Can Government Fix the Over-Built Housing Market?
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Posted: 03/31/08
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Can Government Fix the Over-Built Housing Market?
By Thomas E. Brewton
Why did we get a massive over-building of single family homes and a
plethora of bad mortgage loans?
Responding to Liberals' Wall Street Pirouette www.thomasbrewton.com/index.php/weblog/ a reader wrote, among other
observations:
I was right with you until..."the huge overproduction of housing would not have
occurred."
What "over-production"?
Remember: supply, demand and price balance except where
force or fraud intervene, in a theoretical environment of
scarcity. So, how do you precisely define
"over-production" or "over-supply" or "surplus" or
"shortage"?
My explanation:
Bottom line: the crash of the housing industry, the subprime mortgage
meltdown, and the securitized debt disintegration that threaten the
financial community originated with the Federal Reserve. In the
extended period during the 1990s and into recent times, Fed Chairman
Alan Greenspan kept interest rates artificially low by flooding the
market with excess money. Chairman Bernanke, who believes that the
Depression was caused by the government's failure to spend enough, is
carrying on that destructive policy.
The Fed's current emergency actions may temporarily bail out Wall
Street, but they will only impede and prolong the workout in the
housing industry. Continuing inflationary expansion of the money
supply will keep us at square one, with unqualified buyers who will
have no equity in the properties they aim to buy using mortgage loans
which their incomes are insufficient to service.
The interpretative problem originates in Keynesian macroeconomics,
part of the religious dogma of liberal-progressives. Keynesians
assume that aggregate demand and aggregate supply for the economy as
a whole are single "things" that can be reduced to one supply-and-
demand graph. This is an oversimplification that masks a huge
complexity of demand and supply factors, along with widely differing
time scales of production.
Keynesians' oversimplification leads them to the assumption that, if
aggregate demand is less than aggregate supply, then the government
has only to put more fiat dollars into consumers' hands to increase
consumption and to re-energize economic production and employment.
What in fact occurs is that additional artificial-money handouts from
the government simply drive up prices, prolonging and aggravating the
distress.
Instead, government needs to butt out and let normal market processes
take place. Wage rates, housing prices, and housing inventories need
to fall as fast as possible in order to clear the market. Once
inflation fears are quelled by restricting the money supply and new
lower costs and prices enable buyers to qualify for sound mortgage
loans, the housing industry can rebound on a profitable basis.
I find the Austrian economic school version, as I understand it, a
more reliable analytical tool than Keynesian doctrine.
Ludwig von Mises, Friedrich Hayek, et al focused upon the lengthy
time scale that applies to production of capital goods (which
includes all the intermediary steps from raw materials to
manufacturing the machinery and tools for production) that are
necessary for the production of goods for immediate consumption.
Monetary manipulation by the Fed sends misleading signals to the very
large part of the economy that is involved in long-cycle production
of capital goods. Excess expansion of the money supply leads capital
goods producers to over expand their investments in production
capacity to meet an illusionary, credit-based consumer demand.
Additionally, the artificially low, Fed-managed interest rates make
investment in capital projects appear to be profitable, though they
may be uneconomic at free-market interest rates.
Capital goods producers, in our present case, are home builders and
building materials suppliers. They are parts in a long time-scale of
production that cannot possibly respond to short-term government
consumer handouts or to the Fed's low interest policies implemented
by expanding the money supply.
Homebuilding, in most jurisdictions, is a very lengthy process,
commencing with locating developable sites, demographic analysis,
securing options on the land, drawing up site preparation and
building plans, getting them approved by local authorities (usually
with months or years of lawsuits and other community action opposed
to any new development), and finally obtaining land financing,
construction loans from banks, and arranging packages of permanent
mortgage financing for home buyers when the finished product
eventually hits the market.
It is not unusual for builders of multiple homes on large sites to
have two to five years of time, effort, and money invested before
they see a dime of income. In most cases, their profit on a
development deal is realized only at the back end, after several
years of building homes, when all the original capital investment and
land acquisition financing has been paid off.
That is why real estate, and to some extent all capital goods
production, is such a boom-and-bust business. Once having embarked
on a large project, the developer can't just stop it or put it on
hold, because the interest meter is always running on his land loans
and construction financing.
Misunderstanding the nature of the problem, Congressional liberals
aim to end recessions by churning out an endless array of government
spending programs, and the Fed accommodates them with a flood of money.
That over-expansion of the money supply and, in the early stages, the
artificially low interest rates for loans make developers think that
consumers have sufficient real savings to buy their products and that
the projects will be profitable. Remember that developers must make
multi-year spreadsheet projections of costs and revenues to determine
the economic feasibility of a project and to persuade lenders and
equity investors to finance it. And their spreadsheet projections
must employ assumptions about interest rates.
The result is commencement of long-term projects that lead to
oversupply of finished goods several years later.
Whenever we experience economic shocks such as the current subprime
meltdown, the natural, though misguided, tendency is to search for a
villain, somebody or some institution whose malfeasance caused the
problem.
In fact, such shocks are inherent in the Fed's creation of excess
money supply and artificially low interest rates. Once the dollar
begins falling in foreign exchange markets and inflation worries
begin to take hold, the Fed has to slow down creation of money in an
effort to keep inflation within its policy limits and to fix interest
rates at what its bureaucrats have selected as the appropriate level
of market interest rates. When the Fed begins to change course, the
game is up.
Deals that appeared several years earlier to be profitable no longer
are when inflation drives up production costs and selling prices.
But the capital goods capacity expansion and finished goods
oversupply are already in the pipeline.
Thomas E. Brewton is a staff writer for the New Media Alliance, Inc.
The New Media Alliance is a non-profit (501c3) national coalition of
writers, journalists and grass-roots media outlets.
His weblog is THE VIEW FROM 1776
http://www.thomasbrewton.com/
Email comments to viewfrom1776@thomasbrewton.com
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