The Federal Reserve and Housing:
A Cluster of Errors?
by
Eric Englund
by Eric Englund
Without
bank credit expansion, supply and demand tend to be equilibrated
through the free price system, and no cumulative booms or busts
can then develop.
~
Murray Rothbard
In my two decades
as a surety bond underwriter, I have seen financial fads come and
go. One aspect of my job entails analyzing personal financial statements,
and I most certainly have seen scores of them. Along the way, I
have been able to discern distinct patterns in the financial behavior
of people. What is so striking to me is the herd-like behavior of
human beings – many of whom seem to be easily swayed by the marketing
blitzes of Wall Street brokerage houses, banks, and other financial
services companies. As Ludwig von Mises stated in his magnum opus
Human
Action:
Common man
does not speculate about the great problems. With regard to them
he relies upon other people’s authority, he behaves as "every
decent fellow must behave," he is like a sheep in the herd. It
is precisely this intellectual inertia that characterizes a man
as a common man. Yet the common man does choose. He chooses to
adopt traditional patterns or patterns adopted by other people
because he is convinced that this procedure is best fitted to
achieve his own welfare. And he is ready to change his ideology
and consequently his mode of action whenever he becomes convinced
that this would better serve his own interests.
Unfortunately,
the common American does not understand he is being manipulated
and impoverished by the Federal Reserve. When money is no longer
real (i.e. fiat currency vs. gold and silver), then people may come
to believe in the surreal, and a hyperreality emerges. In particular,
during the reign of Alan Greenspan, money and credit – created out
of thin air – rained upon Americans as if to assure us that crop
failures and misfortune had been banished from U.S. soil. Hence,
we came to live in a world of plenty where one may become wealthy
by simply purchasing a house – with lots of borrowed money – and
by "investing" in stocks for the long run. What a dream
it is to become wealthy without effort. This mass delusion is only
one step away from collectively believing that cotton candy is a
cash crop. Alas, Americans will soon discover that housing values
don’t grow to the sky and that heavy mortgage debt leads to a harvest
of financial despair. The Austrian theory of the trade cycle will
be validated yet again.
So here’s a
quick trip down memory lane. Early in my underwriting career, cash
and savings were king. Accordingly, this frame of mind
was reflected in personal financial statements. As the 80s
rolled on, Americans bought into the pop culture that is Wall Street.
Without fail, I saw people cash in CDs and purchase mutual funds.
Peter Lynch, indeed, popularized such "investment" vehicles
for long-term wealth creation. Then John Bogle flaunted the low-expense-ratio
S&P 500 Index Fund as the wisest way to build a substantial
retirement nest egg. And who can forget the dot.com and telecom
crazes of the late 90s? Americans envisioned themselves retiring
to Easy Street based upon owning shares of Amazon.com and Global
Crossing. Lastly, let’s not forget the Wall Street darling known
as Enron. This company’s common stock was going to make each of
its shareholders wealthy. So why aren’t Americans taking early retirement,
en masse, to lives of luxury? Where is all the wealth promised by
Wall Street?
To date, I
can’t say that I have seen a single individual become wealthy by
investing in the "products" promoted by Wall Street. From
the results I have witnessed, Wall Street preys upon the economic
illiteracy of Americans and does a most efficient job of transferring
wealth from the masses to the bank accounts of the Wall Street –
mostly Ivy League – elites. Over the years, a familiar pattern has
emerged: Wall Street brokerage houses make their recommendations,
the sheeple get fleeced, and I bear witness to a clustering of human
financial error as reflected in the personal financial statements
that I survey daily. For the most part, such financial errors have
not been devastating, but were merely temporary misadventures on
the part of misguided individuals.
As a quick
aside, yes, I have seen some individuals become wealthy. Yet such
wealth emerged by way of starting up and maintaining successful
businesses. Such entrepreneurs, typically, maintain strong personal
liquidity and keep debt loads at reasonable levels.
Nothing, however,
could have prepared me for the horrors I have witnessed the past
few years. Because of the housing bubble, as engineered by the Federal
Reserve, Americans are now drowning in mortgage debt while naďvely
believing that living in a house is the path to wealth creation
via long-term capital appreciation. Thus I am just going to come
out and say it: countless American homeowners are already insolvent
and simply don’t know it; and many of them continue to make ends
meet by borrowing against credit cards and ever-shrinking home equity.
