Some facts gleaned from the Federal Reserve’s Flow of Funds Accounts (the Z.1 releases) on the housing bubble.
An obvious credit boom, in hindsight
There was clearly a credit bubble, as shown in the above figure that depicts the flow of funds of the Financial Sectors, starting in the middle of the last decade, right before it imploded into the still-lingering financial crisis.
A massive leverage-up could be seen on the aggregate balance sheets of the financial institutions. The total net lending of the financial system ranges around $500 billion annually from 1985 to 2001, fluctuating along the business cycles. From 2002 on to 2007, however, the amount of lending suddenly shot up to $2,200 billion annually.
All excess went in mortgages
Almost all the abnormal, “excess” lending went into the mortgages, which trended upward by $1 trillion per annum. Just think about the amazing phenomenon of such scale and efficiency for a moment: somebody have been churning out mortgages in whatever manners for an additional $30 billion per day, over 100,000 medium-priced houses worth.
Source of funding remained an interesting issue
So where did all the money, over $1 trillion per year, come from? It had to be somewhere.
An item-by-item review showed that the major source of funding seemed to be time & savings deposits, up $350 billion from previous period, and GSE-backed securities and bonds issued by financials (probably ABS issuers, as we will see later), which made up another $400 billion, and whatnot.
Types of funding sources being clear, you still have to wonder who purchased all those securities that made up the liabilities site of the mortgage binge. And the time & savings deposits?
A collaboration of banks, GSEs and ABSs
Banks, GSEs and ABS issuers accounted for 1/3 each in the trillion-dollar mortgage production line in 2002-2007. All came out with significantly higher productions/holdings of mortgage assets than previous, almost seemingly orchestrated. The production lines must be worth looking at.
The doomed crash would have dried up the mortgages, if w/o intervention; Financial crisis ensued
The reverberation of the destined crash has been much written about and could be easily imagined, particularly with hindsight.
Key Takeaways
Modern financial distribution network is highly efficient; A credit bubble would come out of nowhere, and there’s no obvious workable policy responses to prevent it from happening again unless cool heads prevail; A bursting bubble, usually sudden and vehement, is no fun. It is a wealth destructor collectively, although someone got rich from it.
