The Housing Bubble, and the Freedom to Fail

In the post “Ron Paul — Federal Reserve To Blame For Housing Bubble

Warbs noted that Ron Paul was blaming the fed for creating, and perpetuating the housing bubble, which is about to burst and deliver a big smackdown to the economy.

“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.” – Ron Paul

Though Brad doesn’t quite agree with the entirety of Pauls comments, he goes on to note:

“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.”

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.”

I’m sorry, but the most basic market principle of libertarianism is that rational actors, will act with informed self interest, to produce optimal results in a market.

This isn’t anyones FAULT, but the people who bought houses they couldn’t afford; and the people who lent them the money to do so.

No-one was deceived by the fed, or the lenders. There’s no such thing as a predatory mortgage on a new house you can’t afford. Lenders aren’t trying to put people into loans they cant pay back, they LOSE money on foreclosures.

No-one was deceived by the fed keeping relatively loose money. The fed could have done whatever they wanted with interest rates; people were too caught up in the “gold rush” mentality to care. In fact, during this “boom” we’ve seen the fed put the biggest peacetime interest rate increases in place, month after month, (in 2000, and then again in 2002 and 2003), and all it did was slow things down slightly.

THere was no deception involved here, except self deception. Everyone thought they could keep surfing the wave; and they pretended that it would never reach the the shore.

As far as I’m concerned, none of this is a problem from a market standpoint. There is no point in this cycle where we could have legitmately said, “OK, now it’s time for the government to step in a do something”. This is just a natural economic cycle..

Or did people forget that markets have boom and bust cycles naturally; based on the psychology of the market?

Oh wait, yes, that’s right, they did.

So a bunch of sub-prime lenders are going to fail.

Oopsie…

That’s going to put pressure on a lot of major banks who invested, or underwrote those subprimes.

Oopsie…

A bunch of builders and contractors are going to go under now, because they were only in existence to take advantage of the bubble.

Oopsie…

A whole bunch of people are going to lose those houses they couldn’t afford; or the second or third houses they bought on spec, to try and sell for far more than they were worth in a rational market.

Oopsie…

None of these are BAD THINGS. Markets make mistakes, and this is the corrective mechanism. If you over invest in something shaky, you get what you deserve.

If you bought a house you couldn’t afford, because someone was stupid enough to give you a loan you couldn’t pay back, whose fault is that?

YOURS, that’s who.

If the lender who loaned you the money goes under, because you and all your neighbors default on his loans, whose fault is that?

HIS, that’s who.

You both made decisions, knowing what the consequences of those decisions could be, and willfully choosing to ignore them.

The most basic freedom of the market, is freedom to fail; because failure makes markets strong.

What we’re seeing right now, and will see over the next.. oh I’d say two years… is the principle of freedom to fail in action. People made risky gambles, and they lost; that’s what happens sometimes.

When the dust clears; you can bet that those involved won’t do that again… or at least the ones with any brains will anyway. The other idiots will be off looking for another boom to bust.

Now, what WOULD be a problem, is if, as Paul suggests (and I think it’s entirely likely); the government decides it “must do something”, to protect those fools from the consequences of their actions.

THAT, would be a BIG problem.

I am a cynically romantic optimistic pessimist. I am neither liberal, nor conservative. I am a (somewhat disgruntled) muscular minarchist… something like a constructive anarchist.

Basically what that means, is that I believe, all things being equal, responsible adults should be able to do whatever the hell they want to do, so long as nobody’s getting hurt, who isn’t paying extra

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

    “No-one was deceived by the fed, or the lenders. There’s no such thing as a predatory mortgage on a new house you can’t afford. Lenders aren’t trying to put people into loans they cant pay back, they LOSE money on foreclosures.”

    The only ones deceived were the people/investors who bought the packaged product (mortgage-backed securities) and had faith that the lenders did their due diligence before the mortgages were packaged and sold.

  • http://anarchangel.blogspot.com Chris

    Oh and the derivatives buyers… why we allow derivatives trading, but disallow sports betting I’ll never know. It’s no better than a bookies racket.

