Alan Greenspan blames Irrational Risk-Taking and not his Keynesian Policies for the Subprime Mortgage Crisis

Posted by PITHOCRATES - October 26th, 2013

Week in Review

Since the Keynesians took over monetary policy we’ve had the Great Depression, the inflation racked Seventies, the dot-com bubble/recession of the late 1990s/early 2000s and the subprime mortgage crisis.  It’s also given Japan their Lost Decade, a deflationary spiral that started in the late Eighties that they are still fighting today.  As well as the sovereign debt crisis still ongoing in Europe.  So Keynesian economics has a record of failure.  Yet governments everywhere embrace it.  Why?  Because they love having the power to create money.  Especially when it’s ostensibly for helping the economy.  Which it never does.  As efforts to do so resulted in the carnage noted above.  But it always gives a good excuse for another surge in government spending.  And Keynesians love government spending.

Why does Keynesian economics fail?  Alan Greenspan, former chairman of the Federal Reserve whose policies helped create some of this carnage (dot-com bubble and subprime mortgage crisis), explains (see Greenspan ponders the roots of a financial crisis he failed to foresee by Martin Crutsinger, The Associated Press, posted 10/21/2013 on The Star).

Now, Alan Greenspan has struck back at any notion that he — or anyone — could have known how or when to defuse the threats that triggered the crisis. He argues in a new book, The Map and the Territory, that traditional economic forecasting is no match for the irrational risk-taking that can inflate catastrophic price bubbles in assets like homes or tech stocks.

This is why the Soviet Union lost the Cold War.  Because their managed economy failed.  As all managed economies fail.  Because it is impossible to know the decisions of hundreds of million people in the market.  These people making decisions for themselves result in economic activity.  But when governments try to decide for them you get Great Depressions, debilitating inflation, bubbles and nasty recessions.  As well as the collapse of the Soviet Union.

People only took irrational risks when the Federal Reserve (the Fed)/government interfered with market forces.  The dot-com bubble grew because the Fed kept interest rates artificially low.  So was it irrational for people to take advantage of those artificially low interest rates and make risky investments they otherwise wouldn’t have made?  Yes.  But if the Fed didn’t keep them artificially low in the first place there would have been no dot-com bubble in the second place.

Was it irrational for people to buy houses they couldn’t afford when the Clinton administration forced lenders to qualify the unqualified for mortgages they couldn’t afford?  Was it irrational behavior for people to buy houses they couldn’t afford because of artificially low interest rates, ‘cheap’ adjustable rate mortgages, zero-down mortgages, interest only mortgages and no-documentation mortgages?  Yes.  But if the Fed/government did not interfere with market forces in the first place to increase home ownership (especially among those who couldn’t qualify for a conventional mortgage) there would have been no subprime housing bubble in the second place.

The problem with Keynesians is they call anyone who doesn’t behave as they hope to make people behave with their policies irrational.  That is, people are irrational if they don’t think like a Keynesian and therefore cause Keynesian policies to fail.  But before there could be irrational exuberance there has to be a climate that encourages irrational exuberance first.  For if we went back to the banking system where our savings rate determined our interest rates as well as the investment capital available there would be no bubbles.  And no irrational exuberance.  What kind of a banking system would that be?  The kind that vaulted the United States from their Founding to the number one economic power in the world in about one hundred years.  And they did that without making money.  Unlike today.

Q: The size of the Federal Reserve’s balance sheet stands at a record $3.7 trillion, reflecting all the Treasurys and mortgage-backed securities the Fed has bought to push long-term interest rates down. You have expressed concerns about this size, which is more than four times where the balance sheet stood before the start of the financial crisis. What are your worries?

A: My basic concern is that we have to rein this thing in well before the demand for funds picks up and makes it very difficult to rein in. (Inflation) is not immediate. It is down the road. But historically, there are no cases where central banks blow up their balance sheets or where countries print money which doesn’t hit (with higher inflation).

The balance sheet is four times what it was before the Great Recession?  That’s an enormous amount of new money created to stimulate the economy.  And yet we’re still wallowing in the worst economic recovery since that following the Great Depression.  I don’t know how much more you can prove the failure of Keynesian economics than this.  About five years of priming the economic pump with stimulus stimulated little.  Other than rich Wall Street investors who are using this easy money to make more money.  While the median household income falls.

