November 7, 2008

Niall Ferguson's "The Lessons of Detroit"

Here's an excerpt from Harvard financial historian Niall Ferguson's massive Vanity Fair article explaining it all: "Wall Street Lays Another Egg:"

The Lessons of Detroit:

In July 2007, I paid a visit to Detroit, because I had the feeling that what was happening there was the shape of things to come in the United States as a whole. In the space of 10 years, house prices in Detroit, which probably possesses the worst housing stock of any American city other than New Orleans, had risen by more than a third—not much compared with the nationwide bubble, but still hard to explain, given the city’s chronically depressed economic state. As I discovered, the explanation lay in fundamental changes in the rules of the housing game.

I arrived at the end of a borrowing spree. For several years agents and brokers selling subprime mortgages had been flooding Detroit with radio, television, and direct-mail advertisements, offering what sounded like attractive deals. In 2006, for example, subprime lenders pumped more than a billion dollars into 22 Detroit Zip Codes.

These were not the old 30-year fixed-rate mortgages invented in the New Deal. On the contrary, a high proportion were adjustable-rate mortgages—in other words, the interest rate could vary according to changes in short-term lending rates. Many were also interest-only mortgages, without amortization (repayment of principal), even when the principal represented 100 percent of the assessed value of the mortgaged property. And most had introductory “teaser” periods, whereby the initial interest payments—usually for the first two years—were kept artificially low, with the cost of the loan backloaded. All of these devices were intended to allow an immediate reduction in the debt-servicing costs of the borrower.

In Detroit only a minority of these loans were going to first-time buyers. They were nearly all refinancing deals, which allowed borrowers to treat their homes as cash machines, converting their existing equity into cash and using the proceeds to pay off credit-card debts, carry out renovations, or buy new consumer durables. However, the combination of declining long-term interest rates and ever more alluring mortgage deals did attract new buyers into the housing market. By 2005, 69 percent of all U.S. householders were homeowners; 10 years earlier it had been 64 percent. About half of that increase could be attributed to the subprime-lending boom.

Significantly, a disproportionate number of subprime borrowers belonged to ethnic minorities. Indeed, I found myself wondering, as I drove around Detroit, if “subprime” was in fact a new financial euphemism for “black.” This was no idle supposition. According to a joint study by, among others, the Massachusetts Affordable Housing Alliance, 55 percent of black and Latino borrowers in Boston who had obtained loans for single-family homes in 2005 had been given subprime mortgages; the figure for white borrowers was just 13 percent. More than three-quarters of black and Latino borrowers from Washington Mutual were classed as subprime, whereas only 17 percent of white borrowers were. According to a report in The Wall Street Journal, minority ownership increased by 3.1 million between 2002 and 2007.

Here, surely, was the zenith of the property-owning democracy. It was an achievement that the Bush administration was proud of. “We want everybody in America to own their own home,” President George W. Bush had said in October 2002. Having challenged lenders to create 5.5 million new minority homeowners by the end of the decade, Bush signed the American Dream Downpayment Act in 2003, a measure designed to subsidize first-time house purchases in low-income groups. Between 2000 and 2006, the share of undocumented subprime contracts rose from 17 to 44 percent. Fannie Mae and Freddie Mac also came under pressure from the Department of Housing and Urban Development to support the subprime market. As Bush put it in December 2003, “It is in our national interest that more people own their own home.” Few people dissented.

As a business model, subprime lending worked beautifully—as long, that is, as interest rates stayed low, people kept their jobs, and real-estate prices continued to rise. Such conditions could not be relied upon to last, however, least of all in a city like Detroit. But that did not worry the subprime lenders.

Although the number of defaults in the Greater Detroit reion (MI, OH, IN, IL, but, oddly enough, not PA) have been high, I suspect the dollars lost are small compared to Greater Los Angeles (CA, NV, and AZ).

The other item I would add is the effects of political correctness and discrimination lawsuits on financial institution's ability to perform reality checks on their own actions. Nobody can send a memo to their colleagues saying "We lent a billion dollars to Detroit?" without being in severe danger of it turning up in the discovery of a redlining discrimination case.

Beyond that, it was just totally uncool to point out that Detroiters, where the high school dropout rate is, what, 75%, couldn't really make enough money over the next 30 years to pay for all that bling they were buying with home equity lines of credit. Who wanted to hear it? Everybody else at Washington Mutual was bringing home fat bonus checks for buying up no money down mortgages from Detroit storefront mortgage brokers. For most of this decade, money and social conformity/political correctness were marching arm in arm toward the brave new dawn, and only evil old bastards were doubting it.

