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U.S. Federal Reserve Chairman Ben Bernanke's latest thesis is that the home mortgage bubble had little to do with record low interest rates, and was actually much more a problem of regulation.
It sounds plausible - until you give it some real thought. After all, I believe that humanity has already tried a system with tight, vigorously enforced regulations, and no price mechanism.
It was called the Soviet Union.
It sounds plausible - until you give it some real thought. After all, I believe that humanity has already tried a system with tight, vigorously enforced regulations, and no price mechanism.
It was called the Soviet Union.
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Okay, that was a bit of a cheap shot - to some extent. Bernanke stated that "borrowers chose and were extended mortgages that they could not be expected to service over the longer term." That appears to make the problem one of regulation: The types of mortgages that banks should be permitted to offer should be limited to ones that borrowers have a reasonable chance of servicing.
In theory this makes sense. However, it is a prime example of what I in the past have referred to as the "Keynesian Bureaucrat Fallacy," or KBF.
Under the KBF, wise bureaucrats - who, like economist John Maynard Keynes, were presumably educated at Cambridge and steeped in the traditions of the Bloomsbury Group - will decide the appropriate regulations for every sphere of the economy.
They will then enforce them with draconian rigor, forcing the economy to behave in a way that optimizes economic welfare, measured by whatever means the bureaucrats devise. Irrational market-based signals - such as the price mechanism, will be ignored - unless the bureaucrats decide it is safe to take account of them.
Keynes would claim that the Soviet Union never tried his theories. Technically, he was correct. In that unhappy society, there was far too much corruption, far too much vodka, far too much cruelty and not nearly enough wisdom for Keynes and his Bloomsbury Group soul mates ever to find it truly congenial. After all, Keynes' wife - the ballerina Lydia Lopokova - was herself a refugee from the Soviet "paradise."
Nevertheless, the problem lay not in the Soviets' flawed implementation of Keynes' dirigiste fantasies, but in the theory itself. As such post-Keynes "public choice" economists as Nobelist James M. Buchanan have discovered, you simply can't get good enough bureaucrats for the Keynesian system to work.
In real life, the bureaucrats themselves have objectives of power, control and ideology that prevent them from imposing the wise regulations that Keynes would prefer. Government bureaucracies aren't all-knowing umpires of the economic market. In fact, the bureaucracies are actually participants in that market. And they are as driven by their own private objectives as any businessman or trader. Corruption is just the most obvious of the myriad problems that occur in practice.
Once you accept this reality, the theory falls down.
Writing regulations governing what kind of home mortgages people are allowed is thus impossible, without defining the product so narrowly you restrict necessary choice. In general, in any kind of free market, you have to rely on the rationality of both parties to the transaction. Banks will normally only write home mortgage loans if they think they will get repaid. And borrowers will only take them out if they think the house they are buying is fairly priced and they are confident of being able to service the debt. Provided the market is not irrationally exuberant or irrationally fearful, dodgy home mortgages will be only a minor problem.
However, we do know that interest rates and money supply have a huge effect on the housing market. And we knew this before 2002, despite what Bernanke and Fed-chairman predecessor Alan Greenspan would have us believe.
Allowing rates to get too low and money to slosh all over the place may not cause inflation - if, at the same time, China is manufacturing up a storm and lowering costs in other parts of the economy. But the artificially low rates will certainly raise what Keynes liked to call the "animal spirits" of borrowers and lenders.
And that will cause those borrowers to behave irrationally.
Borrowers will take out silly mortgages because they think house prices will rise and bail them out. And brokers will see the chance of quick commissions - even if the loans are not repaid - because rising house prices will make the loans good.
I understand Bernanke's wish to absolve himself of blame. But his preference for putting in more regulations over allowing the price mechanism of interest rates to work in the housing market didn't work when Gosplan (Russia's central economic planning commission) tried it, and it won't work now.
Now more than ever, it's obvious we need a new Fed chairman. Let's hope the U.S. Senate in a couple of weeks does its duty to the U.S. economy and votes Bernanke down.
[ Editor's Note : Some experts have labeled the U.S. bailout as "Bernanke's Folly" - and with reason: With all the debt the United States has taken on, the country is facing a financial mess that will take years to fix. But investors who are willing to act boldly and invest decisively will find an unparalleled profit opportunity hidden behind the piles of financial refuse.
With his Permanent Wealth Investor trading service, longtime global investment banker Martin Hutchinson has time and again demonstrated the ability to ferret out those profit moves. With a combination of gold, hefty dividend payers and stocks that are ready to rocket, Hutchinson has already secured windfalls for subscribers. To find out about Hutchinson's latest moves, please click here.]
