…during a period of pretty stagnant incomes, people have been ratcheting up consumption based on increased wealth derived from their homes. People weren’t, however, actually selling their homes to get money and buy stuff. Instead, they borrowed. But with home values plummeting, now there’s big trouble.
That is from Matt Yglesias. If you’re looking to apply "Austrian business cycle theory" to the current crisis, this point is a better place to start than by blaming Greenspan’s admittedly over-loose monetary policy. No one made homeowners treat rising asset values to be the same in value as accumulated monetary savings. But many of them did. And the mechanism may be this: in private terms people treat accumulated money and rising asset values as the same. But in social and macroeconomic terms the implications of those two forms of savings are very different. In particular the social risk of saving through asset values is higher, given the correlation of market values and returns. Nor are their liquidity properties the same if everyone needs to "rush for the exits."
Insofar as you think people are tricked by "savings that aren’t really there," asset values are the most likely the relevant mechanism. This idea has played a surprisingly small role in business cycle thinking over the last century, although it has been floating around since at least the 1930s.
Right now everyone in London is wondering if a real estate bubble is about to pop. Or does UK tax law, combined with greater international mobility, mean the new prices are more or less permanently high?
Actually, I think the “savings that really aren’t there” is THE reason. If you think about it, the “money supply” is the amount of money people THINK they have. Which in itself is a huge problem because if you have liquid assets, should they be treated as money or not?
However, blaming Greenspan IS a good start as well. If you look at the mechanism: mortgage IS creating new money. New money causes prices rise where they are spent first (aka non-neutrality of money). Logically: loose monetary policy causes prices of property rise. Nobody would have every had so much money to lend on consumer debt had there not been a central bank with it’s printing machine and commercial banks confident that if they overblow it, they will be bailed out.
In my opinion the crisis always unfolds because the credit expansion causes people think “they have savings that aren’t there”. If the Fed doesn’t help/intervene, the bad banks default and people realize that they indeed do not have the savings. If the Fed intervenes, it causes inflation and much more people realize that they indeed do not have as much savings as they thought. (don’t dare call it moral hazard).
The problem is that without Fed expanding the money supply the whole bubble, that COULD be created by the commercial banks alone, would have bursted long, long ago. You would have seen high interest rates which would deter majority of mortgages from ever be made. The speculators could speculate on bank failure, on drop in interest rates. They cannot now because the Fed is stronger than all speculators combined.
It is true that people with houses sometimes used them as ATMs, or recklessly traded up increasing their debt burden.
But people without houses took on greater debt as well.
Barbara Kiviat is guest blogging for Justin Fox at The Curious Capitalist and floats one possible explanation. It comes from Stuart Vyse, who in his new book “Going Broke” says that it is all about the ease with which we can make instant purchases in the modern world.
Obviously that is a fractional answer too. The Amazaon order may be “too quick” for our own good, but these houses and these 6 year auto loans take long enough for deliberation.
So I still see this as a wide cultural problem (perhaps stretching to Europe) of indecent debt love.
Justin was on a similar vibe in his post five horrendous ideas for spending borrowed money
And to go a step further, do the regulations that seek to limit new construction ensure that the supply of homes in London will remain well short of demand for them. London is, after all, the original home of the green belt.
Andy,
It’s not just the FED. The FED has tried to tighten but wound up facing a flattening yield curve. This was “Greenspan’s conundrum”; low real rates despite massive debt and low U.S. savings. It turns out it was the result of the shadow banking system that Wall Street and the big banks cooked up to offload lending to foreign investors. Now, however, the shadow banking system has imploded but the FED was long ago castrated by financial engineering.
ideogenetic: Sure, the money supply was expanded by the commercial entities as well. However: what do you think would have happened, if the Fed simply stopped expanding the money supply – let’s say in 2002? Do you think that the mortgage firms would be able to get resources to provide these loans?
It is echoing to places like student loans too, for the same reasons Grant lists above. Cheap money made a big business, encouraged fraud and low-quality loans.
(Are the government guarantees on low quality student loans a shoe waiting to drop?)
“No one made homeowners treat rising asset values to be the same in value as accumulated monetary savings.”
No one held a gun to their heads but abnormally low interest rates and lax (or is that “lack of”) oversight in the lending markets certainly added fuel to the fire.
One of the typical stories about the causes of the great depression was that people should have known something was wrong when bellhops and shoeshine boys were talking about buying stocks on margin.
Perhaps the modern version of that story is all the people who wanted to flip houses and others stretching to buy houses, beyond prudent traditional limits.
Still this doesn’t look much worse then the S&L crisis. Problems are concentrated in about ten communities. Hispanics may have done worse then most groups. But employment is rather steady. If we avoid the collapse of a poorly managed Bank of America ( or another large financial institution ) markets will clear. Detroit will still have the problems it had. Miami will have cheaper retirement condos for baby boomers. Life goes on.
Once again, Tyler, you raise an issue to diss Austrian theory. (The last time, by my account, was on Jan. 3.) But surely you are aware that Greenspan in fact encouraged this kind of activity earlier this decade as a way to speed recovery (unless Gramlich not yet appeared on your “What I’ve Been Reading” list). Why don’t you accept that all of the monetary inflation that occurred under Greenspan (see the MZM figures) can result in sector-specific bubbles notwithstanding a relatively low official inflation rate? When not explaining things like when we should fire our dentists, you are otherwise a dependable defender of the establishment. That is the only way I can understand your dismissals on Ron Paul, Austrian business cycle theory, and any other forms heterodox thinking that might threaten it.
I think people should not borrow money not unless they can prove and have the money to pay the loan back and that’s what we do at http://www.afsloansonline.com Personal Loan
I think I need a primer here.
If we are going to say that “people treat accumulated money and rising asset values as the same. But in social and macroeconomic terms the implications of those two forms of savings are very different.” I (for one) need an explanation of what’s what.
I buy a house. The value rises / falls. My net worth rises / falls.
I guy GM stock. The value rises / falls. My net worth rises / falls.
I buy a 30 year Treasury bond. The value rises / falls. My net worth rises / falls. (Sure, I’ll almost certainly get the money back in 30 years, but what will it buy?)
I buy gold. The value rises / falls. My net worth rises / falls.
I stuff my mattress with $20 bills. Inflation slowly erodes the value, so the value falls.
I inherit appreciated Zenith stock that my grandfather paid pennies for, but now is worth $$$ and pays a big dividend. But, I hold on too long, Zenith goes bust and all I get are capital losses.
So, when it is accumulated money and when it is rising asset values — and why are they so different?
And I think all of this would have happened with or without HELOCs. To the extent that we were banking on homeowners to spend their newfound “wealth” to drive the economy, I think we could be in trouble.
However, I am one of the odd people that think’s it’s OK to have a quarter of negative economic growth every once in a while, if there’s a good reason for it. Restoring consumer spending to a sounder foundation sounds like a good reason to me.
Even if the real estate bubble bursts, the stringent limitations on building around large cities, such as London, will remain. This maintains high housing prices in the long run. The market would probably drop independantly of any bubble burst if the 1947 Town and Country Planning Act were removed.
it is bad of all the market
ask more and more people to deal with the things together
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