Without a Bill Clinton the Bursting of the Canadian Housing Bubble will be less Painful than in the US

Posted by PITHOCRATES - November 10th, 2012

Week in Review

The subprime mortgage crisis caused the Great Recession.  And bad government policy caused the subprime mortgage policy.  First with artificially low interest rates to encourage everyone to borrow money and take on enormous amounts of debt.  Then the Clinton administration took it up a notch.  By charging lenders with discrimination in their lending practices.  And if they didn’t find a away to qualify the unqualified for mortgages they would soon find themselves out of the mortgage business.  So they came up with subprime lending.  Adjustable rate mortgages (ARM).  No documentation mortgages.  Anything to get the government off of their backs.  And the government was so pleased with what they saw they started to buy (and/or guarantee) those toxic mortgages with their Government Sponsored Enterprises Fannie Mae and Freddie Mac.  Clearing those toxic mortgages from the lenders balance sheet by unloading them onto unsuspecting investors.  Clearing the way for even more toxic subprime lending.  The government was pleased.  And the bankers were making money with bad lending practices.  Something they normally would have avoided because it is very risky.  But when the government was transferring that risk to the taxpayer what did they have to lose?

Governments like a hot real estate market.  Because housing sales drives so much economic activity.  Because people put a lot of stuff into those houses.  Which is why governments are always quick to use their monetary authority to lower interest rates.  Which is what they did in the US.  Cheap money to borrow.  Lax lending practices thanks to the Clinton administration.  Creating a housing boom.  And a housing bubble.  It was a perfect storm brewing.  The only thing that it needed was a raise in the interest rates.  Which came.  Causing the subprime mortgage crisis as those ARMS reset at higher interest rates.  Leading to a wave of subprime mortgage defaults.  And the Great Recession.  Which raced around the world thanks to those toxic mortgages Fannie Mae and Freddie Mac unloaded on unsuspecting investors.

Canada did not suffer as much from the Great Recession.  Because they did not pressure their lenders to qualify the unqualified like Bill Clinton did in the US.  But they still used their monetary authority to keep interest rates artificially low.  So while they escaped the great damage the Americans suffered in their subprime mortgage they still have a housing bubble.  And it looks like it may be time for it to burst (see Analysis: Canada braces as housing slowdown takes hold by Andrea Hopkins posted 11/10/2012 on Reuters).

Long convinced the country’s housing boom would never end in a crash, Canadians have watched this autumn as a sharp slowdown in real estate spreads across the country, leaving would-be home buyers hopeful and sellers scared…

Signs are everywhere that Canada’s long run-up in house prices is over, hit by a combination of tighter mortgage lending rules and growing consumer reluctance to take on more debt. Sales of existing homes are down steeply, with condo sales hit especially hard, and some long-booming prices have started to fall…

Canadian households hold more debt than American families did before the U.S. housing bubble burst, which has led the government to tighten mortgage lending rules four times in four years…

Tal believes slower sales activity will be followed by falling prices in many cities. But he says Canadian lending standards have been higher, and borrowers more cautious, than in the United States before its crash, which will prevent large-scale mortgage defaults and plunging prices.

Mindful of what happened in the United States, the Canadian government has tightened mortgage rules to prevent home buyers from taking on too much debt. While interest rates are low and expected to stay low into 2013, the fear is that eventual rate hikes will drive borrowers out of their homes or into bankruptcy…

The last round of mortgage rule changes took effect in July, forcing home buyers to cut back on their budget and pushing many prospective first-time buyers out of the market entirely.

The Canadians may escape the damage the US suffered as Bill Clinton was an American and not a Canadian.  So they only have to suffer the effects of bad monetary policy.  Not the effects of government enforced bad lending practices.  So housing prices will fall in Canada.  And there will probably be a recession to correct those inflated real estate prices.  But housing prices probably will not fall as far as they did in the US.  For the Canadians were more responsible with their irresponsible monetary policy than the Americans were.

