The Urban Refugee Crisis

Photo by Julie Ricard on Unsplash

September 13, 2020

by Steve Stofka

In popular urban areas, affordable housing has been a persistent problem. Housing costs can consume 50% or more of a working person’s pay. Urban residents have become refugees in their own city, living in tents on downtown sidewalks.

Homeless tent “cities” in urban areas were already a problem, and the Covid crisis has exacerbated the situation. The tent areas are a breeding ground for 19th century diseases like cholera and typhus (Gorman, 2019).

The free market has not been able to solve this problem. Wanting to maximize his return on a property investment, a developer has more incentive to build luxury units than lower cost condos or apartments. Are they greedy and rapacious? Let’s take the developer out of the equation. Imagine telling a farmer that they must dedicate part of their land to growing more affordable wheat when rye is twice the price. In front of capitol buildings in mid-west states, there would be tractor protests by farmers. So why should it be different with a developer? They have an asset, an input, and want to get the most out of that asset.

Cities have tried several solutions with poor results. Santa Monica, a destination city in California, passed a rule that 30% of new multi-family housing had to be affordable units. Residential building has come to a halt (SCAG, 2019).

The city and state of California have passed funding laws to support affordable housing, but it is expensive (Camner, 2020). In popular coastal states where taxes are already high, a proposal of affordable housing subsidies to developers arouses ugly passions.

Affordable housing is a negative externality, a cost not borne by the developer or the buyer of a upclass condo or townhome. Perhaps there should be a fee on each unit? The cost of the externality is so expensive that the high per unit fee would limit sales of new units and raise little revenue to build affordable housing.

Let’s suppose that a couple buys a new condo from a developer. The couple has paid in the 75th percentile of housing prices in that area, but they enjoy ocean views and the cultural and social amenities of the neighborhood. In front of their new condo complex, several homeless people pitch tents on the public sidewalks. The couple is outraged. For the price they have paid, they reason that they should not have to endure the sights and behaviors of the homeless. The couple complains to the developer and the city. An urban economist would understand that the couple shares some tiny responsibility for the homeless problem but they, and their fellow residents, are bearing the costs out of proportion to their responsibility.

If there were a way to cut up and distribute the homeless problem among all the residents of an area, the problem might not be so noticeable. Fortunately, we live in a society that does not dismember human beings to achieve a perfectly equitable distribution of society’s costs. There will always be what biologists call a “clustered” distribution of homeless people.

Planned refugee camps have better health conditions than tents thrown up on a sidewalk. Should a city like Santa Monica accept the clustering problem and house their homeless in urban refugee camps? The city could provide better sanitary conditions and perhaps build a clinic at the refugee camp that would relieve downtown emergency rooms of attending to the many medical needs of the homeless.

In want of a perfect solution, our society has created an ever worsening problem. If the homeless can abide living clustered together with little privacy and no sanitation on a public sidewalk, then they would certainly abide a tented refugee camp with a bit more order, sanitation and medical facilities nearby.



Camner, L. (2020, February 10). Santa Monica’s affordable housing policies have failed -. Retrieved September 11, 2020, from

Gorman, A. (2019, March 11). Medieval Diseases Are Infecting California’s Homeless. Retrieved September 11, 2020, from

Southern California Association of Governments (SCAG). (2019). Profile of the City of Santa Monica, p. 12. Retrieved from

Ain’t It Great?!

April 19, 2020

By Steve Stofka

Has this pandemic prompted people to have a greater respect for science? Or has the science of the internet fostered more conspiracy theories and information hoaxes typical of countries with low literacy rates? This week – the rise and fall of science in American politics.

Let’s turn the dial back to World War 2. In the space of thirty years at mid-century, scientific understanding and accomplishment leapt forward. People expected that rate of achievement to continue into this century. Flying cars. Supersonic planes. A cure for cancer and the common cold. Lifetimes of 200 hundred years.

