An Austrian economic perspective.

[maple_leafs182]

I posted this somewhere else but got no responses so I figured I would try again.

The housing bubble was formed when the Federal Reserve lowered interest rates after the dot-com bubble burst, it was the Fed's attempt to stimulate the economy.

It worked, lowering interest rates, mortgage securitization from Frannie and Freddie and loose lending practices by the banks(banks didn't care if people didn't pay back their mortgages because house prices were rising), together they fueled the housing bubble which stimulated the economy.

As soon as people started defaulting on their mortgages, the supply of houses in the market grew which led to the fall in house prices. This led to speculators leaving the market because the could no longer make money off buying and selling houses, this led to the demand for houses to fall which led to an even bigger fall in prices.

As the mortgage market collapsed, the Federal Reserved lowered interest rates to near zero in another attempt to stimulated the economy. It hasn't been working so the Fed is now trying to stimulate the economy threw quantitative easing measures which simply means pump trillions of dollars into the economy. This still isn't working, the only reason GDP is rising is because of the increased government spending, it is the increased amount of debt and resulting spending that is pushing GDP up.

The whole time this has been going on, trillions of dollars of new debt has been created, since money is created through debt, the money supply has been expanding. An expansion in the money supply is what leads to inflation.

The real inflation rate of America is around 9%. The Federal Reserve says it is lower but they only say this because they fudge the numbers. The Federal Reserver does not include the rising food and fuel prices and they substitute higher quality goods out of the basket of goods with lower quality goods and claim there is no inflation.

Inflation is leading to higher commodity prices; food, oil, gold and silver are rising. The cost of living is rising.

First question, how is the Fed suppose to fight off inflation if the only weapon it has to stimulate the economy is inflation. They could raise interest rates but that would derail the economy.

Second question, why should institutions like central banks exist?

[bush_cheney2004]

I feel sorry for you, so to avoid cricket noises again....

The real inflation rate of America is around 9%. The Federal Reserve says it is lower but they only say this because they fudge the numbers. The Federal Reserver does not include the rising food and fuel prices and they substitute higher quality goods out of the basket of goods with lower quality goods and claim there is no inflation.

Nonsense..the US Fed does not go shopping with a basket to determine inflation. That's a consumer price thang.

Inflation is leading to higher commodity prices; food, oil, gold and silver are rising. The cost of living is rising.

So....pay up!

First question, how is the Fed suppose to fight off inflation if the only weapon it has to stimulate the economy is inflation. They could raise interest rates but that would derail the economy.

Some inflation is acceptable compared to stagflation or deflation.

Second question, why should institutions like central banks exist?

Because central banks fulfill the desired roles of money supply management, controlling interest rates, and other systemic monetary policy. They exist because governments want them to exist.

Edited March 14, 2011 by bush_cheney2004

[maple_leafs182]

Nonsense..the US Fed does not go shopping with a basket to determine inflation. That's a consumer price thang.

Ok you're right, it is the CPI which also measures inflation but it is different from core inflation.

Some inflation is acceptable compared to stagflation or deflation.

You didn't answer my question.

Because central banks fulfill the desired roles of money supply management, controlling interest rates, and other systemic monetary policy. They exist because governments want them to exist.

Central Banks encourage people to invest in a market when they normally would not, how is that desirable, central banks create the booms and busts.

Central banks exist because big governments and big banks want them to exist.

[bush_cheney2004]

Ok you're right, it is the CPI which also measures inflation but it is different from core inflation.

Core...schmore...consumers don't care about the academics of inflation. They know it when they see it.

You didn't answer my question.

I did, but you didn't like the answer. The Fed will accept moderate inflation in exchange for sustained economic growth. America already lived through this in the 1970's and survived just fine.

Central Banks encourage people to invest in a market when they normally would not, how is that desirable, central banks create the booms and busts.

Central banks do not by and large influence fiscal policy, just monetary policy. It can only hope to moderate the "booms and busts".

Central banks exist because big governments and big banks want them to exist.

Yea...that's what I said. They are not likely to listen to your recommendation(s).

Edited March 14, 2011 by bush_cheney2004

[maple_leafs182]

Core...schmore...consumers don't care about the academics of inflation. They know it when they see it.

K, do you see it?

I did, but you didn't like the answer. The Fed will accept moderate inflation in exchange for sustained economic growth. America already lived through this in the 1970's and survived just fine.

http://graphics8.nytimes.com/packages/flash/business/DEBT_TRAP/media/interactives/timeline.swf

Look at that graph, Americans saved more and had less debt in the 70's.

What growth has come from QE2 and having interest rates near zero? All I see is inflation and no growth.

Central banks do not by and large influence fiscal policy, just monetary policy. It can only hope to moderate the "booms and busts".

Central banks do influence fiscal policy because they allow governments to monetize their debt.

The busts are created because the market is trying to correct itself. After the bust, central banks try to create and inflationary boom to try and offset the bust. However, they don't allow all the bad debt from the bust to be liquidated, it still sticks around. All Central banks do is just try and re-inflate the bubbles which leads to bigger busts down the road.

Yea...that's what I said. They are not likely to listen to your recommendation(s).

Not until the US dollar collapses.

Edited March 14, 2011 by maple_leafs182

[bush_cheney2004]

K, do you see it?

Yes...it's a nice slow burn.

Look at that graph, Americans saved more and had less debt in the 70's.

