I’ll get to this graph in a minute


When I was a economics undergrad multinational corporations were the public enemy of choice. We were taught as young defenders of the faith, to look beyond the intuitive connection between profits and evil. We were told that the equilibrium was the result of competing forces and that sometimes what looked like a cause was really a symptom. Sweatshops were a case in point.

Today the villain has a very different face. Its big government and its apparently uncanny ability to screw everything up. If something went wrong government is likely to blame.

Queue the housing crisis.

I watched the housing and financial crisis unfold in real time. I had considerable personal interest in the outcome. It seemed beyond doubt among those biting our nails over whether there would or wouldn’t be a crash, that the key player here was the Collateralized Debt Obligation. It was a newly popular product. It promised fantastic results. It had revolutionized the market and from the very beginning many had complained that it was too good to be true.

From an economic standpoint the argument was a standard one. The modern CDO was a technological innovation. Large scale CDO issuance was impractical before David Li developed a Gaussian Copula model to estimate their performance.

This always happens with new innovations from the Railroads to the Internet. Some nut says that its going to change the world as we know it and some old fogy says its no different than the fax machine. Usually they’re both at least right. We have Googles and we have Webvans and no one knows before hand which will be which.

Yet, and still I didn’t find it surprising when millions poured out to blame the housing crisis on corporate greed. I had been trained to expect it.

What did surprise me is that people wanted to blame it on Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac? You mean those old stogy has-beens that the CDO was supposed to make obsolete? A 30 year 80-20, that’s for suckers. Those were the days of the 2/28 ARM at 135% LTV. It was truly money for breakfast.

Yet, that’s where the blame went. The government had intervened in the housing market. The housing market had gone bad. Therefore, the government must have screwed up the market. QED.

This theory was pushed by econ-types, business or pro-market pundits who were used to defending corporations. I was sure, however, that eventually their training would kick-in. They would look for auxiliary factors, try to examine competing theories and most importantly check for evidence that would directly contradict that theory. That didn’t happen.

And, that brings me to graph at top. It seems to me that if you believe the American government did something to screw up the American housing market the very first thing you would ask is – what happened in other countries. Its authoritative since government polices are usually defined over government jurisdictions. Its really convenient, as countries usually collect their own data and post it online for you. Its the first place you should look.

A causal glance, however, tells you that there was a bubble all over the world. The US wasn’t even particularly bad and that even the free market wunderkind of Ireland was about to take it in the teeth.  As far as I can tell that’s pretty much what happened. This makes the Fannie/Freddie done-it theory seem highly implausible. Even if there are international spillover effects, at a minimum one would expect Fannie and Freddie to have done it most in America. America actually had one of the least – which might have something to do with Fannie and Freddie, but that’s for another day.

My take away isn’t that government is the answer. I’m generally a Hayekian and I see the information problems associated with government as being often insurmountable. No, the take away is that villains aren’t the answer. When you see things going wrong its a mistake to assume that someone made them go wrong. And, its got to make you at least a little suspicious if the someone you suspect was a person you didn’t like to begin with.

Economists like to say that the economy is not a morality play, where the good are rewarded and the evil punished. Its not a Bond film either, where there is a super villain – business or government – behind it all. Its a complex interaction of forces that we can only hope to understand by careful examination. Sometimes the government will screw up. Sometimes the private sector will screw up. Sometimes shit happens. That’s not always emotionally satisfying but it is the nature of the discipline we have chosen.