- Okay, good morning, everybody.
Today, we are going to talk
about the housing crisis
and its aftermath, which
could've been subtitled
the tragedy of errors.
And we're gonna work our way
through the various errors
and the tragedy of it
over the next hour or so.
I want to start with President Clinton
speaking in the East
Room of the White House
at a session with his then Secretary
of Housing and Urban Development,
Henry Cisneros in 1995.
- One of the great successes
of the United States
in this century has been
the partnership forged
by the national government
and the private sector
to steadily expand the dream
of home ownership to all Americans.
In 1934, President Roosevelt created
the Federal Housing Administration
and made home ownership available
to millions of Americans who
couldn't afford it before that.
51 years ago, just this month,
Harry Truman rewarded servicemen and women
with the G.I. Bill of
Rights, which created
the VA home loan guarantee program.
That extended the dream of home ownership
to a whole new generation of Americans.
For four decades after
that, in the greatest period
of expansion of middle class dreams
any country has ever seen
anywhere in human history,
home ownership expanded as incomes rose,
jobs increased, the educational level
of the American people improved.
But in the 1980s, as
the vice president said,
that dream began to slip away.
I ran for president in large measure
because I wanted to restore that dream
to grow the middle class,
shrink the underclass,
promote the mainstream values
of work and responsibility,
family and community,
and reform government
in a way that would enhance opportunity
and shrink bureaucracy.
We made good progress, but
we have to do a lot more.
I ask all of you just one more time
to look at that chart,
and I wish I had a lot of other chart
to show you that would reinforce that.
Home ownership declines then
stabilizes at a lower level.
At the same time, more
and more American families
working harder for the same
or lower wages every year
under new and difficult stresses.
It seems to me that we have a serious,
serious unmet obligation to
try to reverse these trend.
- So there you have
President Clinton in 1995
bemoaning the decline in home ownership
that has set in over the
previous several decades
and pledging his
administration to increase it.
And we will see that Clinton was not alone
that the desire to expand home ownership,
which is closely
associated, as you can tell,
from his comments there,
with mainstream accounts
of the American dream has been bipartisan
and pursued by administrations
over a number of decades.
Our agenda today is to
think about what produced
the subprime mortgage
crisis that played out
in the financial crisis that
we talked about on Tuesday.
Think about the results of
the subprime mortgage crisis.
And what are the lessons
that we should draw,
given the larger narrative
and concerns in our course.
And you really, in order
to get an understanding
of the housing crisis and how it played,
has played itself out,
we really have to go back
and understand the place of housing
in fights about justice and particularly
racial justice in America
back to the 1930s.
And what I'm calling here the transition
from hard to soft
apartheid, or if you like,
from legalistic to market-based
apartheid in America,
is something that really
occurred over the course
of a number of decades after the 1930s.
If you go back to the 1930s,
it would not have been unusual
to see signs like this in neighborhoods,
particularly, but not
exclusively in the south.
And this is what I, this
is the height of Jim Crow
and the era in which
explicit racial segregation
was the order of the day.
When people bought and sold houses,
they would often contain
so-called restrictive covenants.
Here's a passage from a
deed transferring some land.
It says: None of the said
lands, interests therein
or improvements thereon shall be sold,
resold, conveyed, leased, rented,
or in any way used, occupied, or acquired
by any person of Negro
blood or to any person
of the Semitic race, blood, or origin,
which racial description shall be deemed
to include Armenians, Jews,
Hebrews, Persians, or Syrians.
So this is a notion of
restrictive covenants
and they were, by the way,
perfectly legal until 1948,
famous Supreme Court decision
Shelley versus Kraemer,
a five to zero decision with
three justices abstaining
because they all own houses
that had restrictive covenants,
and what the court said in that opinion
was that while it was a violation
of the Equal Protection
Clause of the 14th Amendment
for states to enforce these
restrictive covenants,
it was no violation of the Constitution
for people to put them
in the deeds of houses
and voluntary abide by them.
So if you were, wanted to signal to buyers
that this is a Whites only neighborhood
and we shouldn't allow
non-White to come in,
that was not illegal.
And so, and that of course goes back
to something I mentioned to
you in an earlier lecture,
namely after Reconstruction,
we had very restrictive readings
of the civil right, Civil War Amendments
by the Supreme Court
and in particular they
said of the 14th Amendment
that it didn't apply to private action
but only state action.
So Shelley versus Kraemer in 1948
said these restrictive covenants
could no longer be enforced,
but that didn't mean that they went away
and they didn't for some time thereafter.
This is something called
the 8 Mile Wall in Detroit.
Anyone here from Detroit?
Anyone know what the 8 Mile Wall was?
It was actually half a mile long,
it's not eight miles long,
it's half a mile long,
but it's on something called 8 Mile Road,
and 8 Mile Road was a physical barrier
between White and non-White neighborhoods.
So the idea was to keep African American,
presumably principally
African American children
from going into White neighborhoods
and it since, you can see, has
had been covered in graffiti,
but it's still there as a kind of monument
to the physical segregation,
what I'm calling hard
apartheid of the Jim Crow era.
That was actually, the 8
Mile Wall was built in 1941.
Anyone know what this is?
It's a map, yeah,
(students mumbling)
what's all the scribbling on it?
- Redlining.
- This is so-called redlining,
and you can see this saying,
this is an OK place to write mortgages,
this is OK, this is
super, this is the hood,
and this is don't even think
about writing mortgages
in this neighborhood.
And so actually the history of redlining
goes all the way back to the 1930s
and initially the government
was in fact behind it.
In 1934, we got the National Housing Act
which created the Federal
Housing Administration,
and the following year, they commissioned
the Federal Loan Bank Board
to run studies in 239 cities
in the service of underwriting.
They wanted to help underwriters know
where these risky loans actually were.
And so the idea was that
mortgage underwriters would know
what to charge and whether,
and what circumstances
underwriting would be warranted.
But of course, it soon became a proxy
for denying loans, mortgages in minority
neighborhoods and to minority lenders.
