Government Solution: Re-Inflate the Bubble

The end of the recession will not come until the housing market has reached its bottom. The government knows this. Home starts are down. Foreclosures are up. Homes prices continue to fall.

Austrian schoolers warned that the housing bubble would burst, driving the country into a deep recession. They warned that the government had used artificially low interest rates, bank regulations like the Community Reinvestment Act, promotion of moral hazard through FDIC and Fannie/Freddie, and a general movement to expand housing to push up housing prices and ownership rates.

The bubble burst. The recession came.

What is the government solution? Simple. Re-Inflate the bubble.

Post-burst, the government launched what essentially amounted to a smear campaign against banks and other financial institutions. They accused them of being too greedy at the expense of the American citizen. They decried risky lending policies of the banks that brought us here. However, the government encouraged those risky lending policies. This is an entirely different topic, which I've addressed before here and in other mediums. Please see my review of Tom Woods' Meltdown in the new issue of YAR or, better yet, read Meltdown.

But, that is in the past.

It is a good idea to compare government rhetoric and government policy. Government said that lending was too speculative and dangerous. This was far too widespread because of lack of regulation and this caused the market to inflate and burst. Banks are absolutely leveled. Many of them got to the point of bankruptcy and were bought out or bailed out. How do banks respond? Why, naturally of course. They cut lending. This is the prudent thing to do, given that the future of the economy is/was unstable at the very best.

The government, the very same that lectured banks for not being prudent enough, is now doing everything in their power to get banks to lend against their better judgement. They have tried various avenues to accomplish this (primarily TARP). The general strategy is to throw money at them and hope that they lend it out.

Why is the government doing this? For many reasons. However, primary among them is the need to re-inflate the housing bubble, artificially stopping the slide to "save" the economy and end the recession.

This is from a WSJ article on Thursday April 16:

"Builders said sales have been improving in recent weeks due to low mortgage rates and U.S. government efforts to spur purchases by first-time buyers, such as an $8,000 tax credit. However, an indicator of future building resumed falling, according to Thursday's report"

The government is trying desperately to reinflate the housing bubble. The Fed has cut interest rates to zero. The government is throwing hundreds of billions of dollars at banks so that they continue mortgage lending, often to first time buyers (generally less qualified to buy). They are offering gigantic tax cuts to home buyers. They are slashing mortgage rates for homeowners so that less houses enter foreclosure (keeping them out of the market, thus keeping prices high). They know that, if they can push housing back up again, the recession is over.

It hasn't worked yet. However, it might. It might work in that the re-inflated bubble could work for a short time. But bubbles must burst. Prolonging the market correction by reinflating the bubble will only postpone the suffering at very best. The government originally inflated the housing bubble when the tech bubble burst. This postponed the pain of the tech burst, but created the housing monster, which eventually burst. What will happen this time if the government can reinflate the bubble? How badly will the next burst be?

Are We Done Yet? (sans Ice Cube)

After I presented my policy in class on Wednesday, I was met with an interesting question from Mitch. He asked (excuse me for paraphrasing) that, given the fact that the economy is already on the way back up, musn't I conclude that the New Keynesian policies have worked?

To my dismay, I didn't have time to give a full answer. I merely said that, if he were right, perhaps Austrian schoolers would need to rethink many of their objections to Keynesianism. However, that is a big, big if.

There are a series of indicators, both positive and negative, as to the health of our economy.



The positives:
-Q1 profits for firms like Goldman Sachs and Wells Fargo have been stellar. Wells Fargo posted what I believe was their biggest first quarter profit in history, $3 billion.
-The stock market has seemingly leveled out. After months of free fall, the Dow seems to have bottomed out. It has been hovering between 7500-8200 for a few weeks now, rallying for a few days and then taking another dive.
-Builders have marginally renewed confidence.
-New jobless claims fell for the week ending on April 11. This number fell 53,000 to 610,000. This is considered to be a good indicator of recessions' ends

The negatives:
-Unemployment is still on the rise. Unemployment was 8.5% in March and will likely rise again in April. New jobless claims have been volatile. This sharp decrease could have reflected seasonal hiring for a late easter.
-Building permits fell 9.0% for March. They had risen 6.4% for February and were expected to only decrease by 2.5%.
-Retail sales were expected to increase by 0.3% in March. However, they fell 1.1%. Consumer confidence is still low.
-Credit fell as business lending dropped 24 percent at 21 banks that have received more than $211 billion from the government. Auto and student loans have also fell. The only thing that hasn't fallen is mortgage lending.
-Foreclosure filings spiked by 17 percent from February to March. This exacerbates the fear that banks will dump the foreclosed houses on the market, drastically lowering home prices.

So, allow me news a little. Profits from Wells Fargo and Goldman Sachs are encouraging indeed. Hto dissect this owever, these companies were relatively stable before they received bailout money. With the government funds they received plus their already solvent and profitable business, profits were expected (however, not this high). The only real indicator of the recession's end has been the drop in new jobless claims. Economists rely on this data to predict the end of recessions. However, these claims are volatile. They likely reflect both the later Easter and an unwinding of pronounced layoffs in the automobile sector. The housing data is much less promising. February was a fantastic month of statistics for housing. Housing starts were up. Foreclosures weren't too bad. However, foreclosures spiked massively in March. People still aren't buying retail goods. Banks still won't lend to businesses, students, or families. And unemployment is still on the rise.

Recession over?

Not yet, Mitch.

Global Stimulus Rejected

Barack Obama, on a whirlwind rockstar tour around Europe, participated in the G20 conference with the goal of global stimulus. He failed to acheive this goal.

This article provides a good summary of what happened at the G20 meetings:http://www.guardian.co.uk/commentisfree/cifamerica/2009/apr/06/g20-us-economy-obama

However, I shouldn't sell Obama too short. A trillion dollars was pledged to the IMF, mostly to benefit the poorest countries that are suffering through this worldwide recession. However, Obama and US Prime Minister Gordon Brown had been calling for more far-reaching solutions to handle this recession.

Spanish finance minister Pedro Solbes spoke out a few days earlier on a similar package from Gordon Brown:

"In these conditions I and the rest of my colleagues from the eurozone believe there is no room for new fiscal stimulus plans"

German chancellor Angela Merkey had similar sentiments:

"I will not let anyone tell me that we must spend more money"

When numerous European countries sees your policies as too socialist, you're probably pushing it, Obama. lolzjk.