Succumbing to Policy Failure

John Tamny at RealClearMarkets has a lengthy transcript of a speech given at the Jonathan Club in Los Angeles, a private social club with political overtones. The speech traces the ways in which recessions have been caused by failures of public policy from 1929 to the present. It certainly provides food for thought.

A couple of portions caught my eye. For example,

In short, the rush to housing this decade was the recession because it drove limited capital into the ground, and away from the productive parts of the economy. If you buy a house, you’re putting money into the ground, but if you save instead, your capital reaches businesses eager to grow, and if you invest in the stock market over the purchase of a home, you’re providing capital to entrepreneurs as opposed to a housing investment that does very little to enhance productivity.

I’m not so sure of that. Absent the “rush to housing” would there have been more saving or capital investment in the United States? I don’t see it. What I see instead in the housing boom is betting on what was believed to be a sure thing, something hinted at here:

It’s very simple, and it involves the dollar. The dollar collapsed this decade, and as global history reveals in living color, when currencies are debased limited capital flows into hard assets – Ludwig von Mises referred to this as a flight to the real – least vulnerable to devaluation. To put it simply, housing is the ultimate middle class hedge against inflation because it’s a commodity-like asset that does relatively well during periods of currency devaluation, and even better, it’s an investment that can be lived in.

I think that this:

To put it in a very basic way, the recession was once again the rush to housing due to capital flight away from the productive economy, so when companies and banks started to collapse as a result of this inflationary flight to the real, the collapses were a sign that the economy was healing itself. In short, the marketplace was fixing our economy by ridding it of poor banking and business practices that had for several years been camouflaged by a weak-currency money illusion. Had we allowed this necessary process to run its course, the recession would have been just that. Light and short.

But sadly, this time around, there was a collective blink on both sides of the U.S. political aisle in 2008, and I believe it explains what ultimately got us here. Horrific dollar policy led to the very malinvestment that would have given us a slowdown, but our bailout/stimulus culture truly tanked the economy on the way to a crisis.

is likely to be controversial. Absent the extraordinary federal government intervention would the recession have been “light and short” or would the entire financial system have collapsed? I honestly don’t know. The even thornier question is whether collapse would have been worse than what we have, continue to, and will experience? Again, I honestly don’t know but I suspect it’s a question that economists will be debating for generations.

12 comments… add one
  • Icepick Link

    Absent the “rush to housing” would there have been more saving or capital investment in the United States?

    Depends on how one views the creation of capital in the madoern banking system. I imagine (but am not sure) that Steve Keen, for example, would find this proposition wrong-headed. It’s not like people were buying houses with wads of cash, they were doing it with small or no down-payments, ARMs, etc. The money they were spending on houses would have been spent on rent, and there’s nothing indicating that would have made it back to those productive innovative non-existent industries in question.

  • Mr. Tamny’s claim is that investment in housing siphoned money away from other domestic investments. While I agree that housing siphoned investment in its direction, I’m skeptical that increased domestic investment would have taken place without a housing boom.

  • is likely to be controversial. Absent the extraordinary federal government intervention would the recession have been “light and short” or would the entire financial system have collapsed? I honestly don’t know.

    I haven’t read the article yet, so I don’t know if Tamny is claiming that absent intervention the recession would have been light and short. However, what gets me about comments like the above is the assumption many make on those who were opposed to intervention. It wasn’t necessarily the thinking that it would be a lighter/shorter recession (although looking at the Great Depression as a prior indicator one could make a serious argument, IMO) but that it was what was necessary. In other words, the intervention was designed to prop up the failures, prior bad policies and an attempt to return to a state that was not sustainable and one we can’t return to.

  • I don’t know if Tamny is claiming that absent intervention the recession would have been light and short

    Yes, that’s what he’s claiming. Or at least that’s the way I read the article.

    Note that when I say “I don’t know” I don’t mean that I do know that he’s wrong. I mean that I don’t know the right or wrong of it. I don’t know if the intervention that took place caused the recession to be deeper and longer than it otherwise might have been (I suspect it did). I don’t know if no intervention at all would have resulted in a recession that was short and light (or if prior interventions induced the depth of the recession in the first place which I think seems likely). I also don’t know if perfect interventions that took place with perfect timing would have minimized the recession and, frankly, I don’t think that such things are possible in nature.

  • Drew Link

    I have, I guess, a non-standard view on housing. I view it as consumption, not investment. It simply has the illusion of investment because the magnitude of the price forces long term financing, and of course price escalation in the 90s and aughts gave it the (mirage) look of investment. It was speculation. Way different.

    I think I’m at odds with Dave in his comments on the first two paragraphs he cites. I think by definition, the money plowed into housing (consumption) would have found its way into the capital markets for other investment purposes. This capital simply flowed to support a specific sector. The question becomes, was this sector the best and highest use (uh, er, no) and what did the recipients of this funds flow do with it? Allocate it to good use? Or more of the same?

