Housing Bubble

Although these loan policies appeared to be a win-win for all involved, in truth, the system created great dangers. The Senate had distorted the credit market by imposing incentives that favored hut loans and education loans over other loans that had no guarantees. Loans were now being made not because they were necessarily the best use of savings, but because the senators had a political stake in encouraging hut ownership and education.

— Peter Schiff; How an Economy Grows and Why It Crashes

Even after the collapse of the mortgage market, people still don't understand how home prices are influenced by government policies.

— Peter Schiff; How an Economy Grows and Why It Crashes

The last thing the island needed was more huts. There were already too many huts. Any energy or resources spent building more huts would be wasted.

Similarly, hut prices were still too high. They had been bid up to ridiculous levels by a combination of factors that would never return. Trying to keep them from falling was like trying to keep a bridge from collapsing after all the supports had been knocked away.

Despite the fact that many islanders were upset for overpaying for their huts, the island economy would actually be better off if hut prices came down and building ceased altogether, at least until real demand returned. That way people could spend less on huts and have more to spend on things the economy lacked - like new businesses and carts that could be pulled by just one donkey. Resources used for new hut construction, like bamboo and rope, could be used for new businesses instead.

Unfortunately, government interventions would prevent this natural reallocation of resources from occurring.

— Peter Schiff; How an Economy Grows and Why It Crashes

It's hard to overstate the impact the housing boom made on the economy as a whole. During the height of the mania, the financing, construction, and furnishing of homes had become the central dynamo of the U.S. economy. And while everyone acknowledged the good fortune, few spared much concern about the future costs.

In addition to the profits made by real estate "flippers" (those who serially bought and sold properties), homeowners extracted hundreds of billions of dollars per year from their homes. The process turned houses into tax-free ATM machines. People used the money to renovate their homes, take vacations, pay for college, buy cars and electronics, and just generally live better than they would have if their homes had not appreciated in value.

But the wealth was simply a mirage.

— Peter Schiff; How an Economy Grows and Why It Crashes

In his book <em>Irrational Exuberance</em> economist Robert Shiller determined that in the 100 years between 1900 and 2000, home prices in the United States increased by an average of 3.4 percent per year (which is just slightly higher than the average rate of inflation). There were good reasons for this. Prices were firmly tied to people's ability to pay, which is a function of income and credit availability.

But form 1997 to 2006 national home prices gained an astounding 19.4 percent per year on average. Over that time incomes barely budged. So why could people pay so much? The difference was credit, which government policy made much cheaper and easier to get. But credit could not expand forever, and eventually conditions tightened. When they did, there was nothing to hold prices up.

So when the market crested, the easy money that for years had poured into the economy stopped flowing. Even if there had been no other economic reversals that followed the housing bust (which there were), the economy would have had to shrink without all the free cash. A recession was not only inevitable but absolutely necessary to rebalance the economy.

But when the economy started to contract, lawmakers and economists treated the development not as the inevitable consequence of years of easy money and overspending, but as the problem itself. In other words, they mistook the cure for the disease.

— Peter Schiff; How an Economy Grows and Why It Crashes

The policy goals of both the Bush and Obama administrations have been to encourage consumers to spend as they had before the housing crash. But how? If unemployment rose, and incomes and home prices fell, where would consumers get the money?

Economists have declared that if the people can't spend, the government needs to step up and do it for them. But the government doesn't have any money. All it has is what it collects in taxes and what it borrows or prints.

For now, this process is just creating massive public debt ($1.6 trillion per year and counting). And although the numbers look bad, we are still able to sell most of this debt on the open market, primarily to foreigners.

But our "good fortune" can't last forever. Ultimately the U.S. government will have only two options: default (tell our creditors that we can't pay, and negotiate a settlement) or inflate (print money to pay off maturing debt). Either option will lead to painful consequences. Default, which does offer the possibility of a real reckoning and a fresh beginning, is actually the better alternative. Unfortunately, while inflation is worse, it is also the more politically expedient.

— Peter Schiff; How an Economy Grows and Why It Crashes

As a result, the recession of 2002-2005 was one of the shallowest contractions on record. But that benefit came with a heavy long-term cost. The United States ended that recession with greater imbalances than it had before the downturn began. That's not supposed to happen.

Instead of real growth, we kicked off an even bigger asset bubble (in housing) that temporarily overcame the drag of the busted technology bubble. The rising value of housing prices created a great many 'benefits' that masqueraded as economic health. But as we have seen, that vigor was illusory.

The real tragedy is that six years later, when the next crash came, we had failed to learn anything from these mistakes. In diagnosing the causes and prescribing the best cures for the recession of 2008, economists and politicians are gelling it dangerously wrong.

— Peter Schiff; How an Economy Grows and Why It Crashes

Policies enacted by the Federal Reserve, the Federal Housing Administration, Fannie Mae, and Freddie Mac (which were always government entities in disguise), and others created advantages for home buying and selling and removed disincentives for lending and borrowing. The result was a credit and real estate bubble that could only grow—until it could grow no more.

Artificially low interest rates (which made the economy appear healthy) invigorated the market for adjustable-rate mortgages and gave birth to the teaser rate, which made overpriced homes scam affordable. Alan Greenspan himself actively encouraged home buyers to partake. Then government agencies and government-sponsored entities compounded the problem by guaranteeing adjustable-rate mortgages based solely on the ability of borrowers to afford the teaser rates. Without such guarantees most of these mortgages never would have been funded.

— Peter Schiff; How an Economy Grows and Why It Crashes

The word repeated endlessly in these political charades is "deregulation." The idea is that it was a lack of government supervision which allowed "greed" in the private sector to lead the nation into crises that only our Beltway saviors can solve.

What utter rubbish this all is can be found by checking the record of how government regulators were precisely the ones who imposed lower mortgage lending standards - and it was members of "Congress (of both parties) who pushed the regulators, the banks and the mortgage-buying giants Fannie Mae and Freddie Mac into accepting risky mortgages, in the name of "affordable housing" and more home ownership. Presidents of both parties also jumped on the bandwagon.

— Thomas Sowell; Dismantling America

Securities based on risky mortgages are what toppled financial institutions but it was the government that made the mortgages risky in the first place, by making home-ownership statistics the holy grail, for which everything else was to be sacrificed, including commonsense standards for making home loans.

— Thomas Sowell; Dismantling America

What was lacking in the housing market, they say, was government regulation of the market's "greed." That makes great moral melodrama, but it turns the facts upside down.

It was precisely government intervention which turned a thriving industry into a basket case.

— Thomas Sowell; Dismantling America

Mortgage loans with no down payment, no income verification and other "creative" financial arrangements abounded. Although this was done under pressures begun in the name of the poor and minorities, people who were neither could also get these mortgage loans.

— Thomas Sowell; Dismantling America

The housing market collapse was set off when the Federal Reserve returned interest rates to more normal levels, but it was a financial house of cards that was due to collapse, sending shock waves through the economy. It was just a matter of when, not if.

— Thomas Sowell; Dismantling America

Senator Humphrey was not unique in that respect. In fact, our present economic crisis has developed out of politicians providing solutions to problems that did not exist-- and, as a result, producing a problem whose existence is all too real and all too painful.

What was the problem that didn't exist? It was a national problem of unaffordable housing. The political crusade for affordable housing got into high gear in the 1990s and led to all kinds of changes in mortgage lending practices, which in turn led to a housing boom and bust that has left us in the mess we are now trying to dig out of.

— Thomas Sowell; Dismantling America