How Corporatism, Not Capitalism, Caused the Housing Crisis of 2008

by Kristin Knepper

When the housing bubble burst in 2008, big banks were blamed for being greedy, permitting high-risk home loans and then selling them as securities to investors. Everywhere, cartoons such as this depicted the responsibility:

“The banks were too greedy and the government wasn’t regulating them enough! They need to be punished for their reckless behavior!” were common phrases heard in 2008. Americans said this crisis highlighted the flaws of the capitalist system and the greed of corporations. Yes, banks taking on more risk than they could handle was a cause. However, economic pillar number seven: the “rules of the game” guide economic growth. The banking system was not the main cause of the housing crisis in 2008. It was the US government and their support of corporatism over capitalism.

Capitalism is the economic policy that’s classified by an open market with private ownership of goods and capital, with limited government. The United States has a mixed economy, because their government regulates the market and businesses beyond the definition of capitalism.

Corporatism is a structure in which the market is made up primarily of big businesses guided by governments’ regulation and incentives. Jordan Ballor explains, “Corporatism is distinct from socialism, because under corporatism the means of production (capital) remain in private hands. But the private firms are not simply free to respond to market signals. Instead, under a corporatist structure, the government directs firms in the ways in which they should employ their resources, sometimes through moral suasion, but more often through regulation, tax policy, and legal directives.” So what were these policies and legal directives that caused the housing crisis?

Affordable Housing Goals (Thanks, Bill)

In 1992, the Clinton Administration revived the Community Reinvestment Act. This act, first passed in the 1970’s, encouraged banks to approve more home loans to low and middle income families. It was believed that the current standards for home loans restricted ‘The American Dream’ of homeownership to just a small minority of wealthy people. The CRA created a new standard for banks to be evaluated by. This standard was the diversity of their loans, or how many subprime home loans they would approve to ‘benefit the community’s American Dream’. With the incentive to take on some risk, loan institutions increased their subprime mortgages until in 2008, half of all mortgages in the United States were subprime or nonprime. 70 percent of those were guaranteed by the government or government agencies (Wallison and Pinto, 2012).

Fannie Mae and Freddie Mac- “Too Big to Fail”

These government guaranteed loans were created thanks to Freddie Mac and Fannie Mae. Freddie and Fannie were federally mandated by these affordable housing goals to flood the market with subprime loans. Then, in 1995, the Department of Housing and Urban Development authorized Fannie and Freddie to purchase subprime securities, too! (Hensarling, 2009). Which the private sector was selling off left and right, because they knew these loans would not be repaid and they did not want to be liable! “Again, the incentive to approve the loan was much, much greater than declining it.  And if it wasn’t approved at one shop, another would be glad to come around and take the business.  After all, the loans weren’t being held for more than a month or so before they were the investors’ responsibility” (The Truth About Mortgage). The loans were guaranteed by the Freddie Mac and Fannie Mae standards, so they were perceived as high quality and, since they were backed by the government, ‘too big to fail’. This could not have been further from the truth.

The Feds Record Low Interest Rates

The third main factor that influenced the housing market crash was the Federal Reserve lowering the interest rate. “Following the 2001 recession, Fed chairman Alan Greenspan slashed the federal funds rate from 6.25 to 1.75 percent. It was reduced further in 2002 and 2003, reaching a record low of 1 percent in mid-2003—where it stayed for a year. This created excessive liquidity and generated a huge demand bubble” (White, 2009). By 2003, you could buy a house with a mortgage loan of zero percent down and 1 percent interest, encouraging people to buy and refinance their homes. The increase in demand for homes created an overdevelopment of new homes.

Boom… Bust.

In 2008, after 16 years of government-incentivized subprime loans, record low interest rates and zero-down mortgages, the bubble burst. “The housing bubble and its aftermath arose from market distortions created by the Federal Reserve, the government backing of Fannie Mae and Freddie Mac, and the Department of Housing and Urban Development and its Federal Housing Administration. Americans suffered through a severe recession in 2008 and 2009, a downturn unfortunately precipitated by perverse government policies” (White, 2009). Homes went into foreclosure because they were “underwater”, their mortgages were now much more than the houses were worth. Banks were blamed for approving these loans and greedily selling them off. The crisis was seen as a failure in government to regulate corporations, when in actuality it was the government incentives and regulations that led to these risky loans. Americans had tunnel vision of achieving the American Dream, and the government’s policies made middle and low income families think this was possible. The rules of the game were misguided, and the American people suffered drastically because of it.

Works Cited:

Ballor, Jordan. "Corrupted Capitalism and the Housing Crisis." Acton Institute. 15 Feb. 2012. Web. 05 Feb. 2016. <http://www.acton.org/pub/commentary/2012/02/15/corrupted-capitalism-housing-crisis>.

Hensarling, Jeb. "The True Causes of the Housing Crisis." POLITICO. 29 Apr. 2009. Web. 06 Feb. 2016. <http://www.politico.com/story/2009/04/the-true-causes-of-the-housing-crisis-021819>.

Wallison, Peter, and Edward Pinto. "Free Fall: How Government Policies Brought down the Housing Market." American Enterprise Institute. 26 Apr. 2012. Web. 06 Feb. 2016. <https://www.aei.org/publication/free-fall-how-government-policies-brought-down-the-housing-market/>.

"What Caused the Mortgage Crisis?" What Caused the Mortgage Crisis? Web. 09 Feb. 2016. <http://www.thetruthaboutmortgage.com/what-caused-the-mortgage-crisis/>.

White, Lawrence. "Housing Finance and the 2008 Financial Crisis." Downsizing the Federal Government. Aug. 2009. Web. 05 Feb. 2016. <http://www.downsizinggovernment.org/hud/housing-finance-2008-financial-crisis>.

 

Picture source: http://www.politicalcartoons.com/cartoon.aspx?id=cfecfd8f-3c1a-478e-8390-601ae8743ff3