Yet there was still a Misery Index. You have no idea what the 70's were like...inflation...shortages...recession...sky high rates....that was a much harder time in America.

My first home mortgage had an APR of 13.5%...that will get your attention.

What growth has come from QE2 and having interest rates near zero? All I see is inflation and no growth.

The US economy is growing...faster than Canada's last time I checked.

Central banks do influence fiscal policy because they allow governments to monetize their debt.

That's why it is called monetary policy.

The busts are created because the market is trying to correct itself. After the bust, central banks try to create and inflationary boom to try and offset the bust. However, they don't allow all the bad debt from the bust to be liquidated, it still sticks around. All Central banks do is just try and re-inflate the bubbles which leads to bigger busts down the road.

That's OK...there is no intention to pay back all the debt anyway.

Not until the US dollar collapses.

Still waiting until 2013 when you say this will happen. If it doesn't, will you admit you were wrong?

[maple_leafs182]

The US economy is growing...faster than Canada's last time I checked.

What are you basing this on? the rise in GDP?

If so, have you took into consideration how much of that rise in GDP is newly created debt?

Still waiting until 2013 when you say this will happen. If it doesn't, will you admit you were wrong?

Yes.

[August1991]

The housing bubble was formed when the Federal Reserve lowered interest rates after the dot-com bubble burst...

You kinda lost me here. Everybody and his brother has someone to blame or a reason to explain why Americans got involved in a housing bubble except the obvious explanation that some ordinary Americans did this on their own. And you know what? They'll do it again.

Americans (and others) have had financial bubbles throughout their history. Bubbles happen.

It would be difficult to blame the US Fed for the fianancial bubble in Iceland.

IMHO, it is not the cause of bubbles that is the issue. It is how authorities respond to them.

To pick a comparable example, earthquakes happen. Some countries respond better than others.

The real inflation rate of America is around 9%.

Nevertheless ML182, I kept reading your post until I got to this. The US CPI is what it is. If you want to claim that the sky is not blue but a shade of green, go ahead. But I ain't reading any further.

[maple_leafs182]

You kinda lost me here. Everybody and his brother has someone to blame or a reason to explain why Americans got involved in a housing bubble except the obvious explanation that some ordinary Americans did this on their own. And you know what? They'll do it again.

Americans (and others) have had financial bubbles throughout their history. Bubbles happen.

It would be difficult to blame the US Fed for the fianancial bubble in Iceland.

IMHO, it is not the cause of bubbles that is the issue. It is how authorities respond to them.

Of course it is important to understand what causes the bubbles.

It is the Feds fault, if there was a truly free market, interest rates would of naturally risen after the dot-com bubble burst and again after the housing bubble. Since the fed has a monopoly over interest rates, they artificially lowered them to encourage people to borrow and spend in an attempt to create an inflationary boom. There would not of been such an investment in houses if interest rates were not so low.

Nevertheless ML182, I kept reading your post until I got to this. The US CPI is what it is. If you want to claim that the sky is not blue but a shade of green, go ahead. But I ain't reading any further.

Yes, if you look at my next post, I corrected that.

[Pliny]

bush_cheney 2004: The Fed will accept moderate inflation in exchange for sustained economic growth. America already lived through this in the 1970's and survived just fine.

The Carter administration did not fare so well. (Play funeral march here)

A few fundamental facts about the economy should be stated.

Government has certain tools it uses to try and direct the economy. It's effort is to maintain growth in the economy by keeping the general wage and price level stable and low percentages of inflation are desirable over deflation or higher levels of inflation.

The tools it has include control of the money supply, interest rates, credit availability and directing the initial flow of new money by subsidies and other spending means. It has a central bank that it borrows from and it is often argued who is in control - the central bank or the Government. In the US the Federal Reserve is a private corporation and is not a part of the government. In Canada, the Government claims to be the owner of the central bank with one share held in trust by the Minister of Finance. Anyway, the relationship of the central bank to government is not really relevant to this thread. Basically, let's just say the central bank and government collaborate to determine the best fiscal and monstary policy that fits the objective of stable economic growth. Slight inflation being the most desirable scenario.

These tools that government uses are taken from the economic theory of banking and monetary practices, mostly described by John Maynard Keynes (pronounced Canes)in his General Theory published in the 1930's.

These tools are designed from a macro-economic perspective. In other words, they are primarily employed to effect an economy as a whole. That they often create bubbles and cycles of boom and bust is the subject of much discussion. Governments tend to lay claim to responsibility to the boom part and leave the bust part to natural catastrophic influences and artificial effects in the market. Although there is rarely any common element to a macro-economic collapse that isn't a tool of government.

Money tends to flow, or be invested, where it will create wealth and if money is made easily available, such as an increase in supply or by low interest rates; the same as saying easy credit, then it will flow to, or be invested in, areas that may be more risky in the pursuit to create wealth.

That government/central bank monetary and fiscal policy affects the economy is not arguable.

Understanding the effects are the subject of heated debate and discussion. It may be said to be overly simplistic to look at events that will result in macro-economic events as opposed to a natural business cycle or economic cycle. There are few things that will macro-economically affect society. Most of them are the tools of government and others are natural cataclysmic disasters.

What throws confusion into the responsibility of government for cycles in the economy is the fact that there was no immunity from depressions prior to governments taking control of the money supply and and adopting the tools it uses to "stabilize" the economy. Of course, even with the government/central bank influences we still suffer boom/bust cycles. We are not free of depressions. The idea, and indeed the argument was, that having a central bank and adopting the financial structure we have was to enable the government to "stabilize" the economy. The experience is it has not accomplished this but has instead given us a continuous boom and bust economic cycle - the very problem it was to eliminate.

