The UAW and Public Sector Unions devastate Three Michigan Cities

Posted by PITHOCRATES - February 24th, 2013

Week in Review

It’s not been a good year for Detroit.  Well, it’s been more than a year.  It’s been a few bad years.  Actually, it’s been a great many bad years.  Since 1970.  When Ford Motor Company Chairman Henry Ford II joined with other business leaders to form Detroit Renaissance.  To revitalize the City of Detroit.  And some 42 years later, the City of Detroit is still struggling (see Detroit’s Misery Can Be Its Turning Point by Micheline Maynard posted 2/23/2013 on Forbes).

Detroit boosters were dealt a one-two blow this week by the kind of outsiders they have come to resent.

First, a state review panel declared that a financial emergency existed in the city, making it likely that Michigan Gov. Rick Snyder will appoint an emergency financial manager with sweeping powers.

Then, Forbes weighed in by declaring Detroit the nation’s most miserable city, based on a series of criteria that include crime, unemployment, foreclosures and home value…

Although General Motors is based in Detroit, and Chrysler recently opened an office there, the automobile industry is not going to provide the vast numbers of jobs the city needs to become solvent.

And there lies the problem for Detroit.  A city that grew big and rich off of the automobile industry saw a steady exodus and a declining tax base when the automobile industry declined.  Live by the automobile.  Die by the automobile.  And it’s just not Detroit.  A couple of other Michigan cities broke into the top 10 of Forbes’ America’s Most Miserable Cities 2013.

#7 Warren, Mich.

Troy and Farmington Hills are part of the government-defined Warren metro division. Like Detroit, the Warren metro has seen home prices collapse–off 53% the past five years.

#2 Flint, Mich.

Flint has been demolishing homes as the city shrinks with residents leaving in search of jobs. Only Detroit has a higher net out-migration rate. Flint ranks third worst for violent crime, behind Detroit and Memphis.

#1 Detroit, Mich.

Violent crime in the Detroit metro was down 5% in 2011, but it remains the highest in the country with 1,052 violent crimes per 100,000 people, according to the FBI. Home prices were off 35% the past 3 years, which is the biggest drop in the U.S.

If you seek a pleasant peninsula* you’d do better looking for one where the UAW isn’t dominant.  Perhaps Florida.  For the UAW is a city killer based on these Michigan cities.  (*The official state motto of Michigan is “If you seek a pleasant peninsula, look about you.”)

The Big Three dominated these cities.  Where fat pay and benefit packages were passed on to consumers in overpriced vehicles.  The Big Three’s monopoly on car sales allowed them to make fat profits.  And pay enormous amounts of taxes to the cities that had the factories that assembled their cars.  City coffers were so flush with cash city governments grew.  And city workers enjoyed fat pay and benefit packages.  This was the high water mark of the UAW.  Just after public sector unions had joined them on the gravy train.  But then something happened that devastated the UAW.  Consumers got choice.  They no longer had to buy overpriced ‘rust buckets’ the Big Three was putting out during the Seventies.  For the Japanese gave them choice.

And so began the great decline of the Big Three.  Quality and value did them in.  It’s what the people wanted.  While the UAW wanted consumers to pay more and get less.  So they could continue to enjoy their fat pay and benefit packages.  As the jobs went away so do did the taxes.  The cities bloated with all those government workers with their fat pay and benefit packages tried to maintain the size of their governments even while the tax base was declining.  Reducing other government services as they had little money left over after paying those fat pay and benefit packages.

With fewer and fewer jobs available people left these cities.  Empty houses dotted the horizon.  And housing prices fell.  With the tax base continuing to decline.  Poverty rates rose.  As did city services for the impoverished.  Leaving even less for other city services.  Causing a further exodus from the city.  Urban blight followed.  As did crime.  Causing a further decline in property values.

