By Lawrence H. Summers
The views expressed are his own.
The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending. Most policy failures in the United States stem from a failure to appreciate this truism and therefore to take steps that would have been productive pre-crisis but are counterproductive now, with the economy severely constrained by lack of confidence and demand.
Thus even as the gap between the economy’s production and its capacity increases and is projected to increase further, fiscal policy turns contractionary, financial regulation turns towards a focus on discouraging risk taking, and monetary policy is constrained by concerns about excess liquidity. Most significantly the nation’s housing policies especially with regard to Fannie Mae and Freddie Mac–institutions whose very purpose is to mitigate cyclicality in housing and who today dominate the mortgage market–have become a textbook case of disastrous and procyclical policy.
Annual construction of new single family homes has plummeted from the 1.7 million range in the middle of the last decade to the 450 thousand range at present. With housing starts averaging well over a million during the 1990s, the shortfall in housing construction now projected dwarfs the excess of construction during the bubble period and is the largest single component of the shortfall in GDP.
Losses on owner-occupied housing have reduced consumers’ wealth by more than $7 trillion over the last 5 years, and uncertainty about the future value of their homes, as well as the inability to refinance at reasonable rates, deters household outlays on durable goods. The continuing weakness of the housing sector is a major source of risk for major U.S. financial institutions raising significantly the costs of the loans they offer.
In retrospect it obviously would have been better if financial institutions and those involved in regulating them–especially the FHFA–recognized that house prices can go down as well as up; if more rigor had been applied in providing credit; if the GSEs had been more careful in monitoring those originating and servicing loans; and if all those involved had been more vigilant about fraudulent behavior.