It’s often said that generals prepare to fight the last war. To be sure, much of the doctrine painfully learned in any conflict can be useful in future battles but probably not decisive. And this is because the future – at least in its particulars – is never just like the past. While human folly and its manifestations may be mathematically constant, the peculiar combinations may be novel and unpredictable.
Economists also adopt the lessons of the last crisis. And when the next crisis comes along even the most informed react dogmatically – and incorrectly. While policy makers during the Great Depression withheld credit and watched banks fail, their descendants today have opened the spigots wide but have misapplied the flow of cash, maintaining both the institutions and their overpriced housing assets – bad assets that the market should clear from the system by letting prices fall. But this can’t happen when the government applies the lesson of the past in a way that distorts the present. It was government distortion that created our crisis and more distortion – even while ostensibly using lessons learned – cannot help and will surely hurt.
This is the message of two independent commentators today. Writing in City Journal, Nicholas Gelinas discusses the Fed’s misapplication of credit in the present crisis:
But now, the government may take a giant step further. The Fed and the Treasury may set home-borrowing rates in the next few months by purchasing mortgages directly from Fannie Mae and Freddie Mac, and from other mortgage lenders, at a fixed price that would dictate an interest rate of 4.5 percent for new home buyers, as well as, possibly, for owners of existing homes who want to refinance their more expensive loans. After news of the tentative plan got out in December, mortgage rates plummeted to just above 5 percent, the lowest level in four decades.
The government’s reasoning is obvious, if wrongheaded. It wants to keep housing prices from falling further, which would drive homeowners into foreclosure and push banks and investors into deeper distress. To achieve this, the government has to scare up new home buyers, many of whom feel skeptical that prices have hit bottom. So the feds hope to lure buyers with dirt-cheap mortgages, just as they were priced during the housing bubble. The gambit could work—for a while. But in the long run, the federal plan will just make things worse.
Consider the downsides. First, the feds will further warp the housing market. Part of the reason that we’re in this mess is that government policies—from zero percent capital-gains taxes on house appreciation to mortgage-interest tax deductions to support of Fannie and Freddie—long encouraged borrowers and lenders to pour money into houses at the expense of more productive forms of investment. Making easy lending available solely for buying still-expensive houses adds yet another layer of capital deformation. It would be something like trying to reinflate the nineties’ tech bubble by offering cheap government financing only to people willing to buy shares in Pets.com. This time around, such a distortion could delay recovery by directing capital away from where it could do the most economic good and toward yet more investment in houses.
Peter Schiff likewise points out the same misapplication and distortion in U.S. News and World Report:
What’s your take of the Fed’s moves to engineer lower mortgage rates?
It is a bad thing. They are trying to maintain high home prices by keeping interest rates low. That’s how they want to create more affordable housing. What’s a much more efficient way [to create more affordable housing] is to let home prices fall so that houses become more affordable because they are cheaper. And so people don’t have to borrow as much money to buy a house. These low interest rates are only temporary. They can’t stay down here.What should the government do about the foreclosure epidemic? We should allow the foreclosure process to go through. We should allow lenders to foreclose if that’s their choice. We should allow them to work out deals with the tenants if that’s what the parties agree to. In many cases, foreclosure is a good thing because it takes somebody out of a property that they couldn’t afford and puts it into the hands of somebody who can afford it. There can be somebody who is living in a house that bought it with nothing down—they are not going to make the payments, so why even modify the loan? They don’t have any equity. When people own houses without any of their own money at stake, they don’t maintain them. It would be better for the bank to foreclose and sell the property to somebody who actually has money, somebody who is a viable homeowner and not some speculator.
So, what would you advise policy makers to do?
They should do nothing. They’ve done enough damage. Why don’t they just let the market work?
Sooner or later the market’s going to work – in spite of the government. And I’d rather it be sooner.
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