Thomas Sowell, prolific public intellectual, is one of America’s greatest economic thinkers and educators. He has taught the fundamentals through such books as Economic Facts and Fallacies and Basic Economics and chronicled economic history through such scholarly works as Marxism: Philosophy and Economics and On Classical Economics. In his classic work Knowledge and Decisions, he espoused a sophisticated, largely Hayekian approach, revealing how the efficient spread of relevant knowledge is shaped by our social institutions and often warped and misshapen by government.
Now, in The Housing Boom and Bust (Basic Books, 2009), Sowell contemplates the greatest expansion of government power in a generation, which was itself occasioned by the greatest economic crisis in a generation. Sowell shows how government policies led to a huge increase in highly risky housing loans. As he notes, the immense local variability in housing prices and failed loans reveals that the government mistook a set of local problems for a national one and then imposed a single troublesome national solution. Although foolish decisions to indulge in complicated investment vehicles affected the specifics of how the financial contagion spread, Sowell argues, at its root the housing problem was one of bad mortgages. And those came from bad decisions by government and by borrowers themselves.
Reason senior editor Brian Doherty interviewed Sowell about the book, the crisis, and the government’s unfortunate response.
Brian Doherty: Is the economic downturn caused by the housing boom and bust the worst economic circumstance of your lifetime?
Thomas Sowell: Because I was born in 1930, the economic crisis with the most impact of my lifetime was the Great Depression. As to whether this will match that, it’s too early to tell. Right now it certainly is nothing comparable to the Great Depression, but the Great Depression began as nothing comparable to the Great Depression. For the first twelve months after the stock market crash [of 1929], unemployment never reached double digits, but the solution turned out to create more disasters than the problem it was trying to solve.
Whether that will happen again depends on how far and how long the current administration will push policies to solve the present crisis and what their repercussions will be. As mentioned in the book, parallel to the 1929 crash was the stock market crash of 1987. That had the potential to create another Great Depression had Reagan followed policies similar to those of Hoover and FDR. He didn’t, so we just about forgot about the stock market crash of ’87.
Doherty: Do you see or anticipate President Obama’s reactions being sufficient to turn this downturn into another lengthy depression?
Sowell: I hope not, but what we’ve seen in these past few months is an exercise in unprecedented powers. I mean, to fire the chairman of General Motors, to tell credit card companies how they should run their business, tell GM what kind of cars it should be making . . . and there’s no end in sight. Obama’s policies are a work in progress. So a lot depends on how far he will push, but I see no signs of him turning back. I see no substantial resistance in Congress. But you never know; as things start to unfold, voices of sanity may prevail.
Doherty: What is the most dangerous sign you’ve seen so far in terms of policy reaction to the housing bust?
Sowell: The presumption that Obama knows how all these industries ought to be operating better than people who have spent lives in those industries. . . . Only someone who has never had the responsibility for managing anything could believe he could manage just about everything. Doherty: You parcel out some share of responsibility for the specific way the housing bust broke down to borrowers, lenders, financial markets, and the government. What was the borrowers’ share?
Sowell: There are those who borrowed to buy a place to live and speculators who borrowed to speculate and did enormously well for a number of years. Then there were people who simply don’t understand complex mortgages, particularly people who never owned a home before and whose educations were limited. But the people I would blame the most—in the sense that without their interference other problems would have been within manageable means—are the politicians. People in Congress, the president, and regulators pushed the lenders and the banks and Fannie Mae and Freddie Mac into lending and buying mortgages on behalf of people who hadn’t met standards that evolved in the marketplace and that had worked. Those politicians, in addition to that initial mistake, ignored all sorts of warnings from all sorts of sources. As I list in the book, the Economist in London, Fortune, Barron’s, people at the American Enterprise Institute, all over the map, saw that this policy of encouraging home ownership at all costs was leading to trouble.
But the politicians clearly had as their political goal home ownership as “a good thing” and persisted—and for that matter persist to this moment in pushing it. The Federal Housing Administration, last I checked, was promoting supporting mortgages that have a less than 4 percent down payment. We all make mistakes, but politicians have persisted in their mistakes and in the pointing of fingers in other directions.
