Our Unstable Economy:
The Housing Crisis is not Over

March 17, 2011

The consensus from economic experts in the mainstream media is that the worst of the housing crisis is over and the US economy is slowly improving. However, these experts are using the same school of economic thought that brought about the crash in the first place. The truth is that the government's actions to fix the economy are only delaying and worsening the ultimate economic crash that is yet to come.

Economics 101

Economics is not complicated. If there is high demand for a product of service its price is going to be high. If there is a large supply of a product or service its price is going to be low. In a free market unaffected by government manipulation, the price of a product or service is a signal that tells new business people whether or not it is worthwhile to enter the market.

The price of a product or service is important information that the market needs to function properly. When the government manipulates the price of a product or service it sends incorrect information to the market. The government can't move fast enough to respond to every subtle change in a market, and as a result of this government intervention in markets is what leads to boom and bust cycles.

The Causes of the Housing Crash

The government did many things to affect the housing market and bring about the housing bubble. These included setting artificially low interest rates, creating tax incentives, and providing government backed lending programs such as Fannie Mae and Freddie Mac. These actions artificially inflated the demand for housing. Market information was destroyed and a false signal was sent to the housing market.

Builders believed that there was a greater demand for homes than there actually was. Housing speculation grew and grew. Buyers became so convinced that housing prices were always going to climb that they began to buy houses that they couldn't afford. At the time the financial crisis hit, half of all mortgages in the U.S. were of inferior quality and at risk for default.[7] These consumers assumed the value of the house would climb and give them equity they could use to afford the loan. When this didn't happen the housing market crashed and the millions of people that had been counting on an ever-rising market took a hit.

Ultimately, the housing crash was caused by the destruction of market information that would have told buyers and builders what the real market demand was.

Government Solutions are Increasing the Problem

The Financial Crisis Inquiry Report states that a major cause of the housing crisis was the sale of mortgages to risky buyers, otherwise known as sub-prime mortgages. The report labeled the providers of these sub-prime loans a "shadow bank" industry. It called for increased regulation in order to "protect" consumers from such practices in the future. Simply put, the report condemned anything other than establishment banking, and encouraged increasing the powers of the Federal Reserve system.

However, increased regulation is likely to slow down the market's ability to adapt to changing supply and demand. In a market that has transparency, accurate price signals, and a method of holding people accountable for fraud, additional regulation is unnecessary.

By bailing out financial institutions, the FED has encouraged the system to continue to take risks. Bailouts of this type have been standard practice for 40 years. Rather than issuing a bailout, the best government response would have been to do nothing. Lenders would have been held accountable for their bad loans, discouraging such practices in the future. Housing prices would have corrected themselves to their natural level. Builders and buyers would then have had accurate signals on the demand for housing.

Instead, the government has spent billions of taxpayer dollars to keep housing prices artificially high. The more people continue to build and buy homes based on artificially high housing prices, the more damaging the eventual correction will be to the economy.

Current Condition of the Housing Market

Banks have been repossessing homes at a massive rate, but have been hesitant to put these homes up for sale on the market, hoping that the market will improve. According to the National Inflation Association, this hidden inventory consists of 2 to 3 million homes. Banks will need to start selling these homes soon, and when they do the market will take a hit. Those who have been trying to sell their home without getting an acceptable offer will likely rush to lower their price to dump their homes as quickly as possible.[1]

According to the National Association of Realtors, median home prices fell in the last 12 months in all areas of the country. According to the Financial Crisis Inquiry Report, 10.8 million households, or 22.5% of those with mortgages, owe more on their mortgages than the current market value of their house. In Nevada, 67% of homes with mortgages are under water, the highest rate in the country; in California, the rate is 32%. When the next housing adjustment hits, many of these people will simply walk away from their mortgages.[1]

Real Estate vs Metals as an Investment

Based on fundamentals, real estate nationwide is currently overvalued. During the housing crisis of 2008 the market was not allowed to make its full correction, and was instead propped up by the government. Millions of vacant homes are being held and have yet to enter the market.

