The housing problem—the total value lost by the realization that homes were not worth as much as we previously thought—was actually smaller than the dot-com bust (at least initially, but more on that later). The housing problem did not pose any systemic risk to the economy, and would have precipitated just a Normal Recession if the housing problem was indeed the main problem. The main problem was not the question of home values, but the value of the derivatives that were created from housing, and also the value of the second order derivatives created from those created from housing.
The credit crisis & financial meltdown didn’t happen because homes began to lose value, but because there was a mountain of insurance-like paper assets created that made promises that could only be kept if the value of last month’s mountain of insurance-like paper assets rose. So, while it was initially based on housing, the irrational exuberance that surrounded the creation of insurance-like paper assets could have just as easily been based on anything else that some company would want insurance on. And it was the lack of transparency about who had how much exposure to what sorts of insurance-like paper assets that caused financial institutions to stop lending to each other—and that is the mechanism by which a problem in one sector of the economy (which would have only caused a mild Normal Recession like the dot-com bust) spread to all sectors of the economy and became an Epic Recession (Jack Rasmus’s term).
The layoffs were largely confined to construction jobs before the credit crisis, afterward every sector except healthcare (aging baby boomers driving up demand for healthcare services) began to lose jobs. So now, and most importantly, after all sectors except healthcare have declined and stayed depressed for years, the housing problem is large enough that it’s understandable why people think we bailed out the wrong group. But, short of the government forcing every bank and bank-like institution on the planet to reveal all of their insurance-like paper assets for all to see way back before Bear Stearns fell, I think the credit crisis would have still happened even if we bailed out homeowners.
The game was up the moment companies couldn’t find buyers for insurance-like paper assets. And the value of the derivatives had been outpacing housing values for years, so it was only a matter of time till there was a correction in derivative prices. And again, without transparency in derivative markets, that correction couldn’t happen without causing a credit crisis.
To sum up: the housing problem was not the main issue, which was exasperated by derivatives. Housing was just the starting point, the spark. The real fire was, in fact, in the financial industry’s derivative mess. Now, could HAMP, TARP, and virtually every other policy response have been handled better than what we got? Absolutely!
And now? Well the fire has been put out, but I don’t think Dodd-Frank has fireproofed our house for the future; there’s still a bunch of frayed wires & drunk smokers in our midst. And, we still have to rebuild the part of the house that burned down, the middle class. That’s gonna take action on housing, because there’s no way consumer demand comes back until we ease their debt burden. And the government needs to be spending money directly on goods & services to prop up employment until consumers get on their feet again. And if we don’t do this soon, as in ‘letsnotfuckingwaitforthenextpresidentialelectiontoplayout,’ then this troubled and extremely vulnerable economy will certainly cause more and deeper cracks in society and we could fall deeper into Depression (it could also come from an external shock via a possible break up of the Euro, or the Chinese housing bubble). The clock is ticking around, but everywhere in the world politicians are just dicking around.