Asset Prescience
Daniel Davies blogged way back in 2002 that the Fed’s most likely approach to boosting economic growth was to facilitate the creation of a housing price bubble:
Cleverer readers at this point will be formulating an objection. The objection goes along the lines of:
“Yeah, yeah, laughing boy, but what happens when the housing bubble bursts then?”
Which is a damn good question to ask, particularly since the official policy of the Federal Reserve appears to be “hmmm yeh, never thought of that, I suppose we’d be kind of fucked”. Looks like it falls to me to come to their aid, with a solution that smacks of genius.
For all the back-and-forth bluster about Fannie Mae, regulation, “Wall Street greed,” etc. there seems to me to have been remarkably little focus on policymakers decision-making with regard to this issue. One reason there hasn’t been a ton of focus on it is that a lot of smart, well-informed people saw this risk and thought the Fed was right to basically ignore it. But the very fact that the Fed had — or at least was widely thought to have had — good reasons to behave in this manner is all the more reason to shine some scrutiny. Since nobody ever says “my plan is to be corrupt and incompetent” there’s relatively little value in just saying over and over again that corrupt and inept public officials are undesirable. We do, by contrast, need to talk about how and why well-regarded public officials wound up making serious mistakes. There are, presumably, lessons to be learned here.
33 Responses to “Asset Prescience”
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October 3rd, 2008 at 12:08 pm
Was it a serious mistake? By the time the housing market crashed, hopefully the tech industry would be back on its feet and possibly even some other industry.
Now that the bailout bill 1.0 failed and soup lines didn’t begin forming the next day, the idea that this is an emergency crisis that must be dealt with today/this week/this month has been severely damaged.
If this recession is milder, or even exactly as mild as the tech boom recession would have been minus the housing boom, then putting off one recession until later can be a good idea even if the next recession isn’t put off eternally.
October 3rd, 2008 at 12:14 pm
One reason there hasn’t been a ton of focus on it is that a lot of smart, well-informed people saw this risk and thought the Fed was right to basically ignore it….
There were a lot of smart, well informed people who saw this risk and didn’t think the Fed was right to ignore it. But they’re not the ones that got columns in the WSJ & NYT, nightly spots on CNBC and other Fed/Wall Street echo chambers. But they were all over the internet. Doesn’t Matt surf?
October 3rd, 2008 at 12:14 pm
corner calling you out: Unintentionally Revealing [Mark Hemingway]
We get it. Some people hate Sarah Palin and think she’s dumb. But what does it say about these people who in a stampede to prove how stupid she is, will believe anything they hear that validates their opinion — no matter how obviously untrue?
October 3rd, 2008 at 12:14 pm
Of course, the more subtle issue with the housing bubble is that fewer and fewer people could afford to put a roof over their heads without going too far into debt. Some people like to blame home-owners for “buying more house than they could afford” … but what does that mean? What if you cannot afford any decent housing?
The more fundamental issue, though, has to deal with from whom people borrowed. Very soon we’ll be inundated with replays of It’s a Wonderful Life. But evidently the message hasn’t gotten through — in the old days the GOP claims to love so much, people used to put money in banks and S&Ls which then lent money to other people to, e.g., buy houses.
Nowadays, everybody is so afraid of not having enough money on which to retire (thanks GOP for fear-mongering in re. social security) that they don’t save in banks and S&Ls because the interest is “too low” but instead want to invest money. The money available to lend is not in the bank, so to speak, but in the market.
Nu? Markets match supply with demand, social costs be damned. In this case, the markets matched a supply of capital from investors (boomers and their pension fund managers) with various demands for capital. And when demand did not exist, it was cooked up in the form of a string of bubbles, the latest of which was the housing bubble.
Now there is a right way to have a mortgage backed security (you make the loan into an investment, c.f. the “Jewish Mortgage” or “Heter ‘Iska”) but this isn’t how the mortgage backed securities actually worked. Instead, people were shepherded into loans that maximized expected investor return (e.g. make the people who can least afford it pay the most to maximize the expectation value), which ultimately caused people who really could afford their homes not to get the loans they could afford but loans they couldn’t afford (so much for the “it’s all the fault of the feds for ending redlining” arguments — the people involved were still redlined, in a way), ending up in a loss for everyone. And the removal of borrower from lender via selling off securities hampered renegotiations (the media, et al, are finally admitted that foreclosures are not the loss the lenders originally claimed they were).