It is commonplace
for me to see married couples with mortgage-debt-to-income ratios
that are wildly askew. The hyperreality conjured by the Federal
Reserve’s relentless inflation of the money supply is characterized
by a populace which believes that a permanent plateau of prosperity
has been attained. This is the boom phase of the trade cycle. A
mindset, correspondingly, arises in which people have absolutely
no fear of debt. After all, the Federal Reserve has the economy
under control. Debt, in fact, is embraced as a means to lever up
one’s return on investment.
When the bust
phase of the trade cycle materializes – and followers of Austrian
economics know it will, eventually – then the real horror show will
unfold. Let’s face it: highly leveraged Americans have little to
no chance of ever paying back their enormous mortgage debts. All
it will take is for a husband or a wife to lose a job, or for interest
rates to go higher, in order for mortgage debt to become unmanageable.
In the bust phase, mortgage defaults will become a deluge.
Earlier, I
mentioned that the Federal Reserve "engineered" America’s
housing bubble. To be sure, there are those who deny a housing bubble
exists. Hence, such deniers argue there is no correlation between
aggressive growth in M3 and the spectacular rise in housing prices
across the United States – as if the Federal Reserve’s pounding
down of interest rates occurred in a vacuum. To this I respond with
a quote from page 1 of a September 2005 study sponsored by the Board
of Governors of the Federal Reserve System titled House
Prices and Monetary Policy: A Cross-Country Study. Here
is the smoking-gun quote: "Like other asset prices, house prices
are influenced by interest rates, and in some countries, the housing
market is a key channel of monetary policy transmission."
With the bursting
of the NASDAQ bubble signaling that the U.S. was heading into a
recession – not to mention the shock of 9/11 – the Federal Reserve
took desperate measures by goosing the money supply and driving
the Fed Funds rate down to 1%. These monetary central planners knew
that housing demand was very much interest rate sensitive, and they
were counting upon the opiate of easy credit, at remarkably low
interest rates, to stimulate the "animal spirits" of Americans
in order to set the housing market ablaze. The Federal Reserve’s
central plan worked. Uncle Sam’s economy was rekindled as trillions
of dollars were loaned into existence via the housing market – the
Fed’s monetary transmission mechanism. Therefore, America’s housing
bubble did not emerge spontaneously in a bona fide manner. Rather,
it is a debt-laden financial monster created by the
mad doctors populating the Federal Reserve.
As surely as
night follows day, a credit-induced boom is followed by a bust.
Moreover, only the Austrian theory of the trade cycle provides the
intellectual framework allowing one to understand the boom-bust
cycle. Before delving a bit further into this theory, there are
a couple of things to keep in mind. First of all, as premeditated
by the Federal Reserve, the housing boom was credit-induced. Secondly,
America’s savings rate is near zero, so savings-induced growth cannot
explain the housing boom. What we will find, as elucidated by Roger
Garrison, is that central banking is at the epicenter of the boom-bust
cycle. Dr. Garrison provides the following explanation in the Mises
Institute’s remarkable book The
Austrian Theory of the Trade Cycle:
The Austrian
theory of the business cycle emerges straightforwardly from a
simple comparison of savings-induced growth, which is sustainable,
with a credit-induced boom, which is not. An increase in saving
by individuals and a credit expansion orchestrated by the central
bank set into motion market processes whose initial allocational
effects on the economy's capital structure are similar. But the
ultimate consequences of the two processes stand in stark contrast:
Saving gets us genuine growth; credit expansion gets us boom and
bust.
Assuredly,
the housing boom is destined to bust just as the NASDAQ bubble did
– anecdotal evidence
is already pointing toward this end. When the NASDAQ bubble did
burst, I saw the liquidity of many Americans diminish significantly.
Yet the housing bubble is vastly different and the financial pattern
is unmistakable. Trillions of dollars of mortgage debt came into
existence in a very compressed timeframe – in less than five years.
Consequently, over the last three years, I have never seen so many
dangerously-leveraged personal financial statements in my entire
underwriting career.
 This
mortgage-debt bubble, as engendered by the Federal Reserve, is leading
millions of Americans to financial ruin. This may become the most
calamitous clustering of financial error in U.S. history. If anything
positive comes out of this economic mess, perhaps it will be the
demise of the Federal Reserve itself. Regrettably, the Fed’s failure
will have come at an enormous price, including the possibility of
volatile social unrest.
A terrifying
thought it is.
April
22, 2006
Eric
Englund [send him mail],
who
has an MBA from Boise State University, lives in the state of Oregon.
He is the publisher of The
Hyperinflation Survival Guide by Dr. Gerald Swanson. You
are invited to visit his website.
Copyright
© 2006 Eric Englund
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