Dean Baker
NOW (PBS), March 21, 2008

See article on original website

There is a long list of villains who can be blamed for the current crisis in the housing market, and the recession it has caused, but the key figure in this story is Alan Greenspan, who used to be known as the greatest central banker of all-time.

The reason that we are seeing millions of people lose their homes to foreclosure, and tens of millions see most of their life's savings disappear as plunging house prices eliminate the equity in their home, is that we had a housing bubble that is now bursting. Bubbles always burst and the process is often quite painful. That is why it is best to prevent bubbles from growing in the first place.

The fact that the housing market was in a bubble should have been evident to any competent economist. There was no historical precedent for the run-up in house prices that began in the mid-nineties (which coincided with the stock bubble). The run-up could not be explained by fundamentals of supply and demand in the housing market, most of which indicated that house prices should be stable (adjusted for inflation) or even falling.

It is not clear whether or not Greenspan saw the bubble, since he has not spoken consistently on the topic. It is clear that he did nothing to prick the bubble and arguably even promoted its growth, both by publicly denying the existence of a housing bubble and by encouraging homebuyers to take out adjustable rate mortgages.

The irrational exuberance of a housing bubble created the climate in which homebuyers became eager to take on mortgages that they could not possibly afford and banks and investors were willing to make loans that couldn't be paid back. If house prices always rise, then homebuyers can also meet their mortgage payments by borrowing against the new equity created, or alternatively, they can simply sell the home and pocket the profits.

The lenders could apply the same logic. If house prices are rising rapidly, then it doesn't matter if borrowers can't meet mortgage payments. If house prices are rising, then it is likely that a foreclosed home will cover most or all of the value of an outstanding mortgage. The mentality of a bubble created the environment in which bad lending practices could thrive.

Of course Greenspan not only deserves blame for fostering the housing bubble, he was also seriously negligent in his regulatory responsibilities at the Fed. The abusive mortgage practices that are now being reported so prominently were widely known years earlier. When millions of bad loans are being issued all over the country, it is not being done in secret. People did try to get the Fed to tighten up its regulations on bank lending practices, including Greenspan's fellow Fed governor Ned Gramlich. Greenspan ignored these urgings, and insisted on allowing the banks to continue their predatory lending without any check. This helped to sustain and the bubble and snare millions in loans that they could not pay.

Even if Greenspan is public enemy number 1 in the housing bubble story, he did have many accomplices. There are literally dozens of federal and state regulatory authorities that could have tried to crack down on the predatory lending practices under their jurisdiction. In fairness, several state regulators did try to crack down, but they were preempted in several cases by federal law. Still, as a group, one could have hoped for a more vigorous response to outrageous lending practices that were being carried through on a massive scale and hitting the most disadvantaged segments of society.

Along the same lines, one should add to the ranks of villains a long list of political leaders from President George W. Bush on down to neighborhood community leaders. Instead of cracking down on the predatory lending practices, these people celebrated the growth in homeownership, somehow failing to note that a very high percentage of the new homeowners would soon face foreclosure. The extent to which this celebration was due to a blind commitment to the ideology of homeownership or outright corruption would have to be determined on a case-by-case basis, but it was incredible failure of leadership at all levels.

On the other side, there were all sorts of accomplices in promoting the bubble. Virtually the entire economics profession joined Alan Greenspan in his insistence that there was no housing bubble. Having so much high-powered expertise on the side of the no bubble view undoubtedly made investors more comfortable in gobbling up mortgage debt that they should have recognized as junk.

Of course the investors themselves can't escape blame in this story. People who get paid seven figure salaries to manage hedge funds, pension funds and other large pools of capital are supposed to do something for their money. They should have been able to recognize the housing bubble and the fact that housing-based debt was an extremely risky asset, even if the economists told them otherwise. Their astounding ignorance on this point allowed both the growth of the bubble and for the perpetuation of the worst predatory lending practices.

Banks were anxious to issue loans that could not be paid off because they knew that they would be able to quickly sell them in the secondary market. If there were not a vast pool of suckers waiting to gobble up this debt, predatory lending would not have looked nearly so profitably.

This raises another villain in the story - the bond rating agencies. Much of the junk mortgage derivative debt got top credit ratings. This helped to convince investors that they were buying safe assets. As it turns out, the bond rating agencies don't do much independent analysis of the assets they rate, they mostly take at face value the information presented to them by banks and financial companies that pay them to do the ratings.

The media also deserve blame in helping to promote the housing bubble. It is reasonable to expect that at least some reporters would have sufficient expertise that they could independently evaluate the state of the housing market. If the major news outlets were running regular pieces on the housing bubble and the risks it posed to the economy and homeowners, it is likely that it would have burst somewhat sooner. In fact, warnings on the bubble very rarely appeared in the media. (The New York Times is an important exception; it did run several pieces presenting warnings about inflated housing prices). The most widely cited expert on the housing market was David Lereah, the chief economist for the National Association of Realtors and the author of the 2005 best seller, Why the Housing Boom Will Not Bust and How You Can Profit From It.

In short, there is a long list of culprits in the housing bubble disaster. Alan Greenspan sits in the center of the circle, but he is surrounded by a vast group of clowns and criminals. It is not clear that many will suffer any consequences for their actions or even that they will be prevented from doing it all over again.


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer ( He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.