At this point, a bailout is necessary, IMHO. In fact, I was arguing for some sort of federal purchasing of what former Econs Prof. Atrios calls “big shitpile” a while back. But strings, oversight, etc. must be attached. Certainly, the current bailout is too much too late. And also needs some direct money to people in debt (which money will trickle up and thus increase liquidity even better than a bailout as, pace Reagan, money trickles up not down — as it always flows toward a Pareto equilibrium that screws all but the rich … and the solution is not to embrace that equilibrium as the GOP is wont to do — such an equilibrium represents an end of economic growth and return to feudalism — but to fight it via wealth redistribution … which is why “tax and spend” is good for growth!).
But yep. We need to look at the policy failures which got us into this pickle. Note that, until the New Deal, we were in this pickle with regularity (the business cycle was deemed a law of econs) … and now we’ve undermined the New Deal (including the aptly named Social Security) and we’re in the pickle again.
And I’d argue the problem isn’t greed (as the moralizers have been arguing) so much as fear of not having enough. And, y’all know what FDR said about that …
October 3rd, 2008 at 12:23 pm
The housing price bubble was the effect, the cause was mortgage credit bubble. The mortgage credit bubble was the policy. Perhaps this is a distinction without a difference.
The mortgage credit bubble was an absolute necessity in order to keep the much larger system wide credit bubble, which dated from around 1982, going.
October 3rd, 2008 at 12:27 pm
But what does the “credit bubble” mean? People are buying stuff on credit that they “can’t afford”. But that means someone can afford to lend them money … and someone is getting money from the purchases. The question is why so many people (who work hard) “can’t afford” to purchase the fruits of their labors? Where is the money going? Why isn’t it circulating?
The date of 1982 is interesting (a full year of Reagan). The economic pot needs to be stirred … and when did they begin to stop stirring it? hmm ….
Anyhoo … why isn’t the religious right, on the subject of people not being able to afford to purchase their daily bread and water referencing the vision of Deutero-Isaiah? Why no proposals for a Sabbatical year?
October 3rd, 2008 at 12:45 pm
Say it ain’t so, Matt. There you go again with yer backward fingerpointin’. It doesn’t , you know, matter what the situation is or was. John McCain is a Maverick. If we focus on the past, you know -even though you says it’s prologue (whatever that is –French, I assume, with it’s white flag-of-surrender-wavin’), we’ll never get to the change the future holds that we’re going to bring, the Palin and McCain Administration, to the United States of American and Joe Sixpack, like me.
October 3rd, 2008 at 1:06 pm
The question is why so many people (who work hard) “can’t afford” to purchase the fruits of their labors? Where is the money going? Why isn’t it circulating?
The housing bubble helped hide the declining propserity of the middle class. Real income was going down, except for the very rich, but home equity was increasing, and the result was that people borrowed against home equity to maintain their standard of living.
October 3rd, 2008 at 1:12 pm
Here is what credit bubble means.
http://yglesias.thinkprogress.org/archives/2008/10/the_record_ii.php
Here too. Scroll down to the first chart.
http://mwhodges.home.att.net/nat-debt/debt-nat.htm
I know few will grasp this as it sounds like nonsense but much of the money lent and spent was not real money. In the financial sphere all those exotic credit instruments were thought of as money, having a quality called ‘moneyness’. As long as mortgage backed securities and all manner of CDO’s and their derivatives were easily traded, liquid, they were understood as money. They were put on the books a solid assets, as good as cash. With balance sheets thus bursting more credit could be issued, to buy more debt paper. The system was creating it’s own liquidity in a manner outside the old fashioned banking system.
October 3rd, 2008 at 1:27 pm
much of the money lent and spent was not real money -rapier
But the goods and services purchased were real. So have we achieved Deutero (or is it Tritero) Isaiah’s vision of buying drink and food without money?
Or, given that the def of money is pretty much that which buys stuff, it really is money no matter how much not money it is. As any Paul-nut will tell you, our money isn’t real money ’cause it’s not backed by gold. And as any respondent to that will tell you — well, what’s the worth of gold? It’s use in electronics and its purtiness? Or that we’ve all agreed gold is valuable?
October 3rd, 2008 at 1:46 pm
Here’s today’s fun assignment:
1. Find examples of RonPaul making similar warnings.
2. Compare with the concerted effort to discredit him by establishment hacks (or lackeys thereof such as MattY) whose directives I assume came from those who might be termed “Friends of the Fed” whether said hacks/lackeys were aware of it or not.