So redlining became used for that purpose.
And as you can see, just if you Google up
redlining on Google Images,
you can find maps of
virtually any American,
and by the way, also Canadian
cities from this period.
This is one from Seattle,
and you can see there
from the color code, the green is best,
the blue is still desirable,
the yellow is the declining neighborhoods,
and the red, hence
redlining, was hazardous.
And so that's one from Seattle,
I've just put a few up here,
one from San Francisco, Buffalo, New York,
Austin, Texas, and I could've put many,
many more, many more of these.
And so this practice of
redlining reinforced, of course,
racial and class-based
segregation of neighborhoods,
because banks would only
want to lend in the areas
that were least risky and most desirable.
In 1968, the Fair Housing
Act prohibited discrimination
in lending based on race
and also by neighborhood.
This was reinforced by even more
stringent legislation a decade later,
the 1977 Community Re-investment
Act, reiterated these bans,
but they're extremely
difficult to actually enforce.
This is what I'm calling
the era of soft apartheid,
you don't necessarily
need restrictive covenants
and we'll see this play
out in four-part harmony
and in the rest of today's lecture.
But even though redlining and
loans based on discrimination
either against particular
neighborhoods or by race
has been illegal since the 1960s,
as recently as 2015, there were
huge settlements with banks
who had been caught in this practice.
For instance, Hudson City Savings Bank,
which services New York,
New Jersey, and Pennsylvania
reached the largest settlement ever
with the Department of
Justice, $33 million settlement
for denying loans to African
American and Latino borrowers
and were required as
part of that settlement
to open branches in
minority neighborhoods.
And in that same year, there
was actually a $200 million
settlement with HUD, the
Department of Housing
and Urban Development, between,
for a bank called Associated Bank
for doing the same thing
in Chicago and Milwaukee.
And again, they were
required to open branches.
So even though redlining
is no longer legal,
that doesn't mean it doesn't occur.
And so this is one of the ways in which
it's become possible for markets
and market practices essentially
to underwrite the
segregation of neighborhoods.
So I asked you to spend
a little bit of time
with the Parable of the
Polygons, the Schelling,
which is a user-friendly version
of Schelling neighborhood tipping game.
Who did, did you spend some time with it?
What did you take away from it?
- [Student] I found it a little depressing
when I got toward the end.
- What's depressing about it?
- [Student] Well, that
in most of the scenarios,
you end up with very
segregated neighborhoods
and you have--
- But how do we get
to segregated neighborhood?
- [Student] Well, there was,
a lot of the rules were about,
you're only happy if, they
came down with the 1/3 rule,
so if it went down--
- Just back up a little bit
and explain how it works
for anybody who didn't--
- [Student] All right, so
there's two types of polygons.
There's the triangles and the squares.
And basically the point of
the game was to show you
at what point, by looking at the map,
when all the triangles and
all the polygons were happy
based on who their neighbors were.
And what you discovered was that
the more you played around with it,
you needed to have
segregated neighborhoods
for people to be happy
or generally happy with their environment.
- Okay, anyone want to add a point
that was taken away to what he said?
Yeah?
- [Student] Yeah, I was
just really surprised
by how little personal bias it takes
in order to get--
- Okay, sorry,
elaborate on that.
- Collective bias.
Because even though one square or triangle
might only need to be
surrounded by like 1/3 of people
who are like them to be happy,
the way that that ends up playing out
is that in order for everyone to be happy
it reconfigures so that you're
actually really surrounded
by people who are mostly like you.
It doesn't actually factor out to that 1/3
in like a collective way.
- Exactly, so he's, just to
summarize what you're saying,
very mild levels of prejudice,
where mild is understood to mean,
I just want some of my
neighbors to be like me,
20% to 1/3 is enough to, of course,
entire neighborhoods to
segregate completely.
So very low levels of prejudice
will segregate neighborhoods
simply by the voluntary
choices that people make.
You don't need restrictive covenants,
you don't need all this
other stuff to get it,
that's what I'm calling soft apartheid.
And not only that, it's
very difficult to undo,
it's very difficult to reverse,
and less people have an
active desire to integrate.
That we have to change their preferences,
otherwise, with very
low levels of discomfort
at having large numbers of
your neighbors be unlike you
is gonna be enough to
segregate neighborhoods.
And so this is a very famous,
Schelling was a brilliant economist,
most of his works is on arms races,
but this neighborhood tipping game
tells you that if you start off
with a neighborhood that looks like that
and people have these
very low levels of desire
to be surrounded by some
people like themselves,
it's gonna wind up in pretty
short order like that.
And of course, we don't start off
with something like that
in most American cities,
so it's even tougher.
What we really start off
is something much more like this,
this is a map of Chicago
with neighborhoods
are already heavily segregated.
And what would be required
would be to desegregate them
and that's taking Schelling to heart
is not going to happen unless you have
pretty radical changes in the population.
And so in some ways, it
might be said that actually
soft apartheid is harder to combat
than hard apartheid or Jim Crow.
I've given you one reason already,
first of all, you would really have
to have active changes
in people's preferences,
positive desires to
desegregate the neighborhoods,
not just absence of resistance
to the desires of others.
Any other reasons why soft apartheid
might actually be harder to fight
against than hard apartheid?
By hard apartheid, I'm
talking about de jure,
restrictive covenants,
laws outlawing people
living in certain neighborhoods and so on.
Yeah?
- [Student] Is it more
unconscious, like unconscious bias?
- It could be, there could be
issues of unconscious bias,
that might be part of it.
Anything else, what were you gonna, yeah?
- [Student] There's an
economic factor now,
housing prices have gone
so much that it's difficult
to actually, even though you enforce it,
to have people move in if
they have lower incomes.
- So people are gonna self-segregate
by socioeconomic status, yep, okay.
Anything else?
- It's much harder to prove.
- Pardon?
- It's much harder to prove.
- It's harder to prove,
and it's harder to identify.
If you think about hard
apartheid, it provides targets.