If we look at what caused boom and bust cycles earlier than the inceptio of the central bank we have to look at the macro-economic factors that could cause them. There is natural disaster, drought in a primarily argricultural society would definitely affect the economy as a whole. What other things would?

The money supply definitely would and, as a matter fact, Austrian economic theory points to that as a prime cause of most of the economic problems of the nineteenth century. The banking practices included fractional reserve banking, and they still do. This involves issuing more receipts than a bank has on hand in deposits. The receipts were used as currency, sometimes confused as money because they were guaranteed to be redeemable by the issuing bank. These receipts in the economy are the same as a currency, not unlke what we have in circulation today. Only today they are not redeemable for anything.

The banks back then, in issuing too many receipts, could not redeem them either and if a run were created the bank would collapse and the people who still had "receipts" would be holding worthless paper. This would affect an entire economic area and could even result in further bank collapses from uncertainty.

In order for the central bank system to work most effectively it had to be able to move gold from bank to bank easily but what would have been ideal is if it could just move paper currency. A common currency. It did that in the States and then, something the Bank of England never did in it's centuries of banking practices, it decided that it should totally untie it's hands and go off the gold standard altogether. All the central banks followed the lead of America and England and gradually made the "receipts" entirely a fiat currency. After 1973 all ties to a gold standard ended.

So what caused the housing bubble in the US? Well, the Bush administration wanted people to go shopping. They made credit easy to get by lowering interest rates and money flowed into the hands of consumers. Then with low interet rates the demand for housing picked up. The speculators entered the market and kept the demand going. The government encouraged home ownership and Fannie and Freddie guaranteed they would buy mortgages so mortgage companies lent out money and sold the mortgages to Wall street who repackeaged them and sold them to Fannie and Freddie and other high risk investors. Finally, the glut of housing exceeded the demand that even speculators couldn't drive up. Most of the market was no longer about the need for housing but about speculating on housing prices. Last one in, usually those who can least afford it, are usually the biggest losers.

I don't blame American people for following the advices of financial and mortgage sellers. Most don't even know the difference between money and a currency. It is easy to fool someone kept ignorant and they are kept ignorant in my opinion. It isn't broad public issue how the monetary system is designed or how money works to keep an economy going. Or how government tries to manipulate it or works at cross-purposes to provide some social program such as promoting home ownership.

That's my reply. Austrian economic theory goes a long way in explaining the role of government in our current economic structure.

[dre]

So what caused the housing bubble in the US? Well, the Bush administration wanted people to go shopping. They made credit easy to get by lowering interest rates and money flowed into the hands of consumers. Then with low interet rates the demand for housing picked up. The speculators entered the market and kept the demand going.

That wasnt the only thing that made credit flow to easily, and youll have booms and busts with or without a central bank. Booms are caused by human nature... when people see an initial increase in demand they become exuberant and more and more people start buying in, and the prices go up even more, which causes even more people to buy in.

Macro economic controls give the government some tools that they can calm down the economy with in this situation but the fed failed to act... they acted almost a full two years slower than their own formulas suggested they should.

But you have look WAY past that to see why the economic crisis happened. Most of the capital entering the market was not due to expansion of the money supply it was due to securitization, and trade policy. US trade policy and decades of running huge defecits resulted in a lot of countries having huge ammounts of US dollars... securitization allowed them to dump all this money back into the US housing market, so now you had the entire world bidding up the US housing market by buying derivatives, and you had the risk being hidden from investors by private lenders who were making all these crazy loans and buying credit default protection to make the MBS's they were bundled into look safe.

So fed policy and interest rates played an important part for sure, but the biggest problem is how mortgages are securitized, and the huge scam that market makers like GS were running on the rest of us.

This was no accident. These companies intentionally inflated the bubble, and then shorted their own products to make money on the crash they knew would come after.

[dre]

Of course it is important to understand what causes the bubbles.

It is the Feds fault, if there was a truly free market, interest rates would of naturally risen after the dot-com bubble burst and again after the housing bubble. Since the fed has a monopoly over interest rates, they artificially lowered them to encourage people to borrow and spend in an attempt to create an inflationary boom. There would not of been such an investment in houses if interest rates were not so low.

No this is wrong... interest rates would have been very low anyways because of the huge cash glut caused by securitization. When theres that much money in the system its going to be cheap and easy to get, especially when lenders can use credit default swaps to offset risk.

"Free Market" economics is how most of that cash got into the game. Americans gave trillions of US dollars to people in other countries by buying non durable consumer crap, and oil. Those people dumped the money back into the US realestate money by purchasing mortgage backed securities, and private companies cooked up a huge scam to make it look safe even though they knew it wasnt, and were betting on the system for sale by short selling their own financial products.

[Pliny]

That wasnt the only thing that made credit flow to easily, and youll have booms and busts with or without a central bank.

Yes, and I explained how.

Booms are caused by human nature...

when people see an initial increase in demand they become exuberant and more and more people start buying in, and the prices go up even more, which causes even more people to buy in.

This is not the cycle of an economy. This is the cycle of a product or service in an economy.

A product or service does not affect an economy on an over all level.

The housing bubble was not created by an ever increasing demand for houses. The demand was always there.