October 3rd, 2008 at 1:49 pm
Here’s some more information on that concerted effort.
October 3rd, 2008 at 2:03 pm
Matt says:
“We do, by contrast, need to talk about how and why well-regarded public officials wound up making serious mistakes. There are, presumably, lessons to be learned here.”
Indeed. And one of the big, big reasons that everybody who was anybody rationalized debauching traditional credit standards (such as requiring substantial down payments on home mortgages) in the interest of making a quick killing was in the sacred name of “diversity.”
For example, our President:
President George W. Bush addresses the White House Conference on Increasing Minority Homeownership at The George Washington University Tuesday, Oct. 15, 2002
“More and more people own their homes in America today. Two-thirds of all Americans own their homes, yet we have a problem here in America because few than half of the Hispanics and half the African Americans own the home. That’s a homeownership gap. It’s a — it’s a gap that we’ve got to work together to close for the good of our country, for the sake of a more hopeful future.
“We’ve got to work to knock down the barriers that have created a homeownership gap.
“I set an ambitious goal. It’s one that I believe we can achieve. It’s a clear goal, that by the end of this decade we’ll increase the number of minority homeowners by at least 5.5 million families. (Applause.) … And it’s going to require a strong commitment from those of you involved in the housing industry. …
“To open up the doors of homeownership there are some barriers, and I want to talk about four that need to be overcome. First, down payments. A lot of folks can’t make a down payment. They may be qualified. They may desire to buy a home, but they don’t have the money to make a down payment. I think if you were to talk to a lot of families that are desirous to have a home, they would tell you that the down payment is the hurdle that they can’t cross. And one way to address that is to have the federal government participate.
“And so we’ve called upon Congress to set up what’s called the American Dream Down Payment Fund, which will provide financial grants to local governments to help first-time home buyers who qualify to make the down payment on their home.”
http://isteve.blogspot.com/2008/09/2002-bushs-speech-to-white-house.html
October 3rd, 2008 at 6:53 pm
Lowering the interest rate is pretty much a standard response to a recession, and its what the Fed should do. (in 1929 the Fed raised interest rates an that played a big role in turning a recession into a Depression). In the past when the Fed lowers the interesty rate there is both a short term and a long term effect. The long term effect is that businesses borrow more to undertake projects they have delayed, roll out new products or expand into new markets– but that takes while. the short term effect is that a small housing boom occurs as people refi old mortgages at lower rates or look to buy new homes. This starts pulling the economy out of recession until the long term (and more powerful) response from the larger business community kicks in.
What happened in 2002-2003 is that the long-term response never happened. Business failed to borrow and failed to expand. Instead we had stories about a long jobless recovery and corporations sitting on piles of hoarded cash. And the Fed kept the interest rate low far longer than it should have in hopes that this would change– with the result that more and more money poured into housing, inflating the bubble.
Determining why businesses failed to take advantage of lower interest rates to expand operations would explain the bubble and give us some clue on how to avoid another one.
October 3rd, 2008 at 7:08 pm
For all the back-and-forth bluster about Fannie Mae, regulation, “Wall Street greed,” etc. there seems to me to have been remarkably little focus on policymakers decision-making with regard to this issue.
coughRon Paulcough.
But the goods and services purchased were real. So have we achieved Deutero (or is it Tritero) Isaiah’s vision of buying drink and food without money?
I think that rapier is referring to money used to buy abstract assets. The point is that money and credit were created out of htin air, without any actual goods or services to back them up, and the end result was merely a reshuffling of the distribution of goods and services.
Debt and credit bubbles can also come out of consuming that which was previously saved. If we stop saving and manufacture credit out of thin air, we wind up eating our savings – with the very possible end result that we wind up without the necessary real capital goods that we need to keep the economy going ,at which point manufacturing credit results in nothing but inflation and/or shortages – as Rudyard Kipling said, “But, though we had plenty of money, there was nothing our money could buy.”
And of course, some of it financed by the savings of foreigners – but it is not a good idea to continually consume the savings of foreigners, because eventually they may get a little pissy if they begin to suspect that you aren’t going to pay them back – or that you may pay them back in a devlaued currency, effectively cheating them.
