Thursday, July 17, 2008

The Housing Market Crisis

Has become a general crisis in the financial markets, and the reasons have to do with lack of regulations in that market, the invention of new instruments (sub-prime mortgages, jumbo mortgages, Alt-As, all bundled, shredded and served like coleslaw to investors) with severe systemic risks and the desire by everybody and their uncle to pretend that those risks don't exist. The government also has some responsibility for the crisis, because the Bush administration used the housing market bubble to pretend that the economy is doing better than it actually is, just like the Clinton administration used the high-tech bubble for the same purpose. And market bubbles, they pop, just like soap bubbles do.

The latter amuses children, but the breaking bubbles in various markets hurt people, including children. The housing market slump hurts people who were led into believing that they can afford a house they really could not. It also hurts people who were gambling on that market and perhaps deserve to be hurt, and it hurts people who used their home equity to finance other consumption.

The latter has resulted in the odd concept of "negative equity," or the value of the equity being less than all the debt that has been taken against it. The value of a house is not an ATM, in short, and using it as one may well cause unpleasant surprises when house values plummet.

The underlying assumption on which this whole teetering tower of cards was built was the assumption that real estate prices would go on rising for the foreseeable future. When they did not we got the crash and the crisis. But note that the reason why prices stopped rising and started falling is mostly (though not completely) caused by the teetering tower itself. The foundations of proper regulation and proper audits and accounts were not there to stop the tower from collapsing, and once it collapsed it took that belief in ever-rising prices with it.

So what should the government do about all this? Should it intervene now when it did not earlier? Moral arguments can be made both ways, but the real concern now is with the overall economy and the way the financial markets will drag everything else down with them if someone doesn't prop up that house of cards. That "someone" is likely to be the tax-payer, however wrong that might seem from a moral point of view.