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Source link: http://archive.mises.org/8023/did-the-fed-cause-the-housing-bubble/

Did the Fed Cause the Housing Bubble?

April 14, 2008 by

One of the few positive developments from the housing bubble is that many mainstream economists have recognized the pernicious role played by the Federal Reserve. Indeed, some analysts on CNBC have discussed the outright abolition of the Fed. The case against the Fed is straightforward: In an attempt to jumpstart the economy out of recession, Greenspan slashed the federal funds target from 6.5% in January 2001 down to a ridiculous 1% by June 2003.

Ironically, just as many mainstream analysts are seeing the wisdom of the Austrian view, two prominent libertarian economists, Jeffrey Rogers Hummel and David Henderson, have claimed the opposite. FULL ARTICLE


Mark Thornton April 14, 2008 at 9:24 am

We should also note that the bubble started popping in late July 2005 when the Philly home building stock index topped out as I noted on LRC during the first week in August of 2005 on LRC. This was at a time when mainstream and mainstreet economists were still denying the existence of the housing bubble. Therefore H&H’s monetary evidence runs completely counter to their thesis.

James Crosswell April 14, 2008 at 10:41 am

One HUGE piece of the puzzle which is consistently ignored by economists left, right and center is foreign exchange. Where are the dollars? If they are generally held to be valuable by the governments and peoples of other nations in the world then no doubt a good portion of them will remain outside the US. If the dollars start to loose value for those in the rest of the world, then in all likelihood people are going to start trying to spend them and get rid of them as soon as possible (trading them for something useful) – which will increase the velocity of those dollars and thus drive up global prices. In this case you could lay the blame not only on Greenspan but on the central bankers that preceeded him… for the dollars that their monetary expansion created too will be coming back to haunt us, contributing to rising prices around the world.

The final straw that might break the camel’s back for the US would be if foreigners (or indeed Americans) stopped buying US government bonds – in this case the Fed would have to start buying these bonds back to keep the yeilds at their target rate.

Why does no one ever talk about forex or bonds?

Inquisitor April 14, 2008 at 12:25 pm

Well, I think previous pieces have dealt with money held abroad, but I can’t recall which in particular.

Eric April 14, 2008 at 12:49 pm

No one is arguing that there was not a whole lot of money being loaned to the sub prime market; yet where did this money come from? I’ve not heard anyone argue that the sub prime market was a shift away from more conventional loans or that it came from other shrinking investments; that is, there were no cries that borrowers were being squeezed out as the available money was shrinking (in other areas) so it could be used instead for these sub prime housing loans.

So, if the total amount in loans did not stay constant as the new sub prime loans occurred, then the only remaining conclusion is that the total of loans increased. The sub prime loans would have to be made from new funds. It would seem, given all the history of the FED (in the 70′s especially as Murphy writes) and a quick read of Austrian business cycle theory, that there’s only one conclusion: The FED created the new money that poured into the sub prime market (and the housing bubble). The facts and figures presented here simply provide more evidence of what seems pretty obvious to anyone who can add and subtract.

Nima April 14, 2008 at 2:26 pm

Hi Robert,

I would like to supply some data to support your arguments against H&Hs montary aggregates.

The money supply figures that they are incorrect. The true money supply that I have constructed gives a much better picture of M’s growth and contraction: http://nimamahdjour.blogspot.com/2008/03/money-supply-watch.html

Needless to say, it is a much better indicator for impending booms and busts as it’s annual growth drops below 0 before almost every major recession and remains steadily above 1% or even spikes up to rates of 13% during inflationary booms..

Best regards,

Bob Murphy April 14, 2008 at 3:37 pm

Mr. Crosswell,

Why does no one ever talk about forex or bonds?

Fear not! That’s actually in the queue. It should run in another two weeks or so.

Grant April 14, 2008 at 4:53 pm

Here is an excellent article that IMO deserves to be mentioned in a seperate blog post:

A good excerpt:

“We don’t have a true free market,” he said. “The Fed sets an important price” — the interbank lending rate — providing all the reserves the banking system demands at that price. “It would be an accident if the Fed were to set that price at a market-clearing level,” Kasriel said.

James Crosswell April 14, 2008 at 5:24 pm

Fantastic – thanks Robert!

