The Global Macroeconomic Context and the Actions of U.S. Policy Makers
The previous post in this series sought to contribute a synopsis, however inadequate, of the causes of the foreclosure crisis, rooted in statutory changes and the financial innovations that they made possible. To these ends, I prioritize the passage of the Gramm-Leach-Bliley Act in 1999 as a critical moment setting in motion an eminent financial crisis. Being an honest theorist, committed to the notion that economic reality is irreducible to simplistic causes, Gramm-Leach-Bliley was not a sufficient cause for the mortgage market meltdown. Here again, we have to examine everything in its proper context, separating out the contextual culpability of particular institutional agents (e.g. subprime and Alt-A borrowers, specialty primary mortgage lenders, investment banks, Congress and the Clinton and Bush administrations, etc.) for producing the crisis through the intersection of their actions from the idea that there was either diabolical intent or perfect foresight concerning where all of the elements to a financial perfect storm were leading from 1999 to 2006. Most importantly, when it comes to the supply side of secondary mortgage markets, we have to consider the contours of capital investment in the global macroeconomy in the first half of the 2000s. That is to say, we have to ask where capital investment by the major players (the investment banks, the pension funds, the hedge funds) was going and why it was moving in these directions.
At the outset, there is an important point here that has be addressed (one that occupied part of at least fifty pages in my as yet unpublished and undefended doctoral dissertation!). The question here involves capital investment within the global macroeconomy. In this manner, I am not arguing that the macroeconomies of the U.S., the EU states, or any other national-political entity ceased to exist, but I am asserting that state political boundaries have been in the process of partially and selectively breaking down, and, thus, I am going to treat the macroeconomy for high level financial market players is relatively borderless. Financial market agents operate within a world where their resources can readily and rapidly flow from the U.S. to the U.K., to China, to Russia, to Argentina, to South Africa, or to myriad other national economic contexts depending on where the opportunities for high rates of return, subject to appropriate risks, might be. On the other hand, the idea that financial market processes are relatively borderless does not imply that they are placeless in the sense that they could ever take place outside of particular national contexts where the activities of financial agents are governed and, at least somewhat, regulated by state-political entities (i.e. by national governments and their bureaucratic agencies). Entities like the U.S. Federal Reserve system and its Board of Governors remain important because their actions structure, in part, the financial system of the U.S., making it relatively open to continuity or change in patterns of capital investment. Financial market capital may flow in a relatively free sense in contemporary globalization, but it never unilaterally reshapes individual national economies without the cooperative, collaborative, or constraining/restrictive hand of national governments and/or quasi-public national level agents.
Having said all this, we have to understand the shift in investment toward secondary mortgage markets, in the U.S. and in other advanced industrial economies, in relation to the collapse of the high tech sector at the end of the 1990s, and the recession and the "jobless" recovery that followed it. The high tech boom in the 1990s is responsible for shaping numerous conceptions that policy makers, theorists/analysts, and everyday workers and consumers have about what a post-industrial economy should look like and about the effects of economic globalization on individual national economies. Emphatically, we developed a sense that advanced, human capital-intensive manufacturing processes, like those involved in the production of computer hardware, software, and virtual and physical information network infrastructures, could fill the void left by dirty, energy-intensive manufacturing processes (e.g. steel, automobiles, petro-chemicals) as the advanced industrial economies lost their comparative advantages in the latter processes. On the other hand, we learned that such high technology manufacturing processes could be extremely decentralized, articulating buyer driven commodity chains stretching across the boundaries of numerous national economies (see Gereffi and Korzeniewicz (eds.) (1994), Commodity
Chains and Global Capitalism.
Westport, CT: Greenwood Press.), with branded "manufacturers" acting as designers, marketers, financiers, and overseers over subcontracting networks of small scale firms at little offices or workshops in a handful of diverse, developing national economies.
