Wednesday, August 8, 2007

Sowell Reveals the Culprit

To attain some brownie points with Bubba, I'm directing all y'all to a piece by one of his favorite writers, Thomas Sowell. Here Sowell offers an explanation for what we might call the "root cause" of the whole sub-prime, creative financing thingamabob. Excerpt:

But why were housing prices going up so fast, in the first place? A number of studies of communities across the United States and in countries overseas turned up the same conclusion: Government restrictions on building.

While many other factors can be involved -- rising incomes, population growth, construction costs -- a scrutiny of the times and places where housing prices doubled, tripled, or quadrupled within a decade shows that restrictions on building have been the key.

Attractive and heady phrases like "open space," "smart growth" and the like have accompanied land use restrictions that made the cost of land rise in many places to the point where it greatly exceeded the cost of the homes built on the land.

In places that resisted this political rhetoric, home prices remained reasonable, despite rising incomes and population growth.

Construction costs were seldom a major factor, for there was relatively little construction in places with severe building restrictions and skyrocketing home prices.

In short, government has been the principal factor preventing the "affordable housing" that politicians talk about so much.

So, what does this remind you of? "Smart Growth" as opposed to horrible, "cancer-like" consumerist growth which might help keep prices down? As always, it comes down to the free market versus the "sieg heil" crowd. Call them communitarians, control freaks, new urbanists, rich elitists -- whatever name the fascists are going by this season seems to me to be largely unimportant.


Brownie points aside, I was stongly reminded of this related post from the "vault". It seems as if there is a good English word for "do[ing] things to control the rate of change and the direction of the change" and that word is regulation.

21 comments:

  1. I usually agree with Sowell, but he is WAY offbase here. there is a glut of brand new high-end housing where he (and I) live. the housing bubble was caused by easy credit, full stop. any schmoe (who should have been in affordable housing but wasn't) could get a big mortgage. a really big mortgage. this turn of events was engineered by greenspan to end the recession caused by the bursting of the tech bubble.

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  2. what i mean to say is greenspan lowered interest rates and in other ways made credit way too easy. all this was exacerbated by the brand new, under-regulated derivatives market that sought to hide the risks of mortgage-backed securities to various investors (including pensions, doh!). this unwinding of housing, as a consequence, is going to affect every pension and every consumer. we are in for it.

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  3. Capitalism has the unfortunate curse of being considered just another -ism. It isn't: socialist economics, distributist economics, and all the rest are prescriptive, but market economics are descriptive. As a body of knowledge it describes human behavior as it is, not as we would wish it to be. It makes as much sense to insist on a more humane law of supply and demand as it would to demand a humane version of the laws of thermodynamics.

    And yet, that doesn't stop what you rightly call the fascist impulse: those who support government economic control for whatever reason want to impose their wills on not just human freedom, but also human nature and even the natural world itself, as if the reality of scarcity could be wished away.

    Nature will not be so easily controlled by the mad scientists who refuse to learn from either Adam Smith or Mary Shelley. (Ironically, many of these egotists are guilty of the very charge they level at the classical liberals who champion individual freedom: hubris and the sin of pride.) There are unintended consequences, and a man like Dr. Sowell -- who seeks to understand the nature of economics rather than ignore, deny, or control that nature -- could predict these consequences and here very succinctly elucidates the consequences of meddling with the housing market. Decrease the supply of a good, and the price goes up: the housing regulations that limit building lead to higher prices for housing.

    Another point that Dr. Sowell has made elsewhere is that the world economy is a tremendously complex thing: as Friedman explained, no single person knows how to do all that it takes to build something as simple as a No. 2 pencil from the raw materials in their natural state, so it should come as no surprise that no person or group cannot rightly determine what the price of that pencil "ought" to be. Again we see the tremendous hubris of thinking one knows better.

    By no means is Rod Dreher the first to embrace what is essentially socialism, nor is he the first social conservative to embrace what he calls "populism" while smearing us, the defenders of the free market, as greedy and godless materialists, but he gives a particularly good illustration of (admittedly!) know-nothing arrogance in economic matters.

    Neither Jeffrey Tucker nor Douglas Jeffrey missed what the latter rightly described as irresponsible, from Rod's book:

    "What kind of economy should we have, then? I don't know; I'm a writer, not an economist."

