Ignorance is Bliss

Apparently for the Republican members of the Financial Crisis Inquiry Commission, the first rule of a shadow banking run is you do not talk about shadow banking:

The Republicans, led by the commission’s vice chairman, former congressman and chair of the House Ways and Means Committee Bill Thomas, will likely focus their report on the explosive growth of subprime mortgages and the heavy role played by the federal government in pushing mortgage giants Fannie Mae and Freddie Mac to purchase and insure them. They’ll also likely focus on the Community Reinvestment Act, a 1977 law that encourages banks to lend to underserved communities, these people said. […]

During a private commission meeting last week, all four Republicans voted in favor of banning the phrases “Wall Street” and “shadow banking” and the words “interconnection” and “deregulation” from the panel’s final report, according to a person familiar with the matter and confirmed by Brooksley E. Born, one of the six commissioners who voted against the proposal.

A lot of this has been adequately debunked elsewhere, and I won’t rehash it. But consider this. Suppose the housing bubble was 100 percent caused by Fannie Mae, Freddie Mac, the Community Reinvestment Act, and other government efforts to expand homeownership. What, exactly, is it that this theory would explain? Well, it would explain why housing came to be overbuilt. And it would explain layoffs in the construction sector. It would explain an elevated level of foreclosures and it would explain an unusually high rate of FDIC bank closures.

This is basically the story of 2007. Home prices fall, construction activity declines, unemployment rises, people start talking about whether there’s a recession, blah, blah, blah. It’s all somewhat interesting and somewhat important, but it doesn’t even begin to explain how we got to where we were in the winter of 2008-2009 with unemployment heading up to 10 percent. And once unemployment’s at 10 percent, you hardly need a theory of why a lot of people can’t pay their mortgages. If you lose your job and can’t get a new one, you’re going to have trouble paying the bills. But how did we get the 10 percent unemployment? It’s not like 10 percent of the country was previously engaged in building homes for poor folks getting rich on CRA loans.

There was a run. In the shadow banking sector. It came about as a result of regulatory changes. That run led to a huge increase in the demand for safe, liquid assets. For money, basically. And this in turn led to a huge decrease in the demand for goods and services.