In summary, though, the idea of a "diversity recession" that I introduced in August of 2007 is on its way from a scurrilous fringe idea to being a standard part of how economic historians will explain what happened.

My published articles are archived at -- Steve Sailer


Anonymous said...

He reiterates that bubbles, manias, etc. are normal and have always been with us. He then goes on to say that we don't know the extent of how bad it will go on to be. True enough. When he talks of this, I intuit, get a very strong sense, that he is holding back on some of his thoughts. I've also gotten that same vibe from Nouriel Roubini. I'm not an economist, but I believe we'll pick back up some; it's the long term I fear is dire.

Anonymous said...

It looks to me like the American political establishment has just pulled off the classic bait-and-switch.

The rest of the world will be too busy orgasming over how America has changed and how there is now hope in the world to notice that they are being screwed by the American led world financial crisis.

Anonymous said...

Yes, there's no doubt that you were right. There's also no doubt that the Democrats bear more responsibility for this mess than do the Republicans (although Dubya tried awfully hard to keep up in the stupidity stakes with his Dem cohorts, and was probably the single individual most responsible) and that, as big a doofus as John McCain was as a presidential candidate, he actually tried to do something about the wholecluster**** when something could still have been done, and was thwarted by the Dems and Republican "moderates". Good luck getting the mainstream media to admit this, though. I mean, economists have known for at least fifty years that the New Deal actually prolonged the Depression, but that fact is just now filtering out to the general populace. So seventy-five years from now, our great-grandchildren will probably be saying "hey, that mess back in 2008,back just before Paris Hilton became President for Life? That was a diversity recession" and someone will get the Nobel Prize for it. Cold comfort, indeed

Anonymous said...

This bubble was aided by the "Big Man" minions who think wealth and prosperity are given to people, not earned. Just write the proper policy, just jiggle the books the right way, just shake the right "tree", and all flows to those who want. Never mind the evidence that money flows to each according to their human capital. We might have to do something like admit some people have higher earning potential than others.

Anonymous said...

An acquaintance told me he saw twenty to thirty feet trees growing on the tops of buildings when he was flying into the Detroit airport. That is just bizarre. The place is literally being abandoned, like Easter Island or the Aztec temples. What's the city's tax base at this point? Surely the owners of these places aren't bothering with the property taxes. Does the City or County own these sites now?

And speaking of, how long can GM go on pretending to be a going concern? Who the hell still holds their toilet-paper stock?

--Senor Doug

kurt9 said...

An acquaintance told me he saw twenty to thirty feet trees growing on the tops of buildings when he was flying into the Detroit airport.

Detroit can sell itself as a film location to producers who make all of those post-Apocalypse movies. Perhaps this can be source of some tax revenue for the city.

Anonymous said...

ironically, dr housing bubble, a guy who steve thinks is great, has rejected out of hand steve's hypothesis about the diversity recession.

i think steve is probably right, that non-whites made a significant contribution to the crash, as the credit bubble was generally worst in the places where non-whites are the most numerous, and younger too, where they would account for more first time buyers.

dr housing bubble's rejection of steve's idea was not very convincing, in stark contrast to his laser precise math on every other topic.

Anonymous said...

Your "diversity recession" theory seems to have the line of causality drawn backwards. I submit that the biggest driver for debased lending standards was not a desire to put more NAMs into homes, but Greenspan's decision to keep interest rates low and the resulting excess of money that flowed into the financial system. Once this money was "in" the banks they had to do something with it (i.e. mortgages, home equity loans). As a MBA, you know that it is difficult to achieve high growth rates in mature markets (low credit risk borrowers with savings., most of whom already had homes). The way for the banks to achieve high revenue growth rates, and for individuals to make their big bonuses, was to tap into and expand new markets (the NAMs, speculators, etc).

Anonymous said...

also, interesting new angle for steve to explore:

the idea, which i have now heard in a couple places, that single white women who had sex with black guys and who are now single white moms raising mulatto kids, are somehow raising the next barack obama.

this is a ludicrous inversion of reality, as this demographic group is probably the group least likely to produce kids who will amount to anything - full blooded black americans with two parents are more likely to turn out better. yet this is what some white liberals are talking about now.

the US is well and truly screwed if the white liberals in control are really thinking this way.

Anonymous said...

Ahhh, Detroit. Trees on the skyscraper tops?

Of course! And, again courtesy of the excellent Detroitblog, here's another one.

A great photo site chronicling the downfall is The Fabulous Ruins of Detroit. After you check that out, you'll have some idea why a search for houses for sale in Detroit for less than $1,000 yields 166 listings.

