There’s much talk about the “Credit »”>credit crisis” and “housing bust,” but the root cause for both is the housing boom. There are several key regulatory, fiscal, and monetary policy factors that contributed to, and likely can be aggregated to have caused, the unprecedented housing boom that ended in 2006. It was this unsustainable boom that ultimately led to the excesses that nearly collapsed our financial system. We all hear about unscrupulous lenders (there were many of them), greedy investment banks (there were several of them), and lack of regulation to contain the circus. But what about the notion that perhaps this was caused and perpetuated because of regulation?

There are three main groups behind the housing madness: local and state lawmakers, federal regulators, and the Federal Reserve. Land use regulations stand at the heart of the issue, with local and state legislators placing significant and often-times arbitrary restrictions on new development. In coastal California, for instance, cities largely dictate the land use policies of surrounding rural areas, restricting new development to alleviate growth in demand within the cities. This is why housing prices in Los Angeles increased at a far higher rate than those in Houston, despite greater population and living standard growth rates in Houston.

In an effort to increase homeownership amongst low-income demographics (i.e. people who cannot afford homes), the Department of Housing and Urban Development (HUD) pushed the mortgage institutions to increase the number of subprime loans in their portfolios. This was social engineering at its finest, with the results now evident. The Environmental Protection Agency is another regulator itching to enter real estate by connecting climate policy to land use regulation.

Finally, we cannot escape monetary policy. It is the Federal Reserve that controls prices for money through various tools that affect interest rates. After 9/11 Alan Greenspan dropped the federal funds rate to near-zero, which was likely in the negative real interest rate territory. He kept rates in this territory for a sustained period of time, only slowly and very incrementally raising them through the peak of the housing boom. Low rates signal the market to borrow borrow borrow. Negative real rates provide negative incentive to save; the omnipotent, omniscient Federal Reserve board of governors sits on the same pedistal of power that Kremlin Communists used to perch whilst dictating grain prices and pretty much everything else in their defunct economy.

This is only a rough snapshot at how some regulations and government policies affected real estate and drove the market nuts up through 2006. As stated earlier there were certainly many private parties responsible for unethical lending practices, incompetent risk managers at large financial institutions, and just plain old greedy people who tried to take advantage of what proved an unrealistic market. Before we scream for increased government involvement in real estate and financial markets, we should seriously evaluate what caused the problems of the past. It’s clear that government played a significant part, so does it make sense to call on the same institutions to increase their involvement? Or perhaps it makes more sense to reduce their encroachment so that markets can work?