JCR April 16, 2008 at 4:18 am

Great article and great topic. Thank your to Mr Murphy.
“Blame Federal Gov’t, Not The Fed, For Subprime Mortgage Problems” is the title of the H&H article. That’s a nasty way to reinforce the idea that the fed is above politics since it implies it does not belong to Federal government. Why would then the federal reserve get a “.gov” url to use one of the quickest way to prove that the Fed is part of the US federal government?
This H&H article is really fed / government propaganda at work. I find it quite manipulative in that regard.
I have therefore to challenge Robert Murphy’s assertion that:” Coming from other writers, one might suspect political motives for such views. Yet H&H are certainly no tools of the powers that be.”. I certainly do not know the writers but, from my reading of this piece, H&H are, at least, working to strengthen the mystic around the Fed and the dangerous idea that the Fed is somewhere else, above, like God or something…
The good thing about that article is, however, that if the Fed is not the major culprit, responsibility still lies in government people actions:
(1) Fannie Mae, Freddie Mac and Ginnie Mae who creates moral hazards
(2) The comptroller of the currency
(3) Community Reinvestment Act.

marsx November 19, 2008 at 1:13 am

The housing bubble and economic crisis need to be seen in the larger context of the Bush years. The Republicans worked furiously in the early part of 21st century, now that they finanally controlled all the levers of government, to transfer as much wealth tas possible upwards. They achieved this with a coordinated effort using tax policy, deregulation of the financial markets, monetary and fiscal sleight of hand, and, sadly, war.

Coming out of a recession, the Bush tax cuts were passed with the promise they would stimulate the economy. Using the same rationale, all kinds of regulations on business, including environmental, were lifted. This two-pronged strategy caused an enormous transfer of wealth upward while allowing extreme consolidation in business and industry. The longer the Republicans controlled government, the more wealth could be transferred. So why did the electorate not only sit idly by but keep them in office through 2006/2008?

Deregulating the financial industry along with the Feds cheap money policy made this possible. And 9/11 certainly helped.

By lowering interest rates continuously from 2001-2003 and due to deregulation, loaned inordinate sums of money to virtually anyone that asked. They thenchopped up and repackaged their loans (risky and otherwise) and resold them as other kinds of financial instruments, avoiding liability for bad loans.

All this cheap money created unsustainable demand, allowing the middle class to buy all sorts of goods and services they couldn’t afford, including houses. Those that already owned homes weren’t going to complain as they watched their equity skyrocket. Thus, even as most were paying more for everything, while were working harder and longer for less and less money, the Republicans held office through 2006/2008.

And 9/11 certainly didn’t hurt their cause. Not only did lawmakers exploit fear to stay in office, it allowed Bush to start two wars and create a mini-war economy. To stay the course of transferring and consolidating much of he nation’s wealth to his milieu, the wars were kept off book and the money was borrowed, as was the money for the tax cuts and a lot of other govermental activity. This war economy, the artificial demand created by easy credit, and the enormous amount of activity in the financial sector bolstered the illusion that the economy was growing and many economic indicators seemed to confirmed this fallacy.

However, the investor class, to whom this wealth was being transferred, knew what a house of cards was being built. They sought to hedge against what many knew would eventually implode, by buying and selling as much as 65 trillion in credit default swaps, many of which the underlying asset were mortgages.

This house of cards was headed for implosion. However, until there was a crisis, it would be hard to convince voters how big the problem was. Certainly the narrative I have just offered wouldn’t sway voters. The crisis came, however, in the form of the credit crunch that threatened the very fabric of our Western financial system. Fortunately for Obama and the Democrats this occurred before the 2008 election, even though many in the country were already sensing the trouble in 2006 and handed the Congress to the Democrats.

Sadly, the top .25%, including the Bushes and McCains, will keep their unearned, transferred wealth, while the majority of Americans will be paying these theives off for generations to come.

Finally, the theives had to change course. Even they realize that their newly acquired wealth would be of little value if the world fell into chaos.

But they are shrewd players. The cause of the crisis, they say, surely not what I’ve described above, no, it is simply due to “toxic mortgages” or for the more financially savvy, credit default swaps, as if these developed in a vacuum.

The solution: Give the financial industry 700 billion and hope things get better. One would expect that money to come out of the pocket of those who caused it and socked away who knows how many trillions in the process (250 new billionaires just in the last two years). But alas, this isn’t the way the world works. So, as with the war, the cost will be paid by future generations and diffused among all taxpayers, Kinda sad.

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