When an economic bubble bursts, normalcy can only return when price excesses created during the bubble are wrung out of the market. A recession is often the painful but necessary market mechanism that corrects the pricing distortion and consequent misallocation of capital that occurs in a bubble. When government intervention prevents the mispriced asset class from fully deflating, capital continues to be misallocated and economic malaise lingers on. This is the takeaway message from Peter Schiff’s Wall Street Journal editorial:
“By all accounts, the home price boom that began in January 1998, when the previous 1989 peak was finally surpassed, and topped out in June 2006 was extraordinary. The 173% gain in the Case-Shiller 10-City Index (the only monthly data metric that predates the year 2000) in those nine years averaged an eye-popping 19.2% per year. As we know now, those gains had very little to do with market fundamentals, and everything to do with distortionary government policies that mandated loans to marginal borrowers, and set off a national mania for real-estate wealth and a torrent of temporarily easy credit…
From my perspective, homes are still overvalued not just because of these long-term price trends, but from a sober analysis of the current economy. The country is overly indebted, savings-depleted and underemployed. Without government guarantees no private lenders would be active in the mortgage market, and without ridiculously low interest rates from the Federal Reserve any available credit would cost home buyers much more. These are not conditions that inspire confidence for a recovery in prices. In trying to maintain artificial prices, government policies are keeping new buyers from entering the market, exposing taxpayers to untold trillions in liabilities and delaying a real recovery. We should recognize this reality and not pin our hopes on a return to price normalcy that never was that normal to begin with.”
Schiff defended his thesis on CNBC:
“… if Schiff is right, homeowners are looking at pain.We know that Schiff is a tad dramatic – some would say alarmist – but his forecasts are not without merit. In late 2006, Schiff predicted the housing bubble and resulting subprime mortgage crisis and in late 2008, he predicted the automotive industry crisis and the crisis in the banking and financial market.”
Schiff’s holiday forecasts have become a regular feature on this blog. As long as his prognostications prove to be more right than wrong (as we’ve seen over the last five years) it is a tradition we will continue to observe. I do not find it particularly difficult to appreciate the wisdom in his common sense analysis. In fact, I find it much more difficult to understand how anyone could expect that a problem that was:
- Triggered by Federal government market-distorting social engineering policies intended to permit people to buy homes they cannot afford…
- Enabled by Federal Reserve Bank expanding the money supply and keeping interest rates artificially low to create the illusion of affordability for overpriced housing…
- Fueled with massive deficit spending…
could be solved by:
- More federal government market-distorting social engineering policies intended to allow people to to stay in homes they cannot afford…
- Even more Federal Reserve Bank expansion of the money supply enabling even lower artificial interest rates perpetuating the illusion of affordability for overpriced housing and…
- Fueling it all with even more massive deficit spending.
Definition of insanity anyone?
Instead of insanity, how about Insana? On Friday last, Ron Insana opined specifically to refute Schiff’s thesis. Basically he is saying there is so much pent-up demand, real estate prices are so low, and the economy is improving enough that the housing market will stabilize here:
I think Insana may be right as a shorter term (1 year-ish?) call on the stock market. The economy will be feeling better after the latest massive fiscal stimulus from the tax compromise in combination with the Fed’s massive QEII monetary stimulus. I’m told heroin injections always feel good. But, to Schiff’s point, one would think that sooner or later either the needle has to come out of the arm, or you run out of heroin, or you overdose and die. It won’t feel so good then.
Cross-posted from “Divided We Stand United We Fall“
This entry was posted on Friday, December 31st, 2010 and is filed under Bad Decisions, Economic recovery, Economy, Federal Reserve, Fiscal stimulus, Housing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.