In a posting last week, Russ Roberts (one of my favourite bloggers, btw) wrote that he is working on a lengthy essay that might become a book about the recent housing bubble and financial crisis. In that posting, he posed two questions, the first of which was:
Why did prices rise so dramatically between 1995 and 2003? [EE: I'm guessing he is referring to housing prices here.]
Without this price rise, the subprime market never takes off in 2004-2006. There would have been no NINJA loans, no loans for 103% of the value of the house, no second houses with zero down, no 80/20 loans and so on.
Recently I have been reading Fool's Gold by Gillian Tett. One of the themes implied by this book is that the subprime market would not have developed, and the housing bubble would not have occurred (or certainly not been nearly so extreme), if the shadow banking system had not evolved as a way for banks to circumvent the capital requirements that were in place for commercial banks. In one form, they bought tonnes of mortgages and resold the mortgages to off-shore special purpose or special investment vehicles.
These institutions, in turn, paid for these mortgages by borrowing short (while lending long). And when the bubble burst, they lost billions because they were over-leveraged and under-capitalized. Without these vehicles, the supply of lendable funds for mortgages would not have been nearly so great, the subprime mortgage market would not have taken off (and might even not have evolved), and the housing bubble would have been far less likely to have occurred.
In other words, it is possible, even likely, that the causation is backwards from the way Russ Roberts expressed it. Or it might be a simultaneous relationship.
I'll try to do a full review of the book in a later posting.