The past year has not been kind to those who believe in the free market. The collapse of the housing bubble, the subsequent financial crisis, and the worst recession since the early 1980’s have all been described by those on the left as the fault of “right-wing republicans,” or “the result of eight years of deregulation.” Mainstream publications such as Newsweek have run cover stories declaring “We’re All Socialists Now”. Keynesian economists, largely marginalized during the deficit-conscious 1990’s, now urge governments to implement ever-larger “stimulus” packages, regardless of the long-term fiscal consequences. At the same time, there has been an apparent lack of conservative, pro-free market counter-arguments to the Keynesian resurgence.
Thomas Sowell’s The Housing Boom and Bust fills this void admirably, providing a straightforward analysis of the collapse which undermines the current fashionable liberal talking points.
One common problem with writing about major events so soon after they occur is that analysis is often replaced by mere journalism. While the majority of the books published on the subject, such as House of Cards, provide detailed insider accounts of the panic that swept Wall St. in the wake of the housing collapse, there has been as yet a lack of coherent analysis of the larger trends which created the crisis. Furthermore, what discussion there has been regarding the larger causes of the housing and financial crisis has predictably lapsed into condemnations of “greed” and “deregulation” and the “failure of capitalism”, without any attempt to defend the economic system that has been the engine of American prosperity.
Sowell admirably fills this void.
Sowell, a fellow at the conservative-leaning Hoover Institution, has written widely on economic issues, authoring over thirty books, including the widely used textbook Basic Economics. He can therefore be considered an economist of sufficient stature to respond to the neo-Keynesians (such as Paul Krugman) who describe the economic crisis as a failure of capitalism and prescribe ever-growing government spending as the response. Those familiar with his previous work or his syndicated columns will recognize many of the themes of this book, including his strident defense of the free market and his penchant for demolishing politically useful clichés with hard numbers.
Sowell begins by outlining the major institutions involved in the regulation of mortgages and the financial system, and how they are inter-related. This provides a useful primer for those unfamiliar with the complex, overlapping set of regulators involved in the crisis. Sowell goes on to explain how specific restrictions on building in some regions (primarily California) created a housing bubble that was regional, not national in nature. For example, Sowell points out that while housing price growth exceeded 20% a year in coastal California, cities such as Dallas and Houston, without zoning restrictions, saw prices rise barely above the rate of inflation. Thus, the inflation of housing prices was due largely to excessive government restrictions on new development, which drive up the price of existing housing stock. Interestingly, this point was rarely raised in news coverage of the housing bubble.
The book then delves into the politics of affordable housing, demonstrating how an abstract political goal can become disconnected from reality. As Sowell points out, the goal of policies such as the Community Reinvestment Act was to essentially provide unaffordable housing to allow higher-risk borrowers to obtain loans for which they would not otherwise be eligible. The story of how politicians both threatened lenders with greater regulation if they did not provide loans to higher-risk (usually minority) lenders and simultaneously pressured the Federal mortgage corporations (Fannie Mae and Freddie Mac) to repurchase those loans, is recounted in detail. The fundamental point made is that ostensibly laudable goals such as “affordable housing” can quickly turn into the socialization of risk for the benefit of politically valuable groups.
While Sowell’s distrust of government regulation in general is apparent early in the book, he reserves special vitriol for specific politicians who he views as having distorted the housing market for political gain. Despite Sowell’s repeated disclaimer that the errors leading to the housing crisis were “bipartisan”, by far the largest share of Sowell’s criticism is directed at Democratic legislators such as Chris Dodd and Barney Frank, who is the source of several embarrassing quotations regarding the activities of Fannie Mae and Freddie Mac, such as:
I would like to get Fannie and Freddie more deeply involved into helping low- income housing and possibly moving into something that is more explicitly a subsidy…I want to roll the dice a bit more…
Of course, as Sowell points out, Fannie and Freddie were providing a de facto subsidy by purchasing the high-risk loans from lenders because of pressure from politicians like Frank. There is a palpable sense of outrage in Sowell’s writing when he describes the malfeasance of politicians – and the reader is inclined to share it. The author is dismissive of arguments for “smart regulation”, pointing out that effective coordination of all of the overlapping regulatory agencies would be impossibly complex. Sowell makes a compelling argument that the most effective “regulation” would be the absence of political interference.
