27 August 2007

All must have mortgages

The Week on the subprime situation:

What sparked the original splurge in mortgage lending?
Its origins can be traced to the so-called "Greenspan Put": the policy of ultra-low interest rates pioneered by the Federal Reserve under Alan Greenspan to combat the fallout following 9/11 and the dotcom bust. The flood of cheap money ... led to the biggest property and building boom in decades. America went real-estate crazy. By 2005 prices had risen so dramatically that in hotspots like California and Florida even trailers were fetching $2m plus.

How did this affect the US psyche?
As millions of Americans took advantage of what some in Washington dubbed "the new era of democratised credit", renting a house came to be seen as a kind of social failure. Speculation became rife, prices continued to soar and thousands of new-built condos changed hands several times before a single spade of earth had been dug, with more and more punters refinancing their deals in order to secure more cash.
When the full consequences of the lending fiasco eventually develop, 'capitalism' will no doubt be blamed. But it is hardly 'free markets' when both individual borrowers and whole nations are insulated from the negative aspects of economic activity. If borrowers know that the government will protect them from the results of their folly or irresponsibility, the incentive to behave sensibly or prudently is clearly diminished.

What mediocracy particularly disliked about old-style capitalism is that exceptional individuals were sometimes able to act independently of the social will, using money accumulated by their families or supporters. Now that this possibility has been curtailed by means of heavy taxation of private capital, markets for goods and credit can be tolerated. Indeed, such markets can be regarded as a reinforcement for mediocracy, once policies have shifted spending power sufficiently towards the mass. By referring to this reconstructed system by the old name, dissatisfaction can be directed at the original concept. Thus 'capitalism' can be blamed whenever mediocratically distorted markets generate crises.

If financial behaviour becomes dumbed down and irresponsible, this can be blamed on ‘the market’, rather than on those who represent the bulk of economic activity, or on the policies which inflate their financial power. Markets thus function as a useful scapegoat for cultural deterioration. This is part of the reason why mediocracy finds it expedient to retain them.


bgprior said...

There are further ways in which the imbalances in the economy owe a great deal to government intervention:

1. Fannie Mae and Freddie Mac. In that context, it is interesting that the debt that the Fed took as collateral for its recent liquidity-injections included "mortgage-backed securities that are federally guaranteed". That should be a contradiction in terms.

2. Welfare policies generally. The current problems derive largely from a devaluation/underestimation of risk, which has led to an imbalance of debt relative to saving, and thereby to inflation of the broad money supply. One's willingness to risk high levels of debt, whether personally or within one's business depends on the consequences of failure. And the amount that people feel they need to put away for the future and the security of the investments that they choose for those purposes, depends on the extent to which they think the government will pick up the tab if their savings/investments are insufficient. People have become far too complacent about future risk.

Mind you, we shouldn't deny that creative destruction is an important part of free markets, and that bubbles can occur without help from governments. But it is particularly worrying when government folly amplifies human fallibility.

If we have a major crash, they may discover that even governments can run out of money to cover the costs of all their commitments. Like you say, governments will then try to cover their own failures by blaming 'capitalism'. And people will believe them. Perhaps Schumpeter was right, but not inevitably, I hope.

Thanks for the link to Picking Losers, by the way.

Fabian Tassano said...

Good points, thank you.

bgprior said...

Is this the sort of thing you had in mind?

Fabian Tassano said...

Yes, but I'm sure we will eventually get much worse than this - and not just from leftist conspiracy theorists - when the real whatsit hits the fan. Which may be some months away yet.