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 Real Problem With Detroit

I’m a little bit incensed that the government is going to loan the U.S. auto industry $25 billion, and possibly more. I have always thought that these are poorly run companies that design lousy cars, or cars that were too big and fuel-inefficient, and as such they deserve to fail. But I also thought that because of the high labor cost brought about by the United Auto Workers (UAW) union, it was difficult for the U.S. auto companies to be as flexible as they needed to be.

I was recently speaking with a friend who argued that the big problem was management, that the executives at these companies were just plain dumb. It was hard to disagree with that, but after doing a little reading, I can’t really place that much blame on the executives. Ford, GM, and Chrysler have been shuffling through executives in recent years – could they really all be dumb?

It’s really a much more complicated issue than that, and it has to do with the UAW and the Corporate Average Fuel Economy (CAFE) standards. Let’s address the UAW. There are basically two auto industries operating in the U.S. There’s one in Detroit which includes GM, Ford, and Chrysler, where the workers are all UAW. Then there’s one in the southern U.S. which includes Honda, Toyota, and Hyundai. Their workers do not belong to a union and work predominantly for less money (although that is not always the case) and no pension benefits.

Now, the CAFE standard basically mandates that your entire fleet of domestic vehicles has a minimum fuel efficiency, or else you pay a fine based on how much you’re over that minimum. As a result of CAFE, the UAW, and low fuel prices, the U.S. automakers were basically forced to make more SUVs and trucks, because those vehicles have much higher margins, and are much more profitable – at least when they’re selling. But, to meet CAFE, the U.S. automakers also had to offer a line of much lower profit-margin fuel-efficient vehicles. In order to keep costs low, for years the companies skimped on styling, materials, and engineering, to the extent that they lose money on each and every fuel-efficient small and mid-size car they sell.

Instead of letting the free-market dictate the winners and losers in the auto industry, the U.S. government intervened, first through CAFE and now through a generous though not unprecedented lending program. The UAW has huge sway in Washington over our political leaders, and they have Barack Obama as an ally. President-elect Obama also supports the Employee Free Choice Act, which will make it easier for auto industry workers in the southern U.S. to unionize. He also wants to raise tariffs on cars imported from South Korea by renegotiating our trade pact with them. I fear the result of all this will be more expensive, lower-quality cars for the masses. But this isn’t going to hurt the rich, just the lower and middle-class.

November 6, 2008   No Comments