  • http://unrepentantindividual.com/ Brad Warbiany

    Chris,

    My point was the fed set the stage for a major credit expansion. When you flood the market with money, you create asset bubbles. The fed flooded the market, it was largely chance that the bubble formed in real estate. (Not completely chance, because after the tech bubble, people were looking for a “safe” store of value like real estate). As the money flees real estate, and the fed accelerates their credit expansion, another bubble will form. My guess is the energy sector…

    People who bought houses they couldn’t afford and lenders who provided loans that were unlikely to be paid back both deserve complete blame for their actions. I’m not trying to offload that blame. What I’m saying is that the fed’s credit expansion led to the bubble, not to excuse the suckers who jumped in too late from their bad decisions.

  • http://anarchangel.blogspot.com Chris

    Brad,

    I understand this; and you were clear in your assertion. The problem here is that the contributing factors are irrelevant.

    The fact is, these people, and companies, all made bad choices, and should be held accountable for them. Nothing the fed did, made them sign for things they couldn’t afford.

  • http://unrepentantindividual.com/ Brad Warbiany

    Agreed, and folks like Chris Dodd who are looking for ways to steal headlines by bailing them out of their bad decisions should be denounced for it.

  • http://appropedia.org/Hexayurt_Project Vinay Gupta

    Hm. Ok, *if* you have a free market currency – or better, several privately issued competing complementary free market currencies – and you have no central agency providing loan oversight – or loan insurance – or any other government interference in loan issue – then yes, what you say is true.

    But regulation is like pregnancy – one is never “a little bit regulated.” As soon as you tie one leg of the market to a tree, the entire market becomes constrained. And we do not know if the THEORY about libertarian economics works because, frankly, it has hardly ever been tried in history.

    So, with all that said, I think Ron Paul is right on this one, and you are not.

  • http://anarchangel.blogspot.com Chris

    Okay Vinay, if that makes you feel better.

    But please explain to me how market distortion through federal regulation (which I agree is a major factor in the market as a whole), forced people to sign for loans they knew they couldn’t afford?

    Yes, the loose money issue put lenders in a position where they had to issue more loans to remain profitable; but that’s because there were too many lenders for a rational market to support.

    If the lenders had made the rational decision to only make loans they could turn a profit on without excessive risk, then there would be no problem. Companies should have gone out of business, instead they kept extending ever more credit.

    Then theres the lenders who decided that because they could charge more to riskier prospects, they would take that risk. Again, these companies should have gone out of business, instead they chose to go ever further.

    If the lenders had made the rational decision to not make too many excessively risky loans; nothing the fed did, or could have done, would have changed this.

    Remember, prime rate is jsut that; no-one says banks have to charge prime rate. If banks want to put themselves in better competitive position and charge lower rates they can. If they want to focus on profitability of fewer loans, they can.

    What the banks SHOULD have done, was maintain standards of creditworthiness, no matter how much “business” it looked like they were losing; because that wasn’t good business.

    Instead, they made the choice to go after bad business, chasing revenues rather than profitability, and unbalancing their risks.

    If more banks had stayed sane, this whole sub-prime thing would have blown up in a much smaller way, three or so years ago; and we wouldnt be talking about a bursting bubble.

    But, I say again, where is the role of the government in this?

    These were competitive choices made by bankers, to go after more business. This wasn’t forced on them by government regulation. Yes, the loose fed allowed lower interest rates, but the banks don’t have to charge them; and lower interest rates don’t mean the banks have to make riskier loans.

    So, once again, why is this the feds fault?

    Is the fed supposed to play daddy to banks saying “that’s a bad idea, you shouldn’t do that” ?

    And then what about consumer choice? THe banks were offering loans for larger amounts to people who werent very credit worthy.

    Did that force those people to go out and buy twice as much house as they could afford?

    Is the fed supposed to say “Hmm, lots of folks are buying really expensive houses. We should stop them from doing that by raising interest rates”?

    NONE OF THIS IS THE JOB OF THE GOVERNMENT.

    The government does not exist to protect us from bad choices.

    The market operates on choice, and the freedom to choose. That includes the freedom to make bad choices. So long as the decision making factors aren’t being concealed illegally, and no fraud or crime is being committed on the part of the participants in the market, I see no role for the government here.