The final chapters are devoted to explaining how these high-risk loans were overvalued in the derivatives market (primarily because there was limited past experience with them) and how the Federal Government responded to the subsequent economic crisis with an enormously expensive “stimulus” package. The latter story is especially enlightening. Sowell’s criticism of “stimulus” packages is unrelenting – he argues persuasively that they do not stimulate more private investment, crowd out other borrowers, incur serious inflation risks, and make governments increasingly vulnerable to the whims of foreign creditors. As deficit projections continue to rise, the last point is particularly worrisome. Additionally, Sowell aggressively takes on the “New Deal Ideal” pointing out that while it was politically successful, FDR’s stimulus spending failed to bring unemployment under 10% until the eve of the Second World War. The true lesson of the New Deal, so often cited as a positive example by liberals, is that stimulus packages “create uncertainty regarding the extent of future government intervention” and therefore deter the private investment which could spur a real recovery. Indeed, Sowell’s empirically supported conclusion is antithetical to current conventional economic wisdom: recoveries do, in fact, occur more rapidly when the government does nothing.
Stylistically, Sowell is remarkably readable, particularly for an economist. He consistently employs the classic essay technique of laying out his theses before presenting his arguments and reminding the reader of them in his conclusions. While there is a certain repetitiveness to his style (e.g., “once again”), his almost geometric approach to writing is clear, easy to follow for laymen, and minimizes tangents that could distract from the central narrative.
There are, however, two significant criticisms that could be made of Sowell’s argument. While Sowell makes a compelling case that over-regulation was a substantial cause of the housing bust, he fails to account for areas where more (or at least, better) regulation may have mitigated the crisis. The deregulation of the financial sector in 1998, facilitating increased integration between commercial and investment banking, surely merits mention as a reason that the housing crisis evolved into a general financial crisis so rapidly.
The level of concentration in the banking sector, creating banks that were “too big to fail” also ought to have been considered. Finally, the aggressive expansionary policies of the Federal Reserve during the post 9/11 period helped make debt so affordable for so many borrowers. Yet none of these factors are given significant consideration, because they don’t fit the straightforward narrative of destructive regulation.
The Housing Boom and Bust also suffers from the relatively narrow focus of its analysis. While Sowell presents a compelling case as to how housing values became inflated and the negative impact of political pressures on lending institutions, he fails to adequately address the demand side of the housing equation. In producing so concise a book, so soon after the relevant events, he appears to have sacrificed comprehensiveness for timeliness and brevity. Why were borrowers so eager to accept loans so beyond their means, with so little concern over their terms? Why were investment banks willing to accept so high a degree of exposure to complex financial products with such a limited track record? Why were warnings, both from inside the rating agencies and from outside experts (including Sowell) ignored? The demand for sub-prime loans and excessive optimism of the derivatives market were both necessary preconditions for the housing bust, yet neither is adequately accounted for. The housing bust was a complex phenomenon, and deserves a more complex treatment.
These criticisms, however, are only mild quibbles with what is overall a highly persuasive and clearly-expressed argument which allows readers to understand both the current recession and the political response to it within the framework of free market principles.
Much of the mainstream coverage of the housing and financial crisis played to understandable populist outrage and merely sought to identify the villains. President Obama has deftly borrowed from Franklin Roosevelt’s rhetoric, which placed the blame on “malefactors of great wealth.” Sowell, in contrast, has performed a public service by telling a more complex story and providing conservatives with a retort to statist arguments. Fundamentally, The Housing Boom and Bust is a story of unintended consequences. It explains how policies made with essentially decent goals – sound civic planning, wider home ownership, and racial equality – in mind, led to disastrous consequences for their intended beneficiaries. The housing bust reaffirmed an essential conservative belief: that government interference in individual economic decisions, no matter how well-intentioned, usually does more harm than good.
Grant Morgan received his law degree from the University of Western Ontario in 2005 and his MA in International Relations from the University of Chicago in 2009. He is currently a PhD candidate at the University of Pennsylvania.