The Bubble in Real Life

Email Print
FacebookTwitterShare

As my wife
and I were on our way to the home improvement store this past
weekend, I saw the economic bubble that brought about the current
bust illustrated in stark reality. Near our home in Orange County,
California, driving on a beautifully-paved, 6-lane street with
a landscaped median and surrounded by relatively new housing developments,
the conversation went something like this:

HER: Wow,
look at this beautiful street! I remember back in the 1980s when
this was just a 2-lane dirt road.

ME: That’s
right. In fact, I remember driving out here in 1997 or 1998. Even
then all this land was nothing but vegetable fields.

HER: It’s
amazing how quickly it all developed.

ME: This
is a microcosm of the bubble.

HER: What?

[She’s
deserves a lot of admiration for not changing the subject at that
point.]

ME: This
is a microcosm of the economic bubble.

When the
Fed artificially lowered interest rates by creating more money
out of thin air, it accelerated home buying ahead of what normally
would have happened. This area would not have developed as quickly
without that acceleration effect. There were people who otherwise
would have stayed in their old home and eliminated some spending
to save little-by-little for a down-payment. Suddenly they realized
that with lower interest rates, they could afford to buy a new
house without saving, and they could still buy all the consumer
goods they wanted.

Also, because
interest rates were low, home builders could borrow money to buy
the farmland, bulldozers, and so forth to build all these homes.
They hired workers and got the county to build these roads. In
just 10 years, they totally developed this area. The problem is
that without interference from the Fed, this area shouldn’t have
been developed that quickly — there wouldn’t have been that natural
demand. In reality, today there would probably be more demand
for the vegetables they used to grow on this land than for the
homes built on it. Our food prices are higher because we have
to compete with other localities for the vegetables grown elsewhere
and have them trucked in from greater distances.

Now, because
the home purchases were accelerated, the home buyers who would
have bought homes in 2009 had already bought a home in 2002 —
over-simplifying, but you get the idea. So now all the people
who would have bought a house in 2009 have already bought one.
They have no savings because they have been paying on a big loan
and buying all the consumer goods they wanted. As a result, there’s
greatly reduced demand for new houses, and the value of all these
homes around us has dropped over 30%.

Given that
this 6-lane road has about 3 cars on it as far as the eye can
see, the developers were apparently expecting even more development
that’s not happening. So they had scaled up way beyond what real
demand would support. The developer and construction company go
bankrupt because no one is buying new homes and they are paying
loans on the idle land and equipment they bought. They have to
lay off all their employees, who had bought houses in the meantime
and now can’t make their payments. People who are upside-down
on their mortgages and can’t pay start to get foreclosed on. When
that happens a few at a time, banks can handle it. But when it
happens on a bunch of loans at the same time, then banks start
to fail, too.

HER: And
that’s what’s happening now.

ME: Exactly!
Artificially lower interest rates cause future spending to happen
now — that’s the boom. But there’s a limit to how long they can
keep forcing the future into the present — it creates a big gap
at some point, and that’s the bust. What the politicians call
“stimulating the economy” always amounts to nothing more than
accelerating future economic growth to the present, creating a
current boom and a future bust. And of course, things in the economy
as a whole move slowly, so these economic cycles are longer than
our election cycles. That’s why the politicians have an incentive
to do it.

When they
force future spending into the present, it’s absolutely inevitable
that there will be a bust at some point. That’s what we see here.

It’s a microcosm
of the bubble.

HER: Hmm…
When you explain it that way, it makes sense to me.

Isn’t she
the best?

April
28, 2009

Myron Weber
[send him mail] is a management
and technology consultant who dabbles in psychology, economics,
theology, autism research, and taekwondo (among other things). Follow
him at http://twitter.com/myronweber.

Email Print
FacebookTwitterShare
  • LRC Blog

  • LRC Podcasts