Echoes of the Sub-Prime Disaster

By Karl Reiner

Billionaire According to a recent economic report, the warning signs were there for all to see. [Editor: if you want to look at the data set yourself, it is available here and the author's website is a great resource. MDB] Between the years of 1952 and 1986, the richest 1% of Americans took home about 10% of the nation’s income each year.  Starting in the mid-1980s, the share of the richest 1% began to rise.  It reached 18.3% of national income in 2007. The last time the income share of the rich was that high was in 1929 when it reached 18.4% just before the onset of the Great Depression. As in the past, the rising income inequality index was an indicator that things were going wrong in the economy.

Until recently, Americans considered property to be the safest of all investments. The assumption is now in the process of hard revision.  Over 25% of homeowners now owe more on their loans than the house is worth.  Housing prices have fallen back to 2003 levels and are continuing to decline by over 2% a year.  Since American households have more of their wealth tied up in real estate than in other assets ($22.7 trillion in 2006), the economic damage caused by the meltdown was considerable. The severely battered housing sector is slowing the recovery from the recession.  

As the recession triggered by the collapse of the housing market grinds on, the impact on the social fabric of Arizona has been devastating.  The plunge in property values pushed up unemployment, causing poverty levels to rise.   An increasing number of children in the public schools are from families driven to qualifying for food stamps.  The soup kitchens and food banks are having difficulty meeting the increased demand.  The proportion of people living below the poverty line has climbed.  Arizona now has the second highest poverty rate in the country, right behind Mississippi which holds the top spot.  

Starting in the 1990s, housing prices doubled in a decade. The absurdly rapid climb in values should have been a warning to regulators. The amount of American mortgage debt doubled between 2000 and 2007, increasing to $10.5 trillion, the biggest housing debt load in the nation’s history. Because property has a strong attraction for bankers and homeowners alike, the nation happily went along with the trend.  

The deregulation of the financial sector led to the crisis.  The loose underwriting standards and mortgage products that required little in the way of down payments became accepted instruments of public policy.  The result was that subprime mortgages increased from less than 4% to 15% of the mortgages issued.  Although the easy credit boom helped push home ownership to new records, the irrational willingness to bet on ever rising prices helped pump up the housing bubble.

While competition and property rights are important to a functioning market economy, we have lost sight of the fact that sensible regulation is a responsibility of government.  If the market cannot adjust property prices when they overheat, the regulators must be willing to step in, even if it means taking an unpopular political position.  

Perhaps the government should lessen its support for the promotion of home ownership. Asking people to save more for a down payment would be a reasonable price to pay for a safer system.  If the housing sector was somewhat deemphasized, more could be invested in education and training.  Helping people adapt to the challenges brought about by rapid economic change would actually benefit the nation’s future more than continuing the massive subsidization of housing.


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