Take Wall Street “greed.” Is there any evidence that people in Wall Street were any less interested in making money during all the decades and generations when investments in housing were among the safest investments around? If their greed did not bring on an economic disaster before, why would it bring it on now?My response: Because they had new financial instruments! If there was a nuclear war with unimaginable damage - would someone say afterwards, "Take human nature's propensity for war. Is there any evidence that people in the past were any more interested in war than us? If war before did not bring about such widespread death, why would it bring it on now?" It's true human nature doesn't change, but the technology available to do damage has greatly increased. A housing bust is to what actually happened as a fist fight is to semi-automatic gun fight. It's disappointing that Sowell doesn't seem to address this (nor does he apparently in his book, from what I can recall from checking the index).
The bottom line is that busts and booms happen in every asset class be it gold, oil, housing or ... tulips. That's the nature of capitalism. So the question becomes why does a relatively modest 5% foreclosure rate bring the world economy to its knees? I think it's because of the magnifier effect of banks who stupidly made bets that housing would never go down.
But don't believe me - believe Wall Street itself. As one Wall Street titan told then Republican senator Rick Santorum, "we blew it." (Emphasis mine.) Not Freddy & Fanny, although they were egregious.
No one is a truer free market conserative than former Sen. Phil Gramm. A fierce free market advocate with a PhD in economics, he told a Senate debate in 2001: "Some people look at sub-prime lending and see evil. I look at sub-prime lending and I see the American dream in action."
And he's not necessarily wrong in that. Sub-prime lending is not evil as long as there aren't derivatives magnifying the effect. In other words, as long as any possibly deleterious impact is limited to the bank who offers the loan and the individual who signs the mortgage paper then it would seem okay, although perhaps we're all so fiscally interconnected now that it's impossible to have risk apply to only the risk-takers themselves.
To sum up here's a line from the Guardian: "Warren Buffett had long warned about the dangers of dodgy derivatives that no one understood and said often that Wall Street's finest were grossly overpaid. In his annual letter to shareholders in 2003, he compared complex derivative contracts to hell: 'Easy to enter and almost impossible to exit.'"