In the health sciences, the development of vaccines and antibiotics allayed the fears of millions of parents. Many who had survived the Depression and World War 2 remembered  when Calvin Coolidge Jr., the President’s son, had died from a simple blister he got while playing lawn tennis (Rhoads, 2014). Thousands of World War 1 soldiers died from simple bacterial infections on their skin. In the course of two decades, antibiotics were developed and saved thousands in the next war.

The polio vaccine, developed in the 1950s, removed the threat of death or lifelong disability from the disease. In 1916, a quarter of the people in New York City who contracted the disease died (Smithsonian, 2005). Cities imposed quarantines on individual homes and public transportation during summer months when the disease was most prevalent.

The development of plastics, vitamins, TVs, personal radios, semi-conductors and many more inventions changed our daily lives. Men (mostly) of learning and business leaders schooled in efficient business practices were recruited to government to help run a world that was increasingly complicated.

During the 1960s President Kennedy hired Robert McNamara, the head of the Ford Motor Company, to run the Defense Department. Yes, that happened. McNamara was one of the Whiz Kids, experts in management and the efficient deployment of technology that would refashion the U.S. military during the Cold War against Communism. McNamara made many mistakes in the first five years of the Vietnam War, but hid them until his autobiography  in 1995 (Biography, 2019).

Whiz kids headed by economist Paul Samuelson transformed monetary and economic policy with a precise mathematical approach that modeled human economic behavior as well as the movement of money, goods and services. Inspired by the work of John Maynard Keynes, who advocated strong government intervention, the new economic thinking promised to transform fiscal policy into an efficient tool that would benefit all ranks of society.

Big government spending during the 1960s spurred higher inflation. The economic Whiz Kids could not head off a recession at the end of the decade. When the Arab oil embargo caused gasoline prices to jump, inflation bit hard, and President Nixon instituted wage and price controls to curb inflation. After he left office in ignominy, his successor President Ford, fought inflation by wearing a button on his lapel that said “WIN.” Yes, that happened. The acronym stood for Whip Inflation Now (Smithsonian, n.d.). The experts were not as knowledgeable as they thought. They had tried, they had failed and their ascendancy was at an end.

Enter Ronald Reagan. He had developed a folksy manner as a host for a TV western series. He led California during its oil boom heyday in the late 1960s and early 1970s. His tenure ended just as California’s economy hit the skids. Exit the experts. Enter charisma and myth. Mr. Reagan touted Star Wars defense ideas that were products of an illustrator’s imagination. He believed in a form of wishful thinking called supply side economics. He dismissed the evidence from his own scientists when a mysterious disease began to ravage young men in the gay community. He flaunted a simplistic campaign of “Just Say No” to drug use while he backed insurgents in Central America who used American communities to build a drug empire based on crack cocaine. Mr. Reagan was a pragmatic politician who believed that facts should bend to the will of political leaders. He led the country through the most severe recession since the 1930s Depression. His two terms in office were marked by tax reform, strong economic gains, a resurgence of conservative political ideas and repeated scandals. When the Soviet Union collapsed in 1991, the conservative myth machine concocted a narrative that Reagan was responsible for the downfall of the empire. Like the iconic sheriff in a western movie, Reagan had strode out onto the dusty street of the global town and faced down the bad guy, the USSR.

Charisma left the stage when Reagan’s Vice-President, George H.W. Bush, won the election in 1988. Bush was the compromise between charisma and expertise. He had vast experience in many corners of civilian and military government. In the 1991 Gulf War, he and his Secretary of Defense, Colin Powell, demonstrated a technical prowess and efficiency that lifted the reputation of experts once again. Mr. Bush made a bargain with Congressional Democrats to raise taxes to help balance the budget. Conservatives were angry and disaffected and an expert businessman waited in the wings.

Ross Perot was the billionaire founder of a tech company. As a hard-nosed third-party candidate, he promised to bring honesty and efficiency to government finances. He took a whopping 19% of votes from Bush and gave Clinton the election by default. A contentious three-way race had given another Democrat, President Wilson, a default victory in 1912. Clinton’s vote percentage was 43% (Wikipedia, n.d.). Wilson’s was 42%. President Lincoln holds the record with the lowest vote percentage for a winning Presidential race – less than 40%.