If you wanna get rid of
restrictive covenants,
let's say, we can have a campaign
to get rid of restrictive covenants,
gives you a kind of a proximate
goal to organize around
and to get rid of and
I'm gonna come back more
and talk about the importance
of proximate goals.
There's also a literature in psychology
about so-called boundary permeability.
Academics never say in
words of one syllable
what can be said in
words of five syllables.
But here, this is the basic idea.
If there's a law which
says no Blacks and Jews
can join a New Haven Lawn Club,
there will be a campaign
to get rid of that rule.
There will be a campaign
to have Blacks and Jews
allowed to join the New Haven Lawn Club.
If there's no rule, but one Black family
and one Jewish family is
allowed to join every 15 years,
there won't be a campaign.
Similarly, if you have a rule which says
no junior faculty will get tenure.
Then you'll get a junior faculty union.
If you don't have a rule, but in fact,
only one in eight of the
junior faculty gets tenure,
which has been a Yale
equilibrium for many decades,
then you don't get a
junior faculty union, why?
It's not entirely clear,
but it may well be,
and this is claim in the
boundary permeability literature,
everybody thinks I'm gonna be the one,
I'm gonna be the one, so if you have norms
or practices that function
so as to produce exclusion
without actually having formal exclusion,
it becomes much more difficult
to get people to organize, to change them.
And so this is, if you look at something
like the Civil Rights Act,
and you say this is 1964 and
the Voting Rights Act of 1965,
what has been, what's been achieved?
It's mostly that the de jure,
rather that the de facto
forms of racial discrimination
that have been stamped out.
It's much harder to
stamped out the de facto.
So we have inherited a world
in which the hard apartheid
of the Jim Crow era has been replaced
by the much more nebulous,
but in some ways,
more difficult to deal
with, soft apartheid,
that gets generated as a byproduct
of the lack of proximate goals,
the tipping phenomenon
that Schelling describes,
and the very big obstacles to
organizing collective action
in circumstances where you have
high levels of boundary permeability.
So that's something to bear in mind
and we'll come back as we
see how this played out.
People attempting to combat
the effects of soft apartheid
played out in the housing crisis.
Now, if you said, what was the
cause of the housing crisis,
there's no single answer, it
was really a perfect storm.
A number of factors came
together to produce this result.
And I wanna mention four.
The first one we've already heard
from President Clinton's mouth,
and here I, this he wrote
the year before that speech,
but here you can see, "More Americans
"should own their own homes,
"for reasons that are
economic and tangible,
"and reasons that are
emotional and intangible,
"but go to the heart of
what it means to harbor,
"to nourish, and to expand
the American dream."
Home ownership is part of what people
who want to realize the
American dream aspire to,
and a big part of the housing crisis
grew out of the agenda of extending
home ownership to previously excluded
racial and ethnic minorities,
exactly the people who are
being discriminated against
as a result of soft apartheid.
And this graph sort of
reflects the numbers
that Clinton was talking about,
you can see that in March of the,
starting actually at the
beginning of the post-war period,
you see big increases in home ownership,
and then it levels off and
successive administrations
do take actions to increase it.
Now we're gonna talk about
till it finally reaches a peak in 2008.
Second is securitization of
the subprime mortgage market.
So just to be clear, a
subprime mortgage is,
we're talking about the
subprime mortgage crisis,
what is a subprime mortgage?
A subprime mortgage is a
mortgage that is risky to hold.
It is risky because it is
being given to somebody
who either has not a
very good credit history
or it's being given with
a very low down payment
so that the home owner doesn't
have a lot of incentive
to keep paying the mortgage,
we're looking at more about that later.
It's a mortgage that it's
risky for a lender to hold.
It's subprime and so
normally, in a market system,
subprime mortgages charge higher
interest rates than regular mortgages
precisely because they have
to bear the cost of that risk.
So that's what a subprime mortgage is.
Now, securitization of subprime mortgages,
what securitization of
subprime mortgages refers to
is the following, (coughs)
if I had wanted to buy a
house, say, in the 1970s,
I would have gone down to the local bank,
they would've said, "You want a mortgage?
"Well, give us your credit history,"
I would've had an interview
with the bank manager
and I would have had to put
20% down on the house,
the bank would have,
probably the bank manager
would have known me,
it would have been, I lived in Guilford,
that would be in the Guilford Savings Bank
as it in fact was, but they
would run their credit history,
they would become comfortable
with lending me the money,
I would take out a 30-year mortgage
and they would then hold that mortgage
and service that mortgage
and I would spend
the next several decades
paying off that mortgage
back to the Guilford Savings Bank,
that is basically how
mortgages used to work.
Securitization is the
process whereby banks
not only sell, once
they give the mortgage,
they sell it to another bank
or another financial entity
and those mortgages then become chopped up
and sold off in pieces and traded.
So they start, they become securities.
And it's important to understand
that the securitization of mortgages
actually begins with
the federal government.
Fannie Mae, Fannie Mae is so-called
government sponsored entity.
It was established in basically the 1938
as part of the second new deal
in the wake of the depression,
more than 25% of America's home owners
had their homes foreclosed
on in the depression,
and it was extremely difficult for people
to get mortgages, to buy homes.
And so the Roosevelt administration
wanted to make it easier.
And so what the Freddie,
Fannie Mae quickly got involved in doing
was essentially two things.
One was buying up mortgages from banks,
and secondly, creating liquidity,
because if you think about,
if Guilford Savings Bank
is holding that mortgage for 30 years,
they can't use that, they can't give
another mortgage with that same money,
but if they sell that
mortgage to Fannie Mae,
they can then use the money
to give out more mortgages.
So Fannie, starting way back in the 30s,
but much more in recent decades
began buying up mortgages
to create liquidity in
the mortgage market.
And then they also wanted more money
with which to do this.
So they began the process
of securitization.
Fannie Mae actually started chopping
these mortgages up and selling them
and then they would become
traded as securities.
And it's, it was a government entity,
but eventually it became
partially privatized.