The means was not previously there. It was low interest rates and easy credit, an easy monetary policy that provided the means to fulfill the demand.

It was the macro-economic effect of flooding the market with low interest credit and easy money that created the boom in housing.

Macro economic controls give the government some tools that they can calm down the economy with in this situation but the fed failed to act... they acted almost a full two years slower than their own formulas suggested they should.

Failed to act? They acted by lowering interest rates even further. A chicken in every pot was the objective and we'll pay for it later. Bernanke is trying to pay for it by continuing the policy of easy money with bailouts and quantitative easing.

But you have look WAY past that to see why the economic crisis happened. Most of the capital entering the market was not due to expansion of the money supply it was due to securitization, and trade policy. US trade policy and decades of running huge defecits resulted in a lot of countries having huge ammounts of US dollars... securitization allowed them to dump all this money back into the US housing market, so now you had the entire world bidding up the US housing market by buying derivatives, and you had the risk being hidden from investors by private lenders who were making all these crazy loans and buying credit default protection to make the MBS's they were bundled into look safe.

Whatever way you look at it - the driving force was the availability of credit for little cost. Many people, and that would include speculators, would not have even thought about buying if the interest rate had been 8% and they had to carry such a cost.

Your idea of "Securitization" is only a confirmation that flooding the market with easy money was the macro-economic cause of the collapse of the economy. The housing boom wouldn't have happened otherwise.

When ever government floods the economy with money and easy credit it flows somewhere and with low interest rates it flowed into housing with the government's approval and encouragement with accompanying guarantees.

So fed policy and interest rates played an important part for sure, but the biggest problem is how mortgages are securitized, and the huge scam that market makers like GS were running on the rest of us.

Interest rates and easy credit were not just the imnportant part but the essential part. Without the money and credit there would have been nothing to securitize. You have to get that simple point.

It is not the securitization or the manufacture of derivatives that comes first. There has to be something to securitize and form into derivatives first. Mortgages, as a result of low interest and easy credit, provided the "capital" on paper to create them.

This was no accident. These companies intentionally inflated the bubble, and then shorted their own products to make money on the crash they knew would come after.

Of course, it was no accident. With Fannie and Freddie willing to back it all up the risks were minimized. Shorting the products was just further insurance. But you will notice that the Fed did bail their favourites out anyway. There is much less competition now.

[Pliny]

No this is wrong... interest rates would have been very low anyways because of the huge cash glut caused by securitization. When theres that much money in the system its going to be cheap and easy to get, especially when lenders can use credit default swaps to offset risk.

Ask yourself that simple question -

Who created the money in the first place? How was all that huge cash glut possible?

"Free Market" economics is how most of that cash got into the game. Americans gave trillions of US dollars to people in other countries by buying non durable consumer crap, and oil. Those people dumped the money back into the US realestate money by purchasing mortgage backed securities, and private companies cooked up a huge scam to make it look safe even though they knew it wasnt, and were betting on the system for sale by short selling their own financial products.

Free market economics does not create "cash". Printing presses and easy credit creates cash.

Who gave Americans the trillions of US dollars to people in other countries to buy non-durable consumer crap and oil? Once again it gets back to the simple question and easy answer of who first created the money to dump into the economy.

The creation of the money had to occur prior to anyone doing something with it, buying houses, selling mortgages, creating derivatives, the money had to be there first.

Edited March 16, 2011 by Pliny

[maple_leafs182]

No this is wrong... interest rates would have been very low anyways because of the huge cash glut caused by securitization. When theres that much money in the system its going to be cheap and easy to get, especially when lenders can use credit default swaps to offset risk.

After the housing bubble burst, why would banks decide to make more loans when hundreds of banks just failed from making bad loans. You don't think banks would become more cautious when making new loans. A shrinking supply for loans means interest rates would rise.

"Free Market" economics is how most of that cash got into the game. Americans gave trillions of US dollars to people in other countries by buying non durable consumer crap, and oil. Those people dumped the money back into the US realestate money by purchasing mortgage backed securities, and private companies cooked up a huge scam to make it look safe even though they knew it wasnt, and were betting on the system for sale by short selling their own financial products.

Yes, CDO's were a big part of the problem. However, the loans would not have been made without the Fed lowering interest rates and securitization from government sponsored institutions like Freddie Mac and Fannie Mae.

Bush_cheney, you have said that people will continue to buy US government bonds.

In the wake of the US government projecting record budget deficits, Bill Gross, the man who runs the world’s biggest bond fund, has eliminated all government-related debt from his flagship fund

Source

This should be a sign to you for things to come.

[dre]

Ask yourself that simple question -

Who created the money in the first place? How was all that huge cash glut possible?

Free market economics does not create "cash". Printing presses and easy credit creates cash.

Who gave Americans the trillions of US dollars to people in other countries to buy non-durable consumer crap and oil? Once again it gets back to the simple question and easy answer of who first created the money to dump into the economy.

The creation of the money had to occur prior to anyone doing something with it, buying houses, selling mortgages, creating derivatives, the money had to be there first.

Who created the money in the first place? How was all that huge cash glut possible?

Well the government backed the currency but thats kinda besides the point. It was a trade imbalance that resulted in capital moving from here to there, and securitization and the 50 TRILLION dollar credit default swap game that allowed it to come rushing back. Even if the Fed had a very conservative monetary policy or even if currency was pegged to a commodity the same thing would have happened.

