Dean Baker, one of my favorite economists, goes a bit too far in critiquing a column by Robert Samuelson when he tries to exonerate Wall St. for the financial crisis, blaming the amorphous "housing bubble" instead:
However, Samuelson reaches the wrong conclusion in saying that the slump originated in finance. The highlights and headlines, like the collapse of Bear Stearns, Lehman, AIG, Fannie and Freddie are certainly in finance. These events get the most attention and headlines, kind of like the explosions from bombs or artillery in war. But, the cause of the war was not the bombs and artillery.
The story in this picture was an $8 trillion housing bubble. This hugely distorted the real economy by causing housing construction to expand as a share of GDP by 50 percent above its normal level....
I realize this is a Chicken vs. Egg kind of argument but reading Micheal Lewis's latest piece in Vanity Fair would seem to support the "bombs and artillery":
In June 2004 the Fed began to contract the money supply, and interest rates rose. In a normal economy, when interest rates rise, consumer borrowing falls—and in the normal end of the U.S. economy that happened: from June 2004 to June 2005 prime-mortgage lending fell by half. But in that same period subprime lending doubled—and then doubled again. In 2003 there had been a few tens of billions of dollars of subprime-mortgage loans. From June 2004 until June 2007, Wall Street underwrote $1.6 trillion of new subprime-mortgage loans and another $1.2 trillion of so-called Alt-A loans—loans which for some reason or another can be dicey, usually because the lender did not require the borrower to supply him with the information typically required before making a loan. The subprime sector of the financial economy clearly was responding to different signals than the others—and the result was booming demand for housing and a continued rise in house prices.
The problem here is that we can't even begin to think about reforming the system unless we come to grips with what actually happened. To just ascribe everything to a "housing bubble" pretty much is a dead-end since the housing bubble is no longer with us -- so problem solved. Not. Without understanding the framework that led to this bubble, we'll be creating the circumstances for nothing other than a repeat.
