Wednesday, May 25, 2016

Housing: Part 151 - Shadow Banking and the GSEs

It's interesting how derivatives, credit default swaps, synthetic CDOs, etc. are generally derided as the source of the housing boom and bust.  If you look carefully at the timeline of events, these instruments - even the jump in subprime loans themselves - came very late.  I will argue in the book that, rather than a binge of excess, the increase in the use of these securities was actually the first sign of the negative shock of public policies.

It began with the accounting scandals and follow up pressures on the GSEs in 2003 and 2004.  It is generally under-reported and under-remembered because financiers in our narrative of the time can only be rapacious and greedy.  Any repression or contraction is only a sign that finally somebody is putting their thumb on these guys.  So, in 2003 and 2004, when Ginnie Mae, Fannie & Freddie funded half the mortgages in the country, we suddenly knocked 10% off their market share.  If you add the GSEs and Ginnie Mae to the private securitizations (jumbo loans, subprime, Alt-A, etc.), there was no increase in total securitizations.  The private pools were simply filling a huge gap left by an exogenous shock to the system, which cut back on our standard form of public mortgage funding and didn't replace it with anything.

Here is a figure from the Financial Crisis Inquiry Report.  The sub-title is "The funding available through the shadow banking system grew sharply in the 2000s, exceeding the traditional banking system in the years before the crisis."  Notice how the interpretation of the graph actually sort of muddles the timeframe.  But, if you clear your head and look at the graph carefully, what you see is a rise in shadow banking in the 1990s, before home prices and housing starts rose above normal levels.  Then, during the boom, traditional and shadow banking grew together.  Then, in 2005 and 2006, there was a sharp rise in shadow banking.

But, homeownership maxed out in 2004, prices and starts at the end of 2005.  This rise is late in the cycle.  It certainly isn't the cause of rising prices, ownership, and starts in 2000-2004.  What a strange thing to finger as the cause of the boom.

But, going a step further, this rise in shadow banking is really just a sign of the first negative shocks to housing from public policy that was informed by the moral panic we were having.  Next, is a graph comparing the total assets of the GSEs and GSE pools to traditional banks.  It is a mirror reflection of the rise of shadow banks.

The shadow banks were just replacing the GSEs.  And the GSEs were just shrinking because of arbitrary public pressure.

Then, we managed to kill shadow banking in 2008, and by then the entire system was so weak, there was nothing left to fill the gap.  The GSEs didn't recover, the banks didn't recover.  And in 2016, when hundreds of thousands of construction jobs that were lost remain lost, when housing starts have been down for a decade while rent inflation rises at twice the rate of the other components core inflation, when total mortgages, in nominal terms, haven't risen in a decade, everyone's sitting around pondering the deep mystery of why this recovery just doesn't feel right.


  1. Gadzooks, a great post.

    Such a crime, to build housing. Especially where people want to live.

    It is a good thing our federal policy makers snd local burghers are skillfully reducing the supply of housing, especially in these times of tight capital markets.