The Housing Boom and Bust

Abstract

The Housing Boom and Bust. Thomas Sowell. 184 pages, New York: Basic Books, 2009. Virtually from the onset of the U.S. housing market's precipitous price decline in 2006-07, academicians, politicians, and the media have sought to explain how the housing bubble that set the stage for the debacle developed and grew to such dangerous proportions. Not all observers were caught off-guard by the bubble. As early as 2003, for example, The Economist cautioned against the risk of expecting continued housing price escalation or, worse yet, the "risk that house prices will take such a tumble that they take whole economies with them." Again, in 2005, the same publication observed that "the day of reckoning is closer at hand," and "it is not going to be pretty." When it finally arrived, the housing market's "day of reckoning" was ugly indeed, bringing with it bruising housing price declines, unprecedented foreclosure rates and, in a follow-on effect, a crisis on Wall Street in which institutions and investors realized that the default risk embedded in widely traded mortgage-based financial instruments had been grossly mispriced. Whether or not one foresaw it, the core question remains: What actually caused the housing boom (and bust)? Equally important, how might a similar crisis be averted in the future? These are the questions that Thomas Sowell, Rose and Milton Friedman Senior Fellow at the Hoover Institution, addresses in his highly readable and informative book The Housing Boom and Bust. From the outset of the book-totaling a compact 148 pages, excluding 29 pages of source material at the end-Dr. Sowell qualifies that "there was no single cause of the housing crisis, and there is certainly plenty of blame to go around." Readers, of course, will be acquainted with oft-cited explanations for the fiasco, including: the Federal Reserve nurtured a bubble with low interest rates over an extended period of time; lenders offered exotic loan products that simultaneously confused less knowledgeable participants and enhanced the ability of sophisticated speculators to buy and re-sell homes without using their own cash; a lack of serious regulatory oversight enabled lenders to ignore reasonable standards of lending (i.e., those consistent with actual borrower creditworthiness) and make loans based upon inaccurate or incomplete applicant information (e.g., "low-doc" and "no-doc" loans); the credit rating agencies (e.g., Moody's) failed to accurately assess risk inherent in subprime mortgages; and so on. In Sowell's account, borrowers, lenders, government, and financial markets were each responsible for the crisis. As he succinctly puts it, "All were responsible and many were irresponsible." However, the central premise of the book is that responsibility among these players was not shared equally. The chief culprit, by far, was government, both local and federal, in the form of ill-advised interventions (or interference). Writing in language accessible to both expert and layperson alike, and providing extensive documentation to support his case, Sowell lays out a simple causal sequence of what happened: The U.S. housing price boom originated in (and was largely limited to) specific geographic places, such as coastal California and Miami, as land became increasingly expensive. Land price escalation occurred in these places not because of abnormally high construction costs or income growth rates, but rather because, he argues, governmental entities imposed land use restrictions in the name of protecting open space, preserving farmland, preventing urban sprawl, and similar justifications. These restrictions made it either impossible or much more expensive than would otherwise have been the case to build upon land. As the price of land shot up, so did overall housing prices. Having created a "housing affordability" problem as a result of restricting land use, government compounded the problem by enabling increasingly risky borrower financing. …