For the advanced industrial economies, manufacturing processes of all kinds had become so Twentieth century. In the U.S., structural steel production was virtually gone by the mid-1980s. Automobile manufacturing could have been the next to go. By 2003, the largest share of GM's net income came from its financial GMAC division (74 percent, with almost half of this income coming from mortgage financing operations), not from the sale of manufactured cars and trucks (see General Motors Corporation, 2003 Annual Report, "Consolidated Statements of Income" on pages 58-59, available at: https://www.mlcguctrust.com/Document-Download.aspx?Document=1). The macroeconomy of the U.S. was not only becoming increasingly intertwined with manufacturing supply chains contributing to a shift of manufacturing for a wide range of consumer and producer goods to developing economies but also becoming increasingly focused on the production of services, especially knowledge-intensive advanced producer service fields (finance, information technology, real estate, insurance).
The case of information technology, however, demonstrates something important, with consequences for every other contemporary and future center of investment and employment growth. Employment in hardware and software development, together with capital investment and expectations about future returns, reflected in the pricing of equity shares, reached a climax. It certainly was not a permanent climax, but its realization, conveyed by the collapse of stock prices in information technologies starting in the spring of 2000, suggests that technological development of all kinds must travel a temporal cycle, through which new technologies are integrated into the technological milieu of the population and, more specifically, its business community, and newer ideas must sometimes wait their time. Cutting edge technologies do not merit immediate acceptance and will not attain value until they have proven their worth to investors at least as much as toward consumers.
This is equally true for information technologies as it is for pharmaceuticals, advanced medical procedures, and diverse insurance innovations, a warning to anyone investing ahead of the curve/in anticipation of the curve that may never arrive in the medical or health insurance fields! This warning must, likewise apply to hundreds of thousands of students, investing serious resources in training for information-intensive fields, like medicine and information technologies. We as a country are presently accumulating hundreds of billions of dollars in educational debt for occupational opportunities that may never materialize in sufficient quantities to merit borrowing on this scale. There are obviously no guarantees for workers and investors who sink labor and capital into growth sectors awaiting a positive (to say nothing of a sustainable, reliable) return.
All this said, when the dot-coms went bust, the effect on the macroeconomy of the U.S. was relatively neglible. Many high-tech start-up entrepreneurs want bankrupt, investors heavily exposed to the decline in high tech stock prices, especially on the NASDAQ, lost substantial value in their portfolios, and, between the end of 2000 and the end of 2002, 2.8 million workers had become unemployed (see Bernstein, "The Jobless Recovery: Suffering from the recession's aftershocks, labor market conditions continue to worsen," EPI Issue Brief, 186 (Jan. 24, 2003), at: http://www.epi.org/publication/issuebriefs_ib186/). For many, the situation was clearly catastrophic, but, with regard to the larger U.S. economy, it was localized, with effects concentrated in the high tech sector. In a more critical sense, it revealed the shallow character of high-tech as a sector that could bolster the post-industrial U.S. economy and develop sustainable sources of comparative advantage on the global stage. Neither high-tech nor advanced producer service production as a whole adequately met the promise of transforming employment and investment in the U.S. to replace manufacturing industry.
Nonetheless, the drop in stock prices when the bottom fell out of high technology, especially on the NASDAQ, was significant. Moreover, the tense environment after the 9/11 attacks generated some predictable effects - the Dow Jones Average experienced a substantial decline in the weeks after the attacks. Policy makers had to commit to serious actions to reassure investors and the general public that a lingering decline in one of the post-industrial economy's major growth sectors and a dramatic, lethally violent assault by a non-governmental paramilitary organization against one of the world's major financial centers would not precipitate a generalized economic downtown in the Western industrialized economies. In general, the world needed to be reassured that the global economy was not coming to an end. Truthfully, what are the U.S. federal government and the Federal Reserve Board of Governors supposed to do in circumstances like these other than to undertake pro-growth economic measures if for no other reason than to demonstrate that they are committed to maintaining the health of the U.S. economy and the global financial sector? The problem, of course, is that such pro-growth measures do not take place in a policy vacuum - they are shaped by the particular contexts in which they are enacted, and the context in which the Federal Reserve was lowering interest rate targets on interbank overnight loans and in which the Department of Housing and Urban Development was promoting purchases of mortgages in designated under served tracts by Fannie Mae and Freddie Mac was shaped, to a great extent, by the development of the post-Gramm-Leach-Bliley secondary mortgage market. In this manner, any response to the multifarious causes of the economic downturn in 2001 by federal policy makers was going to be analogous to playing a game of jenga. The accumulated effects of financial market deregulation and subsequent stimulation would drive a proliferation of destabilizing investment patterns.