The lesson here is that when markets determine interest rates housing bubbles are smaller and recessions are less painful.  If you don’t believe that just ask an American with an underwater mortgage.

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World War I, Gold Standard, German Reparations, Hyperinflation, Credit-Anstalt, Keynesian Policies and the Great Depression

Posted by PITHOCRATES - March 13th, 2012

History 101

Nations abandoned the Gold Standard to Borrow and Print Money freely to pay for World War I 

Banks loan to each other.  They participate in a banking system that moves capital from those who have it to those who need it.  It’s a good system.  And a system that works.  Providing businesses and entrepreneurs with the capital to expand their businesses.  And create jobs.  As long as all the banks in the system go about their business responsibly.  And their governments go about their business responsibly.  Sadly, neither always does.

World War I changed the world in so many ways for the worse.  It killed a generation of Europeans.  Bankrupted nations.  Redrew the borders in Europe as the victors divvied up the spoils of war.  Setting the stage for future political unrest.  Gave us Keynesian economics.  Saw the beginning of the decline of the gold standard.  A deterioration of international trade.  A rise of protectionism and nationalism.  Punishing German reparations.  To pay for a war that they didn’t necessarily start.  Nor did they necessarily lose.  Which created a lot of anger in Germany.  And provided the seed for the Great Depression.

A set of entangling treaties brought nations eagerly into World War I.  There was great patriotic fervor.  And a belief that this war would be Napoleonic.  Some glorious battles.  With the victors negotiating a favorable peace.  Sadly, no one learned the lessons of the Crimean War (1853-1856).  Which killed approximately 600,000 (about 35% of those in uniform).  Or the American Civil War (1861-1865).  Which killed approximately 600,000 (about 20% of those in uniform).  The first modern wars.  Where the technology was ahead of the Napoleonic tactics of the day.  Modern rifled weapons made accurate killing weapons.  And the telegraph and the railroads allowed the combatants to rush ever more men into the fire of those accurate killing weapons.  These are the lessons they didn’t learn.  Which was a pity.  Because the weapons were much more lethal in World War I (1914-1918).  And far more advanced than the tactics of the day.  Which were still largely Napoleonic.  Mass men on the field of battle.  Fire and advance.  And close with the bayonet.  Which they did in World War I.  And these soldiers advanced into the withering fire of the new machine gun.  While artillery rounds fell around them.  Making big holes and throwing shredded shrapnel through flesh and bone.  WWI killed approximately 10,000,000 (about 15% of those in uniform).  And wounded another 20 million.  To do that kind of damage costs a lot of money.  Big money.  For bullets, shells, rifles, artillery, machine guns, warships, planes, etc., don’t grow on trees.  Which is why all nations (except the U.S.) went off of the gold standard to pay for this war.  To shake off any constraints to their ability to raise the money to wage war.  To let them borrow and print as much as they wanted.  Despite the effect that would have on their currency.  Or on foreign exchange rates.

As Countries abandoned the Gold Standard they depreciated their Currencies and wiped out People’s Life Savings

Well, the war had all but bankrupted the combatants.  They had huge debts and inflated currencies.  Large trade deficits.  And surpluses.  A great imbalance of trade.  And it was in this environment that they restored some measure of a gold standard.  Which wasn’t quite standard.  As the different nations adopted different exchange rates.  But they moved to get their financial houses back in order.  And the first order of business was to address those large debts.  And the ‘victors’ decided to squeeze Germany to pay some of that debt off.  Hence those punishing reparations.  Which the victors wanted in gold.  Or foreign currency.  Which made it difficult for Germany to return to the gold standard.  As the victors had taken most of her gold.  And so began the hyperinflation.  As the Germans printed Marks to trade for foreign currency.  Of course we know what happened next.  They devalued the Mark so much that it took wheelbarrows full of them to buy their groceries.  And to exchange for foreign currency.

