I wrote a paper on the economics of housing bubble in 2006 that summarized the Austrian view of the bubble that was taking place. It was to be published in a book on the housing industry and the editors requested that I remove a couple of paragraphs that predicted dire consequences to come. Given that I was already sticking my professional neck out, I was happy to comply. The publication of the book was delayed by the initial publisher, so as the publication date approached, the editors offered me a chance to add a postscript to my chapter. Initially I thought I had nothing to add, but while watching the opening ceremonies to the summer Olympics I decided to use the deleted paragraphs as the foundation of my postscript. Here is the postscript:
The housing and financial crisis discussed in this paper is now well underway and we may well have entered the worst global economic crisis of this generation. The question of how economic policy will address these problems has also been revealed in that the Federal Reserve and the US Treasury have initiated aggressive and unprecedented policy responses. Under the cover of preventing a financial market meltdown, these policy responses are really attempts to bailout the owners of large financial business. They will do little to help the housing market and will increase the overall economic harm of the housing bubble.
Will policy responses continue to be aggressive and unprecedented in the direction of greater government centralization and power as the economic crisis worsens? The importance of this question goes beyond any measure of economic harm because it can result in fundamental changes in society. It could of course result in correct economic reforms such as the abolition of the Federal Reserve, the restoration of the gold standard, and the abandonment of Federal government subsidies to housing, but as I wrote in the initial draft of this chapter (06/06/06):
“On top of all that, people suffer psychological consequences as well. The people most involved in the bubble are confident, jubilant, and self-assured by their apparently successful decision making. When the bubble bursts they lose confidence, go into despair and lose confidence in their decision making. In fact, they lose confidence in the “system,” which means they lose confidence in capitalism and become susceptible to new political “reforms” that offer structure and security in exchange for some of their autonomy and freedoms.
“In this manner, great nations of people have given away their liberties in exchange for security. The Russians submitted to Communism and the Germans submitted to National Socialism because of economic chaos. In 20th century America, economic crises–and fear more generally–provided the justification for the adoption of “reforms” such as a central bank (i.e. the Federal Reserve), the New Deal, the Cold War, and even fiat money during the economic crisis of the early 1970s. Fear of terrorism after 9/11 resulted in a massive transfer of power to government at the expense of individual liberty. Submission of liberty and individual autonomy in exchange for security and the “greater good” is now often referred to as choosing the dark side.
“The reason economic crises create fear and submission of liberty is that people do not generally know what caused the bust or economic crisis and generally do not even know that there was even a bubble in the first place. In fact, as the bubble is bursting many people will deny that there is a problem and believe that the whole situation will quickly return to what they consider normal. The average citizen thinks very little about what makes the economy work, but simply accepts the system for what it is, and tries to make the most of it.”
The virtual socialization of housing, the Government-Sponsored Entities (GSEs such as Fannie Mae), and the risk of mortgage-backed securities indicates that this dangerous trend will continue.