For my purposes, two policy mechanisms are key in explaining what happened in housing markets (i.e. the price bubble): the extreme pro-growth monetary policies of the Federal Reserve Board of Governors between 2001 and 2004, and the Bush administration's promotion of expanded home ownership to low income populations in under served markets. Addressing each of these mechanisms individually, the Fed Board of Governors began lowering the federal funds rate (i.e. the target rate for overnight loans between member banks) in January of 2001 and bottomed out at a 1 percent rate in June of 2003 before raising rates in June of 2004 (see "Historical Changes of the Target Federal Funds and Discount Rates," at: http://www.newyorkfed.org/markets/statistics/dlyrates/fedrate.html). At the time, these rates constituted historical lows. They were intended to lower borrowing costs across the U.S. economy in order to support a recovery from the financial market correction on high tech stocks, increasing purchases by both consumers and firms. In housing markets, they had the effect of bolstering both home purchases (by lowering rates on fixed and adjustable rate mortgages) and new home construction (by lowering the cost of borrowing for speculating contractors). As a result, housing markets that were already aggressively sustained by the flow of new capital into secondary markets with the passage of Gramm-Leach-Bliley, experienced large increases in demand for housing stock, driving up prices even as new speculative increases in housing stock were being made.
Quantitatively, the impact of the Fed's reduction of interest rate targets on the housing price bubble is difficult to assess, again, in a timeframe when so many things about mortgage markets are changing. Accounting for lagged effects, a possible impact of initial interest rate reductions becomes apparent in 2001, as home sales experienced a 3.5 percent increase over sales in 2000. There is no meaningful way, however, to disentangle the effects of Fed monetary policy here from those of secondary mortgage market expansion/securitization (i.e. the impact of Gramm-Leach-Bliley). A stronger case can be made that the bottoming out of interest rates in 2003 had the effect of producing a surge in demand in 2004. Housing sales increase in this year by 10.8 percent over sales in 2003 as median prices increase by 13.3 percent.
Total Housing Sales and Median and Average Sale Prices in U.S. 1996-2005
Year Housing Units Sold Median Sales Price Average Sales Price
(Thousands)
1996 757 $140,000 $166,400
1997 804 146,000 176,200
1998 886 152,500 181,900
1999 880 161,000 195,600
2000 877 169,000 207,000
2001 908 175,200 213,200
2002 973 187,600 228,700
2003 1,086 195,000 246,300
2004 1,203 221,000 274,500
2005 1,283 240,900 297,000
Source: U.S. Census Bureau, "Houses Sold by Region: Annual Data," at: http://www.census.gov/construction/nrs/pdf/soldann.pdf;
and "Median and Average Sales Prices of New Homes Sold in United States: Annual Data," at: http://www.census.gov/construction/nrs/pdf/uspriceann.pdf.
