If the thunder doesn't get you then the lightning will.

• Author: Wallison, Peter J.
• Position: Business & Finance

THE 2008 FINANCIAL CRISIS was a major event, equivalent in its initial scope--if not its duration--to the Great Depression of the 1930s. At the time, many commentators said that we were witnessing a crisis of capitalism, proof that the free market system was inherently unstable. Government officials who participated in efforts to mitigate its effects claim that their actions prevented a complete meltdown of the world's financial system, an idea that has found acceptance among academic and other observers, particularly the media. These views culminated in the enactment of the Dodd-Frank Act that is founded on the notion that the financial system is inherently unstable and must be controlled by government regulation.

We never will know, of course, what would have happened if these emergency actions had not been taken, but it is possible to gain an understanding of why they were considered necessary--that is, the causes of the crisis. Why is it important, at this point, to examine the causes of the crisis? After all, it was six years ago, and Congress and financial regulators have acted, or are acting, to prevent a recurrence. Even if we cannot pinpoint the exact cause, some will argue that the new regulations now being put in place under Dodd-Frank will make a repetition unlikely.

Perhaps, but these new regulations almost certainly have slowed economic growth and the recovery from the post-crisis recession, and they will continue to do so in the future. If regulations this pervasive really were necessary to prevent a recurrence of the financial crisis, then we might be facing a legitimate trade-off in which we are obliged to sacrifice economic freedom and growth for the sake of financial stability. However, if the crisis did not stem from a lack of regulation, we needlessly have restricted what most Americans want for themselves and their children.

It is not at all clear that what happened in 2008 was the result of insufficient regulation or an economic system that inherently is unstable. On the contrary, there is compelling evidence that the financial crisis was the result of the government's own housing policies. These, in turn, as we will see, were based on an idea--still popular on the political left-- that underwriting standards in housing finance are discriminatory and unnecessary.

In today's vernacular, it is called "opening the credit box." These policies, as I will describe them, were what caused the insolvency of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac and, ultimately, the financial crisis. They are driven ideologically by the left, but the political muscle in Washington is supplied by what we should call the Government Mortgage Complex--realtors, homebuilders, and banks--for whom freely available government-backed mortgage money is a source of great profit.

The Federal Housing Administration, or FHA, established in 1934, was authorized to insure mortgages up to 100%, but it required a 20% down payment and operated with very few delinquencies for 25 years. However, in the serious recession of 1957, Congress loosened these standards to stimulate the growth of housing, moving down payments to three percent between 1957-61. Predictably, this resulted in a boom in FHA-insured mortgages and a bust in the late 1960s.

The pattern keeps recurring, and no one seems to remember the earlier mistakes. We loosen mortgage standards; there is a bubble, and then there is a crash. Other than the taxpayers, who have to cover the government's losses, most of the people who are hurt are those who bought in the bubble years and found--when the bubble deflated--that they could not afford their homes.

Exactly this happened in the period leading up to the 2008 financial crisis, again as a result of the government's housing policies. Only this time, as I will describe, the government's policies were so pervasive and were pursued with such vigor by two administrations that they caused a financial crisis as well as the usual cyclical housing market collapse.

Congress planted the seeds of the crisis in 1992, with the enactment of what...