Keynesian economics attacks the middle class.  While enriching the ruling class.  And their crony friends on Wall Street.  These policies further the divide between the rich and everyone else.  Yet they continually say these same policies are the only way to reduce the divide between the rich and everyone else.  The historical record doesn’t prove this.  And those familiar with the historical record know this.  Which is why the left controls public education.  So people don’t learn the historical record.  Because once they do it becomes harder to win elections when you’re constantly lying to the American people.

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Keynesian Economics Destroyed Good Lending Practices at our Banks and gave us the Subprime Mortgage Crisis

Posted by PITHOCRATES - August 11th, 2013

Week in Review

In the days of classical economics, before Keynesian economics, people put their money into a bank to earn interest.  The banks gathered all of these deposits together and created a pool of investment capital.  People and businesses then went to the banks to borrow this capital to invest into something.  A house to start a new family in.  Or a factory.  And the more people saved the more money there was to loan to investors.  Which kept the cost of borrowing that money reasonable.  And created booming economic activity.

It was a beautiful system.  And one that worked so well it made the United States the number one economic power in the world.  Then John Maynard Keynes came along and ruined that proven system.  By telling governments that they should intervene into their economies.  That they should manipulate the interest rates.  By printing money.  Which changed the banking system forever (see The Housing Market Is Still Missing a Backbone by GRETCHEN MORGENSON posted 8/10/2013 on The New York Times).

Yet with the government backing or financing nine out of 10 residential mortgages today, it is crucial to lure back private capital, with no government guarantees, to the home loan market. Mr. Obama contended that “private lending should be the backbone” of the market, but he provided no specifics on how to make that happen.

This is a huge, complex problem. In fact, there are many reasons for the reluctance of banks and private investors to fund residential mortgages without government backing.

For starters, banks have grown accustomed to earning fees for making mortgages that they sell to Fannie and Freddie. Generating fee income while placing the long-term credit or interest rate risk on the government’s balance sheet is a win-win for the banks.

A coming shift by the Federal Reserve in its quantitative easing program may also be curbing banks’ appetite for mortgage loans they keep on their own books. These institutions are hesitant to make 30-year, fixed-rate loans before the Fed shifts its stance and rates climb. For a bank, the value of such loans falls when rates rise. This process has already begun — rates on 30-year fixed-rate mortgages were 4.4 percent last week, up from 3.35 percent in early May. This is painful for banks that actually hold older, lower-rate mortgages.

In other words, the federal government’s intervention into the private sector economy caused the subprime mortgage crisis.  And the Great Recession.  By removing all risk from the banking industry by transferring it to the taxpayer.  This created an environment that encouraged lenders to adopt poor lending standards.  Because they made their money on loan initiation fees.  No matter how risky those loans were.  And not by managing a portfolio of performing mortgages.  Which kept the bank honest when writing a loan.  As they would feel the pain if the borrower did not make his or her loan payments.  But if they sold those loans and broomed them off of their balance sheets what would they care if these people ever serviced their loans?

This is what you get with government intervention into the free market.  Distortions of the free market.  Keynesian economics was supposed to get rid of recessions.  By cutting away half of the business cycle.  And just keeping the inflationary side of it.  Trading permanent inflation for no recessions ever.  But since the Keynesians began intervening we’ve had a Great Depression.  A subprime mortgage crisis.  And a Great Recession.  All because they tried to improve the free market.  Which also, coincidentally, enabled Big Government.  The ultimate goal of Keynesian economics.  To get smart government planners in control of our lives.  Just like they were in the former Soviet Union.  But revolutions are messy.  So the government planners bided their time.  And slow-walked their way to power.  First they took control of the banks.  And now they have health care.  Which they will destroy.  Just as they destroyed good lending practices.  Which have given us the worst economic recovery since that following the Great Depression.

Anytime you move away from capitalism things get worse.  When this nation embraced free market capitalism we became the number one economic power in the world.  And the destination for oppressed people everywhere in the world.  For the better life that was available in America.  While the nations that chose the state planning of socialism and communism became those places oppressed people wanted to flee.  And life in those nations only got better with a move towards capitalism.  China may soon become the world’s number one economic power.  But they’re not doing this by adhering strictly to their state-planning ways of Mao’s China.  No.  They are doing this by moving away from the state-planning of Mao’s China.  To something called state-capitalism.  Pseudo-capitalism.  Just hints and traces of capitalism simmering in state-planning stew.  Where communist planners still control the people’s lives.  A direction America is slow-walking itself to.  Slowly.  But surely.