Low interest rates helped boost housing prices.  For awhile.  President Clinton’s Policy Statement on Discrimination in Lending kicked off subprime lending in earnest as lenders bowed to the Clinton Justice Department to put more low-income and minorities into homes they couldn’t afford.  Creating a huge housing bubble.  Built on easy credit.  Artificially low interest rates.  And the adjustable rate mortgage (ARM).  When rates went up all those low-income and minorities who bought houses they couldn’t afford defaulted on their higher mortgage payments.  Creating the subprime mortgage crisis.  Giving us the Great Recession.  Creating a flood of foreclosures.  A free fall in housing prices.  And more of the same that helped put those three Michigan cities into the top ten of Forbes’ America’s Most Miserable Cities 2013.

Michigan recently opted to become a Right-to-Work state.  Greatly angering the UAW and those public sector unions.  But it may be just what Michigan needs to reverse the great decline caused by the UAW and the public sector unions that devastated some of Michigan’s greatest cities.  One thing for sure it can’t get any worse.  Not when being a union state for so long secured three places in the top ten of Forbes’ America’s Most Miserable Cities 2013.

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Guns vs. Butter

Posted by PITHOCRATES - February 11th, 2013

Economics 101

When Children get their Allowance their Faces light up as they Think of all that Spending they’ll Do

Parents try to teach their kids to be responsible.  And to understand that they are not rock stars.  They can’t have “everything all the time.”  Because if you can you get bored.  And look for new ways to kill that boredom.  Like developing a coke habit.  (“There were lines on the mirror, lines on her face.”  Life in the Fast Lane.  The Eagles.)  Which is bad.  Very, very bad.  So this is where a weekly allowance comes in.  It teaches kids to be responsible.  And to budget their wants.  To make choices.  If they want more of one thing they learn they have to have less of another.  This is economic reality.  And the sooner they learn it the better off they will be.

So what does a kid want?  Food, candy, games, toys, comic books, going to the movies and consuming a lot of concession food and drinks.  And other stuff.  What does a parent want?  Their kids not to want so much of these things.  And not to whine.  Especially that.  They also want them to learn the importance of saving money.  To spend less and save more.  So later in life should they lose their job they will have savings to live on while they look for another job.  Without having to move back home.  So they may give a child an allowance of $100 a week.  Telling that child it’s for those things they want.  And for putting a little in the bank every week.  So they can have some money for later.  During a time they really need it.  And when the child gets that $100 his face lights up.  Thinking of all that spending he’s going to do.  While thinking nothing about saving.

Kids Allowance and Budget

The parent watches with proud satisfaction as their child budgets his wants.  For 5 weeks he pays for his school lunch.  Spends a fixed weekly amount on candy.  When he wanted to spend more on games, toys and comic books he cut back spending on movie night.  Even not going to the movies at all in Week 4 because he chose instead to buy an expensive game.  The parents are happy to see their child live within his budget.  But are disappointed that he spent all of his allowance without putting any of it in the bank.

With this Easy Credit he soon realizes that he can have Everything all the Time

Then the parents divorce.  The mother remarries.  The new stepdad really wants his stepson to like him.  While he is bitter about his parents’ divorce.  The stepdad keeps the same allowance structure in place.  But in a desperate attempt to get him to like him he is more than willing to make advances on his allowance.  Loaning money easily.  But charging interest.  To continue the lesson of responsibility.

Kids Allowance and Budget with Deficits

With easy credit and wanting more toys the stepson borrows money in Week 2.  $10.  And buys more games and toys.  Paying $1.10 for the allowance advance.  Liking the ability to buy more at the toy store he goes back for another loan in Week 3.  This time $20.  Paying $3.42 in total interest charges at the end of the week.  Losing the lesson of living on an allowance he goes back to borrow more.  This time $30.  Paying $7.10 in total interest.  With this easy credit he soon realizes that he can have everything all of the time.  And in Week 5 he borrows $40.  With his interest on the outstanding balance adding up to $12.28.  Which is almost enough to buy his school lunches for a week.

At the end of Week 5 he owes $100 in allowance advances.  Which he will have to eventually pay back.  Seeing how irresponsible the child got the stepdad refuses future allowance advances.  Upset the kid starts whining.  A lot.  Annoyed the stepdad calls in the loan.  He gives the child his $100 weekly allowance.  And then takes it back.  The child whines more.  For he can’t buy anything that week.  Not even school lunch.  Having to brown-bag it.  A peanut butter sandwich and an apple.  Making pizza day a living hell.  For he has no savings to live on during this difficult time.  As he was a spendthrift with his money.  Ignoring the sage advice of his parents to save for a rainy day.  So he suffers the most painful time of his life.  Extreme austerity for a week.