President Clinton was the folksy governor of a backwater state called Arkansas, home to the Walton family, the owners of Wal-Mart. He was also a Rhodes scholar. Clinton promised to join expertise and charm. As with Lincoln and Wilson, those on the other side of the political aisle regarded Clinton as an illegitimate President and were determined to remove him from office. After five years of investigation, Republicans successfully impeached him on a charge of lying to Congress about an affair – a dalliance might be a more accurate description – with a White House intern. The leader of the Republican effort, House Speaker Newt Gingrich, was himself having a long affair with a young Congressional aide. Yes, that happened.

It was the 1990s. Mr. Clinton presided over an explosion in computer technology. From its early development in research labs, government and universities, the internet became public in 1993. A different group of Whiz Kids were in charge. Dot com this. Dot com that. Too much money chasing too few opportunities in the burgeoning field of online commerce led to a bust.

After 9-11, the invasion of Iraq demonstrated the power of science. The subsequent campaign demonstrated the even greater power of human hubris and folly. In 2007-2009, technological folly and greed produced the greatest recession since the 1930s Depression. Americans split into two factions: those who believed in expertise and  those who mistrusted it.

President Obama was elected by those who were confident in experts. Policy experts would soon get the country out of the financial mess that the bankers and fast fingers on Wall Street had made of the lives of ordinary Americans on Main Street.

Mr. Obama’s two terms in office proved the inefficacy and arrogance of policy experts. The experts joined forces with vain politicians and created havoc in the lives of many Americans. A stimulus program was mismanaged, ill-timed and weighed down by burdensome regulation. An embarrassed President Obama admitted that there weren’t as many “shovel-ready” projects as he had hoped. Each agency protected its kingdom of regulatory power. Programs to help people stay in their homes floundered. A Cash for Clunkers auto buying program gave a temporary boost but its effect vanished within a few months. The promise of an efficient health care system that allowed Americans their choice of doctor was a fiasco. When the health care exchange web site debuted in 2013, it looked like the weekend effort of incompetent programmers. More embarrassment. Washington experts couldn’t be trusted to change the oil on someone’s car.

In 2016, almost half of voters rejected so-called experience, expertise and a posture of stately reserve in their President. After eight years of President Obama, they had had enough. They wanted the bluster of a pro wrestler and the charisma of a reality show star. Send in the clown!

America is home to the world’s best universities and most innovative companies and attract the best minds and the most capital from around the world. Blah, blah, blah. Americans were tired of best. They wanted great. They wanted insanely crazy great. They got crazy instead. Welcome to America.



Photo by humberto chavez on Unsplash

Biography. (2019, October 3). Robert S. McNamara. Retrieved from

Rhoads, J. N. (2014, July 7). The Medical Context of Calvin Jr.’s Untimely Death. Retrieved from

Smithsonian Institution. (2005, February 1). Individual Rights versus the Public’s Health. Retrieved from

Smithsonian Institution. (n.d.). Knowing the Presidents: Gerald R. Ford. Retrieved from

Wikipedia. (n.d.) 1992 United States Presidential Election. Retrieved from

Fault Lines

January 20, 2019

by Steve Stofka

If your twin brother went away on a spaceship a month ago and looked at the current price level of the SP500, he wouldn’t see much change. What a month it has been! A 7% drop in stock price the week of December 17th, followed by a Christmas Eve when Santa left a lump of coal in investor’s stockings, followed by a government shutdown.

Let’s say your twin brother went off to the Romulan Galaxy on a spaceship flying near the speed of light on October 1, 2007. He has just come back and has aged a few weeks. You have aged a great deal. The financial crisis, the housing crisis, the job crisis, the crisis crisis. No wonder you look older. There are too many crises.

