The other day I got into an argument in some distant corner of the internet. That’s not exactly news – it happens far too often in my life. But this particular argument, setting aside how it got personal, was rather important to me.

The other person, with the best intentions, was saying two things about the Housing Bubble: that it was caused almost exclusively by problems in sub-prime lending, and that this market is “unregulated”. I took issue with these statements as dangerously wrong, and off we went. I never learn, do I? But I took up the challenge because I know that action will have to be taken on this mess, and I want it to be the right action. I want it to hit the people that have it coming, not those who are just trying to get by. It wasn’t until later that I learned that my opponent’s view is rather popular in the mainstream nooze even though there isn’t a single economist or investor who backs it. Clearly, I have work to do.

So what is the Housing Bubble, and why does it matter how it started?

The best concise description of what caused the Housing Bubble can be found at wikipedia. Yes, I realize this is unattributed, but it does have excellent notes to go with it. If you want the full version, go here:

http://en.wikipedia.org/wiki/United_States_housing_bubble

The basic summary is that in the around 2000, between the flight out of dot-coms and very low interest rates, housing prices started to rise rapidly. This happened all around the world, so we can take it as obvious that it has nothing to do with US policies and procedures. Real Estate Investment Trusts (REITs) became popular places to stuff gains from the dot-com bubble, and when everything else was going south they were solidly green. The derivatives market, which is the market for futures and things with healthy income streams such as mortgages, really started to heat up.

Then, something funny happened, something that only happens in a mania. Wall Street started totally ignoring the risk associated with sub-prime loans. These have been around forever, and are nothing more than loans to people with less than perfect credit. It’s how the young and the poor often get their first home, so it’s a vital part of the mortgage picture. But as these mortgages were sold into a market salivating for more mortgage backed securities, it simply stopped understanding that a good percentage of these wind up in foreclosure. The thinking was that real estate could go up forever, so they’d always get their money out. Mortgage underwriters kept getting slacker and slacker, pushing the edges of what they could do to get people into homes. Less was put down, salary-based formulae were ignored, and so on.

It’s more accurate to say that the Housing Bubble caused the sub-prime mess than the other way around, but the truth is that they are tightly interwoven after about 2003. And if you don’t believe me, take if from George Soros or a great article expounding on what Soros had to say:

http://www.ft.com/cms/s/0/1a7af090-c956-11dc-9807-000077b07658.html?nclick_check=1
http://www.fnarena.com/index2.cfm?type=dsp_newsitem&n=AF2EE1A2-1871-E587-E17F74B1A0C52FDA

Why does this matter? Because saying that sub-prime lending is the one and only cause of the Housing Bubble allows the financial markets that really made the mess to escape responsibility. The derivatives market is where it was amplified and fed back. Failures such as LTCM and other commodity manipulations were not as devastating as the Housing Bubble, but they are serious problems. As of today, they can blow up just as they have several times.

It’s also important to note that this mortgage market is, indeed, regulated heavily, meaning that changes can come fairly quickly through only the Executive branch of the government. Congress has already authorized the regulation, so they aren’t seriously in the picture. If a suitable scapegoat is found, it can easily have the piss regulated out of it while Wall Street isn’t touched. If we want to regulate derivatives in the same way we regulate mortgages, it will have to move through Congress first – and that will be one Hell of a slog.

That’s the problem with blaming sub-prime mortgages; the likely result is that it will be impossible for people with bad credit to get a mortgage while Wall Street is allowed to continue their happy ways. I happen to find that abhorrent.

So where did this myth that it’s all about sub-prime start? It seems that it came from Paul Krugman of the New York Times. I’ve said many times that this guy is a dinosaur that needs to be overcome if we on the left are ever going to get anything done, but in this case he’s actually provided cover to the other side. To me, that’s the real sin here. Now that I know where this came from, I have to say I’m deeply disappointed, once again, in how shallow the left has become.

We Lefties need to be a lot more honest and a lot more focused on our goals. I can see that Krugman has a good salary and doesn’t have to worry about people with bad credit buying a home, but a real Democrat does. I want to be sure that real Democrats have the facts so that they can do it right. The popular myth about the Housing Bubble is dangerous because it distracts us from the very real underlying problem with capitalism – that manias often destroy vital markets. Let’s start with that and work forward, please.