It appears indisputable that Fed monetary policy nurtured the development of the housing price bubble that, in turn, sustained the flow of capital in secondary mortgage markets to support the issuance of larger and larger quantities of subprime mortgages. More importantly, subsequent increases by the Fed in interest rate targets beginning in 2004 contributed not only to the deflation of the housing bubble but also the first waves of subprime mortgage defaults, as hybrid ARMs reset to interest rates indexed to the federal funds rate or other Fed interest rate targets. On the other hand, in conformity with the larger goal of this post, we must examine the policies of the Federal Reserve Board of Governors in reference to the macroeconomic context in which they were enacted. As much in the period from 2000 to 2004 as today, the Fed has responded with monetary policy tools to a lack of initiative by Congress at engaging in targeted countercyclical fiscal policies in response to recessionary developments. Sadly, monetary policy tools by themselves were too blunt to deal with the particular problems introduced by the collapse of the high-tech stock price bubble. As a result, the Fed traded a stock price bubble for a housing price bubble whose deflation posed much more severe and widespread consequences for the global macroeconomy.
As I suggested in my previous post, the point of this effort to examine the foreclosure crisis is not to exonerate subprime borrowers or any other party of culpability for the mortgage market meltdown. Neither is it to pointlessly concentrate blame. If the Fed Board of Governors enjoys some degree of culpability for what happened with housing markets, then its role must further be situated against all the other cast of characters contributing to the meltdown. Between 2000 and 2004, the Fed was attempting, in lieu of a more targeted effort by Congress to address strategic goals in domestic economic development, to bolster an economy suffering from both the collapse of value in high tech stocks and the shock of the 9/11 attacks. Again, in this respect, what was the Fed supposed to do as the dot-coms went bust, producing palpable losses in financial asset portfolios and declines in GDP?
Clearly, for conservatives and libertarians, committed to the notion that the responsibilities of a central bank should be strictly limited to sound money policies, effectively holding money supply growth steady in relation to the aggregate rate of growth in output/GDP, the answer would have been nothing (see the Austrian perspective of FreedomWorks CEO, Kibbe, "The Federal Reserve deserves blame for the financial crisis," Forbes Op/Ed (6/7/11), at: http://www.forbes.com/sites/mattkibbe/2011/06/07/the-federal-reserve-deserves-blame-for-the-financial-crisis/). I am not convinced that such a course would have necessarily averted the mortgage market meltdown although it almost indisputably would have pushed it off. In my view, securitization of subprime mortgage assets, expanded significantly through Gramm-Leach-Bliley, was critical. Referencing 2011 data from Inside Mortgage Finance, Simkovic shows that securitized subprime and Alt-A mortgages, as a percentage of all subprime and Alt-A mortgages, accounted for over 60 percent in 2002, before the Fed's federal funds target rate bottomed out in 2003 (see Simkovic (2013), "Competition and Crisis in Mortgage Securitization," in Indiana Law Journal, Vol. 88, 213-288, at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1924831). To his credit, Greenspan appears to have reiterated a comparable assessment in his appraisal of the causes of the mortgage market meltdown (see Andrews, "Greenspan Concedes Error on Regulation," New York Times, 10/23/08, at: http://www.nytimes.com/2008/10/24/business/economy/24panel.html?_r=0). On the other hand, relying almost exclusively on monetary policy to provide a countercyclical stimulus in recessionary periods necessarily generates potential adverse consequences in the organization of capital markets, promoting excessive accumulations of debt for both firms and households. In this sense, there is necessarily another side to the critique of actions by policy makers to the deflation of the stock price bubble and the 9/11 shock.
In particular, apart from Fed monetary policy, how did Congress and the Bush administration respond to the economic downturn beginning in 2000? The simplest answer to this question is that, in 2001, they cut income taxes modestly for lower and middle income taxpayers to stimulate consumer spending, cut income tax rates significantly for higher income groups to stimulate investments and domestic employment growth, and significantly increased the exclusion on estate taxes, contemplating the permanent elimination of the estate tax (re-labeled the "death tax") to give away billions of dollars to an exceedingly small segment of the U.S. population presumably in order to create a hereditary plutocracy!