Your twin brother notes a similarity in the behavior of the stock market the past few months and the fall of 2007 when he took his starflight cruise. What similarity you ask? He hauls out his Romulan graphing tool and shows you a plot comparison of SP500 prices (SPY) in the fall of 2007 and the fall of 2018. Not only does your twin brother look younger but he also got a Romulan grapher on his journey. It is not fair.


“In both periods, prices fell about 15% in 15 weeks,” your brother says.

“They happened to fall the same percentage in the same amount of time,” you answer.  “That probably happens all the time and we just don’t notice.”

“15-20% drops in as many weeks doesn’t happen all the time,” your brother says. “It happens when there are fault lines forming. It happened in December 2000, January 2008, again in August 2011 during another government shutdown, and now.”

“Sure, there are some trade problems and the government shutdown,” you protest, “but the economy is good. Employment is at all- time highs, wage gains were over 3% last month, and inflation is relatively tame.”

“Everything was still pretty good in December 2000 and January 2008,” your brother responds. “‘A healthy correction after a price boom,’ some said. ‘The market is blowing off the excess froth before going higher,’ others said. At both times, there was something far more serious going on. We just didn’t know it.”

“You got pretty smart in the time you were gone,” you tell your brother. “Can I get one of those Romulan graphers?”

“Yes, I bought one for your Christmas present 11 years ago,” your brother says and hands you a grapher from his spacesack. “Tell me, what are these picture phones that people are carrying around now? I don’t remember them from when I left. And what’s Facebook?”


September 16th, 2013

September marks two anniversaries that we wish had not happened.  One of those is the financial crisis and the meltdown of the economy in September 2008.  In the fourth quarter of 2008, GDP fell about $250 billion.  By itself, this was not a disaster.  However, it came on the heels of a decline in the 2nd quarter and flat growth in the 1st quarter.

Almost overnight, consumers cut back on their spending.  Retail sales dropped $40 billion, a bit more than 10%.

There was little drop in food sales – people gotta eat.  All of the drop was in retail sales excluding food.

Retail sales are less than 3% of GDP.  Contributing to the GDP decline was the 33% fall in auto sales, about $20 billion.

Offsetting the decline in retail sales, however, total Government spending increased $40 billion in the 4th quarter.

Disposable Personal Income (income after taxes) fell $100 billion, about 1%, but was still on a healthy upward trajectory during the year preceding the crisis.

We routinely import more goods and services than we export.  In the national accounts of domestic production, imports are naturally treated as a negative number, while exports are positive. The difference, called net exports, is negative and reduces GDP.  For all of 2008, we had about the same net exports as 2007.

Gross Private Domestic Investment declined $200 billion or 9% over the year.  This includes investments in buildings, equipment and housing.  Housing accounted for $150 billion of the change.

The TV news media, a visual medium, focuses on crises because it is not well suited for more thoughtful analysis.  On camera interviews in a crisis do not have to be very detailed or accurate.  Viewers understand that it is a crisis.  But viewers are also an impatient bunch with trigger fingers on their remote controls. Video footage has to be loaded, sequenced and edited.  On air interviews and several short video clips run repeatedly during a news hour will have to do.  The recent flooding in Colorado is a reminder that there is only so much video footage available.  TV stations simply reran the same sequences over and over.  On the 9 PM local news, the station featured an on site reporter in front of a driveway heaped full with damaged belongings and furniture.  At 10 PM, a different local station featured their reporter in front of the same house.

In September 2008, the media focused on the financial crisis and the implosion of stock prices.  When the stock market opens up on a September morning 300 points down, what else is there to cover?  It is important to understand that the economy is a big organism with a lot of moving parts.  The housing decline was already two years old before the financial crisis hit in September 2008.