When they can’t reduce Defense Spending anymore they simply Borrow Money to keep Spending

This example is similar to how the federal government works.  The taxpayers are the kids.  And the stepdad are the politicians in the federal government trying to make taxpayers like them.  So they keep voting for them.  Only the politicians don’t want the people to learn to be responsible.  To budget their wants.  To understand that if they want more of one thing that they have to have less of another.  No.  They want them to believe they can have everything all of the time.  If only they vote for them.  How can they do this?  Unlike a parent the federal government can print money.  Making it the best stepdad in the world.

One of the reasons the Founding Fathers created the federal government was to provide for a common defense.  After winning their Independence they couldn’t get the British to leave our soil.  Or prevent the Barbary pirates from capturing our merchant ships and selling our sailors into slavery.  The new federal government was to provide a military force to protect Americans.  The Founding Fathers wrote this into the Constitution.  What they didn’t write into it was all the social spending we see today.  Often at the expense of defense spending.  The great political debate of how to divvy up spending between defense and the social stuff we see today is the guns vs. butter debate.  Where strict constructionists wanting to keep spending per the intent of the Founding Fathers.  All guns and no butter.  The ‘butter’ being an issue for state governments.  While progressives and liberals want all butter and no guns.  Because they hate the military.  And think they can talk to our enemies and make them like us.  Most other people want something in between.  As shown by  this graph.

Gunds vs Butter

If you spend 80% on guns that only leaves 20% for butter.  If you spend 50% on guns that leaves 50% for butter.  If you only spend 20% on guns that leaves 80% for butter.  And so on.  Progressives and liberals want to move as far to the left on this graph as possible.  Because the farther left they go the more they please their stepchildren.  Who become accustomed to all that spending.  And show their appreciation by continuing to vote for their stepdad.  Of course they can’t reduce defense spending to 0% because there are people out there who hate us and want to hurt us.  So when they can’t reduce defense spending anymore they simply borrow money to keep spending.  So they can keep spoiling their stepchildren.  Whose faces light up when they think about all the spending they are going to do.  With the added benefit that they will never have to repay that spending.  Or learn economic reality.  Until, that is, the government gets so overextended they have to implement a little austerity of their own.  Only it won’t last a week like it did for that spoiled child.  Instead it will be more like it was in Greece.  It will last years.  And include some rioting.

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The Easy Credit of Central Banks can’t Stimulate when Recessions are Still Correcting Prices

Posted by PITHOCRATES - July 14th, 2012

Week in Review

Central banks have caused most of our financial woes today.  Easy credit created a frenzy of buying.  Pushing asset prices skyward.  America’s subprime mortgage crisis was caused by easy credit.  Well, that, and bad government policy like forcing lenders to lend even to people who were unqualified.  And they had their government sponsored enterprises (GSE), Fannie Mae and Freddie Mac, unload those toxic mortgages to unsuspecting investors.  You add this to the easy credit of America’s central bank, the Federal Reserve, and it created an incredible housing bubble.  That just didn’t burst.  It exploded.  Sending the U.S. into the greatest recession since the Great Depression.  The Great Recession. 

As housing prices fell back to earth homeowners found themselves underwater in their mortgages.  Some refinanced.  Some just walked away.  Some went through foreclosure.  Leaving the country littered with foreclosed homes.  And all of this financial destruction was brought to us courtesy of the Federal Reserve and their easy credit.  Despite all of this devastation our central bank has caused us some people still think that central banks can stimulate us out of the Great Recession.  Perhaps they’ll finally learn the folly of their thinking (see Roubini: My ‘Perfect Storm’ Is Unfolding Now by Ansuya Harjani, CNBC, posted 7/9/2012 on Yahoo! Finance).