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If you Missed the U.S. Subprime Mortgage Crisis you might be able to catch one in South Korea

Posted by PITHOCRATES - February 23rd, 2013

Week in Review

Stop me if you heard this one before (see S. Korea’s Poisoned Chalice of Household Debt Restricts Park by Sangwon Yoon posted 2/21/2013 on Bloomberg).

Park [Geun Hye, Korea’s incoming president] suggested state institutions could buy stakes in mortgaged apartments that have fallen in value, such as Kwon’s. The stakes would then be used as collateral for asset-backed securities, using rent from homeowners to pay interest to investors…

South Korean regulators have been working on a “soft landing” policy since June 2011, including limits on bank lending and tax breaks for homeowners switching to fixed-rate loans. About 85.8 percent of mortgages are currently adjustable…

“The quality of household debt is worsening,” said Lee Eun Mi, senior research fellow at Samsung Economic Research Institute in Seoul. Park needs “measures to stymie the rising danger of a massive default crisis…”

Some borrowers have staved off default by taking out further loans to pay mortgage interest…

Irresponsible household borrowing began after the 1997-1998 Asian financial crisis, said Kim Mi Sun, a debt counselor at a non-profit organization called Edu Money in Seoul. In the wake of corporate defaults during the crisis, the government curbed companies’ ability to sell credit, prompting banks to expand lending to consumers, including a rapid increase in home loans.

“It became so much easier to get loans after the crisis and everyone started taking out debts and mortgages they couldn’t afford,” said Kim. “The crux of the issue is that people simply don’t know how to manage their finances.”

The credit boom early in the last decade caused house prices to soar and left many Koreans with large loan obligations.

Sound familiar?  Sounds a lot like the subprime mortgage crisis, doesn’t it?  Easy credit encouraged a lot of people to buy houses they couldn’t afford with adjustable rate mortgages (ARM).  Just like in the United States following President Clinton’s Policy Statement on Discrimination in Lending.  Where the president told lenders that they had better find a way to qualify the unqualified or else.  Which they did.  With subprime lending.  And the ARM.  And when the interest rates reset at higher rates there was a massive default crisis.

Interestingly Park Geun Hye is suggesting a solution to help underwater mortgages that the U.S. used to spread the subprime mortgage crisis contagion around the world.  The collateralized debt obligation (CDO).  Fannie Mae and Freddie Mac bought the toxic subprime mortgages and packaged them into CDOs.  And unloaded them on unsuspecting investors.  Telling them that they were high yield.  And low risk.  Because their return came from the cash flows of homeowners making mortgage payments.  And what was less risky than mortgage payments?  Of course, what they failed to mention was that these were ARMs sold to low-income people who had no hope of paying their mortgage payments if interest rates ever rose.  Which they did.  Sending the fallout of the subprime mortgage crisis around the world.

No.  CDOs may not be the best solution to their problems.  And chances are that investors may not buy these.  For they were burned once by Fannie Mae and Freddie Mac.  And they’re probably not going to fall for the old ‘investment backed by cash flows from subprime mortgages’ trick again.

Amazing how some things never change.  Different place.  Different people.  But the same bad government policies.  Producing the same massive default crisis.  This is what you get when you interfere in the free market economy.  But some people never learn this lesson.  Despite the numerous examples of what not to do.  And if anyone taught people what NOT to do was the U.S. in the run-up to the subprime mortgage crisis.  Even the Americans can’t learn from their own lesson as President Obama is already talking about bringing back the policies that caused the subprime mortgage crisis in the first place.  Putting more people into houses that they can’t afford.

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The Democrats issue new Lending Regulations to address the Financial Crisis they Created

Posted by PITHOCRATES - January 13th, 2013

Week in Review

The subprime mortgage crisis is still a political football.  The Democrats are using the crisis to further regulate the financial markets.  Giving us the convoluted Dodd-Frank Wall Street Reform and Consumer Protection Act.  Financial reform.  For apparently there was no financial oversight of the financial markets up until now.  Despite Barney Frank being the Chairman of the House Financial Services Committee (2007-2011).  And Chris Dodd being the Chairman of the Senate Committee on Banking, Housing, and Urban Affairs (2007-2011).  Both of who were responsible for the oversight of Fannie Mae and Freddie Mac.  The GSEs at the center of the subprime mortgage crisis (see Mortgage lender rules released by Daniel Wagner, Associated Press, posted 1/10/2013 on The Washington Times).

In the wake of the national housing collapse that helped bring on the Great Recession, federal regulators for the first time are laying out rules aimed at ensuring that borrowers can afford to pay their mortgages.