Fast forward to this September.  A day ahead of the ISM Manufacturing report on September 4th came the news that China’s manufacturing sector has strengthened, a positive note in the Asian region where capital outflows from emerging nations have weakened the economies of other nations.  The prospect of higher interest rates in the U.S. has sparked a change in money flows to the U.S., strengthening the dollar against the currencies of emerging countries.  This change in flows promises to put pressure on companies in developed nations who had earlier borrowed money in U.S. dollars to take advantage of low interest rates.  The stream of capital follows the deepest channel.  The combination of risk and reward in each country can largely determine the depth of the channel.  Countries can, by central bank policy or law, control the flows of foreign investment into and out of their country.  China and India exercise some degree of control in an attempt to maintain some stability in their economies.  Like other developed nations, the U.S. has few controls.  In the run up of the housing bubble, foreign flows into the U.S. provided the impetus for investment banks like Goldman Sachs to initiate and bundle many thousands of mortgages into tradable financial products that met the demand by foreign investors.

Manufacturing data in the Eurozone was a big positive with several countries recording their strongest growth in over two years.  The Purchasing Managers Indexes (PMI) are not strong but are showing some expansion, a turn about from the slight contraction or neutral growth of the past two years.   The fragile economic growth of the Eurozone has been exacerbated by the concentration of growth in France and Germany, particularly Germany.  Recent strong gains in some of the peripheral countries, those in the former Communist bloc and southern Europe, suggest that economic activity is becoming more dispersed.  Dramatic differences in the economies of countries that share the same currency make the setting of monetary policy difficult and it is hoped that more even growth will take pressure off central banks in the Eurozone.

At an overall reading of 55.7, the ISM Manufacturing report released a week ago Tuesday showed even stronger growth than the previous month’s index of 55.4.  50 is the neutral mark that indicates neither expansion or contraction of manufacturing activity.  New orders began a worrisome decline in  the latter part of 2012 that persisted into the spring of this year, and the turnaround of the past few months forecasts a healthy manufacturing sector for the next several months.  Levels above 60 in any of the components of this index indicate robust growth;  both new orders and production are above that mark.

A few days later ISM reported their Non-Manufacturing composite was 58.6, indicating strong expansion in service industries which make up the bulk of the economy.  The Business Activity index came in at a robust 62.2.  ISM also reported that their figures for June had an incorrect seasonal adjustment.  The New Orders Index for June was revised up a significant 2%.  Prices were revised up 4.3%.  Other changes were relatively insignificant.

The constant weighted index I have been tracking smooths the ISM data so that it responds less strongly to one month’s data but it is showing strong upward movement in both manufacturing and non-manufacturing.

The Commerce Dept reported last Friday that Retail Sales continue to grow at a modest pace.  However, let’s look at retail sales as a percent of disposable income.  Consumers are still cautious.

Speaking of disposable income.  As we import more and export less, disposable income as a percent of GDP continues to rise.  This percentage rises sharply at the onset of recessions.  It is a bit troublesome that the 40 year trend is rising.

Housing: Satellite View

A few weeks ago, Standard and Poors released their monthly Case-Shiller index, showing continued weakness in the housing market.   The graph on page 1 charts the year over year percent change in housing prices for 20 cities in the U.S.  After rising above 0 in the early part of 2010, the index has now taken a dive below 0, indicating increased price pressures from foreclosures and a labor market that is still far from healthy.

Let’s step back and look at another data series, an index of housing prices from the Federal Housing Finance Agency, which compiles data from Fannie Mae and Freddie Mac purchases and refinances.  The large volume of mortgages guaranteed by these two quasi-governmental agencies provides an annual data set of more than a million mortgages, 60 times larger than the Case-Shiller data set that usually makes headlines.

Courtesy of the FRED database at the Federal Reserve in St. Louis, we can see below a 35 year history of housing prices in California (Source)  From this multi-decade viewpoint, we can see the real estate spike that occurred during the past decade. (Click to enlarge in a separate tab)

Spotting trends in stock prices or housing prices is more art than science.  Below I’ve drawn my guesstimation of the 40 year and 20 year trend lines in the California housing index.

As a comparison, let’s look at a more even tempered state, Colorado.(Source)  Here we can see a more sustainable growth pattern in prices. Again, I’ve drawn a trendline in red to show a guesstimation of the long term trend.