Youd still have a housing market that had almost tripled in value between 1997 and 2003 and a shitload of people wanting to pile on for the ride, and securitization provided opened up local housing markets to global investors.

Even if there WAS no government backed currency and people exchanged say... yellow flowers... for goods and services... people would have been trading those yellow flowers for mortgage backed securities.

gave Americans the trillions of US dollars to people in other countries to buy non-durable consumer crap and oil?

A strong economy and a prolonged period of unprecidented economic growth. Even if you factor in the inflation caused by monitary policy most of that capital just came from Americans trading goods and services in the economy. Americans dont just have money to spend because the government prints it and hands it out. Theyre usefull, and productive and generate wealth.

Edited March 17, 2011 by dre

[Pliny]

Well the government backed the currency but thats kinda besides the point. It was a trade imbalance that resulted in capital moving from here to there, and securitization and the 50 TRILLION dollar credit default swap game that allowed it to come rushing back. Even if the Fed had a very conservative monetary policy or even if currency was pegged to a commodity the same thing would have happened.

BS. Credit is created by banks with an entry on a balnce sheet. Loans are not a lending of wealth but merely a creation of the central bank and that is what flooded in.

Youd still have a housing market that had almost tripled in value between 1997 and 2003 and a shitload of people wanting to pile on for the ride, and securitization provided opened up local housing markets to global investors.

No you wouldn't. Not only were mortgages created out of thin air. The credit to developers and builders was created out of thin air.

You seem stuck on the term "securitization" do you really know what's being "securitized"?

Even if there WAS no government backed currency and people exchanged say... yellow flowers... for goods and services... people would have been trading those yellow flowers for mortgage backed securities.

No. The same scenario would have found them trading credits for yellow flowers.

A strong economy and a prolonged period of unprecidented economic growth. Even if you factor in the inflation caused by monitary policy most of that capital just came from Americans trading goods and services in the economy. Americans dont just have money to spend because the government prints it and hands it out. Theyre usefull, and productive and generate wealth.

Most of what you call "capital" was in the form of credit, a mere creation of banks and that capital didn't exist in reality. Wall street was not packaging up capital and securitizing real wealth, which one wouldn't think needed securitization, it was packaging up credit and selling that.

[dre]

BS. Credit is created by banks with an entry on a balnce sheet. Loans are not a lending of wealth but merely a creation of the central bank and that is what flooded in.

No you wouldn't. Not only were mortgages created out of thin air. The credit to developers and builders was created out of thin air.

You seem stuck on the term "securitization" do you really know what's being "securitized"?

No. The same scenario would have found them trading credits for yellow flowers.

Most of what you call "capital" was in the form of credit, a mere creation of banks and that capital didn't exist in reality. Wall street was not packaging up capital and securitizing real wealth, which one wouldn't think needed securitization, it was packaging up credit and selling that.

Most of what you call "capital" was in the form of credit, a mere creation of banks and that capital didn't exist in reality. Wall street was not packaging up capital and securitizing real wealth, which one wouldn't think needed securitization, it was packaging up credit and selling that.

No they were packaging up mortgages... the contractual right to extract wealth from the borrower on a schedule, and the risk that those borrowers might default. You could do this in ANY economy where theres transactions between individuals, regardless of what constitutes currency. The problem is they were hiding the risk from investors in the 50 TRILLION dollar credit default swap market. They pitched these products to global investors as a great thing to buy while they were privately betting on them to fail (because of course they knew that many of the loans bundled into these securities were made to people that could never hope to pay them back).

You could run this scam in virtually any economy where the rules allowed it... under any currency system hard or soft.

The real problem here is that these derivatives allowed the entire world to bid up the US housing industry as opposed to just American families needing places to live.

Wiki describes pretty nicely exactly what I already told you.

In the years leading up to the crisis, significant amounts of foreign money flowed into the U.S. from fast-growing economies in Asia and oil-producing countries. This inflow of funds combined with low U.S. interest rates from 2002-2004 contributed to easy credit conditions, which fueled both housing and credit bubbles. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.[5][6] As part of the housing and credit booms, the amount of financial agreements called mortgage-backed securities (MBS), which derive their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market

The money that drove this thing came from selling oil and tennis shoes. It happened because there was a very high savings rates in many of these countries which was created by a trade imbalance.

Securitization simply provides a way for a third party to "bet" on either the completion or non-completion of the contracts bundled into derivatives. It would generate bubbles whether realestate and securities were being traded in government backed currency or baskets of goat feces.

The Fed does deserve some of the blame for ignoring their own formulas and keeping interest rates down for too long. But even with this they are a bit player. The Fed does not control interest rates, all they control is overnight rates, and the reality is that most of the bad loans were at rates much higher than the fed rate ANYWAYS.. Still though... they MAY have been able to cool the market down a bit by increasing the overnight rate but they didnt.

Edited March 17, 2011 by dre

[maple_leafs182]

K, I get what you are saying and yes, you are correct but that is only part of the problem.

The loans where created threw the fractional reserve system. The money issued by the banks at the time of the loan was created out of thin air.

Like you said it could of happened in any kind of economy. However, if there was a sound currency, the banks would not have been able to give out such a large amount of loans. The scale of the problem would have been much smaller with a sound currency.

Also, interest rate do matter.

I'll assume the American central banking system works in a similar way to Canada's.

