Here are two articles from today’s WSJ. I’ll side with Rep. Ron Paul here. The problem with Blinder’s solution is that an overpriced home (relative to fundamental incomes and rents) is a bad investment for the individual. Multiplied across the population makes it a really bad investment for the nation. In tune with Paul’s argument about the cost of manipulating interest rates, we need to manage the decline in home prices to where they find a floor based on financial fundamentals, not on what somebody mistakenly paid in 2005. We need real price discovery all across our economy after a decade and more of distortion.
Blame the Fed for the Financial Crisis
The Fed fails to grasp that an interest rate is a price, the price of time. Attempting to manipulate that price is as destructive as any other government price control.
By RON PAUL
To know what is wrong with the Federal Reserve, one must first understand the nature of money. Money is like any other good in our economy that emerges from the market to satisfy the needs and wants of consumers. Its particular usefulness is that it helps facilitate indirect exchange, making it easier for us to buy and sell goods because there is a common way of measuring their value. Money is not a government phenomenon, and it need not and should not be managed by government. When central banks like the Fed manage money they are engaging in price fixing, which leads not to prosperity but to disaster.
The Federal Reserve has caused every single boom and bust that has occurred in this country since the bank’s creation in 1913. It pumps new money into the financial system to lower interest rates and spur the economy. Adding new money increases the supply of money, making the price of money over time—the interest rate—lower than the market would make it. These lower interest rates affect the allocation of resources, causing capital to be malinvested throughout the economy. So certain projects and ventures that appear profitable when funded at artificially low interest rates are not in fact the best use of those resources.
Eventually, the economic boom created by the Fed’s actions is found to be unsustainable, and the bust ensues as this malinvested capital manifests itself in a surplus of capital goods, inventory overhangs, etc. Until these misdirected resources are put to a more productive use—the uses the free market actually desires—the economy stagnates.
The great contribution of the Austrian school of economics to economic theory was in its description of this business cycle: the process of booms and busts, and their origins in monetary intervention by the government in cooperation with the banking system. Yet policy makers at the Federal Reserve still fail to understand the causes of our most recent financial crisis. So they find themselves unable to come up with an adequate solution.
In many respects the governors of the Federal Reserve System and the members of the Federal Open Market Committee are like all other high-ranking powerful officials. Because they make decisions that profoundly affect the workings of the economy and because they have hundreds of bright economists working for them doing research and collecting data, they buy into the pretense of knowledge—the illusion that because they have all these resources at their fingertips they therefore have the ability to guide the economy as they see fit.
Nothing could be further from the truth. No attitude could be more destructive. What the Austrian economists Ludwig von Mises and Friedrich von Hayek victoriously asserted in the socialist calculation debate of the 1920s and 1930s—the notion that the marketplace, where people freely decide what they need and want to pay for, is the only effective way to allocate resources—may be obvious to many ordinary Americans. But it has not influenced government leaders today, who do not seem to see the importance of prices to the functioning of a market economy.
The manner of thinking of the Federal Reserve now is no different than that of the former Soviet Union, which employed hundreds of thousands of people to perform research and provide calculations in an attempt to mimic the price system of the West’s (relatively) free markets. Despite the obvious lesson to be drawn from the Soviet collapse, the U.S. still has not fully absorbed it.
The Fed fails to grasp that an interest rate is a price—the price of time—and that attempting to manipulate that price is as destructive as any other government price control. It fails to see that the price of housing was artificially inflated through the Fed’s monetary pumping during the early 2000s, and that the only way to restore soundness to the housing sector is to allow prices to return to sustainable market levels. Instead, the Fed’s actions have had one aim—to keep prices elevated at bubble levels—thus ensuring that bad debt remains on the books and failing firms remain in business, albatrosses around the market’s neck.
The Fed’s quantitative easing programs increased the national debt by trillions of dollars. The debt is now so large that if the central bank begins to move away from its zero interest-rate policy, the rise in interest rates will result in the U.S. government having to pay hundreds of billions of dollars in additional interest on the national debt each year. Thus there is significant political pressure being placed on the Fed to keep interest rates low. The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to “just do something” often outweighs all other considerations.
What exactly the Fed will do is anyone’s guess, and it is no surprise that markets continue to founder as anticipation mounts. If the Fed would stop intervening and distorting the market, and would allow the functioning of a truly free market that deals with profit and loss, our economy could recover. The continued existence of an organization that can create trillions of dollars out of thin air to purchase financial assets and prop up a fundamentally insolvent banking system is a black mark on an economy that professes to be free.
How to Clean Up the Housing Mess
Millions of foreclosures are ruining millions of lives. We can do better than Social Darwinism.
