It looks like Richard Posner is now hawk­ing his blame-the-guvmint thesis over at Andrew Sullivan’s blog:

The low inter­est rates of the early 2000s pushed up hous­ing prices both directly and indi­rectly. Directly by reduc­ing the cost of hous­ing debt–and hous­ing as I men­tioned in my last entry is bought mainly with debt. Indi­rectly by push­ing up the value of common stocks. The low inter­est rates, as I said, caused asset-​price inflation.

…

[T]he basic fault lies with the Fed­eral Reserve in having pushed inter­est rates too far down, and kept them too far down for too long, during the early 2000s, and with the dis­man­tling of reg­u­la­tory con­trols that had for­merly reduced the incen­tive and abil­ity of banks to lend into a bubble.

I’ve talked about it before, but I want to come back to Posner because I’ve pretty well con­vinced myself that his thesis is going to be the stan­dard con­ser­v­a­tive expla­na­tion for the eco­nomic crisis going forward—if and when, that is, they get their intel­lec­tual act together. I mean, let’s face it: it sort of has to be, since it’s the only halfway cogent expla­na­tion they’ve offered.

The prob­lem, of course, is that Posner’s thesis is only halfway cogent. Posner is right about two things: he’s right that low inter­est rates helped create the hous­ing bubble, and he’s right that “the Fed­eral Reserve pushed inter­est rates too far down, and kept them down for too long.” But the story he tells about the ori­gins of the crisis err in two impor­tant ways.

His first error is to mis­un­der­stand the role played by the finan­cial indus­try in help­ing to create the hous­ing bubble. He argues that

banks, includ­ing mort­gage banks, being able to borrow cap­i­tal at low rates, for lend­ing, were eager to encour­age bor­row­ing by relax­ing their credit stan­dards. So people who could not have qual­i­fied for a mort­gage at any inter­est rate ear­lier were now able to borrow at afford­able rates.

If the Ger­manic syntax of that first sen­tence throws you, let me offer an Eng­lish para­phrase: banks had access to cheap money from the Fed, and so they encour­aged people to borrow that money by relax­ing their credit stan­dards. In short, Posner would have us believe that the Fed’s low inter­est rates some­how or other caused (or prompted or encour­aged) banks to ease their lend­ing requirements.

The illogic of this thought should be appar­ent, but let me spell it out anyway. It’s true that low inter­est rates and easy lend­ing stan­dards were both induce­ments for con­sumers, and both there­fore con­tributed to the hous­ing bubble. But the cheap money that banks were get­ting from the Fed had no causal rela­tion­ship to the relax­ation of credit stan­dards. Let me say it again: the one had noth­ing to do with the other. Alan Greenspan and the Fed Open Market Com­mit­tee dropped inter­est rates after the dot-​com bubble burst to try to engi­neer a “soft landing” for the econ­omy. But the relax­ation of lend­ing stan­dards occurred for other rea­sons entirely.

The market for what we used to call mort­gage deriv­a­tives and now mostly call toxic assets (these include mortgage-​backed secu­ri­ties [MBS] and espe­cially collateralized-​debt oblig­a­tions [CDO]) boomed in the 1990s and early 2000s. This boom cre­ated a demand for mort­gages that could not be sat­is­fied as long as mort­gages were doled out under the old judi­cious stan­dards. Here’s how the anony­mous hedge fund man­ager that n+1 inter­viewed last year put it:

It’s kind of an inter­est­ing inter­ac­tion in the sense that a lot of this mort­gage project was almost cre­ated by the bid for the CDO paper rather than the reverse. I mean, the tra­di­tional way to think about financ­ing is “OK, I find an invest­ment oppor­tu­nity, that on its face, I think, is a good oppor­tu­nity. I want to deploy cap­i­tal on that oppor­tu­nity. Now I go look for fund­ing. So I think that making mort­gage loans is a good invest­ment, so I will make mort­gage loans. Then I will seek to fund those, to fund that activ­ity, by per­haps issu­ing CDO paper, issu­ing the triple-A, double-A, A, and down the chain.” But what hap­pened is, you had the cre­ation of so many vehi­cles designed to buy that paper, the triple-A, the double-A, all the CDO paper… that the dynamic flipped around. It was almost as if the demand for that paper cre­ated the mortgages.

Writ­ing in the NYRB, Jeff Madrick echoed the diag­no­sis, and pegged the finan­cial incen­tive for banks to orig­i­nate new mort­gages at half to one per­cent of the total loan—easy money if you know you have some­one on the other end who needs more mort­gages to stuff into their new CDO:

For the banks and mort­gage bro­kers who wrote the mort­gage loans, the finan­cial advan­tage was sig­nif­i­cant. They could now sell the mort­gages they wrote almost imme­di­ately to pack­agers, often invest­ment banks, earn­ing a quick and very hand­some fee—one half to 1 per­cent of the value of the mortgage—in the process. By sell­ing the mort­gage loans, the banks did not have to main­tain cap­i­tal require­ments for those loans, require­ments that were imposed inter­na­tion­ally by the Bank for Inter­na­tional Set­tle­ments in the 1990s. The banks and mort­gage bro­kers were then free to make still more loans with the cash they got back from sell­ing the pack­aged mort­gages and quickly to earn another round of fees.

The upshot of all this is that it was the demand for mort­gages cre­ated by the sec­ondary (derivative/MBS/CDO) market—and not, as Posner sug­gests, the Fed­eral Reserve’s low inter­est rates—that caused banks and mort­gage bro­kers to lower their lend­ing stan­dards. Which means that the finan­cial indus­try was as much to blame for inflat­ing the hous­ing bubble as the Fed.

The second prob­lem with Posner’s diag­no­sis of the crisis is that he thinks it’s all about the hous­ing bubble. He calls it “central to our cur­rent eco­nomic troubles.” That’s true, but it’s not suf­fi­cient. The hous­ing bubble is cen­tral to the cur­rent crisis because that’s where the crisis first began. But as Posner should know, hous­ing bub­bles show up all the time with­out caus­ing the kind of damage to the real econ­omy that we’re seeing right now.

What Posner doesn’t seem to under­stand, even though he’s got all the pieces of the expla­na­tion laid out in front of him, is that the hous­ing bubble was epiphe­nom­e­nal to a credit bubble that had been build­ing since the 1990s. That bubble inflated thanks to the so-​called “risk revolution,” which was sup­posed to have brought with it very sophis­ti­cated means for eval­u­at­ing, pric­ing, and man­ag­ing risk. (Credit default swaps, which were every­where in the news for about three months last fall, were part of this rev­o­lu­tion, since they gave investors a way to make risky assets less risky.) When banks believed that they had a better handle on risk (and when the reg­u­la­tors believed them that they did) they became more eager to lend money.

The recession/depression were in right now is the direct result of the col­lapse of that credit bubble. Remem­ber that as recently as last summer there were still many people (Ben Bernanke included) who believed that the trou­bles in the sub­prime mort­gage market could be con­tained. The reason they believed that is not because they were hope­lessly opti­mistic or deceit­ful. They believed it because they had not rec­og­nized the extent to which the trou­bles with real estate would throw into seri­ous ques­tion the reli­a­bil­ity of the instru­ments with which the risk rev­o­lu­tion was achieved. As soon as those instru­ments proved fal­li­ble, credit evap­o­rated and took the real econ­omy with it.