A comparison graph of the two states reveals just how strongly the California index shot up during the past decade.  The scales are different for each state but reveal interesting historical patterns and a caution to California homeowners. 

Colorado experienced little growth in housing prices during the 80s.  For Californians, their slow growth period was from the late 80s to the late nineties. During the late nineties and early part of the 2000s, the growth pattern was similar to Colorado.  After the recession of 2002-3, California housing prices exploded upward while Colorado prices maintained the same growth pattern.  During the past two years and over the next several years, California prices will continue a painful return to the long term trend.  Colorado homeowners will see the same flatlining of prices that they experienced during the 80s but that is far better than the rollercoaster ride that California homeowners are currently on.

Economic Weather

Understanding and predicting the economic weather is less precise than, well, predicting the weather.  The stock market is a composite “vote” of the direction and strength of corporate profits in the coming six months to a year.  It is not a barometer of what the economy will do, but an indicator of people’s predictions, their fears, their hopes. Predicting the economic weather involves a complex interplay of many factors, which, by themselves, are not that complicated.  It is the interplay and the weight, or importance, given to each factor that accounts for the range of prediction.

Henry Blodget is a former Wall St. analyst who was indicted by the Securities and Exchange commission for ethics violations during the “dot com” boom at the end of the nineties.  Blodget subsequently founded the Business Insider, a blog about trends in business and the economy.  Here  is a compilation of charts on the labor market, housing, and manufacturing output for several decades.  You may or may not agree with Blodget’s dire prognostications but the overall picture of data that he has pulled together is worth a look.

Housing Crisis Causes

A wide array of suspects have been lined up as the causes of the mortgage crisis in this country. They include subprime borrowers, poor underwriting standards, adjustable rate mortgages that lured buyers with low teaser rates then reset at unaffordable rates several years after the initiation of the mortgage.

A professor of economics, Stan Liebowitz, analyzed data from 30 million mortgages and states his findings in an 7/3/09 WSJ op-ed. The chief culprit, the Darth Vader of the meltdown, is an ancient villian familiar to anyone in the business of providing credit. When customers have none of their own money in a purchase, no “skin in the game”, they are more likely to default on a loan.

The fault for this practice is the lender’s. When a lender is asked why they would do something that they have been told will surely put the loan at risk, they answer with a variety of reasons: “I wanted to make the sale”, “I thought they were good for it”, and “the competition was doing it so I had no choice” are some of the more common.

Prof. Liebowitz cites a simple statistic for home foreclosures in the 2nd half of 2008: “although only 12% of homes had negative equity, they comprised 47% of all foreclosures.” His analysis found that “interest rate resets did not measurably increase foreclosures until the reset was greater than four percentage points.”

Following negative equity as the prime culprit in foreclosures, unemployment had the second greatest impact. Prof. Liebowitz concludes that “a significant reduction in foreclosures will happen when and only when housing prices stop falling and unemployment stops rising”.

Government efforts to reduce interest rates spur refinancing but not home purchases and it is purchases, not refinancing, that stabilizes home prices. Government programs to inflate home ownership rates only threaten to recreate the housing bubble that led to this crisis. Mortgage payments that were greater than the 31% target level of the “Making Homes Affordable” plan had so significant contribution to foreclosures and the author doubts that this program will have much effect in reducing foreclosures.

As housing prices are approaching their long term inflation adjusted levels, the author predicts a natural stabilization of prices without any government interference. We can only hope that our political leaders will know when to stop “helping”.


In a 5/6/09 WSJ article, Ruth Simon and James Hagerty report on current housing values after the release of industry results for the first quarter of 2009.

Across the U.S. 19% of mortgage holders are “underwater” or “upside down” – they owe more than their house is worth in today’s market. This is more than a 50% increase in the number of underwater borrowers since the end of 2008. According to one company that tracks this data, “more than one in 10 borrowers … owed 110% or more of their home’s value at the the end of last year.” Las Vegas homeowners have been hit the worst. estimates that over 67% of mortgage holders there are upside down.

