The net results of the credit bubble are as follows:
1) An enormous number of families living in homes they cannot afford.
2) Bank balance sheets laden with current bad loans and lots of potential future defaulting loans.
3) Real Estate Sales, despite being propped up with historic low mortgage rates and tax purchase credits, are continuing to slide.
4) A weak overall economy with a very slow, soft recovery.
Whether a function of populist politics or bad economics, the proposals so far appear to address items one and three. But upon closer examination, they do nothing of the kind. In fact, they are actually gaming the system to help issue two ”” the bad loans the banks are carrying.
Even worse, they are making issue #4 ”” the economy ”” increasingly problematic.
We should allow the real estate market to experience a healthy price normalization process. Even though home prices have fallen dramatically, they have yet to reach their historical means relative to income or the cost of renting. This is to say nothing of the usual careening past the median towards under-valuation that typically follows a massive mis-allocation of capital.
Indeed. We also tend to believe our own times are somehow unique. Let’s go back to the worst depression in American history. Hint: 1929-42 was only the [i]third[/i] worst, and 1782-87 the second worst.
The current depression, of late begun, is only the second in American history to feature the simultaneous collapse of three bubbles: in equities, in real estate, and in commodities. Which brings us to the circumstances of 1837 to 1843.
The 1830s were a period of ebullient economic expansion, fueled by debt. Optimism of this boom fueled the customary speculation, with a real estate bubble peaking in late 1836. As it collapsed in the Panic of 1837 the federal government poured money into the most affected banks.
Sorry, fellow economic and constitutional conservatives … Bush/Obama responses to the 2008 real estate collapse are not unique. For that matter, all you gold-standard advocates, the federal response in 1837 occurred when we [i]were[/i] on a gold standard. A gold standard does not prevent either bubbles or federal intervention. Got that? Now, back to our regularly scheduled comment…
What happened to that federal money? To paraphrase Nicholas Biddle, famous banker of that era, quite closely “[Federal money] piled up in Western [banks]; not circulated, [lent] or used, but held as a defense against the [Department of] the Treasury. Those banks do not use [federal money] but businesses are suffering for the lack of [liquidity]. Commercial intercourse is wholly suspended … Europe is alarmed and the Bank of England uneasy. We are suffering because, from mere mismanagement, the whole balance of currency [has been] shifted from one side of the vessel to the other.”
Now, what followed is interesting. Federal intervention was able to goose the economy, but only for awhile. In 1839 the effort was overwhelmed by the forces of excess debt and poor investment in over-priced assets. There was a second sharp decline in prices, and this time wages fell, too.
[b]Failing businesses and real estate deal were allowed to fail.[/b] To quote Nobel Laureate in Economics (1993) DC North, “The difference between 1837 and 1839 was that the former panic [appeared] temporary, while monetary influences in the latter period combined with the real effects of a decade of uninhibited expansion … which necessarily entailed a long period of readjustment.”
Because it was allowed to run its course quickly and hard, the depression of 1839-43 got rid of the dead wood and malinvestments in a fairly short time, especially compared to what happened under the FDR administration, which attempted to fight natural economic forces. Elsewhere in the world the 1930s depression was largely over by 1935. US federal intervention alone extended to pain by at least seven years. Unemployment in 1938 was unchanged from 1931.
Meanwhile, back in the 1840s, willingness to let bad debt wither away through default not only provided a mercifully rapid end to economic difficulties, it also set the stage for the remarkable economic expansion of 1844-54, which proved to be the greatest of the entire 19th century in America.
Bart,
could you suggest a good book on financial crises/depressions of the past?