  • http://anarchangel.blogspot.com Chris

    Oh and let me put this into a disgusting and offensive analogy; so you can perhaps more clearly see my point:

    “But officer, she was dressed up like a slut, in that miniskirt and heels. She was offering it. She MADE me rape her. It’s her fault for being so slutty.”

    That’s pretty much the argument being used here, taken to it’s natural level of absurdity.

  • http://unrepentantindividual.com/ Brad Warbiany

    Chris,

    I’m not sure anyone is advocating that the government come in and “fix” the problem, certainly not Ron Paul.

    But I think the point still stands. As Vinay points out, if we had multiple free competing currencies, I don’t think we ever would have had a bubble. If one of those free currencies had started to inflate itself, lenders would have written loans in a different currency or devalued their exchange rate for it accordingly.

    Is anyone defending the people who bought houses on mortgages they couldn’t afford, or the lenders who wrote bad loans? I’m certainly not. Nor do I think they should be bailed out for their bad decision.

    But I think the Fed’s inflationary role is the primary cause of the asset bubble cycle, and the asset bubble this time was real estate. The Fed didn’t force consumers to sign bad loans or lenders to offer them, but that doesn’t mean they’re not one of the primary causes of the bubble itself.

  • http://anarchangel.blogspot.com Chris

    And how exactly would an economy based on multiple competing currencies work?

    …and again, as regards the fed being the cause of the bubble: I’m sorry; if set the speed limit on a street, am I the cause of people getting into accidents on that street?

  • http://unrepentantindividual.com/ Brad Warbiany

    And how exactly would an economy based on multiple competing currencies work?

    I’m still working on figuring that out. But I plan to argue the point next week for Point/Counterpoint, so stay tuned.

    Overall, I’m not yet sure that it will work. But I think we’ll find out over the next 10 years that trusting our currency to the government won’t work.

  • http://www.thelibertypapers.org/2006/11/22/comrades-i-hereby-declare-the-revolution/ Adam Selene

    So, back when, after the last of the “Great Depressions” (for those who think we only had one, they obviously haven’t read their history), we decided to avoid the major boom/bust cycle we had dealt with up to that point. Those cycles, on a side note, were created by government intervention in favor of corporations. So, instead, we intervened in favor of consumers and investors, viewing them as the victims.

    The outcome of that has been boom/bust cycles localized to single markets, as Brad is pointing out. Investors and consumers felt confident in over purchasing because the .GOV would bail them out. We can point to gold and S&L in the 80’s, .COM in the late 90’s and real estate in the double oughts as solid examples of this. This sort of oscillation will continue as long as the .GOV is protecting us in ways that encourage bad choices.

  • http://anarchangel.blogspot.com Chris

    Now there is an argument I can credit… of course it’s one I make all the time myself ;-)

    Yes, we should eliminate incentives to make bad choices. One of those incentives if the bailout; and it’s a particularly harmful one because not only does it shield people from the consequences of their bad choices, it deflects those consequences onto others.

    perverse incentives are always a problem in a redistributionist, or authoritarian society (which tend to go hand in hand, funny that).

  • http://www.thelibertypapers.org/2006/11/22/comrades-i-hereby-declare-the-revolution/ Adam Selene

    I should point out that I consider the Fed to be inflationary. That said, mild inflation is preferable to the lack of fluid, freely exchangeable currency created by a “gold standard” (which, by the way, didn’t prevent inflation either). The Fed is probably the best of a series of not so good choices we have right now over how to deal with currency markets. Unfortunately, the Fed does, indeed, feed the boom/bust cycle, on the front end. What keeps it going, in the middle and back end, is the (correct) belief that the .GOV will save us from bad choices. Some significant portion of the sub-prime borrowers will almost certainly get bailed out.

  • Joseph Huang

    The Fed pumping money into the economy fools people by faking lower interest rates. The Fed is not blameless.

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  • Ben Wagner

    The writer is incorrect here on may points. For starters

    “I’m sorry, but the most basic market principle of libertarianism is that rational actors, will act with informed self interest, to produce optimal results in a market.”