Why wouldn’t a bank holding a mortgage agree to write down some of the principal on the mortgage? Let’s say a homeowner with a job is struggling to stay current on a $300K mortage on a house that is now valued at $240K. If the bank forecloses, they will probably sell for closer to $200K and will have expenses for legal fees, maintenance, fix-up and taxes. Wouldn’t it make sense for the bank to at least write down half of the $60K principal difference if that would mean the bank could avoid foreclosure?

The answer is – wait, sit down first. The loss on a foreclosure is a long term loss on the bank’s loan portfolio that can be spread out over several years. A write down in principal on the mortgage is an immediate loss that affects the bank’s bottom line this year. John and Mary Homeowner may have lost their chance to avoid foreclosure because of an accounting rule.

Housing Bubble

In a 4/6/09 WSJ op-ed, a former Nobel Laureate in Economics, Vernon Smith, and a research associate, Steven Gjerstad, examined the several decade long causes of the real estate bubble.

In 1983, the Bureau of Labor Statistics (BLS) changed their methodology for measuring the housing cost portion of the Consumer Price Index (CPI). “They began to use rental equivalence for homeowner-occupied units instead of direct home-ownership costs.”

From 1983 to 1996, home prices were about 20 years worth of rent payments. Between 1996 and 2006, they increased to over 32 years of rent payments. Had this housing inflation been reflected in the CPI, “inflation would have been 6.2%, instead of 3.3%.” Remember that 6% real inflation figure.

The many economists at the Federal Reserve Board (“Fed”) looked at the modest increases in the CPI over the past decade and, concerned as they were about the increasingly heated housing market, didn’t see a direct correlation with the CPI. They attributed this to productivity gains, the lower cost of computers, appliances, etc. The Fed kept interest rates low.

Joe and Mary, average American homeowners, may not have known about the housing component metrics of the CPI. All they knew was what things cost the previous year and what they cost this year. With mortgage money at about 6%, Joe and Mary instinctively knew that they could borrow money on their house at an effective 0% interest rate, the real CPI of 6% minus the 6% mortgage interest rate. It was free money, and “household borrowing took off.” The CPI data model was out of sync with reality, a reality that Joe and Mary knew well.

The authors compare the crash of 2000 – 2002 with this one. That earlier crash wiped out $10T in equity assets yet it caused no damage to the financial system. In this crash, a relatively small $3T decrease in real estate equity has decimated the financial system. How? Like the great depression, it was leverage.

The authors point to a misconception that the market crash of 1929, with 9 to 1 leverages on stock, brought the financial system down. But the banks did not begin their tumble till after the drastic fall in real estate prices beginning in 1930. Mortgage debt during the 1920s had more than tripled.

In the 2000 crash, most owners owned their stock holdings outright. They absorbed the loss of falling equity prices. In this real estate crash, leverages of 9 to 1, or 99 to 1, were common. Lower priced housing was hit hardest, declining by 50% in some cities, and this fall in home equity hit an economic group that could least withstand the impact.

In a WSJ article 3/18/09, Kathy Shwiff reported that delinquencies of Alt-A, or alternative documentation, home loans issued in the past few years have climbed to more than 20%. These loans were issued to people based solely on their credit scores. Often, there was no documentation or verification of income or whether the person’s income would reasonably allow them to make payments on the mortgage.


Investigations into the origins of the credit and housing crisis have revealed that it was a confluence of cheating.

AIG, the mega insurance company and hedge fund, bundled bad mortgage loans with good and wrapped the resulting loan package with a AAA safe credit paper of approval. Under pressure from the banks that securitized housing loans, ratings agencies developed an underwriting formula that would stamp these products as safe. Some mortgage brokers falsified credit applications for home loans or encouraged home buyers to do so. Home buyers fudged their income and expenses to buy houses that they could not afford.

Dan Ariely, a behavioral economist who wrote Predictably Irrational, reveals the results of several experiments on cheating in this video, beginning from about the 5 minute marker and ending at the 13 minute marker in the video.