But whatever you make of the tulip mania, Nocera’s positioning is troubling. First, he repeats and amplifies an underlying fallacy of the FCIC report, that the crisis was at its root a housing bubble. That is simply not true. As we recounted on this blog in the months before its onset, there was an alarming compression of risk spreads in every credit market around the world. If this was a mania, how does Nocera explain it operating across all debt markets, most of which had nothing to do with US housing (take emerging market and the CLO market, for starters) and where prices were set by professional investors rather than the presumed gullible public?
In addition, the math simply does not add up for treating the housing market in isolation as the cause of the crisis. The subprime market is roughly $1.2 trillion. Even in 2009, expected defaults (ultimate, realized to date are considerably lower) were around 30%; they are now more like 40%. One can argue those aren’t all due to bad lending; we also have losses due to high and persistent un and underemployment (these are considered to be normal credit losses, as in “shit happens” as opposed to defective lending). So for the purposes of parsing out bad lending from knock on crisis effects, let’s use the 30% default level as representing bad lending decisions.
Even with a default, on housing, investors will get a recovery from the sale of the house. It’s much lower than in normal housing cycles, so we’ll use a 70% loss (as in 30% recovery). That gives you losses of about $250 billion, or 1.8% of GDP. This would have been a S&L level crisis (remember, we had dumped a lot of the bad paper on foreign banks) in and of itself, not a financial system heart attack.
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