The terms "credit crisis" and "housing bust" will be forever stamped upon our generation. Many ordinary and not-so-ordinary people are suffering, and there's a growing public discontent for the way things have been done. Some are calling for the dissolution of Capitalism in America, declaring that we finally have proof of the failings of free enterprise! The truth is quite to the contrary. This financial meltdown was largely caused and absolutely perpetuited by a series of government incursions into the economy!



There are three main groups behind the housing madness: local and state lawmakers, federal regulators, and the Federal Reserve. Land use regulations stand at the heart of the issue, with local and state legislators placing significant and often-times arbitrary restrictions on new development. In coastal California, for instance, cities largely dictate the land use policies of surrounding rural areas, restricting new development to alleviate growth in demand within the cities. This is why housing prices in Los Angeles increased at a far higher rate than those in Houston, despite greater population and living standard growth rates in Houston.

Federal policy is also largely responsible for this last boom. The Department of Housing and Urban Development (HUD) dictated to Fannie Mae and Freddie Mac to increase their portfolio of subprime mortgages. This was plain and simple social policy in action. The goal was to increase rates of homeownership amongst low-income demographics. We are finding out now the hard way that many of these people could not afford their homes after teaser rates expired and housing prices stopped growing at double digit rates. Thank you HUD for encouraging them into the market! A new and scary player in this regulatory roulette is the Environmental Protection Agency (EPA), linking climate to land use regulation. America, beware!

The other big player in the real estate boom was the Federal Reserve and its manipulation of the money supply. In response to a stock market crash and potential economic slowdown following the attacks of 9/11, then Federal Reserve Chairman Alan Greensplan dropped the federal funds interest rate to near zero. It almost certainly dipped into negative real interest rate territory (deduct inflation from the nominal rate), which discourages saving and signals to the market to borrow. There is no question that what ensued during the heigh of excess in the real estate boom would not have occurred had the capital not been made so easily available.

This is only a rough snapshot at how some regulations and government policies affected real estate and drove the market nuts up through 2006. As stated earlier there were certainly many private parties responsible for unethical lending practices, incompetent risk managers at large financial institutions, and just plain old greedy people who tried to take advantage of what proved an unrealistic market. Before we scream for increased government involvement in real estate and financial markets, we should seriously evaluate what caused the problems of the past. It's clear that government played a significant part, so does it make sense to call on the same institutions to increase their involvement? Or perhaps it makes more sense to reduce their encroachment so that markets can work?