The federal reserve acts as a bank to commercial banks. The overnight interest rate determines how much interest the commercial banks will receive from the deposits they have at the Fed. The higher the rate, the more interest they will receive, the more likely they will have larger deposits at the Fed. With more money out of the system and at the Fed, that means there is less money for the banks to loan out.

The Fed is also responsible for transaction between commercial banks. If one bank does not have enough money to pay another bank, a loan will automatically be created by the Fed. The bank the loan was issued to will then have to pay back the principle plus the overnight rate back. Because of this, at higher interest rates, banks will most like have higher deposits at the Fed to try and avoid having to pay the high interest rates.

Having a central bank and fractional reserve banking system greatly impacts the overall economy.

[dre]

K, I get what you are saying and yes, you are correct but that is only part of the problem.

The loans where created threw the fractional reserve system. The money issued by the banks at the time of the loan was created out of thin air.

Like you said it could of happened in any kind of economy. However, if there was a sound currency, the banks would not have been able to give out such a large amount of loans. The scale of the problem would have been much smaller with a sound currency.

Also, interest rate do matter.

I'll assume the American central banking system works in a similar way to Canada's.

The federal reserve acts as a bank to commercial banks. The overnight interest rate determines how much interest the commercial banks will receive from the deposits they have at the Fed. The higher the rate, the more interest they will receive, the more likely they will have larger deposits at the Fed. With more money out of the system and at the Fed, that means there is less money for the banks to loan out.

The Fed is also responsible for transaction between commercial banks. If one bank does not have enough money to pay another bank, a loan will automatically be created by the Fed. The bank the loan was issued to will then have to pay back the principle plus the overnight rate back. Because of this, at higher interest rates, banks will most like have higher deposits at the Fed to try and avoid having to pay the high interest rates.

Having a central bank and fractional reserve banking system greatly impacts the overall economy.

K, I get what you are saying and yes, you are correct but that is only part of the problem.

Yup, but its a REALLY BIG part.

The loans where created threw the fractional reserve system. The money issued by the banks at the time of the loan was created out of thin air.

I agree that the FR system can be a problem, and I would definately support banks having higher reserve rates.

The problem with assigning too much blame there, is that the vast majority of these loans were not made through the fractional reserve system... They were made by thrifts and pure mortgage companies like Countrywide.

Heres the top 25... Most of them are not commercial banks.

http://www.publicintegrity.org/investigations/economic_meltdown/assets/img/top25-listfull.jpg

Take #1 on that list, Countrywide for example... the biggest sub prime lender. It isnt a bank, and it didnt accept FDIC insured deposits or any other kind of deposits. It took real money from investors around the world and lent it out to borrowers. It raised money by selling stocks and bonds. The money it lent out was not "created out of thin air" it came from investors.

#2 on the list is a mortgage company as well.

#3 is New Centurty Financial. Its a Real estate investment trust which is essential a mortgage company thats set up to avoid paying corporate income tax. Again... it didnt create money out of thin air either it just bilked investors to get money just like countrywide.

Also, interest rate do matter.I'll assume the American central banking system works in a similar way to Canada's.

The federal reserve acts as a bank to commercial banks. The overnight interest rate determines how much interest the commercial banks will receive from the deposits they have at the Fed. The higher the rate, the more interest they will receive, the more likely they will have larger deposits at the Fed. With more money out of the system and at the Fed, that means there is less money for the banks to loan out.

The Fed is also responsible for transaction between commercial banks. If one bank does not have enough money to pay another bank, a loan will automatically be created by the Fed. The bank the loan was issued to will then have to pay back the principle plus the overnight rate back. Because of this, at higher interest rates, banks will most like have higher deposits at the Fed to try and avoid having to pay the high interest rates.

Interest rates DO matter, and I definately think the rate policy was wrong, and raising the rates in 2003 and 2004 might have had a measure of success in cooling off the house market.

But again... All of the subprime loans were made at interest rates well in excess of the fed rate ANYWAYS. And most of the entities doing all the risky lending were not even banks.

Edited March 18, 2011 by dre

[Pliny]

No they were packaging up mortgages... the contractual right to extract wealth from the borrower on a schedule, and the risk that those borrowers might default. You could do this in ANY economy where theres transactions between individuals, regardless of what constitutes currency. The problem is they were hiding the risk from investors in the 50 TRILLION dollar credit default swap market. They pitched these products to global investors as a great thing to buy while they were privately betting on them to fail (because of course they knew that many of the loans bundled into these securities were made to people that could never hope to pay them back).

You could run this scam in virtually any economy where the rules allowed it... under any currency system hard or soft.

The real problem here is that these derivatives allowed the entire world to bid up the US housing industry as opposed to just American families needing places to live.

Wiki describes pretty nicely exactly what I already told you.

The money that drove this thing came from selling oil and tennis shoes. It happened because there was a very high savings rates in many of these countries which was created by a trade imbalance.

Securitization simply provides a way for a third party to "bet" on either the completion or non-completion of the contracts bundled into derivatives. It would generate bubbles whether realestate and securities were being traded in government backed currency or baskets of goat feces.

The Fed does deserve some of the blame for ignoring their own formulas and keeping interest rates down for too long. But even with this they are a bit player. The Fed does not control interest rates, all they control is overnight rates, and the reality is that most of the bad loans were at rates much higher than the fed rate ANYWAYS.. Still though... they MAY have been able to cool the market down a bit by increasing the overnight rate but they didnt.

The artful dodger!!

