Thoughts, essays, and writings on Liberty. Written by the heirs of Patrick Henry.

March 23, 2007

Ron Paul — Federal Reserve To Blame For Housing Bubble

by Brad Warbiany

I’ve been one of the doomsayers regarding America’s economy, with the impending collapse of the subprime lending market (which I think will create a nasty recession). As with any economic downturn, the government and the media will be looking for someone to blame. Ron Paul suggests that we place our sights directly on the Fed.

When the bubble finally bursts completely, millions of Americans will be looking for someone to blame. Look for Congress to hold hearings into subprime lending practices and “predatory” mortgages. We’ll hear a lot of grandstanding about how unscrupulous lenders took advantage of poor people [ed: Chris Dodd is already doing it], and how rampant speculation caused real estate markets around the country to overheat. It will be reminiscent of the Enron hearings, and the message will be explicitly or implicitly the same: free-market capitalism, left unchecked, leads to greed, fraud, and unethical if not illegal business practices.

But capitalism is not to blame for the housing bubble, the Federal Reserve is. Specifically, Fed intervention in the economy– through the manipulation of interest rates and the creation of money– caused the artificial boom in mortgage lending.

The Fed has roughly tripled the amount of dollars and credit in circulation just since 1990. Housing prices have risen dramatically not because of simple supply and demand, but because the Fed literally created demand by making the cost of borrowing money artificially cheap. When credit is cheap, individuals tend to borrow too much and spend recklessly.

Unless and until we get the Federal Reserve out of the business of creating money at will and setting interest rates, we will remain vulnerable to market bubbles and painful corrections. If housing prices plummet and millions of Americans find themselves owing more than their homes are worth, the blame lies squarely with Alan Greenspan and Ben Bernanke.

Paul also points out the use of Fannie Mae and Freddie Mac to offload risk (which many investors consider to be implicitly guaranteed by the US Government). He doesn’t mention the use of derivatives to slice-and-dice the risk and further offload it onto the market, but his point still stands. The Federal Reserve has flooded the market with money, and that money has been chasing returns. Housing has been the “hot” asset class, creating an unsustainable bubble. When that bursts, it will be a lot worse than the tech stock bubble, because it actually hits people right at home.

Much debate on this blog has gone on (and will again soon with the Point/Counterpoint feature) regarding the Federal Reserve and the money supply. Whether you believe in a backed currency or not, it is generally assumed that the quantity of money in a economy should be based on the productive ability of that country. If the money supply has tripled since 1990, I think this is far in excess of any productivity growth we’ve seen since then. Thus, we have inflation.

You flood the market with money, and you see what happens. The rich, who have the ability to move money around chasing these asset classes, get richer. They buy second homes or investment properties to ride the appreciation wave, increasing demand. The poor and middle class, who are just trying to get ahead, struggle to keep their incomes constant or rising relative to the cost of goods. And when housing becomes the asset class bubble, they get priced out of homes and lenders must resort to “creative” financing to allow them to buy. Then, when the returns on investment start drying up, the demand of speculators and investors dries up, and home prices collapse.

The bubble is bursting. The particular nature of the housing market, as a relatively illiquid asset, is making this occur more slowly than a stock bubble would occur. But it’s occurring nonetheless. Blame can be spread around, of course, especially to some of those subprime borrowers who purchased homes they cannot afford. But Ron Paul is right, it is clear that the Fed’s loose money policy created this bubble, and they deserve a great deal of blame when it bursts.

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  • http://www.jackstevison.com/weblog Uncle Jack

    Fantastic, the Fed blew another bubble. But let’s make sure, and hopefully Ron Paul will vote accordingly, that the responsible borrowers do not have to pay to bailout either lenders or borrowers who thought the free-money days would last forever.

    No taxpayer bailout of lenders or foreclosed-on borrowers!

    http://www.jackstevison.com/weblog/index.php/2007/03/19/ron-paul-almost-gets-it/

  • Wild Pegasus

    My one quibble is that the Federal Reserve is, indeed, a capitalist institution. Don’t confuse capitalism and free markets.

    – Josh

  • Joebeo

    The subprime market is a story of poor lending standards. Here is the crazy thing; everyone knew about it; the fed, the lenders, the realtors, and the borrowers. It was something more than an accident waiting to happen. It was an accident planned in advance.

    check out the housing bubble video on:

    http://economicdespair.blogspot.com

    It is a very simple but incredibly moving account of what this subprime thing was all about.

    Asset bubbles are driven by people, and people are always the victims.

  • http://www.ronpaul2008.com Mike

    Awesome article, I loved Ron on Fox News. http://www.youtube.com/watch?v=-Bze5xpW1v4

    I hope other will allow him to speak. Ron has always been outspoken about the illegal Federal Reserve, we’ll see if he even has a slight chance on getting on any MSM networks. Here is Ron at an ecomonic forum: http://www.youtube.com/watch?v=hXZ43h5LJ4Q

    We’re behind you Ron!!

  • concerned american

    I have a feeling that this “bubble”, in the not to distant future, will inevitably burst. People these days do not seem to understand the concept of inflation. They fail to realize that our dollar has devalued around 40% against its level six years ago. Once the general public becomes aware of their devalued dollar, I fear our nations national debt will be(if it isn’t already) exceptionally to great to ever repay. The truth is, our nation will never be able to pay back its national debt. The reason so is solely due in part because of the federal reserve system. Our only hope is to elect Ron Paul in 2008. If we elect another puppet into power in 2008, our country is screwed. We must reinstate the constitution; its being trampled on and torn apart as I’m typing this. Please for the sake of our rights and way of life, and future generations alike, we must take action starting now and expose the evil which infests’ our government. In closing let me ask you this, would you rather die free or live as a slave?

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