The House that Uncle Sam Built

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That's the main thesis of Horwitz. Feb 13, Greyweather rated it liked it Shelves: A good general overview and explanation of the market consequences of the various government policies and regulations that lead to the sub-prime mortgage crisis of today. For a more detailed analysis, including the political motivations behind the many erroneous government actions, I suggest reading The Housing Boom and Bust by Thomas Sowell. For an even more thorough economic analysis, I suggest reading Professor of Economics at Pepperdine University George Reisman's article, " The Myth that Laiss A good general overview and explanation of the market consequences of the various government policies and regulations that lead to the sub-prime mortgage crisis of today.

Nov 15, Michael Van Beek rated it liked it. Plain English explanation of housing boom and bust, perhaps too simplistic at times, but good overall. Teti rated it really liked it Dec 27, Jason rated it it was amazing Mar 14, Kevin rated it really liked it Dec 25, Apr 10, Patrick Peterson rated it it was amazing Shelves: Excellent little book on the financial crisis. Critique of many common myths about the worst economic situation in the US since the Great Depression. Anna Ebers is currently reading it Jul 31, Gerry marked it as to-read Sep 27, Derek Jordan marked it as to-read Jan 07, Enzo Altamiranda marked it as to-read Jan 15, Congress reasoned that any design and construction changes that could save energy would be good.

At this juncture, however, the story ceases to be simple. The bureaucrats insist they have been thorough and thoughtful.


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But critics say the standards being readied are so bland, illfounded and complex that Congress ought to abort the exercise and start anew. One of the problems is that the entire process was speeded up by a year at President Carter's insistence.

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When completed, the standards will be Uncle Sam's recommendations for conserving energy through building design. While states and localities are supposed to incorporate them into their building codes, there is no penalty if they don't. The Senate wanted to make the standards mandatory, the House did not, and the latter prevailed.

HUD and DOE outlined their intentions last month in a lengthy advance notice of proposed rulemaking, a step in the process that will lead to promulgation of the standards. The nonresidential standards came from data prepared by the American Institute of Architects Research Corp.

Yet the proposed standards fall well below what the researchers concluded designers and engineers could achieve with little more education on energy-saving techniques. The residential guidelines came directly from the National Association of Home Builders, the building industry's trade group. Those modest guidelines already are in use, on a voluntary basis, in many parts of the country.

Notwithstanding the time and millions of dollars spent so far on the BEPS, the Farmers Home Administration already has tougher mandatory energy-conservation standards for projects it finances. And HUD is about to adopt similar mandatory standards for other residential developments it underwrites. A question that arises, then, is why DOE and HUD are bothering to go ahead with the BEPS that are neither mandatory nor as stringent as some energy-saving requirements already in place.

Nor does the advance notice provide information on projected savings or possible new costs. He then has a choice to make: If he chooses the latter and endures a few hours of discomfort, he can recover.

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In any event, no one would say the hangover is when the harm is done; the harm was done the night before and the hangover is the evidence. Indeed, this particular and very painful episode affirms what the best nonpartisan economists have tried to tell our politicians and policy-makers for decades, namely, that the more they try to inflate and direct the economy, the more damage the rest of us will suffer sooner or later.

In this essay, we trace the path of the recession from its origins in the housing market bubble to the policies offered to cure the aftermath. There is no better way to understand a crisis that began in the housing sector than to begin by thinking about a house. A house must be built on a firm, sustainable foundation. If too much lumber and too many bricks are piled on top of a weak support structure, or if housing material is misallocated throughout the house, then an apparently solid structure can crumble like sand once its weaknesses are exposed. Americans built and bought a lot of houses in the past decade not, it turns out, for sound reasons or with solid financing.

Why this occurred must be part of any good explanation of the Great Recession. What could be wrong with any policy that aims to make housing more affordable? Well, we may wish it were not so, but good intentions cannot insulate us from the consequences of bad policies. Politicians became so enthralled with home ownership and affordable housing — and the points they could score by claiming to be their champions — that they pushed and shoved the economy down an artificial path that invited an inevitable and painful correction.

Congress created massive, government-sponsored enterprises and then encouraged them to degrade lending standards. Congress bent tax law to favor real estate over other investments. Through its reckless easy money policies, another creation of Congress, the Federal Reserve, flooded the economy with liquidity and drove interest rates down.

For a substantial part of this decade, our policy-makers in Washington were laying a very poor foundation for economic growth. Call it free enterprise, capitalism or laissez faire — blaming supposedly unfettered markets for every economic shock has been the monotonous refrain of conventional wisdom for a hundred years.

Among those making such claims are politicians who posture as our rescuers, bureaucrats who are needed to implement the rescue plans and special interests who get rescued. Rarely does it occur to these folks that government intervention might be the cause of the problem. Understanding recessions requires knowing why lots of people make the same kinds of mistakes at the same time. In the last few years, those mistakes were centered in the housing market, as many people overestimated the value of their houses or imagined that their value would continue to rise.

Why did everyone believe that at the same time? Did some mysterious hysteria descend upon us out of nowhere? Did people suddenly become irrational? The truth is this: People were reacting to signals produced in the economy. Those signals were erroneous. But it was the signals and not the people themselves that were irrational. Imagine we see an enormous rise in the number of traffic accidents in a major city. Cars keep colliding at intersections as drivers all seem to make the same sorts of mistakes at once.


