The recent downturn in the US economy has been blamed on "market failure" and has emboldened critics of free enterprise to suggest that a higher level of government intervention is the only way to solve this mess. The thing that is often missed, IMHO, is that it was the actions of government that led to this crisis. In the interests of providing some counterpoint I will attempt to illustrate this point and provide some historical perspective. There is a precedent that could have been followed for how to best handle this crisis and I believe it will be to the detriment of the nation that it was not.
The roots of the current economic crisis go back to the combination of public policies that encouraged people who in many cases should have been renters, to purchase homes that they could not afford, and an artificially low interest rate that fed this process as well as encouraging rampant speculation. Stories of people buying homes with essentially nothing more than a "statement of income" and little in the way of a downpayment dovetailed with others buying and "flipping" houses in short periods of time. The point to remember is that money is only a means of exchange, it is not the same thing as wealth. Now that this unsustainable combination of spending and speculation has come to an end all the phony "wealth" that people thought they had, often encouraging them to treat their houses like ATM machines, is gone and all that remains is debt.
The public policy that needs to be mentioned in regards to the housing bubble is something called the "National Home Ownership Strategy." It is an initiative developed by HUD Secretary Henry Cisneros at the behest of Bill Clinton. As stated by Ezra Klein at the Washington Post, "The strategy involved lowering standards for homeownership: reducing years of income first-time buyers needed to demonstrate, letting them tap retirement savings, letting mortgage sellers to use their own appraisers, etc." http://voices.washingtonpost.com/...
As this graph illustrates:http://voices.washingtonpost.com/ezra-klein/homeownership_w_strategy.png the increase in home ownership went up as a result of this policy much more than many other initiatives before it. The intention was to help many low income members of society participate in the "American Dream." It was an example of a well intentioned policy that later turned out to have unforeseen, and tragic, consequences for many people. By encouraging people to buy houses that they really couldn't afford under conventional lending standards, one of the seeds of the housing bubble was planted.
The other smoking gun in this mess, that correlates to this, are the actions taken by Federal Reserve Chairman Alan Greenspan during the period between 2001-2005. In response to the bursting of the dot-com bubble, and citing fears about economic downturn post-911, he lowered interest rates below 3% despite monetary rules that suggested they should have been above 5%. This article from Forbes lays it out and explains that had Greenspan followed a more conventional approach to interest rates the bubble could have been prevented. http://www.forbes.com/...
The result of policies that encouraged lending to marginally qualified borrowers, in combination with loose policy by the FED, led to a disastrous situation called the "Business Cycle." This is the theory from the so-called "Austrian School of Economics" developed by thinkers such as Ludwig Von Mises and F.A. Hayek, that explains how years of mal-investment, as directed by poor fiscal policy by a central bank that maintains interest rates below what the market would otherwise set, sets off a bubble that can not be maintained. Ludwig Von Mises uses the following analogy to summarize this cycle: Imagine a builder who has begun construction on a house in which, unknown to him prior to starting, he actually has say 20% less bricks than he needs to complete the job. There is no way he can complete the house, it is an unsustainable project. The sooner he realizes this the sooner he can re-tool the plans to build a structure that he actually CAN complete. Obviously the sooner he realizes this the better, if he doesn't find out until he out of bricks then there will be a great deal of lost effort to tear down this structure that can't be built and complete one that can. This analogy serves to illustrate the idea of resources being poorly allocated to unsustainable efforts. That, according to this theory, is what happens when financial resources are directed towards poorly considered financial projects such as this current housing bubble. This article provides a better summary than I can provide here:http://mises.org/daily/672
So, background aside, what should have been done when this unsustainable boom finally burst? History provides an example in the form of the economic depression of 1920. What's that you say? Never heard of it? That's because, painful as it was, it was over very quickly and a solid recovery was made before it could reach the level of the more famous crisis of 1929. Here's how it went: in 1920 the US experienced a massive economic downturn for reasons that have been attributed to the aftermath of WW I to changes in the labor market. It was the worst economic downturn in 140 years of recorded economic data. The stock market declined by 48% IN A SINGLE YEAR which was worse than any single year of the Great Depression. Unemployment began top rise sharply and approached 12% during the course of the crisis. President Warren G. Harding made a response that seems unthinkable today: he kept the government from pursuing a course of aggressive action, the FED remained largely passive, and this whole crisis which started in Jan 1920 was OVER by Aug of 1921. The nation returned to a full employment rate of about 6% by 1923. There was no bailout of of businesses that went under, wages and prices were allowed to fall, and this massive downturn was quickly a thing of the past. This all occurred despite the protest of Commerce Secretary , Herbert Hoover, who called for activist government intervention. Here's the wiki page: http://en.wikipedia.org/...
When Herbert Hoover, as President, was later faced with a downturn in 1929 he pursued a very different course than Harding. He ignored the advice of Treasury Secretary Andrew Mellon who encouraged him to allow a market correction to occur: http://en.wikipedia.org/... His interference turned what could have been a temporary downturn into a lasting depression. It is my contention that had a similar course of non interference been taken by the Obama administration, of allowing banks and businesses to fail, wages and prices to fall, and foreclosures to occur, we could have already been through the downturn and on our way to full recovery. Instead we have saddled ourselves with mounting debt, expanded the money supply which will have future inflationary consequences, and accomplished nothing other than prolonging the pain of this downturn for years to come. Once the car programs, housing programs, bailouts and money expansions come to an end we will still be in a lot of trouble. Government spending has masked the true effects of this downturn and extended them, it has not solved the issue. I maintain that, as a consequence, we are headed a for a so-called "lost decade" in this country.
This is my first diary! I look forward to hearing your constructive comments!
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Update: apparently I have not expressed myself very well, I apologize. I am not claiming that poor/middle class people CAUSED the housing bubble. It was government requirements that lenders make riskier loans combined with irresponsible FED policy under Greenspan that created this mess. Folks getting hurt by these policies are the victims here.
*Update: Thanks to the folks that have posted CONSTRUCTIVE comments, I have enjoyed the debate and exchange. Folks that resort to immature insults and "straw man" arguments...you put yourself in a poor light. If anyone here is interested in greater detail about some the arguments I've made here, I would refer you to the work of Johan Norberg who has written a fine book on the subject:http://www.amazon.com/exec/obidos/ASIN/1935308130/reasonmagazineA/
Here's a teaser interview that gives an overview of the book:http://reason.com/blog/2009/10/07/now-playing-at-reasontv-author