http://online.wsj.com/article_email/SB124631486277570583-lMyQjAxMDI5NDA2NTMwMTU0Wj.html
I continue to be haunted by Alan Greenspan's statement that financial markets are "self-regulating". I'm sure he is too.
John H Makin has written a brilliant article in the 7/1/09 WSJ (attached) on the fact that the housing bubble was a fully rational response to a set of distortions in the free market - distortions created primarily by the public sector. His point about the intensification of the national push toward home ownership after 2,000 is not arguable: first, the Fed's interest rate policy drove down the cost of borrowing money to unprecedented lows. Second, a common conviction arose that home ownership should be available even to those who, under prevailing conditions, could not afford it. And, finally, private agencies charged with determining the risk and value of securities were exceptionally generous in their assessment of the financial products known as "derivitives" whose collateral resided in the value of thousands of mortgages bundled together. The rating agencies understated the risks from these bundled mortgages by assuming that home prices were simply going to rise forever.
Makin argues that the housing bubble only burst after government subsidies pushed house prices up so fast that marginal buyers could no longer afford to chase prices even higher. So, a "bubble" created by rigged financial markets and a government-sponsored obsession with home ownership is not a result of market failure, but rather, a result of bad public policy. The belief that home ownership, per se, is such a benefit that no amount of government support could be too great and no pace at which home prices rise could be too fast is, therefore, the root of the crisis.
See references in Makin's article to the Clinton administration in 1994, Angelo Mozilo in 2003 (on a "down payment" should no longer be an "impediment" to home ownership), the Fed allowing "bubbles", and a policy of granting monopoly power to rating agencies as examples of a perspective that is difficult to refute.
As a social policy, there are probably less dangerous ways to encourage home ownership for those who might not otherwise "qualify". But the system of regulation that needs to evolve will have to be more sophisticated than those who have "gamed" it in the past. This will have to include the incentives that executives have benefited from in the institutions that purveyed the mortgages that are now the "problem".
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Essentially, people left the system unchecked or some leaders allowed it to spin out of control while profiting from it. Understanding human behavior will take precedence in conducting new regulation efforts. Unprecedented leadership will need to take the reigns on these issues to successfully navigate them in a way that maximizes benefits for everyone over infinite time. However, this will likely not occur. Smart players will simply learn how to manipulate the system to their advantage as in the past. Good people will just try to limit the damage among all the people in the system while accepting that little can be done in this generation. The best leaders are too busy running their own enterprises or burned out from decades of service. What is a society to do?
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