    Tucker's handling of this idiocy bears repeating:

    He is under the impression that the world we live is somehow hammered out by our wishes and desires concerning how we want society to be shaped, and therefore that reshaping it requires nothing more than wishing in a different sort of way.

    So toward the end, we find that he is sympathetic to "distributivism," a theory of property organization that does not need to be explained here but which makes zero economic sense.

    Why do people like Dreher avoid the study of economics? Why do they refuse to engage the topic? Maybe it seems too technical. Maybe he thinks it is something one should study in school and it's too late after.

    But there might be a more subliminal reason: he might vaguely know that economic theory imposes limits on the human imagination. It claims that there are hard realities in this world and explains that there are tradeoffs. You can't always get what you want. Social structure is not just a product of the dreams we dream.

    For example, you can't take steps toward reducing the division of labor in the world and expect people not to be impoverished as a result. Economics imposes a grueling intellectual responsibility that makes writers accountable for what they say. If you want to make a living as a provocateur, economics is best avoided.

    And yet, as Rothbard famously wrote:

    "It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a 'dismal science.' But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance."

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  4. Kathleen, I'm not sure Dr. Sowell would disagree with you, but I think his point is that those areas where the problem was most exacerbated are also those with the most government interference, and he offers a persuasive explanation why.

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  5. Bubba, maybe not, but if Sowell's talking about the housing bubble currently unwinding, he's simply off the mark. it's manifestly not just a case of reduced supply and consequently heightened demand. that explanation is so oversimplified as to be absurd. the distortions in the market were magnified by fed policy and easy credit given to people who could not afford the prices they were paying. (as well as a fed chairman who actually advised people to take out ARMs a couple of years ago. you're a genius, Greenspan!)

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  6. Again, Kathleen, I'm not sure Sowell would disagree with you, but his article didn't focus on why risky loans were more popular nationally, but why, for instance, 66 percent of new mortgages in San Francisco were interest-only loans when the national average is 31 percent.

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  7. I think the problem isn't so much easy credit as it is the rather imaginative mechanisms used to get people into mortgages they could afford now but not later - adjustable rates, balloon payments, etc.

    Getting a fixed-rate mortgage at a low interest rate (and a large balance) is no more of a problem than getting a fixed-rate mortgage at a high interest rate with a lower balance. The problem is adjustable rates and balloon payments in a rising-interest-rate environment.

    The regulation that Sowell describes increased the temptation to take on these large unstable mortgages, because it was the only way to afford a home in some areas.

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  8. "Getting a fixed-rate mortgage at a low interest rate (and a large balance) is no more of a problem than getting a fixed-rate mortgage at a high interest rate with a lower balance."

    uh, that is precisely wrong, anonymous.

    and "imaginitive mechanisms" are, by definition, easy credit.

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  9. if i go to the bank and ask to borrow 200K at 15% interest, the bank is a lot more likely to give that to me instead of giving me 900K at 5% interest. that should be obvious.

    banks could get rid of those 900K 5% interest loans easily and profitably last year. now they can't. that's why consumers are not going to get those 900K mortgages at 5% anymore.

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  10. bubba, i guess i'm saying Sowell's article should not have focused on that if he wants to add new insight into what is going on now. that san francisco and other cities affect the price of real estate by regulating it is decades-old news so that it's simply not topical in this environment.

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  11. "uh, that is precisely wrong, anonymous.

    and "imaginitive mechanisms" are, by definition, easy credit."

    Sorry - let me clarify. By "easy credit" I meant "low interest rates". I don't think those are a problem.

    30 year fixed mortgage at 5%: $1,000/month payment will cover a $186,000 loan.

    30 year fixed mortgage at 10%: $1,000/month payment will cover a $114,000 loan.

    If a person can afford $1,000/month for their house, it really doesn't matter much that the loan amount is bigger. The problem is when a person uses that $1,000/month on, say, an interest-only loan at 3% for a couple of years. Then they get themselves into a $400,000 mortgage that they won't be able to pay after the intial rate/terms expire.

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  12. i'm fully aware interest rates affect payments.

    what do you mean "low interest rates""aren't a problem"? they are a problem now. for the banks. which means you're not going to get them. and housing prices will fall.

    i don't understand what your ultimate point is.