The long-anticipated rules being unveiled Thursday by the Consumer Financial Protection Bureau impose a range of obligations and restrictions on lenders, including bans on the risky “interest-only” and “no documentation” loans that helped inflate the housing bubble…

CFPB Director Richard Cordray, in remarks prepared for an event Thursday, called the rules “the true essence of responsible lending…”

Mr. Cordray noted that in the years leading up to the 2008 financial crisis, consumers could easily obtain mortgages that they could not afford to repay.

So, prior to the Great Recession and the 2008 financial crisis we did not have responsible lending.  Which resulted in consumers obtaining mortgages they could not afford to repay.  Why?  Why were people getting mortgages they had no chance of repaying?  Who was responsible for that?  Well, as it turns out it was President Clinton.  Whose administration overhauled the Community Reinvestment Act (see New Study Finds CRA ‘Clearly’ Did Lead To Risky Lending by Paul Sperry posted 12/20/2012 on Investors.com)

Democrats and the media insist the Community Reinvestment Act, the anti-redlining law beefed up by President Clinton, had nothing to do with the subprime mortgage crisis and recession.

But a new study by the respected National Bureau of Economic Research finds, “Yes, it did. We find that adherence to that act led to riskier lending by banks.”

Added NBER: “There is a clear pattern of increased defaults for loans made by these banks in quarters around the (CRA) exam. Moreover, the effects are larger for loans made within CRA tracts,” or predominantly low-income and minority areas.

To satisfy CRA examiners, “flexible” lending by large banks rose an average 5% and those loans defaulted about 15% more often, the 43-page study found…

The strongest link between CRA lending and defaults took place in the runup to the crisis — 2004 to 2006 — when banks rapidly sold CRA mortgages for securitization by Fannie Mae and Freddie Mac and Wall Street.

CRA regulations are at the core of Fannie’s and Freddie’s so-called affordable housing mission. In the early 1990s, a Democrat Congress gave HUD the authority to set and enforce (through fines) CRA-grade loan quotas at Fannie and Freddie.

It passed a law requiring the government-backed agencies to “assist insured depository institutions to meet their obligations under the (CRA).” The goal was to help banks meet lending quotas by buying their CRA loans.

But they had to loosen underwriting standards to do it. And that’s what they did…

From 2001-2007, Fannie and Freddie bought roughly half of all CRA home loans, most carrying subprime features…

Housing analysts say the CRA is the central thread running through the subprime scandal — from banks and subprime lenders to Fannie and Freddie to even Wall Street firms that took most of the heat for the crisis…

While the 1977 law was passed 30 years before the crisis, it underwent a major overhaul just 10 years earlier. Starting in 1995, banks were measured on their use of innovative and flexible” lending standards, which included reduced down payments and credit requirements.

Banks that didn’t meet Clinton’s tough new numerical lending targets were denied merger plans, among other penalties. CRA shakedown groups like Acorn held hostage the merger plans of banks like Citibank and Washington Mutual until they pledged more loans to credit-poor minorities (see chart).

A Democrat Congress gave HUD the authority to set and enforce (through fines) CRA-grade loan quotas at Fannie and Freddie?  And Democrats say that Community Reinvestment Act had nothing to do with the 2008 financial crisis?  Funny.  Based on the historical record the Democrat Congress that forced lenders to loosen underwriting standards to meet those quotas are solely responsible for setting into motion the events that led to the 2008 financial crisis.  Not Wall Street.  Not the banks.  It was the Democrat Congress that empowered HUD to destroy good lending practices.  And they bear the responsibility for the 2008 financial crisis.  And the Great Recession.

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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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Great Depression, Monetary Expansion, Keynesian, Smoot Hawley Tariff, Gold Window, Subprime Mortgage Crisis and Great Recession

Posted by PITHOCRATES - October 2nd, 2012

History 101

There was Real Economic Activity in the Twenties so the Great Depression should only have been a Recession

The Great Depression began with the Stock Market Crash of 1929.  Which led to a period of record unemployment.  On average the unemployment rate was 13.46% during the Thirties.  Or, if you don’t count all of the make-work government jobs, 18.23%.  So what caused this unemployment?  Was it the expansionary monetary policy of the Twenties?  The Keynesians thought so.  Even the economists from the Austrian school of economics thought so.  The only ones to have predicted the Great Depression.  So were they right?  A little bit.

