The Housing Boom & Bust by Thomas Sowell

(This article was originally posted on my old mainmanX.com blog on 6/3/09; it’s a review I wanted cataloged on this blog)

For awhile now, I’ve been contemplating which book to pick up regarding the current financial mess; when I heard Thomas Sowell wrote a book on the matter, the choice was easy.

I’ve admired Sowell’s work for a long time. More than almost any other economist or columnist, he’s able to make economic issues easy to understand. For example, his series of articles on health care, back in 2003, do an excellent job of explaining the issues surrounding the health care debate in a way for non-policy wonks to comprehend.

The Housing Boom and Bust continues Sowell’s tradition of making the complex simple to grasp. Politicians and the mainstream media have been quick to blame deregulation for the housing meltdown and ensuing recession. Sowell’s explanation on page 57 puts the crisis in proper perspective:

“The development of lax lending standards, both by banks and by Fannie Mae and Freddie Mac standing behind banks, came not from a lack of government regulation and oversight, but precisely as a result of government regulation and oversight, directed toward the politically popular goal of more ‘home ownership’ through ‘affordable housing,’ especially for low-income home buyers. These lax lending standards were the foundation for a house of cards that was ready to collapse with a relatively small nudge.”

Sowell’s book serves as a roadmap for how we got to this point. His book starts by giving a brief overview of the “cast of characters” responsible for the housing boom and eventual bust, and delves into land-use regulations that help drive up the price of housing. He also takes a few pages to explain what adjustable-rate mortgages (ARMs) are and how they differ from traditional mortgages.

The second chapter is definitely the most important part of the book. Sowell explains that government-imposed regulations drastically altered the way banks did business. Regulators strengthened the Community Reinvestment Act (CRA), requiring banks to make “a requisite number of loans to low- and moderate-income (LMI) borrowers.” Also, the Department of Housing and Urban Development set a quota for Fannie Mae and Freddie Mac, that 42% of the mortgages these government-sponsored enterprises bought were for people with below-median incomes. Legal actions were brought against bankers failing to meet these quotas. Since lower-income people were usually unable to meet the down-payment requirements and income requirements of traditional mortgages, lenders lowered their standards and employed “creative financing,” such as a growing use of ARMs, to meet the government-mandated goal of “affordable housing.” Even the deregulatory Gramm-Leach-Bliley Act, which allowed banks to diversify their businesses, came with the caveat that they had to have satisfactory CRA ratings if they were to diversify. President Bush also intervened in the pre-collapse housing market by subsidizing downpayments for low-income homebuyers and permitting the Federal Housing Administration to make loans to low-income homebuyers.

Chapter 3 documents the “house of cards” tumbling down, nudged by the Federal Reserve, which had lowered interest rates to unsustainable levels (thus triggering a demand for housing, and making ARMs and especially attractive method of financing a home) and now brought them back to more normal levels. Sowell explains the accelerating defaults hit the financial markets because Fannie Mae and Freddie Mac bundled them together and sold them on the market as mortgaged-backed securities. One reason for the proliferation of these securities stemmed from the implicit guarantee from Fannie and Freddie’s GSE status, that financial firms would be bailed out by the taxpayers should these securities implode (a revelation that came true).

Chapter 4 debunks the myths of discrimination in the housing market while documenting specific lawsuits the Justice Department launched against banks that allegedly discriminated in their lending practices. The fifth and final chapter serves as a review of everything that has happened, while also looking at the history of FDR’s New Deal in light of President Obama’s various stated plans to turn the economy around.

The book also examines the hyperbole coming from politicians about “affordable housing” and how devastatingly wrong their solutions were, and the role of various “community activists” such as ACORN in the housing bust.

This book is excellent. Sowell tears down the argument that unregulated free markets brought this mess about. Government manipulation and regulation brought this mess upon us. We can only hope the proper lessons will be learned.

Some libertarians might not be happy that Sowell spends little time discussing the Federal Reserve. He makes it clear the Fed triggered a demand for housing with its unprecedented low interest rates in the early part of this decade, but only devotes a couple pages to Fed policy. John Taylor’s study on monetary policy serves as a good companion piece for anyone interested in a detailed explanation of the Federal Reserve’s role in triggering the financial crisis.

However, that’s a small quibble. This book is the definitive source on how government officials brought this meltdown on us. Highest recommendation to buy.

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One Response to “The Housing Boom & Bust by Thomas Sowell”

  1. Deregulation Or Government Meddling: What Triggered The Great Recession? | The Blog For Truth, Justice, & The Josh Way Says:

    […] 40% of the loans financed by Fannie and Freddie had to be for borrowers with below-median incomes (another source says the quota was 42%), and eventually 50% of the loans by 2000. This mandate helped trigger the GSE issuance of MBS […]

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