    This is incorrect, free market principles do not require rational actors, nor does it claim to produce “optimal” results, as who defines what is “optimal”? What it does say is that the free market will tend toward the least cost of providing for the desires of the actors. This is not everyone’s idea of “optimal”, mostly depending on what the actors desire.

    “No-one was deceived by the fed, or the lenders.”

    While I agree the individuals involved have only themselves to blame for the hole they may have dug for themselves, the Federal Reserve has deceived a great number of people. In this case they created money out of thin air and used it (through the loan network) to make loans. Indirectly, the Federal Reserve had houses built, paid for them with counterfeit bills (costing them nothing) and then rented them out (calling it a mortgage). And while they were at it they made sure that even if the “buyer” of the house defaulted on the loan, the government will tax me and give the Federal Reserve the money.

    So, who has been hurt here? Everyone who worked for a dollar and had its value diluted — that diluted value going indirectly to the Federal Reserve and its owners (they just got a house for free and raised the price of construction). Then, again on the other end, not the guy who buys the house, but me, who is going to be forced to pay the taxes to pay off his house that didn’t need to be built — my tax dollars going indirectly to the Federal Reserve and its owners.

    If you’ve ever seen the movie “The Shadow” you’ll know kind of how I feel about this. The Federal Reserve has hypnotized the world. Go read Rothbard again.

  • Joseph Huang

    Adam: Money came about thru voluntary transactions. It should not be controlled by the state, for all the same reasons the state should not control food production.

    I invite u to refute “the laws of the jungle”. http://www.erienet.net/~thornton/jlaws.html

    The “gold standard” worked, it took away the people’s gold & silver. http://www.lewrockwell.com/north/north512.html

  • http://www.thelibertypapers.org/2006/11/22/comrades-i-hereby-declare-the-revolution/ Adam Selene

    Joseph:

    Money came about thru voluntary transactions.

    Yes, and gold/silver would have had little value outside your local transaction without an agreed upon establishment to create the rule of law. Regardless of all our wishful thinking, the modern economy would not be possible without the monopoly of force that we call the government. That does not mean that an advanced economy couldn’t do away with much of government, but rather that we couldn’t have reached this point without it.

    Anything else is wishful thinking that has little do with the real world.

  • http://www.thelibertypapers.org/2006/11/22/comrades-i-hereby-declare-the-revolution/ Adam Selene

    P.S. I never said I liked the gold standard. In fact, the gold standard’s bigger failure is that it creates a zero sum game. That failure is much bigger than “taking away my gold”.

  • http://www.redmountainsw.com/wordpress Chui

    What about the cost of volatility on third parties who do not even participate on the transactions? If the price of heart medication is volatile, you’d have to be pretty nervy not to buy medication when the prices are high. There is a tragedy of the commons in the making when money supply grows too rapidly.

  • http://www.realestatedecline.com Jerm

    This country will be great once again if Ron Paul gets the presidential seat in 2008! Housing will again be affordable and debt will be contained. DOWN WITH THE FEDERAL RESERVE / DOWN WITH THE NEW WORLD ORDER!
    http://www.FIGHT4TRUTH.COM

  • http://hathor-sekhmet.blogspot.com VRB

    The housing bubble can effect more than the lender or the borrower. If you purchased a house slightly before the housing bubble and carefully purchased based on what you could afford including you taxes and homeowners insurance. You also assumed that the increase in your property value would perhaps triple in 30 years, more or less. In actuality your property value increases 300% in 6 years and you are looking at you tax bill tripling when they reaccess and your homeowners insurance has already reflected the new market values. Then all of your careful planning and budgeting are shot to hell.

  • http://thelibertypapers.org/2005/11/22/a-bit-about-kevin/ Kevin

    Housing will again be affordable and debt will be contained.

    Sorry Jerm, I’m looking for a president that will make housing affordable or to contain debt.

  • http://www.thelibertypapers.org/2006/11/22/comrades-i-hereby-declare-the-revolution/ Adam Selene

    Jerm makes Ron Paul sound akin to God. I just want a President and Congress that do what the Constitution says.