Yes, there was monetary expansion during the Twenties.  So a recessionary correction was inevitable.  But a depression?  When you look at the economic activity of the Twenties, no.  The Roaring Twenties were a transformative time.  It was when we began to say goodbye to the steam engine.  And said hello to electricity.  We said goodbye to the horse and buggy.  And said hello to the automobile.  We said goodbye to the horse and plow.  And said hello to the tractor.  As well as said hello to radio, motion pictures, air travel, electric lighting and electric appliances in the home, etc.  So there was real economic activity in the Twenties.  It wasn’t all a bubble.  So the Great Depression should have only been a regular recession.  But it wasn’t.  So what happened?

Government.  The government interfered with market forces.  Based on Keynesian advice.  They said the government needed to increase aggregate demand.  As that demand would encourage businesses to expand and hire new workers.  Thus lowering the unemployment rate.  And part of increasing demand was keeping wages from falling.  So people had more money to spend.  Of course, if employers were to continue to pay higher wages that meant that prices could not fall.  Like they normally do during a recession.  So the Keynesian advice was to prevent the market from correcting prices to match supply to demand.  Prolonging the inevitable recession.  But there was more bad government policy.

The Keynesian Cure for Unemployment is Inflation

The stock market was soaring in the late Twenties.  Because of that real economic growth.  So what happened to that economic growth?  Well, in part, the Smoot Hawley Tariff of 1930.  Which was in committee in 1929 before the great crash.  But investors saw it coming.  And they knew tariffs rising as much as 50% were going to cool those hot earnings they’ve been enjoying.  As well as Herbert Hoover’s progressive plans.  Who would go on to double income tax rates.  When Herbert Hoover won the 1928 election the writing was on the wall.  And investors bailed.  Especially when the Smoot Hawley Tariff was moving through committee.  Because raising the cost of doing business does not help business.  So the great earnings ride of the Twenties was ending and the investors sold their stocks to lock in their profits.  Precipitating the Stock Market Crash of 1929.  And the record unemployment that would follow.  And the Great Depression.

So the Keynesians got it wrong during the Thirties.  Their next grand experiment would be in the Seventies.  As government spending took off thanks to the Vietnam War, the Great Society and the Apollo moon program.  There was so much spending that they had to print money to pay for it all.  As they did, though, they devalued the dollar.  Which became a problem.  As the U.S. at the time agreed to exchange gold for dollars at $35/ounce.  So when the Americans made their dollar worth less our trading partners decided to take our gold instead.  Gold flew out of the gold window.  So to stop this gold flow out of the country Nixon did what any Keynesian would do.  No, he didn’t cut back spending.  He decoupled the dollar from gold.  Slamming the gold window shut.  Without any advanced warning to the world.  So we now call this action he took on August 15, 1971 the Nixon Shock.  The Keynesians were thrilled.  Because they now had no restraint in printing new money.

The reason Keynesians were happy to be able to print more money was because that was their cure for unemployment.  Inflation.  When the economy goes into recession it was just a simple matter of expanding the money supply.  Which lowers interest rates.  Which makes businesses who had no intention to expand their businesses borrow money to expand their businesses.  So to pull the economy out of recession they inflated the money supply.  And did it work?  No.  Of course it didn’t.  It just raised prices.  Increasing the cost of business.  As well as leaving consumers with less real income.  So, no, the economy didn’t improve.  It just stagnated.  The average unemployment rate during the Seventies was 6.21%.  While the average inflation rate was 7.08%.  Also, the top marginal tax rate of 70%.  Which didn’t help the anti-business environment.

The Subprime Mortgage Crisis and the Great Recession were Direct Consequences of Bad Monetary Policy

So the Keynesians failed.  Again.  Their inflationary monetary policy only made things worse during the Seventies.  All of that inflation just kept pushing prices ever higher.  Ensuring that the inevitable recession to correct those prices would be long and painful.  Which it was.  In the early Eighties.  Then Paul Volcker rang out all of that inflation.  And Ronald Reagan began bringing the top marginal tax rate down until it was at 28% by the end of the decade.  Making a more favorable business environment.  So business grew.  And began to hire new workers.  Teaching an economic lesson some in government refused to learn.  Keynesian inflationary monetary policies did not work.

During the Nineties the Keynesians were back.  Inflating the money supply slowly but surely to continue an economic expansion.  Making money available to borrow.  And borrow it people did.  Creating a long and sustained housing boom that would last for about 2 decades.  That expansionary monetary policy gave us cheap mortgages.  Making it very easy to buy a house.  Housing prices rose.  And continued to rise during those two decades.  Then President Clinton had his Justice Department tell banks to lower their standards for approving mortgages for the unqualified.  So everyone could buy a house.  Even if they couldn’t afford to pay for it.  Ushering in the subprime mortgage industry.  Further increasing the demand for houses.  And further driving up housing prices.  Making the inevitable correction a long and painful one.

