Root of the financial crisis

The root cause of the financial crisis was the collapse of the $8 trillion bubble in the US housing market. In August 2002, Dean Baker was the first economist to say that there was a housing bubble in the US, basing his analysis on US-government house-price-data from 1953 to 1995. ^[1] In his analysis, Baker wrote that from 1953 to 1995 house prices had simply tracked inflation, but that when house prices from 1995 onwards were adjusted for inflation they showed a marked increase over and above inflation-based increases. Baker correctly drew the conclusion of the existence of a bubble in the US housing market and, along with a small handful of other economists, predicted an ensuing crisis. It later proved impossible to convince responsible parties such as the Board of Governors of the Federal Reserve of the need for action, however.^[2][3] Baker's argument was confirmed with the construction of a data series from 1895 to 1995 by the influential Yale economist Robert Shiller which showed that real house prices had been essentially unchanged over that 100 years.^[4] Long before the collapse took place, at the end of September 2002, Baker also correctly predicted that, "The collapse of the housing bubble will also jeopardize the survival of Fannie Mae and Freddie Mac and numerous other financial institutions."^[5] A common claim during the first weeks of the financial crisis was that the problem was simply caused by reckless, sub-prime lending. As Baker has pointed out repeatedly, however, the sub-prime mortgages were only part of a far more extensive problem affecting the entire $20 trillion US housing market: the sub-prime sector was simply the first place that the collapse of the bubble affecting the housing market showed up.

References

1. ^ The Run-Up in Home Prices: Is It Real or Is It Another Bubble?, Dean Baker, CEPR, August 2002
2. ^ "Challenging the Crowd in Whispers, Not Shouts" commentary by Robert Shiller in The New York Times November 1, 2008
3. ^ "In Modeling Risk, the Human Factor Was Left Out" article by Steve Lohr in The New York Times November 4, 2008
4. ^ Shiller, R. 2006. Irrational Exhuberance Princeton, NJ: Princeton University Press.
5. ^ Economic Reporting Review, Dean Baker, October 7, 2002 - Note: Though the review is dated October 7, the place where he made this prediction is actually the September, when he discusses a New York Times article of Setpember 29.

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