So you can trade Fannie Mae stocks
on the stock exchange now,
it's a public-private
partnership, if you like,
and that is part of the
source of its problems.
But the securitization of mortgages
essentially got going
because Fannie started
selling them off and
then they would be resold
and repackaged and resold and repackaged,
and more and more finely sliced.
And they got the great book about this
is "The Big Short" which
some of you might have read,
but people had very little understanding
about internal composition
of these buckets
of mortgages that were being traded.
Another thing that nobody
was aware of at the time
but became obvious in hindsight
was people had generally
thought of real estate
as a hedge against the stock market,
because you don't wanna have
all your eggs in one basket.
But the more you had the
securitization and trading
of these mortgages on Wall Street,
the more actually they
were operating in tandem,
and so when the real
estate markets crashed,
so did the stock market.
The government started to do this,
but then private banks
also started to do this,
and the big investment
banks got into their own
securitization and indeed
after 2002, 2003, 2004,
when regulators were
finally getting nervous
and started pulling back the government's
activity in securitization,
that's when the private sector
securitization ramped up.
And so the good news was that
more and more liquidity was being created,
it was getting easier and
easier to write these mortgages,
the bad news was that there
was more and more vulnerability
in the system and people
started to lose the incentive
to conduct the sort of due diligence
that you would otherwise
conduct in giving out a loan.
If the Guilford Savings Bank
is gonna give me a loan,
they need to be confident
that I'm gonna be able
to pay that loan back.
If the Guilford Savings
Bank is gonna sell the loan
they give me to somebody
else the next day,
then it doesn't matter to them
whether two years from now
I'm not gonna be able to pay my mortgage.
So they don't have the same incentive
to do the due diligence
in giving out the loans.
And it's not just in giving out the loans.
If you think about appraisals,
if the Guilford Savings
Bank is giving me a loan,
they wanna be sure that when they're told
the house is worth $150,000,
it is worth $150,000.
If they're gonna sell that
loan, it doesn't really matter,
and so you started to get
not only the phenomenon
of drive-by appraisals, but
what the appraisal company
soon discovered was that if
they didn't give the appraisal,
that the borrower and lender wanted
in order to facilitate the transaction,
they would just go to
another appraisal company.
And so the appraisal
company's also were complicit,
and indeed, I can remember
refinancing a mortgage
in about 2006, 2007,
I wanted to borrow out the
equity to do this and that,
and I needed the appraisal
to be some number,
I've forgotten what it was, $850,000,
and we got the drive-by appraisal,
it said it was worth $900,000,
and I remember sitting
there in signing the papers
looking around the room,
the guy from the bank,
from the attorney, and so on, I thought,
nobody in this room believes
this house is worth $850,000.
And indeed, it turned
out later it was not.
(students laughing)
But there it was, nobody had the incentive
to do the kind of due diligence.
So the securitization of
subprime mortgages is,
and we'll see why we got more and more
subprime mortgages in a minute,
but there were a lot of these
very high risk mortgages
that were being securitized
and being traded
and there was nobody with enough
so-called skin in the game
to have the incentive to
do their own due diligence.
The third component of the crisis
was what we talked about last time,
the behavior of the banks,
the relentless drive
to deregulate them and make it easier
for investment banks in particular
to get involved in this activity.
But the fourth and most
important in many ways piece
that I wanna emphasize was politics.
And so the idea that the government
should get involved in
addressing soft apartheid
goes back at least to the 1980s.
This is Jack Kemp, quarterback
for the Buffalo Bills.
He was actually in 1996,
Bob Dole's running mate
in his failed attempt to
unseat President Clinton,
but before that, sorry, after that,
before that, 1989, he was Secretary
of Housing and Human Development
in the George Herbert
Walker Bush administration
and he called himself a
bleeding heart conservative,
and he came up with this
idea of HOPE programs,
Home Ownership for People
Everywhere is what HOPE stood for,
Home Ownership for People Everywhere.
And he had this idea that the government
should sell off, this was
like Margaret Thatcher's
privatization of council houses in London.
The government should sell off
all its public housing to the owners
and he was beating the drum to do this,
he actually ran into huge opposition
within the Bush administration
from people like Darman
who's managing the budget,
and Congress was not very
excited about funding it
and it turned out that just to get
one of these government owned houses sold
was gonna cost close to $100,000,
so it kind of crashed and burn
but it didn't really work as a policy.
But Bush did it about
whether to get behind it,
then we have already seen
that in the Clinton administration,
there was a lot of effort
to get behind this.
And it didn't just come from Clinton,
it came from the left
of the Democratic Party
and from minorities in
the Democratic Party.
This is Barney Frank,
as in Dodd-Frank Frank.
He was considered a
very liberal congressman
and he was a huge champion
for saying to Fannie Mae
that you have to put
pressure on these private
loan originators to give mortgages
to low income neighborhoods,
to minority neighborhoods.
Maxine Waters, congresswoman
from California
was part of this same group of people,
and so essentially, what
happened was that Congress
started putting pressure
on Fannie and Freddie Mac,
which is a, Freddie Mac is a
younger and smaller Fannie Mae
created in 1970 to have some
competition in this market,
but essentially, Congress, under pressure
from these kinds of people in Congress
was saying that you have only to make,
you have only to make
Fannie Mae funds available
in subprime mortgage markets.
That is what bankers would
call subprime mortgage markets
in minority neighborhoods,
in poorer neighborhoods,
and then came relentless pressure
to make the subprime more and more sub,
so reducing down payments
from 20% to 10% to 5%,
eventually to next to nothing.
And again, using non-traditional criteria
for granting people mortgages
in terms of evaluations
of their credit and so on.
And when people say, oh, so
it's actually the government
that caused the financial crisis,
which conservative sometimes argue,
this is what they're talking about.
Because they're essentially saying
that these practices by Fannie and Freddie
distorted the whole mortgage market
because they, after all,
even though they are publicly traded,
are underwritten by the taxpayer.