Real estate is a poor hedge against inflation and turbulent economic times for several reasons. First, it takes a long time to liquidate real estate. In today's market it takes 12 to 18 months to complete all the transactions and inspections necessary to complete a sale. Secondly, in times of high inflation rents are slow to adjust. In Germany in 1912-1913, the average household spent 30.2% of their monthly expenditures on rent. By 1923 after being hit by massive inflation, rents fell to 0.2% of the average household's monthly expenses. At the height of German hyperinflation households were spending 91.6% of their expenditures on food, making it impossible for landlords to raise rents significantly.[2]

Precious metals are on the rise, and silver is particularly undervalued. In the next ten years, industrial demand for silver is expected to outpace production. Also, precious metals are portable, durable, and can be quickly liquidated. Unlike government currencies, metals have an intrinsic value that can't be stolen away through the magic of a printing press.

Austrian Economics vs Mainstream Economics

Mainstream economics, or Keynesian economics, believes in government control of the economy through the Federal Reserve System. Austrian economics, however, teaches that government manipulation of the economy destroys market information and leads to boom and bust cycles. It also teaches that gold and silver is preferable to government issued currencies because precious metals are immune to the powers of inflation which erode the wealth of the middle class.

An example of the debate between these two schools of thought is the debate as to whether government action helped or prolonged the Great Depression. What many people are not aware of is that in 1920 economic conditions were worse than during the Great Depression. At that time the government did the right thing and allowed the market to adjust on its own. By the summer of 1921 the US economy had recovered. However, in the 1930s the government responded to bad economic conditions through a series of government spending programs and Federal Reserve policies. What followed was the Great Depression.[3]

According to the Financial Crisis Inquiry Report, almost no one was able to foresee the housing crisis of 2008. From page 3:

In public hearings and interviews, many financial industry executives and top public officials testified that they had been blindsided by the crisis, describing it as a dramatic and mystifying turn of events. Even among those who worried that the housing bubble might burst, few - if any - foresaw the magnitude of the crisis that would ensue.

When Keynesian economists were unable to predict or prevent the housing crisis it makes no sense to turn to them to solve the crisis. Instead we should turn to the economic system that was able to predict the crisis, which is what Representative Ron Paul, a follower of Austrian Economics, did on September 10, 2003, speaking to the House Financial Services Committee:

Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.

Despite the long-term damage to the economy inflicted by the government's interference in the housing market, the government's policy of diverting capital to other uses creates a short-term boom in housing. Like all artificially created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.

[1] US Inflation Report, National Inflation Association, June 2010, pg 12
[2] Ibid, pg 11
[3] Ibid, pg 13
[4] The Fincial Crisis Inquiry Report, The Fincial Crisis Inquiry Commission, Pursuant to Public Law 111-21, January, 2011, pg 410
[5] Ibid, pg 404
[6] Ibid, pg 403
[6] Ibid, pg 402
[7] Ibid, pg 448

"No amount of regulation can fix a system that is inherently immoral." - Republic Enterprises

"The Commission concludes the unchecked increase in the complexity of mortgages and securitization has made it more difficult to solve problems in the mortgage market. The resulting disputes and inaction have caused pain largely borne by individual homeowners and created further uncertainty about the health of the housing market and financial institutions." - The Financial Crisis Inquiry Report [4]

"We're seeing and will see in total probably before we're done, between 15 and 16 million foreclosure filings in this country." - John Taylor, president and CEO of the National Community Reinvestment Coalition, to the FCIC [5]

"In a spring 2010 survey, 85% of the responding mayors ranked the prevalence of nonprime or subprime mortgages as either first or second on a list of factors causing foreclosures in their cities. Almost all the mayors, 92%, said they expected the foreclosure problems to stay the same or worsen in their cities over the next year." - The Financial Crisis Inquiry Report [6]

"The same system that was so efficient at creating millions of mortgage loans over the past decade has been ineffective at resolving problems in the housing market, including the efforts of homeowners to modify their mortgages. As mortgage problems mounted, the federal and state governments responded with financial incentives to encourage banks to adjust interest rates, spread loan payments over longer terms, or simply write down mortgage debts. But to date, federal auditors and independent consumer watchdogs have given the federal government's and the banks' mortgage modification programs poor grades. The Home Affordable Modification Program (HAMP) is falling short of the 3 to 4 million families targeted for help by the end of 2010. (The program's resources come from the federal TARP funds.) As of December 2010, HAMP has resulted in the permanent modification of only 520,000 mortgages." - The Financial Crisis Inquiry Report [6]

"Since the housing bubble burst, about four million families have lost their homes to foreclosure, and another four and a half million have slipped into the foreclosure process or are seriously behind on their mortgage payments. When the economic damage finally abates, foreclosures may total between 8 million and more than 13 million, according to various estimates." - The Financial Crisis Inquiry Report [7]