Wednesday, October 08, 2008

Comrade Greenspan's Five Year Plan

Some of the damage from the housing bubble is obvious. People are getting kicked out of their homes, banks are going broke, and the damage to the financial system is bleeding all over the economy as otherwise sound firms, and even state governments, can't get credit.

But that's not the damage that would be obvious to someone who dropped down from Mars. The Martian would see a different kind of damage. For some unaccountable reason, at a moment where the apparently sapient species that dominates this planet is starting, in places (like Beijing), to literally choke and burn on its own fumes, that species chose to put an enormous amount of its aggregate resources not into new technology to deal with the problems, but instead, into building new suburbs of Las Vegas.

The reason we did this, someone might explain to the Martian, is that ultimately, it was investors who had control of these resources who decided how to allocate them --- and new technology is perceived as a risky investment, while housing was perceived as safe.

And yet, the safe investment is now the thing that's blowing up the banks. Why?

Well, at some point just a few years ago, housing was safe. Housing was safe mostly because there were a whole lot of safeguards put into the market to prevent dangerous deals. You couldn't get a mortgage to buy a house unless you demonstrated a serious ability to pay, and put in a large down payment, to make sure you had some skin in the game incase the deal went south. What happened in the meantime, starting around 2000, is that Wall Street eliminated all those safeguards, and hired Ph.D. physicists to come up with messy, complicated arguments that it was still as safe as it used to be. (Arguments which happened, in the event, to involve packaging up the loans into pools, structuring the payouts from the pools in all sorts of arcane ways, and arguing that it was the structure that was now making it safe --- structures so complex that almost no one really understands what they are.)

It seems they were wrong.

And the depressing thing is that it was all predictable. And, in fact, predicted. And, in fact, the result of deliberate policy. As the inimitable Daniel Davies explained in 2002, before the game had halfway started:

... as far as we can tell, the American consumer is basically only still spending because he thinks that magic [stock market] beans grown on the Internet will pay for everything. ... And given that the stock market's been performing pretty badly these days, and is beginning to appear on the cover of USA today, lots of people are beginning to worry that the day of reckoning might be at hand. Which would obviously, leave us in the shit.

This is the doctrine of the "wealth effect", and if you can dig up a few factoids and linear regressions to illustrate it and avoid using the word "shit", you can make a quite decent living as a pundit by repeating the paragraph above. On the other hand, if you had been placing bets on a US double-dip recession so far, you'd have lost them, because Alan Greenspan and his merry gang at the Fed have a solution to this problem. Basically, the solution's pretty simple and it involves screwing interest rates down to the floor until mortgage rates follow them down to Low Low Prices levels, and pointing out to the Great American Consumer that it's "Bye-Bye, Magic Stock Market Bubble Money!" but "Hello, Magic Housing Market Bubble Money!". Marvellous.

Well, he wasn't all right. He left out the structured finance part. But there's an important thing he got right here: the housing bubble was the result of deliberate policy, on the part of the Federal Reserve under Alan Greenspan --- Greenspan, who was also refusing to use the authority Congress had given him to regulate non-bank mortgage lenders, and was instead personally touting risky, safeguard-free new mortgage products to get new, insecure buyers into the housing market.

The result of which, among other things, is all those new suburbs of Las Vegas and the Californian "inland empire" which are incomplete, and falling to pieces even as the few residents get dispossessed. It's not just a financial problem. It's an immense waste of social resources --- money that could have gone into funding green technology, instead spent on enormously wasteful, doomed projects justified by high-flown rhetoric (let's boost home ownership to promote responsibility!) that had gotten completely unmoored from reality.

And with that in mind --- what was wrong with Communist central planning? Well, precisely that it used high-flown rhetoric to justify ill-conceived projects which might have been justified by lofty goals, but which ultimately just didn't work. And that's what the capitalist system seems to be giving us --- Greenspan, acting on his own, gave us the bubble.

Now, we could say that this was still another government program. But consider. The Fed isn't technically part of the government. It is nominally owned, instead, by the member banks. And while its management is appointed by Congress, it seems nevertheless to have been acting, in this case, pretty much as the shareholders would have wanted --- most of them were very active in the new, high-tech markets for subprime mortgages and their even shadier derivatives (in effect, the sheen on Greenspan's bubble), and all of them are suffering for it now. So, if we took government out of the Fed, and made it exactly what it appears to be nominally --- a corporation responsible to its shareholders --- it almost certainly wouldn't have done anything different. Particularly not if Greenspan was still running it.

Which ought, perhaps, to give pause to partisans of the "wisdom of the market", or "the wisdom of crowds"...

3 Comments:

Anonymous Anonymous said...

Not to mention that many of those recent and superfluous suburbs built in California were built on top of some of the best agricultural land in the world, at the same time that food prices were skyrocketing worldwide. Basically, what we have seen is a fundamental lack of long term vision or planning.

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