I think it’s very useful to split the question of the housing bubble from the broken financial markets in evaluating the crisis, and then examine how each influenced each other. The financial markets are supposed to aggregate information across a wide network of individual agents and firms each seeking to do their own thing, and this aggregation of information is supposed to channel savings and investments towards productive uses.
A lot of the discussion of what went wrong concerns agency problems, and there are massive amounts of those at the heart of the problem. But another way to view these agency problems is that powerful private agents were able to control key nodes in the markets, distorting the market signals that channel capital into a way that was privately (very, very) profitable but socially disastrous. Or financial instruments were traded with no ability for the price mechanism to be extrapolated outwards to other agents.
By controlling the way information is disseminated to private agents a lot of local power and money can be harnessed in the medium term however unstable that arrangement becomes in the long term. Information is the justification for having a market economy, and the mechanisms through deregulation allowed information to be manipulated is the key to finding a way out of the broken neoliberal system we find ourselves in.
Keep this informational problem in mind while reading the latest from ProPublica and NPR’s Planet Money’s Banks’ Self-Dealing Super-Charged Financial Crisis:
Faced with increasing difficulty in selling the mortgage-backed securities that had been among their most lucrative products, the banks hit on a solution that preserved their quarterly earnings and huge bonuses:
They created fake demand.
A ProPublica analysis shows for the first time the extent to which banks — primarily Merrill Lynch, but also Citigroup, UBS and others — bought their own products and cranked up an assembly line that otherwise should have flagged.
The products they were buying and selling were at the heart of the 2008 meltdown — collections of mortgage bonds known as collateralized debt obligations, or CDOs.
As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created — and ultimately provided most of the money for — new CDOs. Those new CDOs bought the hard-to-sell pieces of the original CDOs. The result was a daisy chain that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those….
An analysis by research firm Thetica Systems, commissioned by ProPublica, shows that in the last years of the boom, CDOs had become the dominant purchaser of key, risky parts of other CDOs, largely replacing real investors like pension funds. By 2007, 67 percent of those slices were bought by other CDOs, up from 36 percent just three years earlier. The banks often orchestrated these purchases. In the last two years of the boom, nearly half of all CDOs sponsored by market leader Merrill Lynch bought significant portions of other Merrill CDOs.
Remember that by keeping the demand artificially high for the housing market in the post-2005, these banks created its own supply of crap mortgages. These mortgages inflated and then crashed local housing prices. Meanwhile the biggest banks got tossed a lifeline and homeowners can’t even short sale their home much less have a bankruptcy judge that can set their mortgage to the market price with a large penalty. And everyone lines up to tell those people what “losers” they are, how “irresponsible” they’ve been for being pulled into becoming the artificial supply for artificially created demand of housing debt. What sad times we are living in.