The point trying to be made is that the the subprime mortgage collpase that occurred and affected the global economy negatively was caused by the creation of credit and thus the govenrment's and central banks monetary policies were responsible. You, the government and the central bank are trying to point to Wall Street as the culprits but Wall Street never deviated from doing what it has always been trying to do - make money.

Granted they became very creative in trying to divest themselves of bad credit, created by the banks, but that would not have caused a global economic meltdown. It was the creation of M3 that was prime and it is only something as big as M3 that could do it.

Follow the green line - it's inarguable

I notice you don't cite the Wiki quite you posted.

This one:

In the years leading up to the crisis, significant amounts of foreign money flowed into the U.S. from fast-growing economies in Asia and oil-producing countries. This inflow of funds combined with low U.S. interest rates from 2002-2004 contributed to easy credit conditions, which fueled both housing and credit bubbles. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.[5][6] As part of the housing and credit booms, the amount of financial agreements called mortgage-backed securities (MBS), which derive their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market.

Did you write it?

The first part is kind of mileading. An inflow of funds? How is there an inflow of funds from the emerging Chinese and Asian markets when an imbalance of trade was being created by them selling cheap goods to the US? Investment from America was in those emerging markets and they, the Chinese especially were buying up the debt of the US.

Any money that flowed back into the US was borrowed money. Credit. Created by the central bank and the government. The creation of M3 is still occurring. Expect to see, and we are now experiencing the early effects of it, some high inflation; and the Fed is continuing it's low interest policies trying in vain to pump the economy. No one is buying it. They are trying to limit their borrowing which is why you see such high volumes of reserves in the banks. The complaint is that the banks aren't lending money but, in fact, everyone including the banks are being very cautious.

Yes the Fed sets the overnight rate. The banks compete for business and set the lending rates as low as they can to get it. Of course, it will be a higher rate than the rate at which they borrowed it.

Anyway, the Fed basically created the credit, Wall Street tried to take advantage of the situation but it is similar to someone's Dad giving his son a dollar and then chastising him for spending it at the candy store and having nothing to show for it.

There is no other way to argue it. The creation of credit was the prime mover in the collapse and blaming the market for what they do with that credit is unconscionable.

[dre]

The artful dodger!!

I didnt dodge anything. I explained you why this particular bubble was created. It wasnt fed policy that changed (besides the fact they set the rates wrong). It was the financial system itself.

The point trying to be made is that the the subprime mortgage collpase that occurred and affected the global economy negatively was caused by the creation of credit and thus the govenrment's and central banks monetary policies were responsible.

No the feds monetary policy has been pretty much the same for decades. What caused this a systemic change in how the financial system operates, most importantly the invention of the Credit Default Swap in the late 90's, and the rapid proliferation of derivatives. Immediately that changed the way the financial sector viewed "risk", and between 2002 and 2007 the credit default swap game grew to over 60 TRILLION dollars.

I notice you don't cite the Wiki quite you posted.

Search for "Sub Prime Meltdown" the wiki article is right at the top. Or read only of the thousands of other articles that explain why the sub prime meltdown happened and how an influx of foreign money created overly favorable credit conditions, and how the risk in mortgage backed securities was being hidden from investors.

The first part is kind of misleading. An inflow of funds? How is there an inflow of funds from the emerging Chinese and Asian markets when an imbalance of trade was being created by them selling cheap goods to the US?

I explained how... those foreign investors bought mortgage backed securities by the trillions, and all that cash came flooding into the housing market like a tsunami.

Anyway, the Fed basically created the credit, Wall Street tried to take advantage of the situation but it is similar to someone's Dad giving his son a dollar and then chastising him for spending it at the candy store and having nothing to show for it.

This is just factually inaccurate, sorry. The trillions of dollars that investors dumped into the US housing market by buying derivatives was not the result of any expansion of the money supply. For the most part it was really just traditional investment. Mortgage companies and realestate trusts were selling stocks and bonds to raise money from real investors which they would then loan out.

You, the government and the central bank are trying to point to Wall Street as the culprits but Wall Street never deviated from doing what it has always been trying to do - make money.

No Wall Street DID radically deviate from what they had always beeing doing. Between the late nineties and 2007 the credit default swap market grew to over 60 trillions of dollars and ammount of derivatives in the market grew astronomically. Again... that is what allowed all that money into the system.

Your ongoing rant against the fed system is preventing you from seeing the forest through the trees. The large influx of capital was NOT the result of monetary expansion, and as you saw in that list of the top sub prime lenders almost none of them were even commercial banks ANYWAYS. They are completely exempt from both the fed rate and mark to market rules. They took money from global investors and lent it to consumers.

Your narrative also fails to explain the fact that the housing bubble wasnt just a US phenomenon... it happened in countries all around the world, with various different kinds of financial systems, and all kinds of different monetary policies, and it happened because there was a huge systemic change in how realestate investment worked.

[maple_leafs182]

You guys are both wrong because you guys are both right.

However, I would put more the blame more on fractional reserve banking and a fiat currency. If there was a sound currency from the beginning, I don't believe the banks or many of the corporations that exist today would of been able to become as large as they are now.

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs. - Thomas Jefferson

Read this quote over a couple of times, the banks and corporations are depriving the people of their property.

I agree that the FR system can be a problem, and I would definately support banks having higher reserve rates.

I think they should be higher too, I'm thinking at around 100%.

In my opinion banks should not be allowed to create money out of nothing.

Loans should be created threw term deposits not threw demand deposits and fractional reserve banking.

