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?