billroper | (Reply)

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Very interesting and enlightening reading, but blaming the mortgage collapse on investors who blindly followed a formula doesn't get to the root. The underlying questions are: Why did the risk in mortgages suddenly increase across the board, and why did investors across the board fail to anticipate it or at least make a greater allowance for changes in the model? And why did this happen in the mortgage market and not, say, in the auto insurance market?

As a comment by "Javert" on Volokh puts it: "Some second handers who didn't know what they were doing, blindly following others who didn't know what they were doing. But, while bad managers can wreck a company, only bad politicians can wreck an entire economy." This comment cites the Fed's lowering of interest rates to 1%, as well as "the twin government backstops of Fannie and Freddie, and the injection of the government's 'affordable housing' policy."

I keep thinking of ways that the government has been pushing people to put their money into dangerously large mortgages. Capital gains on a personal residence are largely tax-free, while most other capital gains aren't. Mortgage interest is tax-deductible while other interest isn't. There are various loan guarantees. Some of these factors have existed for a long time, while others increased in the past ten years. The result was a bubble produced largely by rational behavior (though not on the part of the policy-makers).

The investors' assumption that changes in risk were predictable surely plays a part, but it doesn't explain why there was so much hidden risk to begin with. Government policy explains that.