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Tag Archives: housing crisis

The media pundits are shocked! The politicians are slack-jawed. What can we do? Our financial system is in tatters! We’re in a housing crisis, a recession, or a depression, depending on which term you prefer. Credit has dried up for all but the squeaky cleanest of borrowers! How could this be possible? After all, here in the good ol’ U.S. of A. we have this wonderful institution called the Federal Reserve that’s supposed to keep the financial system safe from all of those power mad, greedy capitalists who supposedly ruin the good times for everyone. Well, the whole mess can be summed up with two words: credit expansion.

From USAGold.com we see this statement concerning the central banks actions in the aftermath of the September 11 attacks : “The Fed moved aggressively to supply credit and lower interest rates in an effort to resurrect the markets and keep the economy out of recession.”

And from NPR: “Federal Reserve officials kept interest rates artificially low after the Sept. 11, 2001, terrorist attacks and that helped create the housing bubble.”

Even CNBC’s ranting establishment money man, Jim Cramer had harsh words for the Fed when he railed that, “The Federal Reserve created the stock bubble with low margin rates and it created the housing bubble with low mortgage rates, yet I never hear about anyone talking about investigating the Fed,”

And from Robert P. Murphy and Lee Hoskins on Forbes.com: “A good portion of the housing mess itself is the result of Fed policy: In response to the 2000-2001 recession, chairman Alan Greenspan brought the federal funds rate down to a shocking 1% by June 2003, then held it there for a full year.”

Those are just a few comments. However, they illustrate the dangers that are involved when the Fed slashes interest rates below the normal market level in an effort to expand credit and lead people to believe that prosperity can be created out of thin air. The Austrian economists, however, recognized the dangers of reckless credit expansion many years ago. Here a few comments from Ludwig von Mises on this subject. They are all taken from his book Human Action , which was published in 1949.

“The essence of a credit-expansion boom is not overinvestment, but investment in wrong lines, i.e., malinvestment.”

“What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media. The credit boom is built on the sands of banknotes and deposits. It must collapse.”

“If the credit expansion is not stopped in time, the boom turns into the crack-up boom; the flight into real values begins, and the whole monetary system founders.”

“The final outcome of the credit expansion is general impoverishment.”

“Credit expansion is the governments’ foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous.”

These quotations, and many others on various topics and issues are compiled in The Quotable Mises, edited by Mark Thornton.

The hot issue in American politics is the economy. It stems, of course, from the housing boom of the early 2000’s, that inevitably became today’s housing bust. People are angry. They want action. Many of them are calling for tighter regulations and increased oversight of lenders as well as the larger financial sector. Well, the Bush administration has devised a plan. According to this plan, the Federal Reserve would become the great overseer of the financial sector. In fact, the Fed would assume the role of “market stability regulator.” Furthermore,

“The role Federal Reserve Chairman Ben Bernanke and his colleagues have been playing to shore up the financial system would be formalized in the administration plan by giving Fed officials greater power to detect where threats might be lurking in the system.”

How interesting. Under this plan the fox would, indeed, be in charge of the hen house. Let’s remember that the Fed slashed interest rates in the aftermath of the 9/11 terrorist attacks in an attempt to spur demand and encourage consumerism. Americans were led to believe that they could spend and borrow their way into prosperity. Many Americans proceeded to buy overvalued homes which they could not afford. The Community Reinvestment Act, which I highlighted here, also forced lenders to issue loans to many subprime borrowers, who normally would not have qualified for those loans.

Everything that transpired after the interest rate cuts, however, would not have happened if the rates were allowed to be determined by the market. So before we blame the market for the mess, it’s important to remember that it was the Federal Reserve that set and held interest rates well below the normal market level. As far as the great borrowing frenzy is concerned, the Fed was the great enabler.

And now were supposed to trust the Fed to oversee the entire financial sector? We’re supposed to trust the Fed to ensure everything remains copacetic?

Here’s what Ben Bernanke, the Chairman of the Federal Reserve, had to say about the housing boom in 2005, just before President Bush nominated him to become Chairman:

“U.S. house prices have risen by nearly 25 percent over the past two years, noted Bernanke, currently chairman of the president’s Council of Economic Advisers, in testimony to Congress’s Joint Economic Committee. But these increases, he said, ‘largely reflect strong economic fundamentals,’ such as strong growth in jobs, incomes and the number of new households.”

And how did he feel about the prospect of the boom in the housing market coming to an end?

“A moderate cooling in the housing market, should one occur, would not be inconsistent with the economy continuing to grow at or near its potential next year.”

In other words he simply told everyone to take it easy. Don’t worry. Everything’s under control. That was the message.

Congressman Ron Paul, on the other hand, issued these prescient statements on the housing situation in May of 2004.

“Federal Reserve manipulation of interest rates and the money supply has created a perilous situation for millions of Americans,” Paul stated. “Rising interest rates may well cause housing prices to fall dramatically, leaving many homeowners who bought at the height of the bubble owing more than their homes are worth. Homeowners with adjustable-rate mortgages are especially vulnerable, as are those who used paper gains in real estate values as collateral for second, third, and even fourth mortgages. The Fed’s easy-credit policies are directly responsible for lowering creditworthiness standards and encouraging millions of Americans to overextend themselves. If trillions of dollars in housing equity disappear, no amount of Fed sorcery will keep record amounts of Americans out of bankruptcy.”

Keep in mind that Paul’s statements were issued more than a year before Bernanke shrugged off the looming debacle. Paul predicted that rising interest rates could cause housing prices to fall dramatically, leaving many homeowners owing more than their homes are worth. And then we see this article from marketwatch.com on March 25, 2008, in which it is stated:

“Home prices in 20 major U.S. metro areas have plunged a record 10.7% in the past year as prices continued to decelerate, Standard & Poor’s said Tuesday.

The 20-city Case-Shiller home price index fell a record 2.4% from December to January, the 18th consecutive decline in prices. For 10 major cities, prices fell 2.3% in January and 11.4% for the past 12 months.”
Furthermore, from Bloomberg.com on February 26, 2008:

“Falling prices have trapped many homeowners who would like to sell or refinance their houses because they owe more money on them than the homes are now worth.”

Dr. Paul also highlighted the risk for homeowners with adjustable rate mortgages. In the same marketwatch.com article we see:
“Falling home values could also trigger higher monthly payments for many homeowners with adjustable rate loans.”
And from Bloomberg.com on those rising rates:
“Defaults among subprime borrowers and those unable to meet rising payments on adjustable-rate loans drove foreclosure filings to the highest since August and the second-highest since RealtyTrac started keeping records three years ago.”
So, it would appear that the man who has been labeled by some as a paranoid, crackpot, conspiracy theorist actually had it figured out. And he wasn’t afraid to spell it out, either. The man who is now the Chairman of the Federal Reserve, on the other hand, simply brushed the matter aside.
Now what’s that about the Fed possibly being the “market stability regulator?”