If, in this regard, monetary policies can be considered too blunt as a countercyclical measure in response to a downturn concentrated in particular economic sectors, then the same can be said for a vast, indiscriminate fiscal assault on marginal income tax rates, lacking any attention to particular sectoral objectives or structural constraints on domestic investment and employment growth. A further critique can be leveled here, however. If a monetary expansion most critically impacts domestic consumption and debt-financed capital investment, then a tax cut concentrated on higher income groups is more likely, by contrast, to produce at least some macroeconomic leakages in the form of foreign investment expenditures (insofar as higher income groups are more likely to exploit investment opportunities outside of the U.S.). Again, the point is that the macroeconomy constituted by contemporary capital markets is global. There is no reason to assume that an across the board tax cut to higher income groups will manifest a significant increase in domestic investment expenditures, generating consequent employment growth.
There is, however, another side to the Bush administration's engagement with the domestic economy and, in particular, with housing. This orientation concerns the conception of an "ownership society," committed to the promotion of private property ownership as a sine qua non of individual freedom through personal autonomy/self-control. The tenor of this ideological commitment did not, in my understanding, perfectly correlate to the administration's commitment to the terms of the Community Reinvestment Act (CRA). Previously, the Clinton administration and a Democratic Congress, in 1992 amendments to CRA, had committed Fannie Mae and Freddie Mac to purchase larger percentages of their total asset portfolios from census tracts designated "underserved," as a correlation to "redlining" by financial institutions. Under the Bush administration, the Department of Housing and Urban Development (HUD) pressed this commitment further, raising 1992 statutory requirements on repurchases of mortgages by Fannie and Freddie from 30 percent to 56 percent of the total portfolios for the government sponsored enterprises.
At this point we need to reconsider the roles of Fannie Mae and Freddie Mac in the mortgage market meltdown. In 1968 and 1970, respectively, these enterprises were instituted as private, government sponsored entities, wholly owned by private shareholders but chartered by the federal government with a direct line of credit to the U.S. Treasury and a mandate to operate wholly within the secondary mortgage market. Their sponsorship by the federal government tied their hands to follow policies dictated by Congress by virtue of their existence as private organisms arising from the consent of Congress. With this in mind, the chief executives of these entities faced unreasonable choices in 2005. Minding their fiduciary responsibilities for shareholders to maximize enterprise profits, their commitment to pursue a responsible, conservative policy in defining conforming standards for the repurchase of mortgages from originators, and their statutory commitment under CRA to support lending in underserved (urban, minority) communities, they confronted the demands of primary subprime mortgage originators like Counrtywide that they increase their shares of purchases of high-risk subprime mortgage assets and they balked! Pressed by predatory lenders to one side and HUD (CRA) to the other, Fannie Mae and Freddie Mac were forced to swallow poison in massive quantities. Between 2005 and 2008, Fannie Mae and Freddie Mac collectively purchased in the vicinity of $1.8 trillion in subprime mortgage assets. When these assets, composed overwhelmingly of hybrid ARMs, reset and their borrowers defaulted, the two
government sponsored enterprises were rendered, for all intents and purposes,
insolvent. Congress was forced to step in and bail out each of the government
sponsored enterprises, at a significant and avoidable expense to taxpayers (see Duhigg, "The Reckoning: Pressured to take more
risk, Fannie reached the tipping point," New York Times, 10/4/08,
at: http://www.nytimes.com/2008/10/05/business/05fannie.html?_r=1).
Summarizing the larger points of a very long post, the mortgage market meltdown and the subsequent foreclosure crisis were integrally related to the larger evolution of global financial markets. In this regard, the bursting of the dot-com bubble in 2000 necessitated the development of a new basin of attraction for investment capital. Gramm-Leach-Bliley opened the door into mortgage markets and securitization spelled out the method. The Federal Reserve facilitated the development of an overheated housing market, driving up prices and leveling the cost of borrowing. CRA prioritized low-income communities, even if these communities would have been targeted anyway as underserved, high-risk, high-profit opportunities for the global financial sector.
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