Yesterday I posed the question of why the mortgage mess happened, and why at the time that it did. There were two fundamental building blocks of the crisis: the Great Moderation and Securitization. The aftermath of the 2001 recession provided the trigger for the mortgage mess. In this post, I explain the role of The Great Moderation.
The
Great Moderation is the new world of macroeconomic cycles that began in
1983. In the United States and around
the world, recessions became milder and less frequent. (There’s a great interview with Mark Thoma
about this topic in the Businomics Audio Magazine.) The chart of rolling 20-quarter standard deviation of real GDP changes illustrates the calming of the economy:
Back in
1983, a business executive with 25 years of experience would have experienced
five full business cycles. Today, an
executive with a quarter-century of experience has only gone through two full
cycles. We are less experienced in
dealing with recessions because of the Great Moderation.
The
Great Moderation by itself lowered fears of recession, but the nature of the
most recent recession (not counting the current cycle) also reduced concerns
about a possible downturn in housing values. The 2001 recession was triggered
by a decline in business capital spending, especially in high tech and
communications. Housing suffered
relatively little; it was the mildest housing cycle of the postwar recessions.
As a
result of the Great Moderation and the strength of housing in the 2001
recession, the housing sector appeared to be recession-proof. This was a mistake, and those of us who like
to examine long data series knew it, but financial types prefer to look at
recent data. When I attended my first
Credit Policy Committee meeting as a bank economist, back in 1988, the
experienced lenders priced consumer loans based on a five-year average loss
rate. I was thunderstruck! The
five-year period did not go far enough back to include a recession. In fact, credit policy coming out of a
severe recession tends to be tight, so we were probably looking at abnormally
good credit history. This is the kind
of stuff that financial people should do a better job at.
Next:
the role of securitization in the mortgage mess.