRC Krugman suggested that the Fed raise interest rates some, which would increase mortgage costs and would thus slow down demand, possibly resulting in a soft landing. But it would also slow down the economy and seemed politically infeasible.
Also, previous bubbles were local. I barely escaped one in Louisiana in 1980, related to the crash of the oil market. This was the first national one in living memory, and since more people owned houses than did 80 years ago had more impact.
Besides the bank leveraging mentioned people were leveraged with home equity loans as a result of the slow or non-growth in average wages. With less equity price drops had more impact.
JPMorgan Chase is paying a large fine. Please watch Jon Stewart’s Daily Show October 23 episode for an informative take on U.S. media reactions.
The problem is that anytime you’re in a bubble, things are going great right up to the point where they crash. So who wants to listen to the people pointing out there’s a crash ahead when everything is going so great right now? And besides it’s very difficult to deflate the bubble slowly, so it’s more likely that warnings about the crash will trigger it. So the best you can really do is protect your own assets and let the carefree people keep riding without concern.
The specific issue in 2007 was investors thought they had insured themselves against a collapse. But they failed to consider that a collapse could be a mass event. If you’re insuring yourself against something like house fires or car accidents, you can safely assume the events are independent. You’ll get a certain number each year but they don’t occur in a group. But mortgage defaults don’t act like that. There’ll be a certain number every year through normal events and you can insure against those. But it’s also possible that a national drop in real estate prices will trigger a widespread pattern of defaults that outstrips the ability of the insurers to cover.
It was obvious to anyone who had (a) no personal interest in benefitting from the bubble and (b) a brain. It was obvious that the whole thing was pure delusion and I said so at the time to my friends who were thinking of buying.
If you have a personal interest in everyone else believing something you believe it yourself even if common sense tells you otherwise. Groupthink is the rule, not the exception.
The only thing holding the bubble up was “the greater fool” theory.
But here’s the thing: Over the long term, many decades, contrary to what most people believe, home prices are quite constant in real terms. People can pay about 1/3 of their income for housing and that is what housing is worth. When people start paying substantially more than that you are experiencing a bubble and it was painfully obvious at the time.
I did not know when it would burst or how hard but I knew it would happen and said so repeatedly. But I was an outsider with no interest in the matter. Bankers, like politicians, like anyone who is inside the structure, can’t see the wood for the trees and are blinded by their own interest and need to believe their own BS.
And when the crash came so hard I predicted recovery would be slower and take longer than most politicians were saying. But politicians these days do not win reelection by raining on the parade, bursting bubbles or saying they can only offer “blood , tears, toil and sweat”. People want to be told they deserve to consume more than they produce and your friendly politician will make it possible. The people want to be lied to and they get what they voted for. It’s the beauty of democracy. People pay for their own stupidity.
Consider the fate of a bank CEO who saw the bubble coming in 2005. Unless he were very secure in his job, if he backed away from the high return risky investments the return from his company relative to the competition would go down, Wall Street would get mad at him, his stock price would tumble, as would his bonus. In 2006 with the bubble still going he’d look stupid.
Only the government can force bankers to do things against their personal self interest for the interest of the economy as a while.
Was it Greenspan or Volcker who said that the purpose of the Fed was to take away the punch bowl just when the party started going good?
I just skimmed the thread, but the cause of financial crisis wasn’t the bubble per se, it was the collapse of the MBS derivative market, Bear Sterns, WaMu, and Lehman. And those problems were due more to fraudulent NINJA loans and AAA rating of MBSs as well as a virtually unregulated derivatives market.
The reason the collapse of housing market is blamed is because as long as prices were rising, people who had bought homes based on artificially low teaser ARM rates could always refinance since their homes would always appraise for more than what they paid and could therefore continually refinance their way out of their predicament.
This was great for everyone especially in a falling rate environment since banks could originate loans for a nice fee, sell the loans at a profit for repackaging in MBSs, get their capital back and then churn the money through the system all over again. And that’s not to mention the money they made selling ancillary services like mortgage insurance and loan servicing rights.
But once the housing market started to tank, the whole rotten house of cards was exposed for what it really was and while that may have taken a while to hit the MBS market, that’s where the crisis really started. Had it not been for the deleveraging associated with that and derivatives generally, I think it’s unlikely we would have had a credit crisis any where near as severe as the one we saw.
You only need to harken back to the S&L scandal of the 80’s for what I think is probably a legitimate point of comparison and we got through that relatively unscathed. Beyond that, had the loans originated been properly underwritten, a drop in real estate prices shouldn’t have been nearly as devastating since there wouldn’t have been such a high percentage of loans which would have been in the position of either having to re-fi or default. As a result, with fewer defaults, the impact on housing prices therefore wouldn’t have been nearly as severe.