Meanwhile, there was something new in the market place in the Nineties.  The Internet.  And new Internet start-ups (dot-coms) flooded the market.  Investors poured money into them.  Even though they didn’t have a product to sell.  And had no earnings.  But investors were exuberant.  And irrational.  Kids flooded into universities to get degrees in computer science.  To staff all of those Internet start-ups.  Companies went public.  Creating a stock market bubble as investors scrambled to buy their stock.  They raised a boatload of money from those IPOs.  And spent it all.  Many without producing anything to sell.  And when that money ran out they went bankrupt.  Bursting that stock market bubble.  And throwing a lot of computer scientists out of a job.  Causing a painful recession in the early 2000s that George Bush helped mitigate with tax cuts.

And low interest rates.  People were back buying houses.  But this time they were buying McMansions.  Because that easy monetary policy gave us cheap mortgage rates.  And subprime, no-documentation, zero down loans, etc., made it easier than ever to buy a house.  Housing prices soared.  And builders flooded the market with more McMansions.  Pushing prices ever higher.  Fannie Mae and Freddie Mac were buying those toxic subprime mortgages from banks to encourage them to approve more toxic subprime mortgages.  Pushing the inevitable correction further and further out.  Running up prices so high that their fall would be a long and painful one.  Which it was when the subprime mortgage crisis hit.  As well as the Great Recession.  Direct consequences of bad monetary policy.  And the government’s interference into market forces.

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Chinese Government fights Asset Bubbles and Speculation, Housing Prices Fall as does Economic Activity

Posted by PITHOCRATES - April 21st, 2012

Week in Review

The Chinese housing market isn’t what it was.  Which can be quite the problem considering the housing boom was 13% of China’s GDP (see China new home prices slide for sixth consecutive month posted 4/18/2012 on BBC News Business).

Property prices in China have fallen for a sixth consecutive month amid government efforts to control prices and curb speculation.

New home prices in 46 out of 70 Chinese cities fell between February and March. Meanwhile prices were lower than a year ago in 38 cities.

There have been fears of the formation of asset bubbles in China…

The booming housing industry supported China’s expansion in recent years, with real estate investment making up 13% of the nation’s gross domestic product in 2011…

“The ultimate goal of the property tightening is to drive down prices but maintain growth in construction and investment.”

Hey, this kind of sounds familiar.  Prior to 2008, the U.S. housing market was red hot.  People were being approved for mortgages they didn’t have a chance in hell of being able to repay.  And house flippers were walking in and getting mortgages for zero down.  Fixing them up and putting them back on the market.  The subprime mortgage made both of these possible.  And the government was doing everything within its power to put as many people in houses as possible.  Keeping interest rates artificially low.  And having their GSEs Fannie Mae and Freddie Mac buy up toxic subprime mortgages from banks and unloading them onto unsuspecting investors in the guise of ‘safe’ mortgage-backed securities.   The economy was booming.  Then the housing bubble burst.  As did the economy. 

The lesson here is the same the Japanese learned in the Nineties.  If you put your housing market on government steroids (artificially low interest rates, laws to force lenders t make bad loans, loan guarantees, etc.) it will crash and burn one day.  And if you keep building houses you will lower prices on homes already built.  The houses people are paying mortgages on.  And if you build enough new houses the value of the older houses will be less than the mortgage they’re paying.  Especially after the bubble bursts.  And you see how well that worked out in the U.S.  Suffice it to say President Obama is not running for reelection on his economic record.

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Monetary Policy

Posted by PITHOCRATES - January 30th, 2012

Economics 101

Monetary Policy created the Housing Bubble and the Subprime Mortgage Crisis

Those suffering in the fallout of the Subprime Mortgage Crisis can thank monetary policy.  That tool used by the federal government that kept interest rates so low for so long.  Following the old Milton Friedman idea of a permanent level of inflation (but small and manageable) to stimulate constant economic growth.  Why?  Because when people are buying houses the economy is booming.  Because it takes a lot of economic activity to build them.  And even more to furnish them.  Which means jobs.  Lots and lots of jobs.

