The Fed wanted the houses back for Wall Street. It is hard to prove, but could be the truth. We see that the banks made money on toxic loans in the housing bubble, and then on loans to high powered investors on Wall Street, to buy houses that became available when the toxic loans failed. The conclusion for me is as follows:

1. Wall Street first made money on granting dubious mortgages, which had default risk, but the risk was mispriced.

2. This mispriced risk caused investors who were deceived, to grant more money for lending, and house prices soared due to easy money demand.

3. Then with the help of the Fed, Wall Street crashed the prices of subprime properties in mid 2007, knowing they could not be sustained once securitization was destroyed. Securitization was destroyed when the investors realized that they had been fooled.

4. When there were no more buyers for commercial paper from shadow banks, the off balance sheet SIVS had to transfer the bad loans onto the balance sheets of the TBTF banks. Credit was impaired to the rest of the real estate market, including to HELOCS in 2008.

5. The Fed could have immediately started to use base money buy the bad loans that the SIVs placed upon the TBTF banks. But the Fed did not do so. It waited until the house prices crashed! That is premeditated destruction, a liquidation, in my view. Yes, the law was not yet put into place regarding the use of excess reserves, but it could have been. HR 1424 providing for excess reserves, was introduced into the House of Representatives on 3/9/2007, and the subprime crash took place in the summer following. These Fed and government people could have known what was going to happen and what was needed before the initial subprime crash.

6. This price destruction allowed the Street itself to come in and buy the houses low and drive the prices up, in most cases, past where they were at the height of the bubble.

If all this was premeditated from the beginning, that could turn out to be the greatest financial conspiracy in the history of the world! Keep reading.

The argument could be made, in defense of the Fed, that it did not preplan the destruction of the housing market and did not intend for Wall Street to take the houses. And it certainly is difficult to prove that the Fed preplanned the taking of houses simply because it mispriced risk. It could be that the Fed determined that the crash from mispriced risk could have been manageable. I look upon it as a more dark circumstance, simply because of the presence of HR 1424. It is difficult to explain the existence of a plan to buy bad paper prior to there being very much bad paper. We can see that clearly from the chart, showing that in early 2007 there was very little bad paper in the commercial paper market:

I believe the market monetarists are right when they said Ben Bernanke had the tools but didn't use them. In point number 5 above I said the Fed could have started immediately buying the bad loans off the books of the banks that were put there by the failure of the SIVS. SIVS should be considered a criminal concoction when used to hide financial fraud.

Anyway, Kevin Erdmann posted this to an article by Scott Sumner showing MM ideas are started to be appreciated more. Kevin said:

Expectations caused the housing bust. Read the S&P report at the end of the post. This was basically the first round of downgrades in mid 2007. Even then, they were perplexed because borrower characteristics had no explanatory power on the early defaults. The first downgrades were made because they forecasted that home prices would decline at epic unprecedented rates, even though home prices at the time had just begun to falter.

But everyone was so convinced that it was a credit bubble, they assumed that the reason underwriting wasn’t predictive was because it was so fraudulent. That is simply not credible. And the Fed’s response to these downgrades was basically to announce that we should definitely expect home prices to collapse and that they wouldn’t do a think to stabilize it. In fact they were worried about inflation (much like sept. 2008 a year later). To this day Bernanke talks about how they figured home prices were due for a drop...

Expectations caused the housing bust.

I think the Kevin got this right in seeing that the credit agencies were downgrading credit early on, as if they knew that the risk models they were using were not going to work out.

Yes, there was bad underwriting, lots of it, but not all underwriting was bad. I responded to Kevin in this way:

...securitization froze up. So, you can’t say there was no credit crisis. There was a destruction of the commercial paper market as the chart here shows.

Still, the Fed did nothing for over a year and then jobs were lost in non bubble areas. So there is truth the the MM claim for sure. But to say there was no credit crisis when securitization ended, drying up access to credit, is kind of wrong.

And I responded to Kevin here too:

I have no doubt Wall Street wanted the houses back, Kevin. They had MERS all set up, and they had a plan from the beginning, IMO, to get the houses back. They knew securitization would not last forever. They knew it was based upon mispriced risk. They just had to work out the process of fleecing America. It was a process, and probably the Fed forecasted lower home values because that was part of the process too.

I agree with the Market Monetarists that there should have been attempts to keep prices stable on the part of the Fed. The Fed should have been buying those bad bonds at the very beginning of the downgrades, so that banks could continue to lend, even if they imposed a tightening of credit standards. Nations tighten and loosen credit standards without destroying their housing markets. But Bernanke didn't do that.  Had he done that, Wall Street could not have received such great deals on houses. And the banks would not have been paid like they were for foreclosing. What a sweet deal for the elite that was!

I maintain that some local markets could have crashed, but possibly not nationwide, like they did, had the Fed acted sooner.

Just think about it readers. In most places in the USA, those bubble prices have been exceeded by wealthy people buying up the real estate that was once owned by regular people with mortgages! One could say that is highly suspicious and simply wrong. Again, it looks like Wall Street waited for a good deal that the Fed helped to create. And the Fed just abandoned the poorer and middle class in a way that appears malicious and predatory. After being subject to predatory lending, these people were subject to predatory liquidation!

The credit expansion during the housing bubble was built upon mispriced risk. Eventually, the risk was shown to be not only mispriced, but mistrusted by investors who brought the securitization process to an abrupt halt. And yet there turned out to be plenty of credit remaining in the system to give credit lines to well known investor groups to go in and buy houses on a massive scale once they cratered in price.

It is very clear to me that the Fed wanted the houses back for Wall Street even if it cannot be proven beyond a reasonable doubt.