News and Related Story Links:
In theory this makes sense. However, it is a prime example of what I in the past have referred to as the "Keynesian Bureaucrat Fallacy," or KBF.
Under the KBF, wise bureaucrats - who, like economist John Maynard Keynes, were presumably educated at Cambridge and steeped in the traditions of the Bloomsbury Group - will decide the appropriate regulations for every sphere of the economy.
They will then enforce them with draconian rigor, forcing the economy to behave in a way that optimizes economic welfare, measured by whatever means the bureaucrats devise. Irrational market-based signals - such as the price mechanism, will be ignored - unless the bureaucrats decide it is safe to take account of them.
Keynes would claim that the Soviet Union never tried his theories. Technically, he was correct. In that unhappy society, there was far too much corruption, far too much vodka, far too much cruelty and not nearly enough wisdom for Keynes and his Bloomsbury Group soul mates ever to find it truly congenial. After all, Keynes' wife - the ballerina Lydia Lopokova - was herself a refugee from the Soviet "paradise."
Nevertheless, the problem lay not in the Soviets' flawed implementation of Keynes' dirigiste fantasies, but in the theory itself. As such post-Keynes "public choice" economists as Nobelist James M. Buchanan have discovered, you simply can't get good enough bureaucrats for the Keynesian system to work.
In real life, the bureaucrats themselves have objectives of power, control and ideology that prevent them from imposing the wise regulations that Keynes would prefer. Government bureaucracies aren't all-knowing umpires of the economic market. In fact, the bureaucracies are actually participants in that market. And they are as driven by their own private objectives as any businessman or trader. Corruption is just the most obvious of the myriad problems that occur in practice.
Once you accept this reality, the theory falls down.
Writing regulations governing what kind of home mortgages people are allowed is thus impossible, without defining the product so narrowly you restrict necessary choice. In general, in any kind of free market, you have to rely on the rationality of both parties to the transaction. Banks will normally only write home mortgage loans if they think they will get repaid. And borrowers will only take them out if they think the house they are buying is fairly priced and they are confident of being able to service the debt. Provided the market is not irrationally exuberant or irrationally fearful, dodgy home mortgages will be only a minor problem.
However, we do know that interest rates and money supply have a huge effect on the housing market. And we knew this before 2002, despite what Bernanke and Fed-chairman predecessor Alan Greenspan would have us believe.
Allowing rates to get too low and money to slosh all over the place may not cause inflation - if, at the same time, China is manufacturing up a storm and lowering costs in other parts of the economy. But the artificially low rates will certainly raise what Keynes liked to call the "animal spirits" of borrowers and lenders.
And that will cause those borrowers to behave irrationally.
Borrowers will take out silly mortgages because they think house prices will rise and bail them out. And brokers will see the chance of quick commissions - even if the loans are not repaid - because rising house prices will make the loans good.
I understand Bernanke's wish to absolve himself of blame. But his preference for putting in more regulations over allowing the price mechanism of interest rates to work in the housing market didn't work when Gosplan (Russia's central economic planning commission) tried it, and it won't work now.
Now more than ever, it's obvious we need a new Fed chairman. Let's hope the U.S. Senate in a couple of weeks does its duty to the U.S. economy and votes Bernanke down.
[ Editor's Note : Some experts have labeled the U.S. bailout as "Bernanke's Folly" - and with reason: With all the debt the United States has taken on, the country is facing a financial mess that will take years to fix. But investors who are willing to act boldly and invest decisively will find an unparalleled profit opportunity hidden behind the piles of financial refuse.
With his Permanent Wealth Investor trading service, longtime global investment banker Martin Hutchinson has time and again demonstrated the ability to ferret out those profit moves. With a combination of gold, hefty dividend payers and stocks that are ready to rocket, Hutchinson has already secured windfalls for subscribers. To find out about Hutchinson's latest moves, please click here.]
News and Related Story Links:
- Wikipedia:
Lydia Lopokova
- The Free Dictionary:
dirigiste
- Wikipedia :
John Maynard Keynes
- University of Cambridge:
Official Web Site
- Wikipedia:
James M. Buchanan
- The Bloomsbury Group:
Informational Web Site
- Wikipedia:
Gosplan
- Bernanke's Folly:
Special Report
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Tags: Ben Bernanke, Housing Market, Interest Rates, Second Housing Bubble, Soviet Union, Subprime
TVM Happy New Year!
Pathetic commentary! When the only real alternative to "Bernanke's Folly" is guaranteed Great Depression 2 RIGHT NOW (Of course, there's still no guarantee in the long run). And the people who are seemingly anti any kind of regulation are obviously condemning us to repeat events of the recent past ( need I say it – NOT GOOD). Just even the tiniest bit of common sense would be appreciated.
