There is no such thing as a free lunch.

The Housing Boom and Bust

I just finished reading Stanford economist Thomas Sowell‘s new book, The Housing Boom and Bust. It’s a really easy read, not too technical, but filled with a lot of good statistics. The thesis of the book can basically be summed up by the following paragraph:

In a complex story about intricate financial arrangements, it is possible to lose sight of a plain and fundamental fact – that behind all the esoteric securities and sophisticated financial dealings are simple, monthly mortgage payments from millions of home buyers across the country. When many of those payments stop coming, no amount of financial expertise in Wall Street or government regulatory intervention from Washington can save the whole investment structure built up on the foundation of those mortgage payments.

The bedrock question then is: Why did so many monthly mortgage payments stop coming? And the bedrock answer is: Because mortgage loans were made to more people whose prospects of repaying them were less than in the past. Nor was this simply a matter of misjudgment by banks and other lenders. The political pressures to meet arbitrary lending quotas, set by officials with the power of economic life and death over banks and over Fannie Mae and Freddie Mac, led to riskier lending practices than in the past.”

I wish Sowell wrote more about the effect of credit default swaps and other complex financial derivatives, but he pretty much dismisses those as “downstream effects”, while the real cause of the crisis was that people were living in homes they couldn’t afford, due to the political pressures on banks and regulators to lend or allow lending to those people, in the name of “affordable housing”.

Sowell also raises an interesting argument that I haven’t heard before. He says that the boom in real estate prices was really a local issue, and that most communities across the country did not see prices rise much more than inflation and incomes. In localities such as coastal California, Miami, Phoenix, Las Vegas, etc. land use restrictions were put in place to limit the land available for building homes. For example, in bubble areas such as San Mateo County in California, more than half of all land is designated as “open space” and cannot be developed. In places like Houston and Dallas, which have no such restrictions and which have seen incomes rise faster than the national average, there was no housing bubble. He argues that such land use restrictions are often put in place by wealthy elites in the name of environmental friendliness, smart planning, or protecting the community from urban sprawl. It has the secondary effect of artificially raising the home values for the people that already live in the community. Furthermore, he argues that these restrictions are unconstitutional, as it allows people to restrict building on land (the “open spaces”) that they do not own.

Sowell also leaves us with this discouraging statement regarding President Obama and his various economic interventions:

Whatever its shortcomings economically, what government job creation programs can do politically is create a large class of people beholden to the government and likely to vote for those who gave them jobs in hard times. The political success of the New Deal is beyond dispute. That FDR could be re-elected in a landslide in 1936 and re-elected again to an unprecedented third term in 1940, despite never having gotten unemployment down into single digits during his first two terms, is a sign that President Obama may also be able to succeed politically, even if his policies turn out to be an economic disaster for the country as a whole.”


June 7, 2009   4 Comments

The Case for Doing Nothing

Harvard economist Jeffrey Miron on how your government effed it all up and how it is continuing to eff it up:

April 30, 2009   No Comments

Economists Against Stimulus

There is no disagreement that we need action by our government, a recovery plan that will help to jumpstart the economy. —President-Elect Barack Obama, January 9, 2009

With all due respect Mr. President, that is not true. Notwithstanding reports that all economists are now Keynesians and that we all support a big increase in the burden of government, we the undersigned do not believe that more government spending is a way to improve economic performance. More government spending by Hoover and Roosevelt did not pull the United States economy out of the Great Depression in the 1930s. More government spending did not solve Japan’s “lost decade” in the 1990s. As such, it is a triumph of hope over experience to believe that more government spending will help the U.S. today. To improve the economy, policymakers should focus on reforms that remove impediments to work, saving, investment and production. Lower tax rates and a reduction in the burden of government are the best ways of using fiscal policy to boost growth.

I’m a little late blogging about this, but the preceding excerpt is from a full-page ad taken out in the New York Times by the Cato Institute in January. It lists some 200 economists including 3 Nobel Laureates (take that Krugman) who are against Barack Obama’s stimulus plans. You can view the ad here:

March 17, 2009   1 Comment

Liberal vs. Conservative on Government Spending

I recently read two opinion pieces regarding what to do about the economy, specifically, whether the government needs to spend more or less money.

In one of the pieces, Paul Krugman of the New York Times argues that this is not the time to be cutting public spending and investment. He says that state and local governments, since they are required by law to have balanced budgets, are trimming social programs and public spending in order to eliminate their deficits. This behavior, in turn, is exacerbating the crisis by downsizing the local safety net and increasing unemployment by eliminative public sector jobs.

In the other piece, Peter Schiff, writing for the Wall Street Journal, argues that the government is broke and really has no money to spend. It can only borrow money from the future, or in the absence of willing lenders, take it out of the current economy by printing money, and then put it back in somewhere else. He says that individuals, local, and state governments are responding to this crisis rationally by spending less, but the federal government wants to respond by spending more, in the form of a giant stimulus package.

Who do you agree with?

December 29, 2008   1 Comment

When Less is More

In the wake of the collapse of Lehman Brothers and Merrill Lynch, both presidential candidates are calling for tighter regulation of the U.S. financial markets. That might make for good soundbites, but it’s more important to look back at the root cause of today’s troubles.

Under Presidents Bill Clinton and George W. Bush, the government heavily promoted home ownership to all citizens, even those with lower incomes and weak credit. Fannie Mae and Freddie Mac bought these loans from the primary lenders (banks) because they offered the highest rate of return, and coincidentally, the most risk. Fannie and Freddie casually assumed those risks, because the two companies were effectively guaranteed by the federal government, i.e., the taxpayer.

Whose idea was it to create Fannie Mae? It was part of Franklin Roosevelt’s New Deal administration. Who’s idea was it to make Fannie Mae a private corporation with implicit government backing? It was Lyndon Johnson’s (Freddie Mac was created in 1970 during Richard Nixon’s administration to provide some competition to Fannie Mae). Whose jobs were to make sure that Fannie and Freddie were able to handle these high-risk mortgages? The regulators. Why didn’t the regulators do their jobs? It might be that the incentive for someone to do his/her job as a regulator is much less than the incentive for someone else to try to make millions of dollars. The end result is that the seeds sown by the government years ago probably set the stage for the takedown of two huge financial companies, and possibly more to come.

I think what we can learn from all this is that when the government intervenes in the free market, any short-term benefit will likely be counteracted by an unforeseen catastrophe in the long-term. What’s happening now is probably a much needed correction in the financial markets that will be necessary for long-term economic health. Hopefully, the government doesn’t throw too many wrenches in the works during the meantime.

September 15, 2008   No Comments