| | Yaron Brook: "The current crisis was caused by the housing bubble, and the primary cause of the housing bubble was the Federal Reserve keeping interest rates at 1 percent in 2003."
Merlin Jetton: "The primary cause was government intervention in the mortgage market. The Fed's low interest rates supported low, teaser interest rates on adjustable rate mortgages (ARM). Little thought was given to the borrower'a long-run affordability of an ARM, and it was assumed the borrower could easily refinance when the interest rate jumped up."
I sanctioned Merlin's post. But I think it is important to see that there are three elements that have to be present to arrive at our current crisis.- The intervention of government in the mortgage markets with the CRA and the part the government creatures named Fannie and Freddie played.
- And it could not have happened without the hot air of fiat credit that the artificially low price of money (Greenspan's interest rates) and the inflated supply of money that kept that bubble inflating for years and years.
- And, there is a third factor, one that isn't government, but rather human nature. Periodically, a belief visits investors that isn't completely rational - a euphoria - and it is acted upon. It was irrational to believe that housing prices could continue to go up at the rates they did, but people bought as if they would.
The first item, the CRA, was put in place to force lenders to make bad loans. Fannie and Freddie were there to buy bad loans (and good) and to repackage them to make room for more. This formed the pipeline for moving mortgages into the financial markets. It wasn't just a housing bubble but also a financial markets bubble.
But with a fixed supply of credit, there is little that would have flowed down that pipeline. Without that contribution from the Fed, it would have collapsed on its own in a much shorter period of time. The fed pushed fiat money into the pipeline where needed to pump those mortgages from buyer to lender to GSE to financial institutions. The lower than market interest rates and housing deductions helped suck more money into this pipeline.
Reality - a free market - brings euphoric buying sprees to a halt in fairly short order. But when government intervention sides with that euphoric, irrational position it has the effect of multiplying it - giving it a sense of reality it could not have acquired on its own. Government built a pipeline out of regulations to coopt sound business practices, they fueled it with cheap money and these encouraged and supported a long period of euphoric, irrational purchases.
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