Martin Hutchinson, Contributing Editor, Money Morning hardly undersatands Keynesian economics. Any effort to compare Soviet economics to that of Keynes would have been an offense to both.
Hutchinsons problem is he is too ideological to seek ways out of the morass the US finds itself in and it is a pity he tries to make it an all or nothing game, state v non state regulation, oppression v. freedom, pure market v. mixed market. Liquidationism is what Hutchinson preaches and I personally have no desire to applying such madness to bring additional widespread suffering to the US economy to discover the shortcomings of massive liquidationism.
Oddly enough Keynes knew better than to get into ideological sword fighting. I would suggest for starters Martin read the General Theory of Keynes.
right arrow >
wrong target >
>>———–> Geithner <————<<
That was a cheap shot..big time.. to imply that no regulation is necessary…I don't have the right adjective to describe that craziness. Selling to people you knew could not repay and bundling those mortgages and unloading them might sound proper to you, but not me.. I understand about "Buyer Beware" but seriously who reads all the fine print?? All share some blame.. lets face facts.. plain greed was the motivator.. The Republican mantra "GREED IS GOOD" That is ok for a lot of folks, but how they square that creed with the "Party of God" is beyond me.. Thanks for letting me unload.
W B
To Mr. Kenney; newsflash! It was the congress, i.e. Barney Frank and Bill Clinton who mandated that mortgage lenders ease lending requirements to that everyone could own a home. As a result, obtaining a mortage when u really couldnt afford was made possible. Mortgage companies required little or no documentation, etc. and yes, those mortgage backed securities were sold off to investors, etc. Both government and greedy business is to blame. Lastly, most people are smart enough to know how much of a mortgage payment they can afford without the government telling them that!!
Dont be so stupid!
The real reason for insane mortgages is obvious: those originating the mortgages knew they didn't have to worry about being repaid because they sold it right away to somebody else. When I was a young lad back in the 60s, the bank lent you the money once they were confident you'd probably pay them back, because if you didn't pay they'd be out some money. Regulation that keeps the risk with the investor is perfectly reasonable, because pricing mechanisms don't work in a system that can be gamed big time.
Peter, Thank goodness someone finally hit upon the root of the problem. Lenders who were no longer going to be left holding the bag if a borrower didn't pay simply had no incentive to lend only to those who showed ability to repay. Of course other factors helped things along tremendously. Low interest rates made easy money even easier. Relaxation of government lending requirements made it easy to put the gloss of credibility on a mortgage app. And, greed on the part of both borrowers and lenders made it possible for everyone to believe that real estate prices worldwide would never fall again. But, none of those other factors would have worked had it not been possible to sell off the risk, citing statistics that showed that pooled mortgages were virtually risk free assets. Of course, those statistics were from the era you and I remember where bankers were hard-eyed arbiters of mortage risk. In the new world, they were slick salesman just looking for a commission. And, that was a recipe for disaster.
Unfortunately we have a situation where the free market did not create the problem, but the bureaucrats certainly did. They made public money available to promote the housing market and made it available with nothing down. They created a moral hazard by rewarding flippers and financial incompetent people, ie creating socialistic capitalism whereby those who made a profit kept it and gave back properties on which they would be taking a loss, all this with no risk to themselves.. You see that in Fannie Mae, Freddie Mac, and AIG. And Bernanke is trying to perpetrate that system by giving more loans tohigh risk people to cover what they cannot themselves. What a deal for them and what a shot in the face for the good old taxpayer! In other words we want to go back to the same old unhelathy economy we just got busted in!
Many free-market developed countries have more regulation than the US. Just take a look at many countries in Europe or even Australia.
There are so many examples where a certain amount of regulation has strengthened the economy and banking sector. Regulation in Australia helped keep the banks out of trouble and kept it one of the few countries not to go into recession during the downturn.
Warren Brown
The mortgage lending system in Australia is very different to that in the USA. Firstly, in Australia, the borrower is personally liable for any shortfall if a property is repossessed and sold at a loss. This means that repossessions are very few in Australia and borrowers are more careful before taking out a mortgage. Secondly, house mortgages are generally at variable interest. Lenders increase the interest rate to borrowers when their cost of funds increase. This helps to protect lenders. Lastly, Australia does not have a government or quasi government guarantee of domestic mortgages such as Freddy Mac or Fannie Mae, which I do not fully understand but appear to be ridiculous.
The USA could do well to better understand the Australian system of domestic mortgages which has been a major contributor to the very strong performance of the Australian banking system in the recent crisis. Little Australia now has four of the highest rating banks in the world. Another factor protecting Australia is that Australia is an importer of capital and was not looking for investments such as the securitised products from the USA. Funds were borrowed on the international market and used for useful purposes in Australia.
Just imply the european rules in mortgaging.