So they can take more risk than they would
if they were not
underwritten by the taxpayer.
But that means that private sector lenders
have to do the same thing if
they're gonna be competitive.
So the argument gets
made that these practices
distorted the entire mortgage market
and create and even as the government
started to get out of the business
of securitizing subprime mortgages
in the new millennium, nonetheless,
they had already created this world
in which the only way in which lenders
could compete was by giving
more and more risky loans
and further because of the
process of securitization,
everybody underprice the risk
because everybody was passing them on.
It's one of the reasons
I think Alan Blinder
called his book that I
was referring to last time
"After the Music Stopped,"
you don't find out
who doesn't have a chair to sit on
until the music actually stops.
And so that is what they,
that became the game.
And there was enormous pressure
in the Clinton administration
and it continued
into the George W. Bush
administration as well.
Again, pressure to reduce
underwriting standards and so on.
And it was heralded just
as Clinton had heralded it
and Bush had also heralded it as expanding
the American dream into
minority communities
and making home ownership available
on a more equitable basis.
So let's talk about the aftermath
when it all came crashing
down for a minute.
And I wanna have you listen
to a colleague of mine
in economics department for a few minutes
by the name of John Geanakoplos.
He is one of the most
brilliant people at Yale.
He's one of those people,
if he's giving a paper, you just go.
You know you'll learn something.
He also happens to, he
happens to have a hedge fund
that invests in mortgage
backed securities,
so he knows whereof he speaks,
and this is his post-mortem on
the subprime mortgage crisis.
- Some errors.
So what we did right, I guess,
is we averted a complete
collapse of the banking sector,
but that is also the source
of what we did wrong,
because we were so obsessed with the banks
that we forgot what caused the crisis,
which was the subprime mortgage market
and the mortgage market in general,
home owners and what would
happen to home owners.
So we've lost about four million
or five million households
to the crisis who've been
thrown out of their houses,
and another couple million
more that are on the way out
that still haven't finished
with the foreclosure process.
So altogether, they're gonna be
something like six million or more,
maybe even will get to
seven million households
that will have lost their houses.
If you're thinking three
people per household,
maybe some people had multiple houses,
so it might be a slight exaggeration,
but we're talking about 20
million people lost their homes
and who would've thought
that America would ever
have to deal with 20 million
people losing their homes?
And who would have had to deal
with this long period of
stagnation and growth,
which I think is related
to the housing crisis.
So I think the biggest mistake we made
was concentrating too much
on the banks and recapitalizing the banks
both during the crisis and still now
and too little on helping the home owners,
who I think were the heart of the crisis.
So to give you an example,
we have a lot of data now
on what happen to people
who lost their homes
and what happen to the lenders.
So a typical subprime loan might have been
for say $160,000 and the house
originally was worth a
little more than $160,000.
But during the crisis, housing prices fell
quite dramatically and that kind of house
conceivably could have fallen to $100,000.
So think of yourself
as a subprime borrower
with a bad credit rating to begin with,
that's why he is or she
is a subprime borrower,
who owes 160,000 on a house
that's only worth 100,000
in a time period where the future
looks very bleak for
earning money, for example.
It would be almost crazy for
such a person to keep paying.
And in fact, most of the
people didn't continue paying
for a while in 2008 and 2009.
Six or, people now
position six or 7% a month,
not a year, six or 7% a month
were defaulting on their mortgages.
So every month, there'd
be a new and different set
of 6% or so who defaulted
on their mortgages.
So what we did in most cases
was tell them they'd stop paying.
The Obama administration
might have lept in
and said, "Oh, it must be
because you don't have a job,
"we'll try to reduce your interest
"payments for a little while."
But so, imagine again you're that person
who still owes 160,000, instead of paying
8% a month, you now pay 4% a month.
Your house is still worth only 100,000.
So what happened was 50
to 80% of those people
after about a year re-defaulted.
So the plan of helping the homeowners
by reducing their interest
payments for a while
till they got over the bad times
was completely unsuccessful.
They defaulted.
And what happened to the
lenders after the default?
The homeowner didn't just
walk away from his house,
he sat there until he was thrown out,
which took on average almost three years,
during which time the homeowner
didn't pay his mortgage,
after he found he was
gonna lose his house,
he didn't pay his mortgage,
he didn't pay his taxes,
he didn't fix the house, and
on the way out of the house,
maybe some things got taken
or the house got ruined on the way out.
So we have the data now, the
recovery in such a situation
was in fact, on all the
subprime loans was under 25%.
So the lender would've gotten
back 40,000 out of the 160.
Had we forgiven some of the debt,
had the lenders gotten
together and reduce the debt
from 160 to 90 and maybe
even slightly subtle,
more subtly said, "We'll
reduce your debt to 90,
"but in case the house
goes back up in price,
"we'll raise the debt, 50%
of the increase in the house
"we'll add to the debt again."
Had they done that, they
probably would've gotten their 90
because the home owner now could've seen
that his house was worth
more than the debt.
At worse, the home owner
could've sold the house
and pay back the 90 and kept 10.
And so the home owner
would've been better off,
the lenders would've been better off,
because they would've
gotten 90 instead of 40,
and the economy would've
been immeasurably better off,
and by the way, the banks,
would've been better off,
because that's where they were losing
all their money in those kinds of loans.
So I think our biggest
mistake was that we focused
on the banking sector and
trying to recapitalize it
and find enough money for the banks,
and we didn't focus on the home owners
whose debts were actually
owned by the banks
and who were gonna determine
the fate of the banks at the end anyway.
And we would've done much better
concentrating on the home owners.
I think that is the major mistake,
major policy blunder that the
Obama administration made.
And they made it not because
it never occurred to them,
because people like
me, and I wasn't alone,
went and talk to them and said,
"This is what you should do."
I even testified in Congress a few times.
And it's not just academics like me
who were saying things like that,
it was the business people who
were making the investments
and who effectively owned the loans
who also wanted to see the debt forgiven.