  • http://thelibertypapers.org/2005/11/22/a-bit-about-kevin/ Kevin

    Oops, that should have said I’m not looking for a president that will make housing affordable or to contain debt.

    I shouldn’t post before I have my first cup of coffee.

  • Scott Miller

    Is “now” a good time to buy a home in the Washington DC area, or would it be better to wait for some more time? Can anyone throw some light on that?

  • http://unrepentantindividual.com/ Brad Warbiany

    Scott,

    I’d say now is not a good time. I think the hottest areas of home growth over the last few years haven’t really hit bottom yet. I don’t think it will be good in places like DC, San Francisco, LA, San Diego, etc, until mid-2008. I think people are still trying to keep the prices up, and as long as the job picture stays strong, we won’t see another major hit to prices. However, I think we’ll plunge into recession late this year, and that will be what it takes to finally deflate the bubble.

    I’m no expert, so take that advice for what its worth.

  • http://www.realestatedecline.com Jerm

    Kevin can’t read. My post states exactly what he said…..Adam: Ron Paul is the only president that holds the constitution sacred. Ron Paul is the only prez candidate that has a track record of doing so!

  • http://thelibertypapers.org/2005/11/22/a-bit-about-kevin/ Kevin

    Jerm,

    Perhaps if you had not typed IN ALL CAPS and posted the link to the kook site, maybe I would have understood you much more clearly.

    I am probably giving a kook like you far more time than I should, but I would still love to know how Ron Paul will make housing affordable and contain debt.

  • http://thelibertypapers.org/2005/11/22/a-bit-about-kevin/ Kevin

    Is “now” a good time to buy a home in the Washington DC area, or would it be better to wait for some more time?

    Scott,

    I am in real estate, although not in Washington D.C.. Just looking at the states available from the D.C’s Board of Realtors, I would concur with Brad and hold off on even looking until at least this fall and buy in the winter. Inventories are at their highest then plus the there is a drop off sales also in that period.

    This should be a helpful chart:

    http://www.gcaar.com/statistics/2007-home-sales/dcsf0207.pdf

  • http://thelibertypapers.org/2005/11/22/a-bit-about-kevin/ Kevin

    states should be stats.

  • http://thelibertypapers.org/2005/11/22/a-bit-about-kevin/ Kevin

    One final thing about the housing “bubble”, there is no such thing as a national housing market.

    Whether or not the housing sector will be strong or weak in a given area will depend on the local economy. Some parts of the country will be in for a rough ride, to say the least, but other areas will be in for continuing growth.

  • http://www.thelibertypapers.org/2006/11/22/comrades-i-hereby-declare-the-revolution/ Adam Selene

    Jerm, first, Ron Paul is not President. He is a potential candidate. That said, you are still viewing a President as actively doing things for me. That’s not what I want. All I want the President to do is negatives.

  • Scott Miller

    Thanks Brad and Kevin. I have been waiting to buy for over 4 years now, and my wife has become really impatient. Hopefully in the next few months prices should go down further. They have receded by about 5% to 10%, but still out of reach of the common man.

  • http://unrepentantindividual.com/ Brad Warbiany

    Yikes. You really should have bought four years ago.

  • Bret

    Brad,

    I don’t know Scott’s situation 4 years ago, but most of us were still priced out even then. At the time I was starting a family and a career. In the 4 years that have followed I’ve been unable to save as fast housing prices have jumped, even though I was able to save 25 – 50k a year. Things are settling down now, so it looks like there is an opportunity. Of course, if it wasn’t for the damn mortgage interest deduction I’d be in much better shape relative to the landowners.

  • http://unrepentantindividual.com/ Brad Warbiany

    Bret,

    Don’t get me wrong, I’m not criticizing. I was living in Southern California and looking at property about 3-4 years ago. If I had bought then (I was on the edge of affordability) I would have been at least $100K ahead by now. Instead, I didn’t buy, and moved cross-country to Georgia where I bought a house, and at most it’s jumped maybe $15K in price in the last two years.

    I should have bought in CA, even though it would have been tough to afford. But I didn’t.