Links - Great Recession, GFC, and Real Estate Share a Broken Script

Counter Conventional Wisdom

A lot of economic experts, most financial market participants, and basically all business journalists get most of the following wrong. So if you find this surprisingly insightful if not downright contradictory to what you’ve been told, know you’re in good broad company.

Let’s start with what Scott Sumner calls his most contrarian view: What really happened in 2008.

I believe that the Great Recession was caused by a tight money policy during 2008. Probably fewer than 1% of economists agree with me. Most blame the housing slump and the subsequent banking crisis.

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I claim the Fed could have and should have continued steering the economy along a 5% NGDP growth path. Their failure to do so caused the Great Recession. My critics raise two objections.

One argument is that the housing slump and banking crisis were severe real shocks that would have caused a recession even if NGDP had kept growing at 5%, just as Covid likely would have caused a recession even with sound monetary policy. But before the tight money began, housing had been slumping for nearly two years (during 2006 and 2007) without any significant negative effect on the broader economy. And the post-Lehman banking crisis was largely caused by a recession that began nine months earlier and was itself caused by tight money. More a symptom than a cause.

In a counterfactual where the Fed kept spending growing at 5%/year, the banking crisis would have been far milder, analogous to the March 2023 banking crisis when Silicon Valley Bank and First Republic Bank both failed. Many economists thought this smaller crisis would slow the economic recovery, but it did not. Economists tend to overestimate the importance of real shocks. Today, the 2023 banking crisis is largely forgotten. As an aside, the initial Trump tariffs might have been a severe enough real shock to have caused a mild recession, even if the Fed maintained 4% or 5% NGDP growth. The new reduced tariffs will be unlikely to cause a recession unless the Fed fails to maintain adequate spending growth.

Along similar lines, the 1929 stock market crash is more famous than the 1987 crash, even though the latter was almost identical in magnitude, occurred much more recently, and occurred at a time when far more Americans owned stocks. The explanation is simple. After the 1987 crash, the Fed adjusted monetary policy to keep NGDP growing at a steady rate. The economy not only avoided another Great Depression, there was no economic slowdown at all. The 1987 crash shows that the Fed can and should adjust monetary policy to prevent financial turmoil from impacting the broader economy.

The entire post is very valuable reading not just because it gives insights into deeper thinking about that period of economic history but also because it shows how, as Sumner says,

Monetary economics is a sort of Alice in Wonderland world, where nothing is quite what it seems. Low interest rates can represent easy money, but usually they do not. Quantitative easing can represent easy money, but usually it does not. Because monetary policy operates in such a counterintuitive fashion, it often gets misinterpreted. If a tight money policy is misjudged as easy money, it will not be surprising that economists become pessimistic about the prospects for easy money to stimulate the economy.

The simplistic narratives that continue widespread today range from half-baked stories that don’t add up (or stand up to the scrutiny of the data) to continuations of the motivated reasoning that arose in the midst of the chaos back then. These too don’t stand up to scrutiny. In all cases defenders of them either deny the logical/evidential problems or simply keep adding epicycles to keep their theories theoretically alive.

So it was unsurprising when Sumner needed a follow-up post a few days later.

Commenters cited a myriad of things that went wrong with our financial system in the lead-up to what came to be called the “Global Financial Crisis.” But my post wasn’t about the GFC, it was about the Great Recession. The post focused on showing how the Great Recession was caused by tight money, not by the financial crisis. I don’t doubt that The Big Short is full of fascinating observations about our financial system, but that wasn’t the topic of the post.

Here’s an analogy. During February and March of 1933, the US experienced that worst banking crisis is US history. Many banks remained shut down for much of 1933. So how did the economy do? Industrial production rose 57% between March and July 1933, the fastest rate in US history. That’s because the US also had the most expansionary monetary policy in US history—a sharp devaluation of the dollar after more than 50 years of pegging at $1 = 1/20.67 ounces of gold. Monetary policy drives the business cycle, not financial turmoil.

If you read my critics, you would have assumed that the economy did poorly during March through July 1933. You would also assume that there’s nothing that monetary policymakers could have done with thousands of banks shut down and interest rates stuck at zero. Neither statement is true. Monetary stimulus more than offset the worst banking crisis in history.

The GFC was not the Great Recession; they were two distinct events.

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So why not just say, “The Fed should have done more”, a claim that many would agree with, and indeed a proposition endorsed by Ben Bernanke in his post-Fed memoir? Why be so provocative?

My goal here is to move thinking about monetary policy from the widespread impression that it consists of a series of gestures that might or might not “fix problems” to a perception that it’s more like a captain steering an ocean liner.

Bus drivers don’t fix steering problems, they try to avoid creating problems by driving sensibly. I believe it would be very helpful if the Fed were to stop thinking in terms of fixing problems, and instead focus on refraining from creating problems. I’d like to see central banks take ownership over the value of money, and by implication the broader nominal aggregates, because their monopoly on base money gives them a responsibility that they cannot dodge.

Often, I personally run into well-credentialed and experienced people making this mistake of thinking the Great Recession = the Global Financial Crisis. I’m sure I’ve actually conflated the two myself on occasion.

