Politics, Markets, and The Housing Boom and Bust

I recently read the revised edition of Thomas Sowell’s excellent The Housing Boom and Bust. One of the most striking things about the role of housing in the financial crisis is the resonance of the “villains, victims, and valiant government” narrative that goes as follows: greedy bankers exploited everyone while the regulators were asleep at the wheel, and the valiant government must ride to the rescue. It makes for a good set of talking points, but it’s wrong (or, at the very least, lacking). Sowell ably traces the distorted and perverse incentives that emerged in the housing market to (seemingly worthy) political goals. As he puts it on page 31,

Like many disasters, this one began with good intentions, or at least intentions that sounded good politically. At the heart of those good intentions was the quest for “affordable housing,” another way of expressing the crusade for more home ownership among a wider range of people.

Political pressure in pursuit of this goal meant that financial institutions could make risky loans and enjoy all of the benefits while other people bore the risk, and borrowers could (sometimes fraudulently) borrow money they couldn’t pay back on terms they didn’t understand to buy houses they couldn’t afford.

Sowell illustrates some of the fundamental differences between politics and markets. When politicians make decisions and implement policies that turn out to be disastrous, they bear no personal cost and if anything, they are often rewarded by voters for “working to increase affordable housing” or “fighting for the poor” or something like that. Disastrous policies are not produced by having the wrong people in office. They are the product of the incentives in place. In F. A. Hayek’s Law, Legislation, and Liberty, he suggested that politics be dethroned. The Housing Boom and Bust shows us why Hayek was right.