But there is a danger in making money too cheap to borrow.  A lot of people will borrow that cheap money.  Creating an artificial demand for ever more housing.  And not for your parent’s house.  But bigger and bigger houses.  The McMansions.  Houses 2-3 times the size of your parent’s house.  This demand ran up the price of these houses.  Which didn’t deter buyers.  Because mortgage rates were so low.  People who weren’t even considering buying a new house, let alone a McMansion, jumped in, too.  When the jumping was good.  To take advantage of those low mortgage rates.  There was so much house buying that builders got into it, too.  House flippers.  Who took advantage of those cheap ‘no questions asked’ (no documentation) mortgages (i.e., subprime) and bought houses.  Fixed them up.  And put them back on the market.

Good times indeed.  But they couldn’t last.  Because those houses weren’t the only thing getting expensive.  Price inflation was creeping into the other things we bought.  And all those houses at such inflated prices were creating a dangerous housing bubble.  So the Federal Reserve, America’s central bank, tapped the brakes.  To cool the economy down.  To reduce the growing inflation.  By raising interest rates.  Making mortgages not cheap anymore.  So people stopped buying houses.  Leaving a glut of unsold houses on the market.  Bursting that housing bubble.  And it got worse.  The higher interest rate increased the monthly payment on adjustable rate mortgages.  A large amount of all those subprime mortgages.  Causing many people to default on these mortgages.  Which caused the Subprime Mortgage Crisis.  And the Great Recession.

The Federal Reserve System conducts Monetary Policy by Changing both the Money Supply and Interest Rates

Money is a commodity.  And subject to the laws of supply and demand.  When money is in high demand (during times of inflation) the ‘price’ of money goes up.  When money is in low demand (during times of recession) the ‘price’ of money goes down.  The ‘price’ of money is interest.  The cost of borrowing money.  The higher the demand for loans the higher the interest rate.  The less the demand for loans the lower the interest rate.

So there is a relationship between money and interest rates.  Adjusting one can affect the other.  If the money supply is increased the interest rates will decrease.  Because there is more money to loan to the same amount of borrowers.  When the money supply is decreased interest rates will increase.  Because there will be less money to loan to the same amount of borrowers.  And it works the other way.  If the interest rates are lowered people respond by borrowing more money.  Increasing the amount of money in the economy buying things.  If interest rates are raised people respond by borrowing less money.   Reducing the amount of money in the economy buying things.  We call these changes in the money supply and interest rates monetary policy.  Made by the monetary authority.  In most cases the central bank of a nation.  In the United States that central bank is the Federal Reserve System (the Fed).

The Fed changes the amount of money in the economy and the interest rates to minimize the length of recessions, combat inflation and to reduce unemployment.  At least in theory.  And they have a variety of tools at their disposal.  They can change the amount of money in the economy through open market operations.  Basically buying (increasing the money supply) or selling (decreasing the money supply) treasury bills, government bonds, company bonds, foreign currencies, etc., on the open market.  They can also buy and sell these financial instruments to change interest rates.  Such as the Federal funds rate.  The interest rate banks pay when borrowing from each other.  Moving money between their accounts at the central bank.  Or the Fed can change the discount rate.  The rate banks pay to borrow from the central bank itself.  Often called the lender of last resort.  Or they can change the reserve requirement in fractional reserve banking.  Lowering it allows banks to loan more of their deposits.  Raising it requires banks to hold more of their deposits in reserve.  Not used much these days.  Open market operations being the monetary tool of choice.

There is more to Economic Activity than Monetary Policy

Fractional reserve banking multiplies these transactions.  Where banks create money out of thin air.  When the Fed increases the money supply a little this creates a lot of lendable funds.  As buyers borrow money from some banks and pay sellers.  Then sellers deposit that money in other banks.  And these banks hold a little of these deposits in reserve.  And loan the rest.  Borrowers create depositors as buyers meet sellers.  And complete economic transactions.  When the Fed reduces the money supply a little this process works in reverse.  Fractional reserve banking pulls a lot of money out of the economy.  Some treat these economic transactions, and the way to increase or decrease them, as simple math.  Always obeying their mathematical formulas.  We call these people Keynesian economists.  Named for the economist John Maynard Keynes.

Big interventionist governments embrace monetary policy.  Because they think they can easily manipulate the economy as they wish.  So they can tax and spend (Keynesian fiscal policy).  And when economic activity declines they can simply use monetary policy to restore it.  But there is one problem.  It doesn’t work.  If it did there would not have been a Subprime Mortgage Crisis.  Or any of the recessions we’ve had since the advent of central banking.  Including the Great Depression.  As well as the Great Recession.

