In ABCT and the Community Reinvestment Act (CRA), Peter Klein makes readers aware of new evidence, contra Krugman, that Federal housing policy, and especially the CRA, significantly contributed to the financial crisis.
Peter concludes, “Raghu Rajan [author of the new NBER paper Klein is highlighting] puts it in a very Austrian-sounding way” and then argues, “I’d reverse the order of emphasis — credit expansion first, housing policy second — but Rajan is right that government intervention gets the blame all around.” Klein is correct to reverse the emphasis.
Roger W. Garrison in Alchemy Leveraged: The Federal Reserve and Modern Finance (pp. 445-446) as he often does, very clearly lays out this Austrian argument concerning the relationship between the interaction of central banking policy and housing policy in creating this most policy driven bubble/boom/bust cycle and crisis.
Putting housing policy in the right perspective, Garrison writes:
Unsound as these policies were, they were not the principal cause of the financial crisis. Again, Dowd and Hutchinson are right in identifying the expansion-prone Federal Reserve as the principal institutional cause. Had the Fed provided no fuel for the boom, federal housing policy, though perverse, would not have been unsustainable [emphasis mine]. The mortgage market would have had to compete with all other markets for the funds that savers provided. There would have been a continuing bias in favor of the mortgage market, and the ongoing rate of foreclosures would have been higher. House prices would have been higher (because houses and mortgage loans are complements), but they would not have been high and rising. Practitioners of modern finance would have paid due attention to the higher VaR, which would have reflected the expectation of an ongoing higher foreclosure rate.
Thus given Fed policy but without the housing policy there would still have been a boom and a bust with a bubble in some other interest rate sensitive sector.
In Garrison’s words:
… had the federal government not enacted legislation and created institutions that rigged mortgage markets so as to increase home ownership, credit expansion by the Fed would nonetheless have created an artificial boom, which inevitably would have ended in a bust.
In conclusion, Garrison adds:
The housing crisis in 2008 occurred because a credit expansion took place during a time when the federal government was pushing hard for increased home ownership for low-income families. We understandably identify these different cyclical episodes (the dot-com crisis, the housing crisis) with “what was going on at the time.” The common denominator, however, is the Fed’s propensity to expand credit.
Business cycles are complex but a critical factor in almost all cyclic, rather than shock driven macroeconomic crisis, is the Fed (or any central bank) feeding (turbo charging or piggy-backing on) whatever is going on elsewhere in the economy. Without the created credit and the associated lower (relative to the natural rate) interest rate accompanied by less risk adverse credit environment generated by monetary policy, distortions in the economy are more easily discovered and corrected before they can become unsustainable with economy wide repercussions.