Who's to blame for the sorry mess the economy finds itself in? Is it former Federal Reserve chief Alan Greenspan, who failed to sound an alarm about "no doc-no income" loans and kept short-term interest rates too low for too long in an attempt to jump-start the economy early in this decade? Is it the investment banks that packaged and sold billions of dollars' worth of high-risk home loans, often bundled in complicated "tranches" that nobody really understood? Or perhaps it's the bond-rating agencies that stamped these loans AAA.
The answer is: all of them and none of them. Yes, they all contributed to the housing boom and the proliferation of subprime mortgages. But they were not out to deceive the public. Instead, it was the free-market zeitgeist, which encouraged the creation of easy-money mortgages and their enthusiastic purchase by yield-hungry investors, that ultimately led to the credit fiasco.
Out of reach. Don't lay the housing boom and subsequent bust only in the lap of Alan Greenspan. The surge in housing prices was a worldwide phenomenon that transcended U.S. monetary policy. The fall in long-term interest rates, made possible by low inflation and purchases by Asian countries sitting on huge trade surpluses, left interest costs on mortgages at near-record lows. Moreover, aging baby-boomers' desire for second homes pushed up prices, a situation clearly out of the government's control.
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What about the mortgage lenders? The demand by institutions and the public for high-yield mortgage investments was enormous. Investment banks that sold these loans were responding to legitimate market forces that enabled them to package and place hundreds of billions of dollars' worth of subprime mortgages.
In hindsight, it is easy to see that the packages of subprime loans were much riskier than had been assumed. But it is hard for a central bank to call the top or bottom of a market. As I have noted in the past, Greenspan's 1996 "irrational exuberance" speech came years before the stock market became excessively overvalued.
Furthermore, the rating agencies, such as Standard & Poor's and Moody's, properly responded to the historical data that they had been given. The data indicated that, on a national level, real estate prices rarely, if ever, declined. The agencies did not fully appreciate the risks. But that does not mean it was wrong for them to offer opinions.
In pointing out these facts, I am not excusing Greenspan, the rating agencies or investors for greatly underestimating the risks in this housing bubble. And I am appalled that the chief executives of many of the mortgage companies were "rewarded" with millions of dollars in severance pay after leaving their firms near bankruptcy.
But regulators and lenders should not be censured for trying to outguess the markets. Markets are certainly not always right, and free-market economies will always be subject to cycles. But free markets have led to economic prosperity, and they've maximized freedom for their participants.
The housing crisis has had some surprisingly benign results. The lending boom allowed the homeownership rate to hit a record high of 69.2% at the end of 2004, up 2.3 percentage points from five years earlier. Although the number of foreclosures is rising, most subprime borrowers are current with their mortgage payments or are working out a payment schedule with their lenders. Their homes are far more valuable to the economy than the hundreds of billions of dollars of fiber-optic cable (most of it now nearly worthless) that was laid during the tech bubble of the late 1990s.
When markets sour, it does not mean that someone or some institution must be blamed. As legions of football fans who bet on the Patriots in the Super Bowl know, being wrong does not mean being blameworthy.
Columnist Jeremy J. Siegel is a professor at the University of Pennsylvania's Wharton School and the author of Stocks for the Long Run and The Future for Investors.
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