By ALAN S. BLINDER
About four years ago, as the housing bust worsened, our country faced an entirely predictable problem: A huge wave of foreclosures was headed our way. The issue of the day was how to stop it before it engulfed the entire economy. My suggestion then was to revive the Depression-era Home Owners’ Loan Corporation, which refinanced about a tenth of all the mortgages in America and closed its books with a small profit. Never mind the details; the suggestion was ignored. Maybe there were better ideas, anyway.
Sadly, however, we did almost nothing to stop the predicted foreclosure wave, which is now drowning us. The issue at this late date is how we can mitigate the damage.
One oft-repeated answer comes from the intellectual descendants of Andrew Mellon and Herbert Spencer: liquidate, liquidate, liquidate. Let the housing market find its natural bottom, and the chips fall where they may.
I beg to differ. Some of the reasons are humanitarian. Millions of foreclosures are ruining millions of lives and devastating many communities. We can do better than Social Darwinism.
But many of the reasons are strictly economic. The seemingly-endless housing slump is dragging down our economy. By now, massive underbuilding during the slump far exceeds the overbuilding during the boom. So, by rights, a shortage of houses should be pushing up house prices, incentivizing home builders, and boosting growth in gross domestic product. Instead, actual and prospective foreclosures hang over the housing market like a wet blanket.
Why the failure? Three formidable barriers have stood between us and success—and still do.
The first is money. Given the huge magnitude of the aggregate gap between house values and mortgage balances, a comprehensive anti-foreclosure solution requires hundreds of billions of dollars. (Note, however, that this money would be lent, not spent.) Compounding the tragedy, we now know that there was probably enough money in the Troubled Asset Relief Program (TARP) to do the job—but neither Treasury Secretary Hank Paulson nor Treasury Secretary Tim Geithner knew that at the time. Now TARP is no longer available, and we are still trying to fix this massive problem on the cheap.
The second barrier is a host of legal complications—stemming from such things as securitizations, second mortgages, and the like—that make it difficult to design and execute a comprehensive plan. The details would put you to sleep. But the bottom line is that most serious solutions entail modifying somebody’s property rights—which is something we don’t do lightly in America, and for good reason.
The third barrier may be the biggest: politics. Apparently, many Americans view it as unfair to bail people out of unaffordable mortgages. Do you remember the famous Rick Santelli rant on CNBC in February 2009—the one that gave the tea party movement its name? Mr. Santelli was griping about President Obama’s new foreclosure mitigation programs—the ones I just characterized as half-hearted. It would have been a brave politician indeed who pushed to make those programs larger and more generous.
So what can be done now? There is no silver bullet; we need different remedies for different types of (actual or prospective) foreclosures. And to succeed, we must overcome the three barriers. Foreclosure mitigation is expensive. It will encounter political resistance. It probably requires bending some property rights. Not very appetizing. But remember, the alternative may be continued stagnation, which is making everyone dyspeptic.
Here are some ideas.
• To get millions of refinancings done expeditiously, simplicity is essential. As nationalized companies that dominate the mortgage market, the government-sponsored enterprises, Fannie Mae and Freddie Mac, should be taking the lead, not watching their profits and mortgage-backed security (MBS) prices. If GSE managements won’t move, their regulator, the Federal Housing Finance Agency, should push them. If the regulator won’t push hard enough, the U.S. Treasury, their major shareholder, should. If Treasury officials won’t, President Obama should order them to. If the whole administration is too timid, Congress should change the law.
Here’s one concrete example of a legal barrier: When a mortgage owned by Fannie or Freddie is proposed for refinancing, it has the legal right to “put” the original mortgage back to the originating bank if there was even the slightest irregularity in the original documents. That right can make the originating bank afraid of refinancing, even if the homeowner is at risk of default. And if Fannie or Freddie does indeed block the refi, it will be left with the vast majority of the risk in the original mortgage, anyway.
• Most economists see principal reductions as central to preventing foreclosures. That takes money, of course—plus ignoring the Rick Santelli rant. Perhaps the cost to taxpayers could be reduced by giving the government—or even private investors—some of the upside when house prices finally start climbing. One encouraging sign is that settlement talks between the government and the five biggest mortgage servicers (Ally Financial Inc., Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co., and Wells Fargo & Co.) are reportedly coming around, at last, to principal reductions.
• Many vacant houses could be converted into rental units by enterprising developers. The government could make such investments more attractive, e.g., by using mechanisms similar to what the Federal Reserve and the Treasury did during the worst of the financial crisis. Back then the government lent money to investors who were willing to buy mortgage-backed securities; this time it could lend money to investors who are willing to invest in certain rental properties.
An old adage says, “Where there’s a will, there’s a way.” There is a way, or rather several ways, out of the mortgage mess. What we need now is the political will to take them.