Thursday, May 27, 2010
The current financial crisis is not really an economic crisis. It is a political crisis. The long evolution of this situation is rooted in the tendency of our political leaders to avoid the truth. Repeatedly, our Congress has granted economic benefits to special interests which have benefited the few at the great expense of the many. A recent case in point is the Fannie Mae and Freddie Mac bailouts. The ostensible purpose was to prevent a “financial meltdown.” But financial assets will only lower in price if the perception in the public’s eye is that prices will continue to fall. That perception can only be correct if the financial system is built upon false values which cannot be sustained by economic reality; the proverbial “house of cards” then comes crashing down. The process is exacerbated by the tendency of people to adapt a herd like mentality and to think alike. Thus, if everyone is first convinced that home values (or dot com stocks etc.) will never drop then like a mad crowd the public goes on a housing feeding frenzy and prices go crazy. The opposite effect, rapidly deflating home values, occurs when prices get so high that people can no longer afford to pay the prices posted on new homes. The prices start to crack and then the whole house of cards falls as the crowd now runs the other direction. Congress is responsible for this debacle because its constant subsidies to encourage home ownership pushed the market for homes far past its natural price point. They created a bubble. In this area home prices are still too high for the average newly married couple. New families are the natural driver of home demand and when new families cannot buy homes the house of cards starts to wobble. Amongst the most pernicious of subsidies has been those made to Fannie Mae and Freddie Mac now and in the past. Fannie Mae and Freddie Mac have spent millions on lobbying to incumbent politicians. Several of their politically connected CEOs have pocketed hundreds of millions of dollars while running a bankrupt organization. Rather than make housing more affordable they have made housing less affordable by luring people into buying homes who cannot afford them and by creating a mechanism to artificially raise the price of housing. The problem becomes unmanageable when prices get so high that demand dries up whereupon the house of subsidized cards falls. The current Fannie Mae and Freddie Mac bailouts are estimated to cost the average family $25,000.00 apiece. Thus, we must be taxed and our income so diminished in order to artificially support home prices and to keep people who cannot afford them in homes they can never pay for. This is economic madness. Home prices must be allowed to adjust to their natural level. At that point basic economic demand will take over and houses will start selling again. Those lenders who imprudently made loans must be allowed to take their lumps. Economic recovery will not occur until economic reality sets in. Any more bailouts merely delay the recovery process at great expense to the average American family. You can keep a popped balloon from completely deflating with great and unsustainable effort but you ultimately will exhaust yourself and fail. We cannot afford to exhaust our remaining economic strength trying to inflate the popped balloon of home prices.
Posted by Doug Cloud at 2:22 PM