At some point in the early months of 2007, the words ‘sub-prime mortgages’ began to filter into the popular press. By the end of that August, they were ubiquitous. This small section of the high-risk, high-yield housing finance market in the United States sparked a global financial and economic crisis that would scar a generation. The stories that emerged to explain how this happened were the stuff of fiction or perhaps something even stranger. Banks booked mortgages to people with no demonstrable assets or income, at introductory rates that quickly reset to terms that only the most resilient of households could afford. By the time the borrowers defaulted, however, the banks had sold the mortgages to other investors using complicated securitization instruments that effectively hid the risks involved. The institutions left holding the bag were not only unaware of the dangers the faced but completely unprepared for the consequences. In his powerful new book on The Political Economy of Housing Financialization, Gregory W. Fuller explains why that happened, how the dynamics differed across countries, and what we might do to anticipate similar crises in the future.
The sub-prime mortgage disaster sounds improbable after the fact and caught many by surprise from start to finish. It would be easy to assume, therefore, that the whole episode could be marked down to some horrible financial accident where the most dangerous financial market participants played with the most volatile financial instruments and nearly brought the whole advanced industrial global economy down with them. Indeed, it would be comforting if that were the case. Then all we would need to do is discipline the people and regulate the instruments.
Unfortunately, the forces that created the U.S. sub-prime mortgage problem are not accidental; they are structural. Moreover, once you understand which are the structures involved, there is little mystery to why the crisis started in the sub-prime mortgage sector, why the epicenter was located in the United States, and why the securities created out of sub-prime mortgages found their way onto the balance sheets of financial institutions across advanced industrial economies. There is also no mystery why a crisis in the U.S. sub-prime mortgage sector would bring the global financial economy to its knees.
This structural account is what Gregory W. Fuller brings to life in his analysis of The Political Economy of Housing Financialization. Building upon his previous work on The Great Debt Transformation, Fuller explains why it is that banks have come to rely on households to create assets for investment as the money that can be made from intermediating savings in the non-financial corporate sector have outstripped the revenues available from real investments. The role of securitization in this account is to provide an essential lubricant, making it easier for banks to create assets out of household borrowing and then turn those into cash that can be lent again.
Moreover, the story traces back to the problem of macroeconomic imbalances where savings in one country move across borders to chase foreign opportunities for investment. In the reverse of the usual pattern, what looks like a finance and microeconomic problem on the surface quickly reveals its underlying macroeconomic foundations.
Residential real estate lies at the center of this dynamic because housing is the most valuable asset that families have to pledge when they take on debt. In turn, this means that households can enhance their leverage when borrowing — which is another way of saying that banks can create larger assets at lower risk by convincing households to take on mortgages. Even the famous sub-prime mortgages are backed by residential real estate as collateral and so compare favorably to unsecured student loans or consumer debt.
This dynamic manifests differently from one place to the next. Countries that attract more savings from abroad are more powerfully affected by the hunt for yield in the financial sector and the pressure to convince households to take on mortgages; so are countries where the governments make it easier for banks to securitize new lending and so pass along the risks associated with the assets they create. The United States is the world’s leader in both attributes, as a haven for foreign portfolio investment as an efficient securitization market. Other countries like Denmark tend to finance their mortgage markets domestically and they also tend to force their domestic banks to hold onto the risks associated with the assets they create. The Danes have enormous household borrowing and associated housing bubbles, but their problems are not those found in the United States.
These cross-country differences are important because they explain the variation in how the dynamics of housing finance manifest across countries; the differences in national experiences do not shed much light on how policymakers can solve the associated problems. Instead, they present policymakers with a series of complex tradeoffs — many of which boil down to striking a balance between the advantages of extending credit to poorer or at-risk members of society and the stability that comes from financial repression.
There is no magic formula for avoiding the next crisis or for escaping the inequalities of income and access. Instead, what Fuller offers is a better understanding of how everything is connected through housing finance and what are the consequences of policy inaction and inattentiveness. His book may not help us avoid the next crisis. Anyone who claims to have beaten the financial cycle should be regarded with deep suspicion. But Fuller’s book can help us anticipate problems before they emerge, and it can help us recognize the symptoms that spell impending disaster. As such, Fuller’s book is essential reading not only for understanding the last crisis but also for preparing for the next.
The Political Economy of Housing Financialization. By Gregory W. Fuller. London: Agenda Publishing, 2019.Follow @Erik_Jones_SAIS
This book is part of the Comparative Political Economy series at Agenda Publishing. The editorial board for that series is provided by the research network on European integration and the global political economy of the Council for European Studies. The series produces short, topical volumes with the goal of influencing the broader policy debate in comparative political economy. Series titles include:
- Central Bank Independence and the Future of the Euro by Panicos Demetriades
- Europe and Northern Ireland’s Future by Mary C. Murphy
- The New Politics of Trade by Alasdair R. Young
- The Political Economy of Housing Financialization by Gregory W. Fuller
- Populocracy by Catherine Fieschi
- Understanding the European Union’s Migration Crisis by Peo Hansen
- Whatever it Takes by George Papaconstantinou
Authors interested in contributing to that series should contact me directly (email@example.com).