“Dr. Doom” Nouriel Roubini, says the “perfect storm” scenario he forecast for the global economy earlier this year is unfolding right now as growth slows in the U.S., Europe as well as China.

In May, Roubini predicted four elements – stalling growth in the U.S., debt troubles in Europe, a slowdown in emerging markets, particularly China, and military conflict in Iran – would come together in to create a storm for the global economy in 2013…

Policy easing moves by the European Central Bank (ECB), Bank of England (BoE) and the People’s Bank of China (PBoC) last week did little to inspire confidence in global stock markets…

Bill Smead, CEO of Smead Capital Management, agrees that there is little central banks can do arrest the global slowdown.

Last week, he told CNBC that there is “virtually zero chance” that pump-priming by central banks will succeed, suggesting that policymakers should instead let the economic bust work itself through the system.

Yes.  We should let the economic bust work itself through the system.  Because that’s what recessions are supposed to do.  That’s why we call them corrections.  When rising prices create asset bubbles recessions come along and correct these prices back to where they should be.  Where the market would have had them had it not been for all of that easy credit.

Recessions aren’t pleasant.  But it’s the price we must pay.  Especially when we interfere with market forces to keep interest rates artificially low to stimulate economic activity.  Because the economic activity they stimulate is as artificial as the interest rates.  People don’t base their purchasing decisions on supply and demand.  They base them on the availability of easy credit.  Where people say things like, “I had no intention of buying a 3,000 square foot home for me and my wife but at these mortgage rates I’d be a fool not to.  And wouldn’t a Cadillac look just great in the driveway?  At these low interest rates I can afford both.  I mean, it’s not like I’m going to lose my job or anything.”

Of course people do lose their jobs.  And their homes.  And their cars.  What happens then?  Why, we have a subprime mortgage crisis.  And a Great Recession.  That’s what.

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Goldsmiths, Specie, Bank Notes, Bank Reserves, Spanish Dollar, Continentals, Bank of the United States and the Panic of 1819

Posted by PITHOCRATES - June 26th, 2012

History 101

When Spain came to the New World they Brought Home a lot of Gold and Silver and Turned it into Coin

Our first banks were goldsmiths’ vaults.  They locked up people’s gold or other valuable metals (i.e., specie) in their vaults and issued these ‘depositors’ receipts for their specie.  When a depositor presented their receipt to the goldsmith he redeemed it for the amount of specie noted on the receipt.  These notes were as good as specie.  And a lot easier to carry around.  So these depositors used these notes as currency.  People accepted them in payment.  Because they could take them to the goldsmith and redeem them for the amount of specie noted on the receipt.

The amount of specie these first bankers kept in their vaults equaled the value of these outstanding notes.  Meaning their bank reserves were 100%.   If every depositor redeemed their notes at the same time there was no problem.  Because all specie that was ever deposited was still in the vault.  So there was no danger of any ‘bank runs’ or liquidity crises.

When Spain came to the New World they brought home a lot of gold and silver.  And turned it into coin.  Or specie.  The Spanish dollar entered the American colonies from trade with the West Indies.  As the British didn’t allow their colonies to coin any money of their own the Spanish dollar became the dominate money in circulation in commerce and trade in the cities.  (Which is why the American currency unit is the dollar).  While being largely commodity money in the rural parts of the country.  Tobacco in Virginia, rice in the south, etc.  Paper money didn’t enter into the picture until Massachusetts funded some military expeditions to Quebec.  Normally the soldiers in this expedition took a portion of the spoils they brought back for payment.  But when the French repulsed them and they came back empty handed the government printed paper money backed by no specie.  For there was nothing more dangerous than disgruntled and unpaid soldiers.  The idea was to redeem them with future taxation.  But they never did. 

Thomas Jefferson believed that the Combination of Money and Politics was the Source of all Evil in Government 

During the American Revolutionary War the Americans were starving for specie.  They were getting some from the French but it was never enough.  So they turned to printing paper money.  Backed by no specie.  They printed so much that it became worthless.  The more they printed the more they devalued it.  And the fewer people would take it in payment.  Anyone paying in these paper Continentals just saw higher and higher prices (while people paying in specie saw lower prices).  Until some just refused to accept them.  Giving rise to the expression “not worth a Continental.”  And when they did the army had to take what they needed from the people.  Basically giving them an IOU and telling the people good luck in redeeming them.