1. a fixed income is needed (somebody without a job for example. can't get a loan)
2. You have to proove your income
3. You are only allowed to borrow 1/3 of your family income.
4. When you fail to pay there is no walk away. The bank is not interested in your house but will hold you and your spoose, if necessary, personally responsable for paying back the mortgage.
WHO IS RIGHT IF BEN IS NOT CONFIRMED?
I think Martin is correct in as far as regulations imposed by politicans and bureaucrats will not help that much. However, finding another FED Chief besides Ben may not be especially helpful, or different either. It really depends on how the "short list" of potential FED Chairman replacement candidates is formulated and who determines the list of names which are eventually forwarded to the President for possible appointment.
It is more likely the same old gang at the FED. As Congressman Ron Paul (R-Texas) often says, and as the legislation he sponsored suggests, we don't need a FED at all. Ron Paul thinks the FED's monetary manipulations cost the taxpayers and consumers much more than they are worth. So, the ultimate solution for monetary policy would be to abolish the FED and put the responsibility where it belongs. The next fix would be to elect responsible politicans to move towards a balanced budget with stricter controls on spending and any future increases in spending. Right now, neither solution seems plausable, given the past choices of the American electorate.
THE PROBLEM with Martin's "Poor Shot" IS
that BAD GUYS are in abundance ALL OVER THE WORLD!
That includes BOTH our USA (with its ENRONs & MADOFFs,…) AND the Russians, et al…
THE PROBLEM, IMO, is the SAD LACK of true States"men" (Male & Female)
in OUR Congress & Government(s) generally…!
There is a wonderful woman in Texas who found THE PERFECT WAY to KNOW
when the Texas Legislature IS in SESSION:
It IS when almost ALL of the Villages in Texas report that
"THEIR IDIOT is Missing!"
Unforuntely, THAT Method also WORKS at the FEDERAL Level
and nearly every State & Local Level too…
THE PROBLEM/answer is GREED, plus a SAD lack of Intelligence, Honesty and (uncommon)"COMMON SENSE"…
CURRENT EXAMPLE:
WHY don't OUR Congress-People WANT to have their HEALTH Program BE
what they want OUR NATIONAL HEALTH PROGRAM to be
(whatever THAT may finally be…)!???
You HAVE the ANSWER just above… and it applies more generally to almost all Government…
and to the Markets\Businesses\BANKs\Wars (and Martin?)…
Fortunately, Martin seems "Honest" but in dire NEED of Education…
(Is he "SMARTER than a 5th Grader?..
Want to WAGER on that, Martin???)
GOOD Fortune\LUCK TO ALL of US, present & future…!
Fraud.
Plain and simply that's all it was. It is nearly impossible to prove, but like pornography, we know it when we see it.
The excesses of the market were not reigned in because regulators didn't stand up and say we've passed sustainability and crossed over into fraud. Fraud became obvious to the most casual observer when No-Doc, Liar's Loans, 125% mortgages became the norm. Both Democrats and Republicans are responsible. Make that irresponsible.
Sadly the government response has been to reinforce the bad behaviors. Bear Stearns failed, but the price was bumped from $2 to $10, Lehmann failed, Merrill Lynch failed but was given $50 a share! They too should have been given $2. Morgan Stanley and Goldman Sachs should have failed also. But the Federal Government, made sure they were made good.
Martin comparing regulation with the Soviet Union is, I hope, merely hyperbole. All industries need some regulation. Upton Sinclair's The Jungle being the definitive proof. And I might add, the sheer number of meat recalls in the late 00's, confirm this.
The job average Americans expect our government to perform is simple, regulate to protect us. Government has failed this simple task.
Not many years ago, people had to put a 20% down payment on a house. No longer is that required but should be. Now banks are allowed to use the money from mortgages to gamble with derivatives and that should not be allowed. We should also go back to keeping banks separate from the investment and insurance industries.
Regulation and corruption go hand-in-hand. The minute a bureaucrat is handed a regulation the special interests start knocking on his door for relief, exceptions, favors, etc. When the regulators are corrupt – as we've seen many times – the regulations become intolerable. Regulation and corruption are bed partners.
The housing debacle was industry greed & the Fed's motivation to keep the economic boom going. We did it to ourselves. Big Ben is right! Fanny & Freddie abandoned over 50 years of loan underwriting experience & the Fed's stood by counting the production of #5 trucks while assisting its Banking system to survive by loan sharking! Two & two are still four but Ben & Tim think they have the skill to keep it @ six. Unfortunately there is no way the American people can correct the system w/ the electorial process now in place. Too much congressional lobbying by the Banks, too much ineptness in the beauracracy, too much political greed & too much Vodka. Sounds familiar. God Bless America & help us in our time of need!