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  13. PS: you don't seem to understand that lower interest rates made house prices go up, so generally there was no net gain for the buyer.

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  14. I was going to comment, but then Bubba had to go and spoil it by quoting Rothbard.

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  15. My point is that low interest rates are not a problem for banks or borrowers. Loan defaults are the problem.

    Low interest rates do not cause loan defaults. Variable interest rates and interest-only and balloon payments and other "imaginative mechanisms" cause loan defaults (when rates are rising).

    High home prices caused by low interest rates are balanced by the market and the payment stays the same so those don't tempt people to imaginative financing.

    High home prices caused by government regulation have no market mechanism for relief and so tempt people to imaginative financing - which later results in defaults.

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  16. "Low interest rates do not cause loan defaults."

    you're just wrong. yes they do. interest rates have to stop at zero whereas house prices can rise to infinity. even if you have an interest rate of zero, you can't afford a $10 million mortgage

    "imaginative financing" is just another term for low interest rates. there is no meaningful difference. it ALL means easy credit.

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  17. anonymous, what i'm confused by is your saying that "loan defaults are the problem" and then divorcing that completely from a period of low interest rates and/or imaginative financing (all of which is simply easy credit). easy credit CREATES loan defaults. that should be obvious. people didn't even have to document their income to buy a house. they still got the low rates even with bad credit scores.

    this is on top of the argument i make above, where if you make money too cheap to borrow you attract speculators who buy housing and cause a bubble in prices. then the bubble feeds on itself -- banks make credit even easier because even the bankers believe "housing always goes up" (we all heard that one).

    in the old days bankers were prudent and didn't buy into the falsehoods like "housing always goes up". unfortunately this generation of bankers is not all that prudent (or bright for that matter). now housing is going to collapse.

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  18. Kathleen,

    I didn't say that the creative/imaginative financing was not a source of defaults. I agree with you that the imaginative financing is a source of defaults - that was the first thing I wrote. I just don't believe that low interest rates are a source of defaults or of the creative financing.

    A low interest rate doesn't drive a banker to careless lending - he's making money on the difference between the interest he pays and the interest he charges and this difference is largely independent of the interest rate.

    If bankers had the same lending standards they have traditionally had, the default rate would be unchanged, even with low interest rates.

    The questions to ask are 1) why were bankers so reckless in their lending?; 2) why were borrowers so reckless?

    I think the answer to the first is short-term focus - bankers (like all executives) are rewarded almost exclusively on quarterly results now. Defaults are a problem for the future, when the interest rates change.

    I think the answer to why borrowers are so reckless are a) the bankers cooperate in their recklessness; b) in some areas, the excessive government regulation drives home prices out of reach of traditional mortgages for many people, like Sowell wrote.

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  19. anonymous, first of all, please identify yourself or this is the last thing i will write to you, it's ridiculous to have a discussion with "anonymous"

    second of all, this statement is absurd: " I just don't believe that low interest rates are a source of defaults or of the creative financing." It's like saying a lack of money is not a source of bankruptcy. Low interest rates are a major component of creative financing. I guess you don't know what an ARM is.

    anyway, things are coming to a head, people in the financial industry are beginning to lose their jobs, and anyone interested should read the following:

    http://www.denninger.net/ofheo.pdf

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  20. "Low interest rates are a major component of creative financing."

    I think I understand the confusion - when I say "low interest rates" I am referring to low overall interest rates, but I think you mean that the creative financing results in a lower interest rate than traditional financing. I don't dispute that.

    You can have an ARM when interest rates are high or when they are low, and the ARM will always have an initial interest rate that is lower than that of a fixed-rate mortgage. ARMs and interest-only loans aren't a consequence of the Fed policy of lowering interest rates.

    My claim is not that the lower interest rates offered by interest-only loans or ARMs aren't the problem. My claim is that if bankers were just as reckless with their loans, you would have the same problem with defaults even if interest rates were at historical highs (say 15% for 30-year fixed mortgages, instead of 4.5% like they got to in 2003).

    The key is reckless lending and borrowing, not low overall interest rates.

    Rod

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  21. bye "rod", i won't bother to read your last comment

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