Sunday, March 25, 2007

The Housing Bubble, and the Freedom to Fail

In the post "Ron Paul — Federal Reserve To Blame For Housing Bubble", Warbs noted that Ron Paul was blaming the fed for creating, and perpetuating the housing bubble, which is about to burst and deliver a big smackdown to the economy.
"When the bubble finally bursts completely, millions of Americans will be looking for someone to blame. Look for Congress to hold hearings into subprime lending practices and “predatory” mortgages. We’ll hear a lot of grandstanding about how unscrupulous lenders took advantage of poor people [ed: Chris Dodd is already doing it], and how rampant speculation caused real estate markets around the country to overheat. It will be reminiscent of the Enron hearings, and the message will be explicitly or implicitly the same: free-market capitalism, left unchecked, leads to greed, fraud, and unethical if not illegal business practices.

But capitalism is not to blame for the housing bubble, the Federal Reserve is. Specifically, Fed intervention in the economy– through the manipulation of interest rates and the creation of money– caused the artificial boom in mortgage lending.

The Fed has roughly tripled the amount of dollars and credit in circulation just since 1990. Housing prices have risen dramatically not because of simple supply and demand, but because the Fed literally created demand by making the cost of borrowing money artificially cheap. When credit is cheap, individuals tend to borrow too much and spend recklessly.

Unless and until we get the Federal Reserve out of the business of creating money at will and setting interest rates, we will remain vulnerable to market bubbles and painful corrections. If housing prices plummet and millions of Americans find themselves owing more than their homes are worth, the blame lies squarely with Alan Greenspan and Ben Bernanke." -- Ron Paul
Though Brad doesn't quite agree with the entirety of Pauls comments, he goes on to note:
"Paul also points out the use of Fannie Mae and Freddie Mac to offload risk (which many investors consider to be implicitly guaranteed by the US Government). He doesn’t mention the use of derivatives to slice-and-dice the risk and further offload it onto the market, but his point still stands. The Federal Reserve has flooded the market with money, and that money has been chasing returns. Housing has been the “hot” asset class, creating an unsustainable bubble. When that bursts, it will be a lot worse than the tech stock bubble, because it actually hits people right at home."


You flood the market with money, and you see what happens. The rich, who have the ability to move money around chasing these asset classes, get richer. They buy second homes or investment properties to ride the appreciation wave, increasing demand. The poor and middle class, who are just trying to get ahead, struggle to keep their incomes constant or rising relative to the cost of goods. And when housing becomes the asset class bubble, they get priced out of homes and lenders must resort to “creative” financing to allow them to buy. Then, when the returns on investment start drying up, the demand of speculators and investors dries up, and home prices collapse.

The bubble is bursting. The particular nature of the housing market, as a relatively illiquid asset, is making this occur more slowly than a stock bubble would occur. But it’s occurring nonetheless. Blame can be spread around, of course, especially to some of those subprime borrowers who purchased homes they cannot afford. But Ron Paul is right, it is clear that the Fed’s loose money policy created this bubble, and they deserve a great deal of blame when it bursts."
I'm sorry, but the most basic market principle of libertarianism is that rational actors, will act with informed self interest, to produce optimal results in a market.

This isn't anyones FAULT, but the people who bought houses they couldn't afford; and the people who lent them the money to do so.

No-one was deceived by the fed, or the lenders. There's no such thing as a predatory mortgage on a new house you can't afford. Lenders aren't trying to put people into loans they cant pay back, they LOSE money on foreclosures.

No-one was deceived by the fed keeping relatively loose money. The fed could have done whatever they wanted with interest rates; people were too caught up in the "gold rush" mentality to care. In fact, during this "boom" (which people seem to forget began before the end of the stock bubble) we've seen the fed put the biggest peacetime interest rate increases in place, month after month, (in 2000, 2001, and then again at the end of 2002 and 2003), and all it did was slow things down slightly.

There was no deception involved here, except self deception. Everyone thought they could keep surfing the wave; and they pretended that it would never reach the the shore.

As far as I'm concerned, none of this is a problem from a market standpoint. There is no point in this cycle where we could have legitimately said, "OK, now it's time for the government to step in and do something". This is just a natural economic cycle..

Or did people forget that markets have boom and bust cycles naturally; based on the psychology of the market?

Oh wait, yes, that's right, they did.

So a bunch of sub-prime lenders are going to fail.


That's going to put pressure on a lot of major banks who invested, or underwrote those subprimes.


A bunch of builders and contractors are going to go under now, because they were only in existence to take advantage of the bubble.


A whole bunch of people are going to lose those houses they couldn't afford; or the second or third houses they bought on spec, to try and sell for far more than they were worth in a rational market.


None of these are BAD THINGS. Markets make mistakes, and this is the corrective mechanism. If you over invest in something shaky, you get what you deserve.

If you bought a house you couldn't afford, because someone was stupid enough to give you a loan you couldn't pay back, whose fault is that?

YOURS, that's who.

If the lender who loaned you the money goes under, because you and all your neighbors default on his loans, whose fault is that?

HIS, that's who.

You both made decisions, knowing what the consequences of those decisions could be, and willfully choosing to ignore them.

The most basic freedom of the market, is freedom to fail; because failure makes markets strong.

What we're seeing right now, and will see over the next.. oh I'd say two years... is the principle of freedom to fail in action. People made risky gambles, and they lost; that's what happens sometimes.

When the dust clears; you can bet that those involved won't do that again... or at least the ones with any brains will anyway. The other idiots will be off looking for another boom to bust.

Now, what WOULD be a problem, is if, as Paul suggests (and I think it's entirely likely); the government decides it "must do something", to protect those fools from the consequences of their actions.

THAT, would be a BIG problem.