California Leads the Way!
Posted by leowalker on 11
There is an interesting article in today’s WSJ (subscription only):
http://online.wsj.com/article/SB122350900347317291.html
It describes the housing boom and bust in California. “Home prices rose higher and faster than in most of the US, and started weakening earlier, in 2005.” As home prices fell, defaults rose. Those families saddled with big mortgages started decreasing their other spending to keep from defaulting. Economic growth slowed, and then fell, and the layoffs began, leaving the state with a 7.7% unemployment rate.
If you don’t have a job, you probably can’t make your mortgage payment. So job losses lead to more defaults, and the spiral continues.
All of this is bad news for California, but it the damage would have been contained had it not been for one big factor: Fannie and Freddie.
While California was growing, F&F were decreasing Design Margin, acting as a monopoly but with executive incentives like a competitive business. So rather than wiping out a couple of California banks, the recession there caused the beginning of a cascade that has yet to abate.
The risk was right there in front of the risk managers back in their 2007 off-site. They didn’t need imagination. They didn’t need scenario planning. They didn’t need fancy models.
They just needed to see the gorilla in the room.
h/t Leo Linbeck III
