MacroFinance

I found this on Capital Gains and Games, but really, it is a debate (mostly) between Paul Krugman and Raghuram Rajan. Here is a brief synopsis:

Of all the canards that have been offered about the financial crisis, few are more repellant than the claim that the “real cause’’ of the mortgage meltdown was blacks and Hispanics.

Oh, excuse me — did I just accuse someone of racism?   Sorry.  Proponents of the above actually blame the crisis on “government policy’’ to boost home-ownership among low-income families, who just happened to be disproportionately non-white and immigrant.  Specifically, the Community Reinvestment Act “forced’’ banks to make bad loans to irresponsible borrowers,  while Fannie Mae and Freddie Mac provided the financial torque by purchasing billions worth of subprime paper.

The argument has been discredited time and again, shriveling up almost as soon as it’s exposed to sunlight.  But it keeps coming back, mainly because the anti-government narrative gives Republicans a way to deflect allegations that de-regulation allowed Wall Street to run wild.   It’s the financial version of Sarah Palin’s new line that “extreme environmentalists”  caused the BP oil spill.

Paul Krugman caught a whiff of it in a recent commentary by Raghuram Rajan in the FT, and quickly denounced it. [link]

Here’s what Rajan said:

The key then to understanding the recent crisis is to see why markets offered inordinate rewards for poor and risky decisions. Irrational exuberance played a part, but perhaps more important were the political forces distorting the markets. The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans. And the willingness of the Fed to stay on hold until jobs came back, and indeed to infuse plentiful liquidity if ever the system got into trouble, eliminated any perceived cost to having an illiquid balance sheet. Chastise the banker who hankers after his bonus, but also pity him for he is looking for his primary measure of self-worth to be restored. Rather than attempting to instill social purpose in him, however, it is probably more useful for society to target the forces that distorted the market. [link]

And here’s Krugman’s response:

That’s a claim that has been refuted over and over again. But what happens, I believe, is that in Chicago they don’t listen at all to what the unbelievers say and write; and so the fact that those libruls in Congress caused the bubble is just part of what everyone knows, even though it’s not true.

Just to repeat the basic facts here:

1. The Community Reinvestment Act of 1977 was irrelevant to the subprime boom, which was overwhelmingly driven by loan originators not subject to the Act.

2. The housing bubble reached its point of maximum inflation in the middle years of the naughties:

3. During those same years, Fannie and Freddie were sidelined by Congressional pressure, and saw a sharp drop in their share of securitization:

while securitization by private players surged:

Of course, I imagine that this post, like everything else, will fail to penetrate the cone of silence. It’s convenient to believe that somehow, this is all Barney Frank’s fault; and so that belief will continue. [link]

The debate continues here, as Rajan responds to Krugman.

To complete the circle, let’s go back to Capital Gains and Games. Here’s the last word on the debate from Edmund Andrews:

The big lesson here was not about government distortions to the market (except perhaps the Fed’s low interest rates).  The big lesson here was that unrestrained, unregulated lending practices by the private sector can be dangerous for consumers and for the financial system as a whole.   To the extent that “government policy” contributed to the crisis, the first failure was in not stopping the reckless private-sector lending and the second failure was in not stopping Fannie and Freddie from following suit. [link]

‘Nuff said, I think. And rightly so.