Elsewhere, in the new Europe that emerged from WWI, there was a growth in regional banking.  Savvy bankers who were pretty good at risk evaluation.  Who were close to the borrowers.  And informed.  Allowing them to write good loans.  Meanwhile, the old institutions were carrying on as if it was still 1914.  Not quite as savvy.  And making bad loans.  The ones the more savvy bankers refused to write.  Weak banking regulation helped facilitate these bad lending practices.  Leaving a lot of banks with weak balance sheets.  Add in the hyperinflation.  Heavy debts.  Higher taxes (to reduce those debts).  Trade imbalances.  And you get a bad economy.  Where businesses were struggling to service their debt.  With many defaulting.  As a smaller bank failed a bigger bank would absorb it.  Bad loans and all.  Including an Austrian bank.  A pretty big one at that.  The largest in Austria.  Credit-Anstalt.  Which was ‘too big to fail’.  But failed anyway.  And when it did the collapse was heard around the world. 

As banks failed the money supply contracted.  Causing a liquidity crisis.  And deflation (less money chasing the same amount of goods).  Currency appreciation (further hurting a country’s balance of trade).  And low prices.  Which made it harder for borrowers to service their debt with the lower revenue they earned on those lower prices.  So there were more loan defaults.  Bank runs.  And bank failures.  Spreading the contagion to Amsterdam.  To Warsaw.  Germany.  Latvia.  Turkey.  Egypt.  Britain.  Even the U.S.  Soon countries abandoned the gold standard.  So they could print money to save the banks.  Lower interest rates.  Depreciate their currencies.  And wipe out large swathes of wealth denominated in that now depreciated currency.  What we call Keynesian policies.  People’s life savings became a fraction of what they were.  Making for a longer working life.  And a more Spartan retirement. 

Abandoning the Gold Standard didn’t fix the U.S. Economy in 1971

Meanwhile in the U.S. the government was destroying the U.S. economy.  Trying to protect domestic prices they passed the Smoot-Hawley Tariff.  Raising the price for businesses and consumers alike.  And kicking off a trade war.  Both of which greatly reduced U.S. exports.  New labor legislation keeping wages above market prices while all other prices were falling.  And higher taxes to pay for New Deal social programs.  Wiping out business profits and causing massive unemployment.  Then came the fall in farm prices due to increased farm productivity.  Thanks to farmers mechanizing their farms and greatly increasing their harvests.  Thus lowering prices.  Making it hard to service the bank loans they got to pay for that mechanization.  Thus leading to bank failures in the farming regions.  That spread to the cities.  Causing a liquidity crisis.  And deflation.

Then came Credit-Anstalt.  And all the woe that followed.  Which caused a speculative run in Britain.  Which made the British decide to leave the gold standard.  To stem the flow of gold out of their country.  Which destroyed whatever confidence was still remaining in their banking system.  People thought that the U.S. would be next.  But the Americans defended the dollar.  And instead raised interest rates (by reducing the money supply).  To keep the dollar valuable.  And to protect the exchange rate.  Making it less attractive to exchange cash for gold.  And to restore confidence in the banking system.  Of course, this didn’t help the liquidity crisis.  Which Keynesians blame for the length and the severity of the Great Depression.

Of course, it wasn’t the gold standard that caused the fall of Credit-Anstalt.  It was poor lending practices.  A weak banking regulation that allowed those poor lending practices.  And a lot of bad government policy throughout Europe.  Especially those punishing German reparations.  And the gold standard didn’t cause the economic collapse in the United States.  For it worked well the previous decade.  Providing all the capital required to produce the Roaring Twenties that modernized the world.  It was government and their intrusive policies into the free market that caused the economic collapse.  And abandoning the gold standard wouldn’t have changed that.  Or made the economy better.  And we know this because leaving the gold standard didn’t solve all of the countries woes in 1971.  Because the government was still implementing bad Keynesian policies.

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