This isn't some pie in
the sky, academic idea,
there were a number of hedge funds,
these mortgages, they're
not done individually.
A bank may give the mortgage,
but the banks then sells
the mortgage into a pool,
and it's the shareholders of the pool
who are effectively lending the money,
the bank is just the middle man.
So a bunch of, but these bondholders,
shareholders of the pools,
they don't know each other,
so it's very difficult for them
to coordinate any activity.
That's why we need the
government to coordinate things
that are difficult to
coordinate otherwise.
So a bunch of those hedge
funds and other investors
also testified in Congress
that they would like to see
the debt forgiven not
because they were good guys
but because it would help them
as well as helping the economy.
And we just weren't
willing to be bold enough
to listen to those voices
and we didn't take,
I think, the most important
step we could have
to make the ensuing
recession less dramatic.
- So why didn't the politicians
take Geanakoplos's advice?
He's saying it would've
been an all around win.
The banks, the home owners,
the investors would all
have been better off.
Why didn't the government do that?
Any,
any thoughts about why?
Yeah?
- [Student] I just feel
that everyone thought
that they had a good
thing going at that point,
and they didn't want to put
a monkey wrench in there.
- Well, but this is when
we were having mortgages
defaulting at a very alarming rate.
So that can't be the story.
Any, yeah?
- [Student] For me, this is akin
to getting away with murder.
So if you know that you can taken a loan
and they'll cut it to half,
then why pay the loan at all,
'cause you know you can get away with it.
- So you're worried about
the moral hazard problem.
Well, let's hear elaboration
of the moral hazard problem here.
- I tell you what, I have an idea.
The new administration's big
on computers and technology,
how about this, President,
new administration,
why don't you put up a
website to have people
vote on the internet as a referendum
to see if we really wanna
subsidize the loser's mortgages
or would we like to at least
buy cars and buy houses
in foreclosure and give 'em to people
that might have a chance to
actually prosper down the road
and reward people that
could carry the water
instead of drink the water.
- Hey Rick, it's a novel idea.
- Hey, Rick--
(others mumbling)
They're like putty in your hands.
Did you hear--
- No, they're not, Joe.
They're not like putty in our hands.
This is America, how many of you people
wanna pay for your neighbor's mortgage
that has an extra bathroom
and can't pay their bills,
raise their hand, hello, we all.
(others booing)
President Obama, are you listening?
- How about we all stop
paying our mortgage?
It's a moral hazard.
- Hey, Rick, how about the notion
that Will reported that
you can go down to 2%
on the mortgage--
- You could go down
to minus 2%, they can't afford the house.
- And still have 40% not be able to do it,
so why are they in the house?
Why are we trying to
keep 'em in the house?
- I know Mr. Summers is a great economist,
but boy, I love the answer to that one.
- Jason, Jason--
- You're thinking
of having a Chicago Tea Party in July,
all you capitalists that wanna show up
at the Lake Michigan, I'm
gonna start organizing.
(someone whistling)
- What are you jumping--
- So that is so-called
Rick Santelli's rant.
He is a financial commentator,
that was a morning on the
Chicago Mercantile Exchange
in February of 2009,
the Obama administration
had just taken office
and it's a famous rant
because you've heard him
calling for a tea party in July
and that is often
credited with galvanizing
what became the Tea Party
movement, Rick Santelli's rant.
Although some people dispute and say
his influence has been exaggerated,
but it's become emblematic of
the scorched earth resistance
to doing anything remotely like that.
And so one argument he's making there
is the moral hazard argument.
Now, people like Geanakoplos and others,
they weren't entirely
ignorant of such things,
and there were ways to address it,
namely first of all,
to point out to people
that if you didn't write down these loans,
say of your neighbor's home,
your house has become even worse,
even, it's gonna lose value,
because it's gonna be
next to a decrepit house.
And secondly, the people who
did get mortgage assistance,
for example, what the government,
as John Geanakoplos said,
they would give them a lower
interest rate for a while,
it didn't work because of the underlying
incentives didn't line up,
but they were put
through humiliating hell.
It wasn't like you just filled out a form
and said, now I get my mortgage reduced,
or my interest rate reduced,
you went through
endless interviews with people
that made you prove your need,
this is like the sorts
of humiliating things
people have to go through
to get out of government assistance.
So the argument was that there are ways
to manage the moral hazard, if you like,
even if you can't make
it entirely go away.
But the Rick Santelli's
rant, I think is instructive
for other reasons, which is, go back to,
remember our discussion
of the Capuchin monkeys
when I said that the researcher
misinterpreted the
result of his experiment
when he said that the angry monkey
was like a Wall Street protester,
and it's really people make
much more local comparisons,
and it's the idea even if
you're gonna be worse off
because your house is
gonna get less valuable
being next to a dilapidated house,
you make the local comparison
and that becomes the
source of your resentment.
And so for this reason,
the kind of proposal
that Geanakoplos and others
were pushing is dead on arrival.
Even though people are
gonna have to actually
take an absolute hit for refusing
this kind of assistance,
it's not gonna possible to
mobilize them behind that.
And it might not surprise
you to know that,
you maybe can guess from his name
that John Geanakoplos has
over the last number of years
be in acting for the Greek government
in its dealings with the
IMF and the European banks
where he's made exactly the same argument.
He said the Greeks cannot pay their debts
and you should write the principal down
because all we're doing by,
they just keep rescheduling
it into the future,
they're not solving the problem.
What they should be doing is
saying for every euro you pay,
we will forgive the principal
you owe by two euros,
or something like that.
And it won't surprise
you to know that he's got
no further defending the Greek government
than he got defending the home owners
during the mortgage crisis.
And that is because
brilliant economist as he is,
he's not paying enough attention
to the politics of the situation
and the resentment that
would get generated
if the government did do
this on a significant scale.
So even though it makes
pristine economic sense
and Geanakoplos is right that everybody
would have been better off,
it was something that was
politically was dead on arrival.
And that's scarcely surprising.
It should also just be said
that the banks were divided about this.