[Pliny]

In my opinion banks should not be allowed to create money out of nothing.

Loans should be created threw term deposits not threw demand deposits and fractional reserve banking.

Precisely.

[Pliny]

I didnt dodge anything. I explained you why this particular bubble was created. It wasnt fed policy that changed (besides the fact they set the rates wrong). It was the financial system itself.

Right. The financial system outside the central bank and government monetary policy.

No the feds monetary policy has been pretty much the same for decades.

Ha ha ha!

What caused this a systemic change in how the financial system operates, most importantly the invention of the Credit Default Swap in the late 90's, and the rapid proliferation of derivatives. Immediately that changed the way the financial sector viewed "risk", and between 2002 and 2007 the credit default swap game grew to over 60 TRILLION dollars.

If you remember the S & L scandal of the eighties you know the financial system hadn't changed that much.

They were swapping credit. Not real wealth. Cre-dit...created by an easy monetary policy.

They were trying to sell off credit - packaged debt - not real wealth. The 60 trillion dollars was credit. Where does credit come from????????? It's extended from banks - banks following the lead and policy of the central bank and the encouraging policies of government. Investors make loans, or extend credit, on real savings and wealth not out of thin air. Only banks create credit out of thin air.

A credit default swap is a form of insurance against loan defaults. That is - defaults on "credit".

Why you even mention it is bit of a puzzle.

Search for "Sub Prime Meltdown" the wiki article is right at the top. Or read only of the thousands of other articles that explain why the sub prime meltdown happened and how an influx of foreign money created overly favorable credit conditions, and how the risk in mortgage backed securities was being hidden from investors.

Of course the blame is with the market and Wall street, right!!! There isn't a shortage of politicians or economists that wish to foist off all responsibility.

I explained how... those foreign investors bought mortgage backed securities by the trillions, and all that cash came flooding into the housing market like a tsunami.

"Mortgage backed securities", meaning debt extended to mortgage holders? Credit? Who created and extended that credit for the mortgages in the first place? Mortgage companies cannot create credit out of thin air and investors would definitely not supply the capital for risky mortgages.

This is just factually inaccurate, sorry. The trillions of dollars that investors dumped into the US housing market by buying derivatives was not the result of any expansion of the money supply.

Sure - Investors just "dumped" their real wealth and savings in the amount of trillions of dollars into the US housing market.

"Credit" was trying to be dumped and sold to investors. You seem to be implying investors buy these repackaged mortgages for their face value and are "dumping" their money on the market. Sure, sure. That's what happened. Investors all got together and decided to dump their trillions on the market.

Your list of companies that held mortgages (mortgages being extended credit) were trying to dump those mortgages on the market.

For the most part it was really just traditional investment. Mortgage companies and realestate trusts were selling stocks and bonds to raise money from real investors which they would then loan out.

Sure, real investors loaned out the mortgages from their real savings. 60 trillion dollars worth of savings. Why they even approved NINJA loans in their exuberance.

No Wall Street DID radically deviate from what they had always beeing doing. Between the late nineties and 2007 the credit default swap market grew to over 60 trillions of dollars and ammount of derivatives in the market grew astronomically. Again... that is what allowed all that money into the system.

Your ongoing rant against the fed system is preventing you from seeing the forest through the trees. The large influx of capital was NOT the result of monetary expansion, and as you saw in that list of the top sub prime lenders almost none of them were even commercial banks ANYWAYS. They are completely exempt from both the fed rate and mark to market rules. They took money from global investors and lent it to consumers.

Where do mortgage companies get their loans? From the banks.

The definition of a mortgage company is a company that borrows from the banks, lends to the consumer, and then sells the mortgages to investors. You are suggesting that the money for mortgages comes form investors in the first place and already existed, a very rare occurrence and most probably a private loan based on already existing savings, not credit created out of thin air.

There is no shortage of people, especially politicians and short-sighted econometrists, who will defer responsibility of an economic downfall to the market. You can quote whomever you like. The creation of M3, large amounts of paper in the form of credit, is the problem.

Your narrative also fails to explain the fact that the housing bubble wasnt just a US phenomenon... it happened in countries all around the world, with various different kinds of financial systems, and all kinds of different monetary policies, and it happened because there was a huge systemic change in how realestate investment worked.

My narrative explains it quite well, with emerging markets buying US debt and similar monetary policies of central banks in other countries, such as low interest rates and easy credit.

It is your reasoning that falls short of explaining a global collapse. You are blaming the dumping of trillions of dollars in the market, thinking it actually existed as something other than credit as though these trillions of dollars represented real savings and wealth.

As if people had trillions of dollars in savings and just "dumped" it on the market as though it was a reasonable and sensible thing to do. Real savings and actual wealth doesn't work that way. It was all those people trying to sell off and get rid of the toxic credit they were holding which central banks created through easy credit created out of thin air and low interest rates.

If you wish to believe that everyone on Wall Street and homeowners and banks were working with real savings that were dumped on the market then go ahead. Real wealth and savings, will not be dumped on a market nor will the market try and dump real wealth. Only the creation of credit that is not based upon existing savings and wealth will be "dumped" by the market especially if it is very risky credit, which it was and they were dumping the credit around the world, even creating credit default swaps to hedge against the high risk.

The boom was basically a ponzi scheme and thus created out of "money" that wasn't there - it was credit created out of thin air.

Edited March 20, 2011 by Pliny