What went wrong with the economy?
Lots of things, obviously.
Yet, there is one thread of cause and effect that is more central than any other.
I've begun, with the assistance of a sociologist, a sizable statistical analysis of the causes of the crash.
The big banks and investment houses had put too much trust in mortgages, and thus fell victim to “predatory securitizing“—the 21st Century mirror image of old-fashioned predatory lending. The Street was snookered by conmen—borrowers, mortgage brokers, and lenders—closer to the actual street, who had a more realistic idea of how little chance there was of these mortgages ever being paid back.
The financial wizards assumed that if a recession came along, the default rate would subsequently go up, but they never counted on defaults causing a recession. Of course, it's exactly what you are not expecting that you are most vulnerable to.
Indeed, due to its enormous population and outlandish home prices during the Housing Bubble, California alone accounts for a substantial majority of defaulted dollars.
DataQuick reported recently on California mortgages:
“Of the 3.7 million home loans made in 2004, less than 1 percent have since resulted in a lender filing a default notice. Of the 3.7 million loans originated in 2005, 4.9 percent have triggered a default notice so far. Of the 3 million in 2006, 8.5 percent have so far resulted in default.”So, we know the What, the Where, and the When. What about—
Look at this pie chart:
It shows subprime lending in California by ethnicity. In 2006, lenders handed minorities 77 percent of subprime dollars. Hispanics alone got a majority: 53 percent.
This data is from the federal Home Mortgage Disclosure Act website. (See reports 4-2 and 11-3). The federal government keeps careful track to make sure that minorities get enough mortgage money. But, strangely, it pays no attention whatsoever to whether or not minorities are paying back their mortgages.
To get a sense of who is defaulting on their mortgages, we can match data up geographically from the government's HMDA database and from RealtyTrac's Q1-2009 table of foreclosure rates in metropolitan statistical areas (MSAs) with populations of at least 200,000. (Thanks to RealtyTrac for emailing a file not publicly online.)
Let's first focus on subprime lending, which accounted for over a quarter of all dollars lent in California in 2006 for home purchases—i.e., to buy a home, not for refinancing or repairing an already owned home. (The ethnic patterns for refis are similar but not quite as ethnically skewed. But it was easy home purchase mortgages that inflated the Bubble the most.)
In California, subprime only accounted for 14 percent of all borrowing by non-Hispanic whites, but 47 percent of borrowing by Latinos and 52 percent by blacks.
This graph shows the strikingly close relationship between ethnicity and default rates among California metropolitan areas.
Let's focus first on the lower left corner of the chart. Among the 20 largest MSAs in California, the lowest foreclosure rate is found in bucolic Chico in Northern California (0.80 percent), followed by three affluent coastal regions: San Luis Obispo (0.84), Santa Cruz (0.90), Santa Barbara (0.98).
In these towns, subprime loans to non-Asian minorities accounted for merely six to ten percent of mortgage dollars (prime and subprime).
The worst foreclosure rates are in the graph's upper right: Merced (4.21 percent), Stockton (3.72), the huge Inland Empire of Riverside and San Bernardino counties (3.54), and Modesto (3.42).
In these hot inland regions, subprime loans to non-Asian minorities accounted for 30 to 36 percent of all mortgage dollars.
The correlation coefficient showing the goodness of fit of this very simple model is r = 0.89, which is extremely high. (A rule of thumb in the social sciences is that an r of 0.2 is "low," 0.4 is "moderate" and 0.6 is "high.")
What about all the white people who took out subprime loans—like that defaulting New York Times reporter who covers the Federal Reserve Board?
Well, in California, the epicenter of the economic collapse, there just weren't all that many white subprime borrowers relative to the large number of subprime minorities. Subprime loans to non-Hispanic whites accounted for only 6 percent of all home purchase dollars lent in 2006, while subprime loans to minorities accounted for 21 percent.
Not surprisingly, there is only a vague relation between white subprime loan shares of total lending and the default rate:
The correlation coefficient is just 0.21.