Hope and Change!

Anonymous said...

Wall Street Lays Another Egg

Look at it another way: a lot of people, and not just on Wall St, made tons of money off all of this. Note how he mentions how brokers and mortgage sales boiler room operations were active in Detroit. (Not to mention all over the internet -- anyone who opened almost any website over the last few years was accosted by flashing and gyrating mortgage ads.) Many of these people worked on commission and did really well. And don't forget sundry others who got their share too -- e.g. title companies. And last but not least of course the oft-mentioned Wall Street-ers and their huge bonuses. That money has been made and is gone. Now what's happening? On behalf of now and future taxpayers -- who are ever so grateful -- Uncle Sam is taking on more huge loads of debt in order to try to fix the mess.

As they say: the Wall Street-ers are among those laughing all the way to the bank. Which from their point of view hardly seems like laying an egg.

Anonymous said...

No, Steve, it's still scurrilous fringe racist BS. Saying that 50% of subprimes went to minorities is just saying that minorities got subprime loans at twice the rate you'd expect them to in the population. That's just what you'd expect -- it's a low-income product, it's going to have some minority overrepresentation.

But the real reason that number tells you nothing is that this isn't a subprime crisis, it's a mortgage crisis. The subprimes went first because their rates reset the earliest. Then the Alt-As followed them, the default problems among that category are going to end up being bigger then subprimes. And people all over the financial community are talking about the rapidly approaching time bombs in the prime and jumbo markets. Do you know how many overstretched white "flippers" and speculators there are out there? You damn well must, since if you ever went to an LA cocktail party you would have met half a dozen.

Trying to pin the one of the biggest messes in the history of financial speculation on low-income minorities really shows a level of obsession with race that's, well, something.

Anonymous said...

Very new houses in the suburbs of Detroit are still being marketed with the bubble like prices, look at this and this.

Anonymous said...

I am Lugash.

dr housing bubble's rejection of steve's idea was not very convincing, in stark contrast to his laser precise math on every other topic.

I think that's to be expected. Most of the data, and subsequent analysis, only goes back to 2001 or 2002. To really get an idea if this is a "diversity recession you probably have to go back four decades. Starting at 1976 or 1977 puts you at the CRA, and you need a baseline before you can analyse that.

The data isn't consistent as well, nor is broken down into the stats we need, like race.

You also need to be an expert to look at the stuff and offer a real analysis. "Subprime" has changed over the years. I'd guess that most of these people were laid off or have since retired.

Personally, eyeballing the data with my non expert eye, I get the feeling that Wall Street made the money available and by and large NAMs took it. Wall Street was so full of hubris they didn't have a flipping clue about how stupid their (lack of) standards were. The NAMs by and large didn't know what they were getting into. The exceptions are some big time Hispanic fraud rings in the usual states. The results speak for themselves.

Steve is spot on, as usual, with his "email" comment. I'd take it further though. Current middle and upper middle management have had any politically incorrect thoughts beaten out of them since they were fresh out of college. They're more afraid of HR than the EEOC. The firings would take place long before the lawsuit.

I am Lugash

Anonymous said...

As I've been saying, the people responsible for the sub-prime disaster was: Everybody

The homeowners knew their homes in Detroit (and elsewhere) hadn't tripled in value overnight, so why not take advantage of the situation by going into hock knowing that your home was going to be an abandoned mess in an abandoned community anyhow.

The lenders knew that homes in Detroit (and elsewhere) didn't triple in value overnight so why not lend the money, and sell the mortgage at a profit to someone else.

The ratings agencies were just interested in the fees.

The bank employees who bought the mortgage packages used the AAA ratings as CYA protection.

The bank executives needed to put the savings they were getting from pension funds somewhere.

And the pension funds needed returns higher than prime to pay off their obligations.

And employeres knew that promising benefits in the future was better for them than giving to their employees money today.

Martin said...


Given Professor Ferguson's previous fulminations on subjects as diverse as his move from being McCain campaign adviser to Obama supporter; his puerile suggestion that Scotland be privatised in its entirety; his touting of the canard that ensuring that you're properly skilled will save you from hardship; and his onetime assertion that he was 'a fully paid-up member of the neo-imperialist gang', some of us tend to take his opinions with very large doses of salt.

Brett said...

"the Greater Detroit region (MI, OH, IN, IL, but, oddly enough, not PA)"

Just a word from somebody who used to live in Southeast Michigan: Nobody anywhere near Detroit who lives outside of the borders of Detroit refers to the area as "Greater Detroit". In fact, the city of East Detroit changed their name to East Pointe a few years back.