They were not as united
as that clip suggests.
Some of them actually preferred
the wholesale buyouts,
bailouts of the banks
rather than worrying
about the home owners,
partly because there would've
been quite substantial
transaction cost to doing
it they would have had,
because the mortgages
are owned by many people
and so how you're actually
coordinate the writing down.
At the end of the day, the
really simple way to do it
would be even harder politically,
which namely the government
would've just given
the money to the home owners,
written them a check, but again, I think,
for reasons we're gonna go into next week,
for government to give people checks
is politically very difficult.
There's also, was also
some sunk cost fallacy,
so this is related to loss aversion
that I've talked to you about,
which is if a lender writes down a debt,
you're admitting you made a bad loan.
Whereas if you hope against hope
that the market's gonna come back,
you will not have to own the
fact that you made a bad loan.
So you see this all the time,
an economist will tell you
if you're trying to decide whether or not
to sell a stock, the only
important question is
what is it gonna be worth in the future
if I don't sell it today.
But nine of 10 people will focus
on what did I pay for this stock.
It's the wrong question.
For an economist, it's a
completely irrelevant question
what I paid for the stock,
but Kahneman inference, a
psychologist who understands
the human psychic cost
of internalizing the fact
that you've lost something
means that you will irrationally ignore
the data that you should
be paying attention to,
which is not what did I pay for it,
but whether, what, if
I don't sell it today,
what will I be able to
sell it for tomorrow.
So it wasn't only the
issue that Geanakoplos
was speaking about, but certainly,
that was a significant part of it.
So what do we to make of all of this.
So here, we've had this long history,
as I said, the transition
from hard to soft apartheid
did not get rid of class-based
and race-based discrimination
in housing markets,
it just made it more
difficult to deal with.
Here we had decades where
success of administrations,
Democratic, Republican,
Democratic, Republican,
sought to address this problem
by first outlawing discrimination
based on neighborhood and discrimination
in who you would give mortgages to.
This created all this
pressure on Fannie Mae
from the federal government to restructure
mortgage markets to make them
more friendly to minorities,
but when we look at how
this all played out,
it's not a happy story, if you look here,
the run up to the financial crisis here,
you can see that African
Americans and Hispanics
received a great majority of the increase
in subprime mortgages.
And if you look into the
aftermath of the crisis,
when everything came crashing down,
Blacks were 47% more likely
to be facing foreclosure than Whites,
Latinos were 45% more likely
to be facing foreclosure.
If you look at the loss of property,
you see from 2007 to nine,
nearly 8% of both African
Americans and Latinos
lost their homes to foreclosures,
basically double the rate of Whites.
African Americans were 80% more likely
to lose their homes compared
to similarly situated Whites
and Latinos was 70% more,
and if you look, more likely.
And if you look at the recovery after the,
that I ended with last time,
you can see again that
this is household wealth.
By 2009, it was starting
already to turn around
for Whites but not so
for African Americans.
If you look at changes in home equity,
you can see that in the
run-up to the crisis,
Whites represented there by the blue bar,
their increase in equity
slowed relative to Blacks,
but in the crash, the Whites lost less
and turned around more quickly,
turned around more quickly
than it did for African Americans.
So not entirely a straightforward story.
In fact, in 2016, right at the end
of the Obama administration,
they did start doing a little bit
of what Geanakoplos had been advocating.
Fannie and Freddie
approved a one-time plan
to reduce mortgage balances
with unpaid principal
balances of 250,000 or less,
but 33,000 home owners
were expected to qualify,
many fewer than that actually
took advantage of it.
They also, in their
settlements with banks,
the government gave the
banks some incentives
to write down principal.
In 2013, they gave JP
Morgan Chase $1.15 credit
towards its huge settlement
for every dollar of loan forgiveness
that they offered home owners.
So they did, and they did a
similar thing with Goldman.
So they did do a little
bit of this at the margin,
but nothing on the scale
that would have made
a dent in the problem.
And if you look at
projections of the effect
that this has had on the creation
of wealth into the future,
you can again see that this big wallop
that African Americans have taken
during the collapse is gonna cost them
and their children for many
decades into the future,
I'm not sure projections
this far out worth that much
and so I wouldn't put too much stock
by the absolute numbers,
but the general trend is clear.
If you look, this is
the peak to the trough.
You can see African
Americans and Hispanics
lost more value in their homes,
and then the trough to the
peak, they gained back less.
And we see, if you look at
home ownership rights by race,
you can see that African Americans,
again, the pink line on that graph
have fallen to levels that
hadn't existed for many decades.
And this has produced a new
rounds of outrage in people,
you could be saying, here we go again.
These are some headlines
from newspapers last year
complaining that Black home
ownership is as low as it was
when housing discrimination was legal
and Black home ownership rates
are where they were 50 years ago.
The Urban Institute, a
liberal think tank says,
"We've made important progress,
"but we can't claim to have
vanished housing discrimination
"and its pernicious effects."
And so here we are again, we
are starting to see pressure
to make home ownership available
to less advantaged groups.
Now you might say, well why is
home ownership so important,
why is it centrally associated
with the American dream?
And anyone wanna take a shot at that?
Why do we, why do people care
about home ownership so much?
Why is it important
that people own a home?
- [Student] Financial security.
- Financial security is one answer.
We'll see how much financial
security it really gives them.
- [Student] It's a major
avenue for wealth creation.
- Pardon?
- Wealth creation.
- Okay, so let's start with that.
People think that home, it's
a way of creating wealth
because most people believe
that the value of homes always goes up.
People believe that, that's one reason,
but Shiller's book
"Irrational Exuberance",
this is Robert Shiller, our colleague
in the Economic Department,
a Nobel Prize winner,
he wrote a book, this book
"Irrational Exuberance" in 2000
right before the dot com bubble burst
and predicted the dot
com bubble would burst.
He then wrote a second edition in 2006
about the mortgage market saying
they're gonna collapse, and they did.
You might say, "Why don't
people listen to Shiller?"