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Is the most likely explanation that drivers have irrationally stopped paying attention to the road, or would we suspect that something might be wrong with the traffic lights? Even with completely rational drivers, malfunctioning traffic signals will lead to lots of accidents and appear to be massive irrationality. Market prices are much like traffic signals.

Interest rates are a key traffic signal. In a market economy, interest rates change as tastes and conditions change. For instance, if people become more interested in future consump- tion relative to current consumption, they will increase the amount they save. This, in turn, will lower interest rates, allowing other people to borrow more money to invest in their businesses.

Greater investment means more sophisticated production processes, which means more goods will be available in the future. As was made all too obvious in , ours is not a normally functioning market economy. Government has inserted itself into almost every transaction, manipulating and distorting price signals along the way.

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Few interventions are as momentous as those associated with monetary policy implemented by the Federal Reserve. Like blood circulating in the body, it touches everything. When the Fed tinkers with the money supply, it affects not just one or two specific markets, like housing policy does, but every single market in the entire economy. When central banks like the Federal Reserve inflate, they provide banks with more money to lend, even though the public has not provided any more savings.

Banks respond by lowering interest rates to draw in new borrowers. The borrowers see the lower interest rate and believe that it signals that consumers are more interested in delayed consumption relative to immediate consumption. Borrowers then begin to invest in those longer-term projects, which are now relatively more desirable given the lower interest rate. The problem, however, is that the demand for those longer-term projects is not really there.

The public is not more interested in future consumption, even though the interest rate signals suggest otherwise. These longer-term processes are then abandoned, resulting in falling asset prices both capital goods and financial assets, such as the stock prices of the relevant companies and unemployed labor in sectors associated with the capital goods industries.

The bust is the economy going through a refitting and reshuffling of capital and labor as it eliminates mistakes made during the boom. The important points here are that the artificial boom is when the mistakes were made, and it is during the bust that those mistakes are corrected.

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From to about , the Federal Reserve pursued the most expansionary monetary policy since at least the s, pushing interest rates far below their natural rate. In January of the federal funds rate, the major interest rate that the Fed targets, stood at 6. Just 23 months later, after 12 successive cuts, the rate stood at a mere 1.

The rate was so low during this period that the real Federal Funds rate — the nominal rate minus the rate of inflation — was negative for two and a half years. This meant that, in effect, banks were being paid to borrow money! In order to maintain that low Fed Funds rate for that five year period, the Fed had to increase the money supply significantly. One common measure of the money supply grew by It is unlikely that lots of very similar bad investments are the resut of mass irrationality, just as large traffic accidents are more likely the result of malfunctioning traffic signals than lots of people forgetting how to drive overnight.

With such an expansionary monetary policy, the housing market was sent contradictory and incorrect signals. On one hand, housing and housing-related industries were given a giant green light to expand.

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It is as if the Fed supplied them with an abundance of lumber, and encouraged them to build their economic house as big as they pleased. But the public did not. Interest rates were not low because the public was in the mood to save; they were low because the Fed had made them so by fiat. Worse, Fed policy gave the would-be suppliers of capital — those who might have been tempted to save — a giant red light. With rates so low, they had no incentive to put their money in the bank for others to borrow. So the economic house was slapped together with what appeared to be an unlimited supply of lumber.

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It was built higher and higher, drawing resources from the rest of the economy. But it had no foundation. Because the capital did not reflect underlying consumer preferences, there was no support for such a large house. The weaknesses in the foundation were eventually exposed and the story skyscraper, built on a foundation made for a single-family home, began to teeter.

It eventually fell in the autumn of It is true that easy credit financed a consumer-borrowing binge, a mergers-and-acquisitions binge and an auto binge. But the bulk of the credit went to housing. Government intervention in the housing market dates back to at least the Great Depression. The more recent government initiatives relevant to the current recession began in the Clinton administration. Since then, the federal government has adopted a variety of policies intended to make housing more affordable for lower and middle income groups and various minorities.

Among the government actions, those dealing with government-sponsored enterprises active in mortgage markets were central. They were chartered by the federal government, and although nominally privately owned until the onset of the bust in , they were granted a number of government privileges in addition to carrying an implicit promise of government support should they ever get into trouble. Fannie and Freddie did not actually originate most of the bad loans that comprised the housing crisis. Loans were made by banks and mortgage companies that knew they could sell those loans in the secondary mortgage market where Fannie and Freddie would buy and repackage them to sell to other investors.

Fannie and Freddie also invented a number of the low down-payment and other creative, high-risk types of loans that came into use during the housing boom. The loan originators were willing to offer these kinds of loans because they knew that Fannie and Freddie stood ready to buy them up. With the implicit promise of government support behind them, the risk was being passed on from the originators to the taxpayers.

If homeowners defaulted, the buyers of the mortgages would be harmed, not the originators. The presence of Fannie and Freddie in the mortgage market dramatically distorted the incentives for private actors such as the banks. When banks saw that Fannie and Freddie were willing to buy virtually any loan made to under-qualified borrowers, they made a lot more of them. Greed is no more to blame for these bad mortgages than gravity is to blame for plane crashes.

Gravity is always present, just like greed. Many of the new mortgages with low or even zero-down payments were designed in response to this pressure.