As any Paul-nut will tell you, our money isn’t real money ’cause it’s not backed by gold. And as any respondent to that will tell you — well, what’s the worth of gold? It’s use in electronics and its purtiness? Or that we’ve all agreed gold is valuable?
Gold is preferable to paper money not because it has some magic value, but because (a) its value is independent of any institution decreeing it has value (and people want gold for its properties even in the absence of a law decreeing gold to be money), and because (b) its supply cannot be increased easily.
The problem with paper money is that the government can print as much of it as the government wants, thus taxing savings through inflation.
Some people like to blame home-owners for “buying more house than they could afford” … but what does that mean? What if you cannot afford any decent housing?
If you cannot afford any decent housing, that is certainly a bad thing and society should help you to find shelter.
But if your question is, “What if you cannot afford TO BUY any decent housing,” then the answer is: RENT IT INSTEAD. One of the causes of the bubble was the government trying to encourage as many peopleto actually ownthir homes a possible, which is not always a good idea.
October 3rd, 2008 at 11:57 pm
The numbers, from the father of Credit Bubble analysis Doug Noland.
Looking back, Total Non-Financial Debt (NFD) expanded $578bn during 1994. By 1998, NFD growth for the year had surpassed $1.0 TN. Non-Financial Credit increased $1.153 TN in 2001, $1.415 TN in 2002, and $1.676 TN in 2003, before reaching the $2.0 TN milestone in 2004. Incredible as it was, debt expansion then surged over the next fateful three years. Growth rose to $2.319 TN in 2005, $2.428 TN in 2006 and then to last year’s record $2.561 TN.
Over the years I’ve chronicled this historic Bubble in Wall Street Finance. It is worth noting today that Wall Street assets began year 2000 at about $1.0 TN and ended 2007 at $3.0 TN. The ABS market surpassed $1.0 TN in 1998 and ended 2007 at $4.5 TN. GSE assets surpassed $1.0 TN in 1997 and ended last year at almost $3.4 TN. Agency MBS surpassed $2.0 TN in 1998 and closed 2007 at almost $4.5 TN. “Fed Funds and Repos” reached $1.0 TN in 2000 and ended 2007 at $2.1 TN. This Bubble in Wall Street Finance was one of history’s most spectacular Credit expansions. It also comprised the greatest use of speculative leverage ever.
http://www.prudentbear.com/index.php/commentary/creditbubblebulletin?art_id=10125
Scroll 3/4 down the page to the header, ‘The Wall Street Bust’ to read the commentary.
October 4th, 2008 at 6:56 am
Greenspan was the leading public official responsible. He is simply a fool who didn’t know or understand history. It’s always a new age as the bubble takes flight. The lesson of Greenspan is that his like cannot be avoided. Economic cycles always include bubbles and the exact same delusions always accompany them. A Greenspan will always appear and be deified as genius because that is what people want. It’s a function of human nature, the nature of crowds.
Sure there were voices whispering no no no. Of course they were ignored when not being derided and mocked. The masters of finance are paid not to understand the warnings. The politicians just respond to the popluar will. Show me a politician who worried about home prices rising too fast and…. well they don’t exist. A skeptic in such matters is unelectable butsuch skeptics are don’t run for office because they are not politicians.
Everyone played their part, their role, in the cycle. As they always will.
October 4th, 2008 at 4:41 pm
There was an remarkable article by Benjamin Wallace-Wells in the Washington Monthly back in 2004 that nailed all of this stuff nicely.
And let us not forget that Greenspan actually recommended at that time that people should refinance their fixed-rate mortgages into adjustable rate. That certainly would’ve made his job easier; he would have been able to adjust the rates of all of the ARMs in America, at will, from where he sat. A nice gig if you can get it.
October 6th, 2008 at 12:52 pm
consuming that which was previously saved.
Unless we’re talking about hoarded food or some such here, you’re argument doesn’t quite make sense. When I “save” money, I am really lending it to the bank which lends/invests it elsewhere … and ultimately someone else is consuming it. I hate to seem like I get all my econs knowledge from sappy movies, but again I ask — doesn’t anyone pay any attention to those It’s a Wonderful Life marathons?
As to the issue of rentals vs. ownership: sometimes you can’t find a rental that meets your needs either …
November 30th, 2008 at 5:19 pm
A couple of years ago, I walked uptown to Central Park on one of those perfect November days. The air had a bite to it while the sun shone bright. It was the day of the New York Marathon and I thought it might be fun to watch the runners
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