Hey Everybody,
I need to find some information on the genesis of the housing market collapse. How does the Austrian Boom-Bust Cycle Theory fit in and how did it come about?
Is there any good analysis, articles or posting that address this?
Thanks!
In Austrian Economics, there is no Boom-Bust Cycle.
Badda bing!
If you want an education on the housing market and over consumption, expanding credit, and excessive borrowing, just watch some Peter Schiff videos (here). He’s on Fox Business all the time as the market Bear 
i agree that peter schiff is probably the best guy to explain the housing collapse. this is a great lecture where he explains the whole story of the US economy, including the housing bubble.
this is how i see the housing issue:
Clinton and Greenspan created the dot-com bubble, which burst in 2000. The result of this should have been a recession as the bad investments are purged from the economy. however, Bush didn’t want the recession to happen during his first term… so Bush and Greenspan blew up an even bigger bubble in the housing market which was even bigger than the dot-com bubble. They did this by dropping interest rates down to 1%, so there was a ton of money out there for banks to loan to people. Since the banks had all this money that the FED created, they abandon all their lending standards. So cheap credit and lax lending standards resulted in more people being able to afford houses. Since there was now more demand for houses, the price of houses went up. People were under the dilusion that housing prices only go up, and never go down. That’s why the banks didn’t care who they lent money too, because they figured that the price of the house would only go up, and therefore if the people couldn’t make the payments, they can still sell the house and get their money back. housing prices were bid up to very high levels. people who had very little income or savings were now home owners with adjustible rate mortages (ARMs). People with these ARMs figured that once they payments reset higher in a few years, the price of the house will have gone up, and they can refinance. However, housing prices stopped going up, and people’s rates started to reset higher. These people with sub-prime ARMs now could not afford the payments when their rates reset higher, and the price of the house went down, so they couldn’t refinance. These people start to default on their payments, and the house goes into forclosure. The banks see this happening and tighten their lending standards, which limits people’s ablility to buy houses. The demand for houses therefore falls, and the bubble prices collapse.
So an austrian economist would look at the housing crisis as a bubble that was created by artifically low interest rates by the FED, in combination with lax lending standards by banks. Also, Wall St. and everyone else was making a ton of money off all of these transactions as they took these bad loans and packaged them up to look like safe investments, and then sold them all around the world in mortage backed securities. In addition to the real estate industry getting rich off of this…a good chuck of the US economy became dependent on the housing market. People who owned a home thought they won the lottery, since the house that they paid $200K for is now worth $500K or something. Therefore, they thought they just made $300K, so they refinanced their homes and extracted the equity based on the theoretical appreciated value of the house. So people borrowed a ton of money off the temporary high value of the house, and they took the money and spent it on consumption. They used their home equity to pay off credit cards, go shopping, take vacations, remodel their kitchens, etc. Therefore, all the spending in the economy was made possible from the home equity loans. So once people can no longer borrow money against their house, the spending stops. When the spending stops, the bubble economy implodes because all the businesses in the US economy were based on people spending money. This is why it is said that the United States has a service economy based on consumption, rather than a manufacturing economy based off production. this is why we’re seeing them send $600 checks to everyone in hopes that they will take the money and spend it on consumption so that they go deeper into debt. so it’s not just housing prices that are collaping, it’s the whole economy that was based around the housing industry. There are all sorts of people who built homes, did home renovations, land scaping, sold furniture, etc. then there’s all the normal businesses that sold services and imported prodcuts that people were able to afford because they could borrow off the value of their house.
but peter schiff explains it the best… read his book crash proof… it’s a great book. (peter schiff is an economic advisor to Ron Paul and believes in Austrain Economics).
I’d suggest Mark Thorton’s working paper at http://mises.org/journals/scholar/Thornton13.pdf.
Interestingly enough, an attorney whom I am working with asked me as a rhetorical question if I would have invested in Bear Stearns prior to last Friday. The point that he was trying to make, related to a case that we are working on, was that companies that appear strong can suddenly collapse. This is true in regard to the company that we were discussing, which is privately held, does not issue financial statements to the public, and is not rated by the credit rating agencies. Bear Stearns, however, was a publicly traded company. Based on my regular reading of this web site and other Austrian literature, I had become completely convinced that the housing market and the related mortgage securities would eventually collapse by February 2004 and sent an article to all of my clients explaining this. If I had considered investing in Bear Stearns at any time since then I certainly would have read their financial statements, seen their exposure to mortgage securities, and avoided investing in them as anything other than a short-term momentum play.
I can’t comment on the first bubble, but I’d like to speak up on the second one. For some reason Greenspan does not want to admit that he created the housing bubble explaining that interest rates were low in the past and it didn’t produce the housing bubble. This is his favorite explanation. He is right .. in the second half. But it does not prove that the housing bubble is not his fault. Interest rates were merely some conditions. There were something else that was not there before when interest rates were low. Debt securitization was long in works and didn’t work well before due to complexities. Eventually, credit alchemists came up with a schema that was more reliable (you can see the diagram here http://www.fdic.gov/news/news/speeches/archives/2007/chairman/spapr1707.html). That was the tool, that was waiting for its showtime. Greenspan just overlooked this trend… Or ignored… At least, this is my a bit simplified understanding.
Thanks for the links to videos. I’ll watch them.
I am not sure where you would find the article, hopefully I can remember to look for it for you, but I read an article that a large cause for the housing bubble was the fact that the government required financial companies to give out loans without doing background checks, because the banks were “discriminating” against minorities. Well guess what, minorities happen to fall into the poor category more often than white people, which means they have worse credit, and duh, they have a harder time getting loans. But the “bright” people in government decided they should get loans just as easily as rich people, and so they made the banks lower their standards for making loans.
You are correct in general, although I’m not sure about the specifics. The program is known as the Community Reinvestment Act, and it requires banks to make loans in low-income neighborhoods. Also Fannie Mae, supposedly an organization insuring only the most conservative loans, created a program to insure loans with a 103% loan-to-value ratio in low-income neighborhoods. This meant that you could buy a $100,000 home in these neighborhoods for no money down and have an extra $3,000 in the bank.
Maybe I’m oversimplifying but I think this is what happened: the Fed created money out of thin air and lent it to the banks who lent it to homebuyers. Well actually if the Fed had lent it and they would really have to repay it with interest the money supply wound contract, not expand. It expanded which means they didn’t really lent it, in the long run, lent and had it repayed and then lent more in the end of the day it means they didn’t lend it, they gave it away.
Now basically it has the same effect as if houses would have been subsidized from taxes but with a remarkable difference. I the government taxes each cone of ice cream $1 and gives it to homebuyers the situation is at least clear: real resources will be diverted away from something else to building houses. It can happen two ways: either the customers suck up the $1 price increase in which case they can spend less on something else, say, burgers which means resources from making burgers are diverted away to build houses. Or they refuse to suck it up, they buy less ice cream which means real resources from making ice creams are diverted to building houses. Each case, even though intervention is wrong at least the market KNOWS what happened and can act accordingly.
The sinister thing about fiat money lending is that it makes people believe they had as much resources to make ice cream and burgers as before but MORE resources to build houses. Of course that’s wrong.
That’s the reason of the collapse IMHO. I don’t know whether it’s Austrian enough, I have not yet read Human Action - it’s just what I think the most logical thing and I think it’s not far away from the way of thinking in Economics For Real People.
I think the story is very far from being over.
March 19, 2008
Fannie, Freddie cleared to pump $200 billion into market
http://news.yahoo.com/s/nm/20080319/us_nm/usa_housing_gses_dc_3
Basically, he doesn’t understand that this is a total inversion of market signals.