Skip ahead to the War of 1812 and the Americans had the same problem.  They needed money.  So they turned to the printing presses.  With the aid of the Second Bank of the United States (BUS).  America’s second central bank.  Just as politically contentious as the First Bank of the United States.  America’s first central bank.  The BUS was not quite like those early bankers.  The goldsmiths.  Whose deposits were backed by a 100% specie reserve.  The BUS specie reserve was closer to 10%.  Which proved to be a problem because their bank notes were redeemable for specie.  Which people did.  And because they did and the BUS was losing so much of its specie the government legislated the suspension of the redemption of bank notes for specie.  Which just ignited inflation.  With the BUS.  And the state banks.  Who were no longer bound by the requirement to redeem bank notes for specie either.  Enter America’s first economic boom created by monetary policy.  A huge credit expansion that created a frenzy of borrowing.  And speculation.

When more dollars are put into circulation without a corresponding amount of specie backing them this only depreciated the dollar.  Making them worth less, requiring more of them to buy the same stuff they did before the massive inflation.  This is why prices rise with inflation.  And they rose a lot from 1815 to 1818.  Real estate prices went up.  Fueling that speculation.  Allowing the rich to get richer by buying land that soared in value.  While ordinary people saw the value of their currency decline making their lives more difficult.  Thanks to those higher prices.  The government spent a lot of this new money on infrastructure.  And there was a lot of fraud.  The very reason that Thomas Jefferson opposed Alexander Hamilton’s first Bank of the United States.  The combination of money and politics was the source of all evil in government.  And fraud.  According to Jefferson, at least.  Everyone was borrowing.  Everyone was spending.  Which left the banks exposed to a lot of speculative loans.  While putting so much money into circulation that they could never redeem their notes for specie.  Not that they were doing that anyway.  Bank finances were growing so bad that the banks were in danger of failing.

Most Bad Recessions are caused by Easy Credit by a Central Bank trying to Stimulate Economic Activity 

By 1818 things were worrying the government.  And the BUS.  Inflation was out of control.  The credit expansion was creating asset bubbles.  And fraud.  It was a house of cards that was close to collapsing.  So the BUS took action.  And reversed their ruinous policies.  They contracted monetary policy.  Stopped the easy credit.  And pulled a lot of those paper dollars out of circulation.  It was the responsible thing to do to save the bank.  But because they did it after so much inflation that drove prices into the stratosphere the correction was painful.  As those prices had a long way to fall.

The Panic of 1819 was the first bust of America’s first boom-bust cycle.  The first depression brought on by the easy credit of a central bank.  When the money supply contracted interest rates rose.  A lot of those speculative loans became unserviceable.  With no easy credit available anymore the loan defaults began.  And the bank failures followed.  Money and credit of the BUS contracted by about 50%.  Businesses couldn’t borrow to meet their cash needs and went bankrupt.  A lot of them.  And those inflated real estate prices fell back to earth.  As prices fell everywhere from their artificial heights.

It was America’s first depression.  But it wouldn’t be the last.  Thanks to central banking.  And boom-bust cycles.  We stopped calling these central banking train wrecks depressions after the Great Depression.  After that we just called them recessions.  And real bad recessions.  Most of them caused by the same thing.  Easy credit by a central bank to stimulate economic activity.  Causing an asset bubble.  That eventually pops causing a painful correction.  The most recent being the Great Recession.  Caused by the popping of a great real estate bubble caused by the central bank’s artificially low interest rates.  That gave us the subprime mortgage crisis.  Which gave us the greatest recession since the Great Depression.  Just another in a long line of ‘real bad’ recessions since the advent of central banking.