“Affordable housing” covers a number of problems. There was this sense in Washington that the cost of buying a house had become a nationwide major problem that would require a federal answer, as opposed to a local answer. All the data say that was not true. People weren’t paying a higher percent of their income nationwide for housing than they had a decade earlier. In fact, it was a somewhat lower percentage in some areas. Now in some areas, including California—coastal California—people were paying half their family income to put a roof over their head. That in turn was a result of local political people putting all sorts of restrictions on building.
Implicit in the idea of affordable housing is the notion that third parties know what people can afford better than those people know themselves. If you spell it out it sounds so absurd you wonder how anyone could have believed it. But for politicians the question is not whether it is absurd. The question is whether or not the public will buy it.
Doherty: How much weight do you place on the notion that Federal Reserve expansionary money and credit policies primed the bubble, and bust, in housing?
Sowell: I find it hard to accept. I’m sure if the interest rates had been at 8 percent the boom would not have gone as far and the bust would not have been as big. I’m not saying monetary policy had no effect. But I am struck by the fact that Federal Reserve policy is nationwide and that in places like Dallas the increase in housing prices was in single digits and the decrease has been in single digits. So although Fed policy undoubtedly aggravated circumstances, it can’t be the fundamental cause because the defaults were so heavily concentrated. Sixty percent of all defaults nationwide were in five states, and I suspect that if you broke down the data even more you’d find specific regions in those five states heavily implicated in defaults.
Doherty: What does a crisis like this, and public reaction, say about the general public understanding of economics?
Sowell: I think in the United States and most of the world the public understanding of economics is abysmal. But it’s one thing not to understand something—I don’t understand brain surgery—but it’s another to want to form policies on things about which you are ignorant. I hear the wonderful phrase “I want to make a difference” when it comes to policy. It would be horrible if I wanted to make a difference in brain surgery; the only difference is that more people would die on the operating table.
The only encouraging thing about public reaction to the crisis is that citizens seem to have more misgivings about some of these policies than politicians or the media do. Still, though there have been studies that indicate the New Deal prolonged the Great Depression by years, what is also clear is it was enormously popular. FDR was elected four straight times and more than once without ever having brought unemployment down to single digits. An economic disaster does not necessarily mean a political disaster. If we could raise the average level of understanding of economics to what Alfred Marshall had in 1890, the vast majority of politicians would be voted out of office.
Doherty: Do you think the policies we’ve seen Obama pursue so far threaten another Great Depression–level downturn?
Sowell: I would hope not, but I certainly do think serious consequences are likely to follow and aren’t really discussed much. The ease with which we are now throwing around the word trillion—I remember when billion was a shock word. To talk about trillions as though they are nickels and dimes is a classic example of doing something that sounds good at the moment but whose repercussions are beyond the horizon. When bad effects of his policies come, will people connect the dots? Or will Obama be able to get away with it as FDR did, blaming it all on his predecessor?
Doherty: What sort of reactions should the federal government have to the current situation?
Sowell: First, the government should not try to keep housing prices up artificially. The tremendous irony is that the very politicians who for years talked of affordable housing are fighting to keep housing prices from falling. How does housing become more affordable except by keeping prices down? They really have no interest in having housing become affordable by means other than their largesse.
Doherty: Do you think they need to be doing anything to ease the woes of people in foreclosure?
Sowell: Not at all. Foreclosure is not something that just happens to you, like being struck by lightning. Foreclosure is the result of things people have done that they need to stop doing in the future. And the market can take care of that. California is one of those states in which we’ve seen a drastic reduction in fancy no-money-down mortgages and creative financing; we’ve seen those things drop sharply within just a couple of years as housing prices fell and foreclosures rose, as long as the government isn’t there to prop them up.
But though the market’s reaction in California shows that borrowers and lenders can learn from the discipline of the market, one group has not learned: politicians. Rather, they have learned that they can get away scotfree by simply pointing fingers at others and making pious statements. I have no doubt that Barney Frank will get re-elected. But if people had any idea of the damage he’s done [by promoting the “affordable housing at all costs” policies], he’d be out of there. These problems have happened before, though not on this scale. Republicans in the 1920s were pushing home ownership, which led to increased foreclosures; in the 1930s the Democrats did it too, which led to increased foreclosures. This is all a cycle, though we’re in the worst of the cycles. But politicians don’t stop doing this because they never pay any price.
And I think we see politicians today repeating one of the features of New Deal policies in that the policies seem geared not toward getting us out of our current problem as quickly as possible but toward using the problem to create enduring institutional changes to the very nature of the American economy.