This article first appeared at mises.ca.

With another financial crisis fast approaching the cause of the ‘08 crash hasn’t been settled. Austrians generally line up on the side of the all-powerful Fed having lowering interest rates below what the market would produce, sending capital into malinvestments: In this case, too many subdivisions of houses and other real estate. When the Fed hit the brakes in ‘06, raising its fed funds rate, housing peaked and the party was brought to an abrupt and painful end as the value of mortgage backed securities melted down.

I’ve given this talk plenty of times, most recently for The Nassau Institute in the Bahamas.

Screen Shot 2015-05-31 at 11.52.24 AMThe visual of fed funds combined with Las Vegas land and housing prices on top of a busted subdivision aerial photo is worth a thousand words.

There is another part of the story touted by Austrians such as Tom Woods and Tom DiLorenzo that government required banks to provide mortgages to those who couldn’t afford them through the force of the Community Reinvestment Act (CRA).  Predictably, these borrowers couldn’t or wouldn’t pay and their mortgages turned into toxic paper that led to Wall Street’s almost demise.

Because of my experience in the non-bailed-out part of the banking sector, I’ve always doubted the CRA-did-it thesis. CRA seemed easy for the little bank I worked for as we made a number of development and construction loans for entry-level housing and even received credit for a loan made on a building where X-rated movies and sex toys were sold. These loans were made for economic reasons with no thought to CRA.

But Peter Wallison’s book Hidden In Plain Sight has changed my mind. Wallison is no tin foil hat wearer, being the Arthur F. Burns Fellow at the American Enterprise Institute and serving as a member of the 2010 Financial Crisis Inquiry Commission (FCIC). The 10-member commission was armed with something other historians and writers only dream about–subpoena power. That doesn’t mean they came to right conclusion.  The group summarized,

“While the vulnerabilities that created the potential for crisis were years in the making, it was the collapse of the housing bubble—fueled by low interest rates, easy and available credit, scant regulation, and toxic mortgages—that was the spark that ignited a string of events, which led to a full-blown crisis in the fall of 2008. Trillions of dollars in risky mortgages had become embedded throughout the financial system, as mortgage-related securities were packaged, repackaged, and sold to investors around the world. When the bubble burst, hundreds of billions of dollars in losses in mortgages and mortgage-related securities shook markets as well as financial institutions that had significant exposures to those mortgages and had borrowed heavily against them. This happened not just in the United States but around the world. The losses were magnified by derivatives such as synthetic securities.”

In other words, the private sector did it.

Mr. Wallison, selected by John Boehner, vigorously dissented from his fellow commissioners. He dismisses the Fed-did-it thesis right away, along with the Wall Street did-it theory. The author may be a lawyer but he thinks like a credit underwriter. History compellingly shows that default rates for mortgages made with weaker than prime underwriting metrics increase dramatically.  An acceptable level of defaults (less than 1%) will be experienced when borrowers put 20% down towards the purchase, no more than 38% of income be used for housing expense and the borrowers have credit scores of 660 or higher.  End of story.

However, this hard-nosed approach didn’t work with Washington’s affordable-housing agenda. Wallsion explains that in 1992, D.C. put the CRA screws to Fannie Mae and Freddie Mac, and “forced them to abandon their traditional focus on prime mortgages and to begin accepting NTMs (non-traditional mortgages).

These goals were increased over time and led to, not only, the insolvency of Fannie and Freddie, “but spread NTMs to the rest of the market.” Wallison points out that by 2008, “57 percent of all mortgages in the United States–31 million loans–were NTMs with far higher rates of default than prime mortgages.”

The mistake I’ve always made was thinking CRA applied only to banks, forgetting about Fannie and Freddie. It shouldn’t have shocked me (but did) when Wallison revealed, “Three-quarters of these deficient mortgages were on the books of government agencies, and their failure in unprecedented numbers caused housing prices to fall throughout the United States.”

From the GSEs, the downdraft spread to commercial banks that were holding $2 trillion in mortgage backed securities. Mark-to-market accounting forced immediate write-downs creating losses and weakened capital positions.

So, who knew Fannie and Freddie were loaded with the less-than-prime mortgages? Not the market or the regulators. Counter to what he titled his book, Wallison explains “Fannie and Freddie did not begin to fully disclose their exposure to NTMs until after they had been taken over by a government conservator in 2008.” In his view, “their failure to provide a true accounting had a profound effect on the severity of the financial crisis.”

So while the FCIC majority concluded the private sector was the chief cause of the financial crisis, Fannie and Freddie’s hiding of their exposure to subprime mortgages kept everyone in the dark. Inexplicably, the FCIC report claims “these two entities contributed to the crisis, but were not a primary cause.”

Wallison rightfully points out that Fannie and Freddie were the dominate players in the mortgage market and “were subject to HUD regulations that required them to reduce their underwriting standards.” He chastises his fellow commission members, writing, “To fail to explore their [the GSEs] role in detail reflects a willful blindness that was inconsistent with the commission’s responsibility to the public.”

The commission played into the hands of Barney Frank and Chris Dodd who wished to use the crisis to impose, as Frank described, a “New New Deal.” And while Dodd-Frank’s 2,300 pages are Washington’s response to the financial crisis the act doesn’t lay a hand on the GSEs.

While Austrian Business Cycle Theory is still valuable in understanding the financial crisis, the numbers Wallison provides are too big to ignore. It was government’s housing agenda that provided the means for the average Joe and Jane to harness the Fed’s post 9/11 easy money to speculate on the price of houses, assets many believed would never decrease in value.

The federal government’s pro-housing program hasn’t abated. Two years ago President Obama urged lenders to loosen up. The Washington Post reported in 2013, “administration officials say they are working to get banks to lend to a wider range of borrowers by taking advantage of taxpayer-backed programs — including those offered by the Federal Housing Administration — that insure home loans against default.”

Lenders have responded. “Reports of lenders lowering standards and subprime lending making a comeback have not been exaggerated. Nearly 40% of consumer loans in the first 11 months of 2014 were to people with a credit score below 640, aka subprime borrowers, The WSJ reports, citing data from Equifax. That’s the highest level since 2007,”  Yahoo.com reported earlier this year.

Government’s pro-housing cheerleaders are getting what they want (again), and to paraphrase Mencken, the economy will get it good and hard (again).