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Debt Crises in Ireland, Greece, Portugal and now Spain may Prove too much for the Euro to Survive

Posted by PITHOCRATES - June 3rd, 2012

Week in Review

The woods are lovely, dark and deep.  But I have promises to keep.  And miles to go before I sleep.  And miles to go before I sleep.  Lines from a poem by Robert Frost.  For some reason this came to me as I read about the never-ending crisis that is the sovereign debt crisis in Europe.  And the Eurozone.  For the Euro is lost in those dark and lovely woods.  Woods that are so deep that it will never find its way out.  And the only kind of sleep the Euro is going to get is the kind you don’t wake up from (see Britons face £5bn bill to help out Spanish as fears grow that Madrid will have to ask IMF for €300billion bailout by Hugo Duncan And James Salmon posted 6/1/2012 on the Daily Mail).

British taxpayers could be forced to stump up another £5billion to rescue Spain as the crisis in the eurozone spirals out of control.

Fears are mounting that Madrid will have to ask for an emergency bailout of up to £300billion as it struggles to prop up its basket-case banks.

A third of that money could come from the International Monetary Fund – including around £5billion from the UK, even though Britain is not in the eurozone.

UK taxpayers have already coughed up £12.5billion to rescue debt-ridden Greece, Ireland and Portugal…

But growing doubts over how the Spanish government will finance the £15billion needed to rescue Bankia, one of its biggest lenders, have raised fears that it will follow Ireland, Greece and Portugal in requiring a bailout from Europe and the IMF.

This week US investment bank JP Morgan warned a joint rescue of Spain could cost around £300billion.

The Spanish banking system has been crippled by nearly £150billion in toxic property loans.

At the heart of the sovereign debt crisis in Europe is debt.  They have way too much of it.  So much that the odds are not good that they will ever be able to repay it.  Which makes people very reluctant to loan them any more money.  It’s like loaning a friend money who already owes you a lot of money.  Do you loan him more money?  It just may help him turn his life around.  Start anew with a new job.  Earning enough money to support himself and pay you back.  That’s one possibility.  Then there’s the possibility he may just blow the money on booze, drugs and women.  You know he’s just going to spend whatever else you loan him.  And not pay any of it back.  So it would be rather foolish to loan him more money.

This is the decision facing the people who could attempt to bail out those in the Eurozone.  They’ve already loaned them a lot of money.  So these in-trouble countries can sustain the government spending their current tax revenue can’t support.  But the deal was to cut back that spending so they can live on what their tax revenue CAN support.  But there’s only one problem.  The people of these countries reject calls for them to live within their means.  And have had enough of austerity.  And that’s a big problem.  Because if they don’t live within their means they will perpetuate the sovereign debt crisis.  As they will always need to borrow more money to pay for the things that their tax revenue can’t afford.  Until the day this house of cards collapses.  And the longer it goes on the more money people will lose in bad loans to these in-trouble countries.

The central problem in this crisis are bad loans.  Caused by the easy credit policies of central banks to loan money to anyone so they can buy a house.  All this easy credit caused housing booms in countries all around the world.  And housing bubbles.  Then the bubbles burst.  Leaving countries with debt crises as toxic mortgages weakened banking systems everywhere.  And still Keynesian economists are urging central banks to repeat this reckless lending behavior again to stimulate economies.  And to bail out the Eurozone.  The problem is that the central banks have so destroyed their economies no one is borrowing money.  Or spending money.  Because no one thinks the worst has passed.  And businesses and private citizens have learned the lesson from the great debt crisis we’re going through everywhere.  Too much debt is a bad thing.  And are refusing to take on new debt.  And using what income they have to pay down existing debt.  Contrary to all Keynesian doctrine.  For they want reckless and irresponsible spending.  Because they believe only spending is good.

Politicians and central bankers said the situation in the eurozone was unsustainable and drastic action was needed to prevent the ‘disintegration’ of the single currency.

They spoke out as European leaders scrambled to stop the financial crisis in Spain spiralling out of control and infecting other countries such as Italy…

Mario Draghi, president of the European Central Bank, said the eurozone was unsustainable in its current form.

In his sharpest criticism yet of eurozone leaders’ handling of the crisis, he said the European Central Bank could not ‘fill the vacuum’ left by governments in terms of economic growth or structural reforms.