There is more to economic activity than monetary policy.  Such as punishing fiscal policy (high taxes and stifling regulations).  Technological innovation.  Contracts.  Property rights.  Etc.  Any one of these can influence risk takers.  Business owners.  Entrepreneurs.  The job creators.  The people who create economic activity.  And no amount of monetary policy will change this.

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Write in Hillary Clinton if you want more Economic Destruction

Posted by PITHOCRATES - December 24th, 2011

Week in Review

There’s talk about Hillary and Condi on the 2012 ticket.  On opposing parties, of course.  Both have denied any interest to be on the 2012 ticket.  Or any future elected office for that matter.  But no matter.  There’s still hope on their respective sides.  Which isn’t all that interesting.  But what is interesting is what some thing a Hillary Clinton presidency would deliver (see Are Condi and Hillary about to join the 2012 race? Rivals tipped to run for VP (and the top job in 2016) by Meghan Keneally posted 12/19/2011 on the Mail Online).

Politico reports that a group called Run Hillary 2012 arranged automated phone messages to call voters in New York, Florida and North Carolina.

‘America would be better off today if Hillary Clinton was our president. The Wall Street robber barons would be jailed, young people could afford college and find jobs and six million home owners wouldn’t face foreclosure. We need to change our course. Please sign our petition to draft Hillary Clinton for president,’ the message said.

It was her husband, Bill Clinton, who carries a far greater responsibility for the Great Recession than Wall Street robber barons.  His Policy Statement on Discrimination in Lending put pressure on mortgage lenders to qualify the unqualified.  The rest is history.  And the Great Recession.  But that’s old news.

Would Hillary cap university professors’ pay and benefits?  To bring down the high cost of college tuition?  Somehow I don’t think that’s what the ‘draft Hillary’ people mean.  I think they mean to have other people pay for college and mortgages.  Through higher taxes.  As for those jobs?  That’s a head scratcher.  Because you don’t create jobs in the private sector by raising taxes.  So the jobs they’re talking about will probably be more government jobs.  Paid for by more taxes.  Which will, of course, stifle economic growth further.  And hinder job creation in the private sector.

So if you want more economic destruction, write in Hillary Clinton.  I guess.

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After Enabling the Subprime Mortgage Crisis, Fannie and Freddie are still Losing Money and want Another Bailout

Posted by PITHOCRATES - November 13th, 2011

Week in Review

Fannie Mae and Freddie Mac are still losing money.  And are now asking for another taxpayer bailout.  Imagine that (see Falling home prices leads to bigger Fannie Mae loss; asks taxpayers for $7.8 billion more by the Associated Press posted 11/8/2011 on The Washington Post).

Mortgage giant Fannie Mae is asking the federal government for $7.8 billion in aid to cover its losses in the July-September quarter…

Michael Williams, Fannie’s president and CEO, said Fannie’s losses are increasing for two reasons: Some homeowners are paying less interest after refinancing at historically low mortgage rates; others are defaulting on their mortgages.

When property values drop, homeowners default, either because they are unable to afford the payments or because they owe more than the property is worth. Because of the guarantees, Fannie and Freddie must pay for the losses.

The problem now isn’t low mortgage rates and defaults.  That was the problem when government policy used Fannie and Freddie to create a housing bubble.  This is what gave us the subprime mortgage crisis.  Putting people into houses they couldn’t afford.  By forcing banks to qualify the unqualified.  And then having Fannie and Freddie buy these toxic mortgages from the banks.  So the banks could qualify more of the unqualified.  And continue the cycle.  All the while putting more and more risk onto the American taxpayer.  Because, as we have seen, it is the American taxpayer that bailed out Fannie and Freddie.  And now they’re asking for more money.

Government created the subprime mortgage crisis.  With their enablers of bad credit Fannie and Freddie.

Washington-based Fannie and McLean, Va.-based Freddie own or guarantee about half of all mortgages in the U.S., or nearly 31 million home loans. Along with other federal agencies, they backed nearly 90 percent of new mortgages over the past year.

Fannie and Freddie buy home loans from banks and other lenders, package them with bonds with a guarantee against default and sell them to investors around the world. The companies nearly folded three years ago because of big losses on risky mortgages they purchased.

This wasn’t the banks on Wall Street causing this mess.  The deed was already done by the time they sold those toxic mortgages.  For had it not been for Fannie and Freddie they would have been no toxic mortgages for Wall Street to sell.  And no subprime mortgage crisis.

And there would have been no Fannie and Freddie mess without their overseers.  The federal government.  And their policy to put as many people into houses.  Whether they could afford it or not.

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