The casting call is nearly complete for the Great Morality Play that’s evolving out of the Great Recession.
The villains are a steely band of big banks, led by the cunning and diabolical Goldman Sachs. The do-gooders are a few scrappy government investigators, overmatched in wits and computing power but armed with the mighty subpoena. The victims and the audience are the same: mainstream America, suffering through a denuded economy plundered by the pirates of Wall Street.
Yet the simpler the storyline becomes, the less it tells us what really happened. And the oversimplified plot, now solidifying as government prosecutors look into possible illegal behavior some of the nation’s biggest banks, makes it easy to forget that the Wall Street villains had a lot of accomplices—including many ordinary Americans now portrayed as victims. But it’s poor theater to make the audience feel bad about itself. So Main Street is getting off the hook as the spotlight shines on stock villains primed for the pitchfork.
Much of the action in this drama is set in 2007, when the epic housing boom went into reverse. So let’s flash back to what was happening back then. We know now that housing prices ended a huge, 10-year run-up near the end of 2006. A few ingenious folks guessed what was happening before everybody else, and took advantage of it. Banks like Goldman Sachs, Morgan Stanley, Citigroup, and JPMorgan Chase—the whole Wall Street firmament, basically—created securities that allowed these investors, and the banks’ own trading arms, to bet that a housing bust was coming. Within months, many of those securities had plunged in value, generating huge profits for wizards like hedge fund manager John Paulson, who bet that that’s exactly what would happen.
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State and federal investigators are now probing whether the Wall Street firms created built-to-fail investment products designed to benefit one set of in-the-know investors at the expense of dumb-money investors on the other side of the trades. The picture emerging from legal complaints, Congressional hearings, and press leaks is one of manipulative bankers shaking down unwitting clients. There may be truth to that. But the banks couldn’t have done this without millions of home buyers who were greedy in their own way, and made it all possible.
To create and peddle all those mortgage-backed securities and derivatives linked to them, the banks needed one important thing: a steady stream of new mortgages to build them around. Americans happily obliged, continuing to pay sky-high prices for overpriced homes, even at the peak of the housing bubble. In fact, home buyers generally did the opposite of what smart investors do. Instead of buying low, in order to sell high, they bought high hoping to sell higher. In massive numbers. In 2005, when home prices rose by a record 16 percent or so, Americans took out a record $1.5 trillion in new mortgages, according to the Mortgage Bankers Association. That was almost 40 percent more borrowing than just three years earlier. The value of new mortgages was nearly as high in 2006, when home prices rose by about 12 percent. All the borrowing provided a humongous pool of new mortgages to be securitized, derivativized, and bet against by 2007.
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There’s no simple cause-and-effect relationship that accurately captures all the reasons for the housing boom and bust. Some people who bought homes during the boom simply needed a place to live, whether they were moving to take a new job or upgrading to accommodate a growing family. They may be the true victims of the bust. But many, many others thought they could get rich without taking a risk or breaking a sweat. Some people bought homes they couldn’t afford because they thought values would rise forever, creating free equity. Others speculated, buying homes they hoped to flip for a profit in a few months, without doing anything to enhance the actual value of the property. A lot of subprime borrowers who lacked the income to pay for a mortgage took one out anyway, because a broker told them not to worry about little details like that.
It wasn’t easy to forecast the housing bust back in 2005 or 2006, but there were lots of signs that the housing market had gone haywire. In hot markets like Las Vegas, Phoenix, Miami, and southern California, prices skyrocketed for no apparent reason. Real estate wasn’t scarce. Population growth wasn’t outstripping the rest of the economy. For the most part, the only trend different from historical patterns was the housing boom itself. When a product gets bid up and sold at a premium the day it goes on the market—which was a common phenomenon in those housing markets—any smart buyer would ask why. Few did.
Again, it’s easy to say this looking back. But you could fill books with all the clichés warning people against the kind of hucksterism and mania that characterized the housing boom. Buyer beware. Buy low, sell high. Hedge your bets. If it seems too good to be true, it probably is. We’re now excoriating Wall Street for institutional greed that wrecked the economy, but it percolated up from Main Street and gripped the entire nation.
This is rapidly being forgotten. A recent survey by research firm Communispace found that 45 percent of people blame the government for the recession, 43 percent blame the banks, and only 12 percent blame consumers (or in other words, themselves). Don’t expect public officials to argue otherwise. There will never be a Congressional hearing on consumer greed, and politicians won’t risk a single vote to point out Main Street’s role in the mess. An effective villain, after all, represents all the dark forces swirling everywhere in the universe. And helps deflect blame from where you’d rather not find it.