    I think ice pick errs in noting low down payments. Well, that capital not going into a down payment could be used for the very same purposes had a housing purchase not have been made. That is, it was actually an attenuating affect on capital misallocation. If the point is that it induced the capital misallocation, fine, but I think the real story is that these were people who were hellbent on homeowning. And were encouraged. Ifwe want to start telling people how to invest their money we have Obama, and solar and wind and all sorts of inane investments. I dont want to tell individuals how to invest their money, housing or otherwise. BTW..There is nothing wrong with an ARM. The risk can be managed very simply.

    As for the dollar argument. Well, how many people who bought RE in the last 15 years think their housing investment protected them from the dollar/inflation problem right now? On the other hand, if housing resumes its historical inflation hedge status then now may be a great time to start thinking about overweighting in RE in a portfolio. But I still worried about shadow inventory and latent foreclosures. At least for another 6-12 months until I see evidence of firming.

  • I think by definition, the money plowed into housing (consumption) would have found its way into the capital markets for other investment purposes.

    Sure. But in all likelihood not here. The distinction I’m making is between domestic investment and non-domestic investment.

  • I have, I guess, a non-standard view on housing. I view it as consumption, not investment.

    When a construction company purchases land and construction materials and pays labor to construct a house for resale that is, indeed, investment. That’s the investment I’m talking about. When a company or individual purchases a house for resale with no intention of living in it, that’s investment, too. When an individual purchases a house and lives in it for a while under the assumption that he or she will be able to resell it quickly and “trade up”, that’s a bit of a gray area. It’s certainly consumption. Is it also investment? I’ve known, literally, scores of people who operated just that way.

  • michael reynolds Link

    Again, I honestly don’t know but I suspect it’s a question that economists will be debating for generations.

    So we’ll never get an answer. We will however get 100 answers.

  • Icepick Link

    Drew, I agree that ARMs in and of themselves aren’t necessarily bad. They CAN be bad decisions. What we were getting in Florida was people taking out ARMs with the idea that they would sell the house and make a mint before the rates changed. People were flipping houses like crazy down here. It wasn’t uncommon for someone to buy a house that hadn’t been built yet, and for that house to be sold two or three times before the thing was finished.

    Some people were making mints, and probably did alright if they got out before the markets crashed. I imagine that almost none of them got out before the markets crashed.

    When we were looking to buy back in 2005, we looked at a house in the neighborhood we were living in. The woman looking to sell owned about 15 houses at the time. She had cut her numbers down considerably because of the divorce she was getting. She told us that was the only thing she did to make money, just buying and selling houses. As long as prices kept going up, she was set!

    Minimum payment ARM options were a favorire of that behavior. That was insane, and the ARMs contributed to the behavior.

    OTOH, my sister and brother-in-law used ARMs for most of his first career, but they were moving something like every 14 to 18 months. For them is was a sensible option.

  • Icepick Link

    It’s funny, when I was younger and renting, I wanted to own. Now that I’m old and own I’d prefer to rent. I hate having to pay for all the damned upkeep. Someday, just once, I would love it if my preferences and circumstances could line up.

  • steve Link

    Given the prevalence of repo in the shadow banking system, how could we not have had a collapse? Everyone was loaning to everyone else. No one was underwriting, they were all hedging. AIG was bearing the weight of a lot of that. If AIG went, how many major banks went? Since we have never gone through a bankruptcy with an international bank, what are the odds that would go well?

    Steve

  • Drew Link

    Dave

    Perhaps we are talking past each other. I’m viewing it as final demand, or the purchaser. So..

    “When a construction company purchases land and construction materials and pays labor to construct a house for resale that is, indeed, investment. That’s the investment I’m talking about.”

    Of course. That’s working capital investment. But then everything would be investment.

    “When a company or individual purchases a house for resale with no intention of living in it, that’s investment, too.”

    I prefer to think of it as speculation, a highly risky subset of investment.

    When an individual purchases a house and lives in it for a while under the assumption that he or she will be able to resell it quickly and “trade up”, that’s a bit of a gray area.

    Still speculation, IMO. Obviously, I’m making a value judgment.

    In other words, what I’m saying is that those who view, or viewed, housing as an investment rather than consumption made a grievous error. Musical chairs is a game for speculators, not for investors. If viewed, financed and utilized as housing consumption you dont get into trouble. Those who didnt generally got their heads handed to them.

    icepick

    “Drew, I agree that ARMs in and of themselves aren’t necessarily bad. They CAN be bad decisions. What we were getting in Florida was people taking out ARMs with the idea that they would sell the house and make a mint before the rates changed. People were flipping houses like crazy down here. It wasn’t uncommon for someone to buy a house that hadn’t been built yet, and for that house to be sold two or three times before the thing was finished.”

    Trust me. I know. I got so many come ons for RE investment partnerships it would make your head spin. Never bit. Could have made a fortune in the 90’s, but thought the whole housing thing was absurd. I was early, but eventually correct.

    That said…an ARM is a financing decision, its not a purchase decision, whether that decision be a speculative one or a sound investment. People in my business find that distinction important.

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