I did hear one economist opine once
the trouble with Shiller
is that he's predicted
nine of the last three recessions.
(students laughing)
But the most famous,
the most famous graph in
Shiller's book is this one
where he points out that if you
deflate nominal prices from,
you control for inflation and you,
basically the story is that the real value
of homes does not change,
they've been flagged for over a century.
So people think it's gonna go up,
you might say why would people
think they're gonna go up,
the price of nothing else just goes up,
and people would have theories like,
well, populations are growing and so on,
but as Shiller points out,
you've also got a factory and
cost of building comes down,
all sorts of things, but
so it's just not true.
It's just not true that assets keep,
that homes, that real
estate keeps appreciating.
Goes up and down like other things
and the actual deflated value by inflation
is more or less flat
over the last century.
Another reason you might
think it would lead
to building up security is
that people are forced to save.
Americans are notoriously bad savers,
and if you spend, every month,
you're sending in your mortgage payment,
you're paying, you're
building up that nest egg,
it's forced saving,
so-called the third leg
in the three legged stool
that you're gonna need for retirement.
The other being social security
and your private pension.
So you build up the nest egg.
The trouble with this theory
is that it's no longer true.
And it's no longer true principally
because of the 1986 Tax Reform.
The 1986 Tax Reform
was, tax simplification
was the big issue in
the 1986 Tax Reform law.
So they were trying to, this
is the Reagan administration,
they were trying to
greatly simplify the code
and among other things, they
sought to get rid of the home,
deductions off your taxes
for paying interest on debts.
And so they were gonna get rid
of all interest deductions.
They rapidly ran into the buzzsaw,
which is that the mortgage,
the banking lobby is extremely powerful
and the real estate
industry's extremely powerful,
and they were strongly
opposed to getting rid
of the deductibility of home
interest mortgage deduction.
But the '86 Act did get rid
of credit card interest deduction.
Used to be until '86, you could have,
whatever interest you were paying
on your Visa card was deductible,
just like your mortgage
interest is deductible.
And so the '86 Act got rid
of deduction for credit cards
and not for home owners, for mortgages.
Well, enter the HELOC, HELOC,
you could all remember HELOCs, right.
The home equity loans.
So what people would
then do is essentially
borrow out the equity in their house,
pay off their credit cards with it
or spend it on vacations
in the south of France
or whatever it was, and then
the HELOC would be deductible.
And so what people started to do was to,
if you like, the government
gave them a big incentive
to raid the nest egg, and so
the net result of this was,
after '86, people would regularly
refinance their mortgages,
borrow out the equity, and so in effect,
there wasn't gonna be a,
there isn't gonna be a nest egg there
whenever you finally sell the house,
people essentially were financing this.
And of course, it should be said,
going back to what I said right
at the beginning of the course,
and forward to what I'm gonna
be talking about next week,
that as wages stagnated
and people were going
from one income to two incomes
to keep the same amount of
money coming in the door,
the pressure to finance
current consumption
out of one's home equity
would get ever stronger.
And this is the source of Rosner,
he teamed up with Gretchen
Morgenson to write that book
"Reckless Endangerment" in 2011,
that's the best political
book on the politics
of the financial crisis, I think,
and certainly the best book
on the mortgage crisis.
He had predicted in that
piece I posted in 2001
that this market was gonna
become unsustainable.
In that piece, the subtitle of which
is called "Housing in the New Millennium"
and the subtitle is "A Home Without Equity
"Is Just a Mortgage with Debt."
so it doesn't give you
any appreciating asset.
A source of security.
Not in an era of permanent
employment insecurity.
So just, let's just listen to
John Travolta for a minute.
- How many of you work
jobs that just pay the rent
no matter how many hours you put in?
I see.
My momma worked jobs like
that after my daddy died.
I remember her coming home from work
just bummed, weary, you know what I mean.
And I know she wanted to play with me
and ask me about school,
but sometimes you're just
too tired to do anything
but heat up a TV dinner,
blob out in front of tube.
- You got that one right.
- There you go.
And I don't have to
tell you how hard it is
to be looking for work.
Hey, I don't have to tell you
anything about hard times.
So you know what I'm gonna do?
I'm gonna do something really outrageous.
I'm gonna tell the truth.
(audience applauding)
I know, I know what you're thinking.
You're thinking he must really
be desperate to do that,
but if you had to swallow enough garbage--
- You can say shit, we're X-rated.
(audience laughing)
- Yeah, me too, if you believe
what you read in the paper.
(audience laughing and applauding)
All right, here's the truth.
No politician can reopen this factory
or bring back the shipyard jobs
or make your union strong again.
No politician can make it
be the way it used to be
because we're living in a new world now,
a world without economic borders.
A guy can push a button in New York
and move a billion dollars in Tokyo
in the blink of an eye,
and in that world, muscle jobs go
where muscle labor is
cheap and that is not here.
So if you wanna compete,
you're gonna have to exercise
a different set of muscles,
the one between your ears.
- So that is "Primary Colors,"
an anonymous book, it turned out later
was written by Joe Klein
about the Clinton candidacy.
And the reason I put that up there
is because of the
contrast between Clinton,
and he did actually say that,
I couldn't find an actual clip
of the New Hampshire Primary,
so I took it from the movie,
but it's a radical contradiction
between his claim in the clip I showed you
from 1995 saying he wants
to expand home ownership
to his argument in the
New Hampshire Primary
three years earlier that
the era of long term
permanent employment is gone.
And if you look, this is data
released earlier this year
by the Bureau of Labor Statistics
looking at baby boomers
and the takeaway point here
is that they change jobs 12
times during their lifetimes.
And only the first five
or so could be explained
by summer college employment
or something like that.
So people are looking at long
term employment insecurity,
and if you're not gonna
know whether and when
you're gonna be in a position
to service a mortgage,
then a home without equity is indeed
nothing more than a rental with debt.
Okay, so next we will talk
about backlash, 2016 and beyond.
(slow music)
