The Great Housing Bubble - Who is Responsible?

Who is responsible for the Great Housing Bubble? It is one thing to identify who or what caused the bubble, but it is another to assign responsibility and blame. Borrowers, lenders, investors, and the FED are all responsible; it is only a matter of degree.

Irresponsible borrowers are like children, if you offer them something they want, no matter the terms, they will take it. The federal government realized this basic fact years ago when they passed predatory lending laws. This does not make the borrower any less responsible, but by definition, subprime borrowers are irresponsible. If they took responsibility for their debts, they would not be subprime. So if a large amount of money is lent to the most irresponsible among us, it is reasonable to expect them to spend it irresponsibly and not worry about paying it back. In this case, past performance is an indicator of future performance. It should come as no surprise that the subprime experiment ended badly.

Despite the low expectation of subprime performance, people need to be held accountable for their actions. It seems our entire culture is based on having victim status and being irresponsible. Borrowers should not be bailed out by any government program as it would just create more dependence and greater risk taking. The people who paid too much and cannot pay it back have to be allowed to lose their homes. That is life. The responsible should not pay to subsidize the irresponsible. This is one of those instances where irresponsible will be made to take responsibility.

Lenders are also responsible in this matter. Mortgage lenders provide a service because without them most people would be dead by the time they had saved enough money to buy a home for cash. However, when lenders start handing out home equity lines of credit for consumption, they are as bad as the credit card issuers preying on people's reckless irresponsibility. Once mortgage lenders crossed that line, they ceased to be serving the needs of homebuyers and instead began serving the wants of the credit addicted: shame on them.

Of course, none of this would have happened without the contributions of the enablers at the Federal Reserve and on Wall Street. The Federal Reserve lowered rates and then Alan Greenspan told borrowers to take out adjustable rate mortgages under certain circumstances. As one might suspect, he did this so his fellow bankers would not be stuck with low-interest loans for 30 years, but he gave the world of homebuyers the "green light" for taking on high risk loans. Then Wall Street investors flooded with liquidity from cheap money from home and overseas started chasing returns. High-interest, subprime loans looked attractive, and as long as house prices went up and nobody defaulted, everything was fine. Who is to blame for that situation? The Bank of Japan for creating the carry trade? The Federal Reserve for lowering rates to avoid a recession? The financial wizards who invented collateralized debt obligations? The ratings agencies who labeling these investments "AAA?" the investors who were chasing high yields? Or all of them?

The borrowers are certainly at fault; if for no other reason than they signed the papers and took the money. The lenders are also at fault because they should have known better than to give borrowers loans they could not afford, provide loans with no income documentation, and ignore proven guidelines for loan-to-value and debt-to-income. Lenders simply cannot abdicate responsibility in this matter for financial, legal and moral reasons. The Federal Reserve and Wall Street investors are also at fault for creating the situation and enabling this to occur. In the end, all the responsible parties were ruined: borrowers lost their houses and went bankrupt, lenders like New Century went out of business and/or lost billions, Wall Street investors shared in the losses with the lenders, and Alan Greenspan is remembered by history as the architect of the largest, most painful financial bubble in history.

In assigning blame, it is also important to recognize that many innocent people were victims of the housing bust: children of the overleveraged and dishonest, neighbors of homes with dead lawns and graffiti, taxpayers whose money might be used in a bailout, responsible depositors who have to endure returns less than the rate of inflation, condo owners who have to pay the gap left in condo dues on foreclosed units, government employees who were hired in the optimism of rising budgets who are now laid off when tax revenues decline, and bubble buyers who were not motivated by speculative gains but merely looking to shelter their family. The decline of house prices punishes sinners and saints alike.

The Great Housing Bubble was a credit bubble. It was enabled by the widespread use of structured finance and collateralized debt obligations, and it was inflated by the irrational exuberance of buyers. The infrastructure for delivering capital to inflate the bubble was put in place years prior with the development and evolution of the secondary mortgage market. The system for delivering capital was greatly enhanced by the creation of collateralized debt obligations. Errors in the evaluation of risk to mortgage capital caused money to flow into this market that should have been diverted elsewhere. This free-flow of capital inflated the Great Housing Bubble.