The May 15 New York Times noted in the passive voice: Minorities Hit Hardest by Foreclosures in New York [by Michael Powell and Janet Roberts]. One of my readers commented:
"As Orwell might have said, this shows why good writing produces clear thinking. To put the headline in the active voice: 'Minorities Default More than White Borrowers.'
The NYT 's Powell and Roberts blamed "reverse redlining" and argued that the high minority default rate observed in New York was the fault of lenders charging too high a risk premium. Yet a recent study by the Federal Reserve of New York economists Andrew Haughwout, Christopher Mayer, and Joseph Tracy, Subprime Mortgage Pricing: The Impact of Race, Ethnicity, and Gender on the Cost of Borrowing, did not find that black or Hispanic borrowers had to pay too much relative to their risk factors.
Indeed, if you stop and think about it, you'll realize that the fact that so many of the lenders who strove to serve "underserved" minority communities, such as Washington Mutual and Countrywide, are now out of business or are on taxpayer life support suggests that lenders charged blacks and Hispanics on average too low of a risk premium.
What if we look at total lending, with prime and subprime aggregated together?
Minorities borrowed 56 percent of all dollars, prime and subprime, in California in 2006.
The correlation between total non-Asian minority borrowing and default rates is still very high, with an r = 0.81:
In sharp contrast, the white share of total lending is inversely correlated with defaults;
One problem with this analysis is that it's not granular enough. For example, RealtyTrac's report lumps together Los Angeles County and Orange County into one vast MSA.
If you look within MSAs, however, this pattern of the Housing Bust being worse in heavily Non-Asian Minority neighborhoods is even more evident.
For example, DataQuick has a useful list of the change in average home sale price from 2007 to 2008 for hundreds of California neighborhoods. (Price declines correlate closely with foreclosure rates.)
Within vast Los Angeles County, the seven communities with the sharpest price declines are rapidly Hispanicizing Palmdale, Lancaster, and Little Rock in the high desert, San Fernando and Pacoima in the all-minority north end of the San Fernando Valley, and Maywood and Compton in South Central. (Maywood is all Latino, while Compton, the spiritual home of gangsta rap, is now majority Latino.)
In contrast, the only LA County communities to enjoy price increases in 2008 were the expensive beach towns of Malibu and Venice, idyllic Avalon on Catalina Island, San Marino (Pasadena old money and Hong Kong zillionaires), and Brentwood (which you may recall from the OJ Simpson trial).
Perhaps it's not fair that the rich got richer while the poor got, well, free rent until the sheriff finally tossed them out. Yet, it's important to understand what happened—even though few politicians and pundits seem interested.
This is hardly the only cause of the financial crisis. Still, this is, more than anything else, the central chain of cause and effect of recent history.
Which brings us to the final question:
Why did California crash the country?
In a word: diversity.
Diversity is a word with diverse meanings these days. And, not surprisingly, diversity contributed in diverse ways to the mortgage catastrophe. It's important not to oversimplify this explanation and blame everything on the Community Reinvestment Act or any other single mistake.
Instead, the root cause was the elite's intoxication with the concept of diversity—and its concomitant suppression of dissent.
For example, the massive immigration into California unsurprisingly increased demand for housing while decreasing the percentage of the population who were good credit risks. Last week, the Pew Hispanic Center released its multiple regression study of foreclosure rates by county, "Through Boom and Bust: Minorities, Immigration, and Homeownership." It wound up with an unwelcome finding much like mine:
"Of the several demographic attributes included in the analysis, the immigrant share of the county population is the one that emerges as the most important correlate with the foreclosure rate. And within the immigrant population, the share of foreign-born Latinos stands out as a more notable influence than the share of non-Hispanic immigrants." (Appendix Table A5).
One obvious reason for this correlation: Latin American immigrants brought with them a fiesta culture not conducive to thrift.
But the federal government's war against redlining discrimination made it a legal offense for financial firm employees to point out inconvenient facts like this—engendering what Orwell called "protective stupidity".
In the long run, however, stupidity isn't terribly protective. Reality always gets its revenge.