So, no, more easy credit isn’t the solution.  Countries must live within their means.  Which means adopting austerity measures.  And find ways to achieve real economic growth.  Not the kind that leads to bubbles.  Or sovereign debt crises.  And the best way to generate real economic growth is with tax cuts.  Cutting spending as needed so they spend only what their tax revenue can afford.  They must stop running deficits.  And stop borrowing money.  (Good advice for the United States as well).  As the private sector economy picks up because of a more business-friendly tax structure they will create jobs.  So all of those government workers who lost their jobs in the public sector can get new jobs in the private sector.  Whose salaries and benefits will not have to be paid for by more government borrowing.  If they adopt pro-growth policies like this the international community may still be able to help them.  And save the Euro.  But will they?  With all of that public opinion against any more austerity?  Don’t know.  Probably not. 

It’s unlikely that the Euro will ever find its way out of the woods.  For these woods are scary, dark and deep. 

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Low Interest Rates in Canada are creating a Housing Bubble Similar to the one that led to the Great Recession

Posted by PITHOCRATES - February 5th, 2012

Week in Review

Easy credit created a housing bubble in the U.S.  And inflation.  When the Fed increased interest rates to stop that inflation they burst that housing bubble.  And caused the U.S. Subprime Mortgage Crisis.  Which caused the Great Recession. 

Easy credit.  The hallmark of Keynesian economics.  To maintain a small but ‘manageable’ permanent level of inflation.  To make recessions a thing of the past.  But this permanent inflation has only created bubbles.  Like housing bubbles.  Such as the one that led to the Great Recession.  Making it longer and far more painful than it would have been had they left interest rates to market forces.

Credit wasn’t as easy in Canada.  So they escaped much of the fallout from the Great Recession.  But they still practiced Keynesian economics.  Kept interest rates low these past few years to stimulate their economy.  And stimulated they did.  Perhaps a little too much (see Look out below posted 2/4/2012 on The Economist).

When the United States saw a vast housing bubble inflate and burst during the 2000s, many Canadians felt smug about the purported prudence of their financial and property markets. During the crash, Canadian house prices fell by just 8%, compared with more than 30% in America. They hit new record highs by 2010. “Canada was not a part of the problem,” Stephen Harper, the prime minister, boasted in 2010.

Today the consensus is growing on Bay Street, Toronto’s answer to Wall Street, that Mr Harper may have to eat his words. In response to America’s slow economic recovery and uncertainty in Europe, the Bank of Canada has kept interest rates at record lows. Five-year fixed-rate mortgages now charge interest of just 2.99%. In response, Canadians have sought ever-bigger loans for ever-costlier homes. The country’s house prices have doubled since 2002…

Bankers are becoming alarmed. Mark Carney, the governor of the central bank, has been warning for years that Canadians are consuming beyond their means. The bosses of banks with big mortgage businesses, including CIBC, Royal Bank of Canada and the Bank of Montreal, have all said the housing market is at or near its peak. Canada’s ratio of household debt to disposable income has risen by 40% in the past decade, recently surpassing America’s (see chart). And its ratio of house prices to income is now 30% above its historical average—less than, say, Ireland’s excesses (which reached 70%), but high enough to expect a drop. A recent report from Bank of America said Canada was “showing many of the signs of a classic bubble”…

However, the state has refused to use its most powerful tool. To protect business investment, the central bank has made clear that it plans to keep interest rates low. As long as money stays cheap, the balloon could get bigger—perhaps big enough to become a fully fledged bubble after all.

So, to further stimulate the economy (i.e., to protect business investment) they are keeping interest rates low.  When all the signs indicate that this economic growth is growing a rather large real estate bubble.  Normally a good time to start raising interest rates.  So housing prices don’t get so high that when they fall they hurt.  Like they did in the U.S.  Where they fell over 30%.  And are still falling in some areas.  And when they fall from that height it hurts.  It really hurts.  Just ask someone whose mortgage is underwater.  Where their mortgage is greater than the current price of their house.  You can ask just about any homeowner in the U.S.  Or, perhaps, any homeowner in Canada in the not so distant future.

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