Beyond that, though, I don’t make the mistake of thinking the GFC cause the recession. And I’ve understood since early on (from reading Sumner among others) that the Fed was the major culprit in the recession and contributor to the GFC indirectly (tight monetary policy) and directly (crafting TBTF bailouts, failing to then bailout Lehman). And yes, the Congress and U.S. Treasury deserve a lot of blame on the direct part of the GFC’s magnitude.

Of course, bad policy doesn’t stop even when it finally specifically stops. There are always knock-on effects. Loyal readers know where I’m heading next—Housing Policy.

Kevin Erdmann asks a pertinent question: Are we going to legislate mass evictions?

Democrats for mass eviction.

What a freaking time to be an American.

Clowns to the left of us (whose cruelties are, blessedly, procedurally limited by the rule of law), jokers to the right (exacting cruelties at the whim of a dictator), and here we are, stuck in the middle.

I’m bad at politics. I’m probably bad at attracting readers, too. Insulting people isn’t good public relations. But I don’t know what else to call this.

The leftist critics of the Abundance agenda that like these bills are similar to people who can believe in 2025 that lending standards are still too loose. They are too far gone to be reasoned with. You don’t win policy debates by explaining to people that they are prejudiced. So, how do you approach a topic that is entirely driven by prejudice? You have to hope that everyone else can add up to 50.1% of the votes to defeat it. I think that’s where you have to put your efforts. And, I think you have to be very careful trying to find common cause with activists that are drawn to these bills, even if they are otherwise YIMBYs.

That means that these bills will never go away. We just have to hope to stop as many of them as possible for as long as possible. I’m afraid that with the passage of time, that seems like a guaranteed losing proposition. Texas passed many great YIMBY reforms this session. There were 4 bills filed to limit single-family landlords. They all failed to advance. But there were 4 of them.

Note that his post was written before Zohran Mamdani’s victory in the NYC primary. So if any thing, the momentum signal is stronger.

The moral crusade to fix housing policy by exorcising all the demons has brought us to the last boss—Wall Street Investors. How unironic that we’ve circled back to them since that is where much of the GFC moral panic arose in the first place.

As Erdmann discusses, somehow we are going to make housing cheaper and more available by . . . making owners sell it and, therefore, jeopardize the housing future for current tenants. If the tenants couldn’t buy housing and instead had to rent it in the first place, how are they better off by these transactions forced upon their landlords?

Note how this will gain traction within the corridors of NIMBY nonsense regarding the undesirability of renters. That makes this Bootleggers and Baptists story really just a tale of Dumb and Dumber.

Not all mistakes in housing policy are quite so easy to foresee. Lurking behind every public policy is the terrifying gingivitis! known as unintended consequences.

Craig Richardson discusses how a lawsuit against realtors went sideways.

As a result, sellers who thought they would save money by paying, say 3%, to their own agent and 0% to the buyer’s agent faced a lot of problems they didn’t anticipate. When buyers discover this arrangement, more than likely it’s time to move onto another listing that pays their agent. A smaller pool of buyers will translate into fewer offers and lower home prices. This explains the lack of change in the commission structure a year later. The traditional 3%-3% split seems to be an equilibrium towards which the market naturally gravitates.

Indeed, the largest change from last year is that the plaintiff lawyers got massively rich. The plaintiff’s lawyers walked away with a third of the settlement- $208 million- and the estimated 50 million affected homeowners will pocket $8 on average, if they bother to apply for past damages.

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The NAR is not an all-powerful oligopoly, contrary to The New York Times reporting. Companies like Open Door and Redfin often pay commissions closer to 2% but they are not that popular, with less than 1% of the market. For sale by owner (FSBO) is another option for every homeowner. Most pass because they will get a lower home price, and more hassle in selling their home. The FSBO market share hit an all-time low of 7% in 2023 according to NAR statistics.

In other words, even though there are alternatives, most buyers and sellers aren’t seeing the value proposition. Any hungry new real estate company could enter the market paying lower commission splits, yet this is rare. More than 9 in 10 home buyers and sellers apparently prefer the traditional approach of having a highly personal interaction with an agent from a trusted real estate company.

The reason: Buyers and sellers got a reminder that agents provide value that is both tangible and intangible, and often difficult for newcomers to foresee. They have connections to reputable service providers, checking on everything from plumbing to roofing, understand the fair market value of a home relative to other homes in the area, and provide intuition on the negotiating position of the buyer or the seller.

In addition, there are intangibles that include an agent navigating a client’s idiosyncratic tastes that may differ from the spouse, local environment, style of the home, and much more.

By attempting to shut down important information about disclosing commissions on MLS, the unintended consequence of the NAR lawsuit could have been a decline in new homeowners, unable to come up with cash payments for their agents. Luckily, the market innovated with information hacks that helped these prospective homeowners dodge a bullet.

Among many attributes, each of the stories above share what can be summed up in a pithy lesson: Attempting to script free market outcomes is not the same thing as allowing free market outcomes.