Wednesday, February 13, 2013

Collective Amnesia About Housing Crisis

The Republican response to the State of the Union was peppered with stale Paul Ryan-esque ideas and uncompromising right wing rhetoric. What struck me most about Sen Marco Rubio's (R-FL) statement was his insistence that the housing crisis was caused by bad government policies. After belching out this gem, he goes on to encourage using a non-discriminating chainsaw to the federal budget.

Congressional Republicans seem to have a collective amnesia about what caused the housing crises. Sen Rubio wasn't even in Congress when the Financial Crises Inquiry Commission released a report detailing the causes of the financial collapse. In short, the housing crisis was caused by a mix of high risk investments, a shadow banking system, the proliferation of complex financial instruments and lax oversight on part of government watchdogs in the financial and housing sector. 

High risk investments were concentrated around the obsession by lenders to package risky, sub-prime mortgages into securities, paying rating agencies to slap a favorable rating on them and selling them to investors, both government backed (Freddie and Fannie) and private (WaMu, BofA, Citigroup, etc.). The shadow banking system refers to a proliferation of complex and unregulated financial instruments, like over-the-counter derivatives and credit default swaps. 

Even after a series of economic crises that led to unprecedented government intervention (Savings and Loan crisis, high level defaults, etc), the government had little appetite for continued oversight. Under the leadership of chairman Alan Greenspan, the housing and financial markets were essentially deregulated. Under these conditions, the derivatives market ballooned to a value of over $600 trillion and companies like Freddie and Fannie had trillions in securities investments with little capital to insure against default. 

The securities that some of the entities held were diverse and numerous in nature. Analysts justified their positive review of these assets by relying on the relatively harmless nature of a few thousand defaults in a diversified portfolio coupled with the assurance from the Fed that the economy was on sound financial footing and could absorb a massive default. Greenspan also instructed the fed to inject liquidity into the housing market through interest rates to further grow a bubble that would inevitably burst. 

In short, this was a failure of both the government through their insistence on not regulating complex financial markets and propping up a bubble. But, it was also a failure of the public financial sector by approving mortgages that were below standard, packaging these loans as securities, giving them positive ratings and not ensuring that some of the investor houses had enough capital. 

But all of this information is trumped by emotion. Sen Rubio knows that government failure under both a Democratic and Republican administration contributed to the housing crises. But, by employing the evil "G" word, people will connect the economic crisis and all of its ills to the current president. 

Politicians from both sides of the aisle have not (or do not want to) connect the dots between slashing spending indiscriminately and its effects on the ability of the government to stave off and discourage the type of disastrous and risky speculation that led to the housing downtown. 

By using government policy as a scapegoat for a event that had so polarized the nation, Republicans are assuring a emotional response to the task of deficit reduction. An emotional response leads to what many on the right like to call "starving the beast." The supposed failure of the government will be used as a means to cut the budget of some essential oversight agencies. This creates a self-defeating cycle that will only foster an environment of further reckless risk taking, negligence and crisis.