In a monetary regime of sound money — as opposed to our present discretionary fiat monetary arrangements — the boom and bust of the U.S. housing industry during 2002-09 could not have happened. The damage done to the national economy by the bursting housing bubble can be understood only in the context of the government’s role in fostering that bubble.
The incorrect lesson of the bursting of the “dot-com” bubble of the 1990s had been that timely injections of massive amounts of central bank–manufactured liquidity could insulate the “real economy” from the collapse of a financial-sector bubble. That is, the contention was that trillions of dollars of wealth losses incurred by investors in stock markets — especially the vaporizing of market capitalization of new “e-commerce” enterprises — need not affect the aggregate amount of goods and services produced and consumed by a nation’s businesses and households. This fallacy fostered complacency about emerging bubbles in asset prices — including residential home prices. On the contrary, some analysts and policymakers viewed rapidly rising real estate prices — facilitated by central bank created fiat money — as a healthy stimulant to consumption demand by U.S. households.
The painful lesson of the past decade is that not all bubbles are created equally. While there is no doubt are many people who went from being suddenly rich to even more suddenly poor during the e-commerce boom and bust of the 1990s, only a relatively small share of U.S. households experienced that roller-coaster ride in their financial well-being. The housing-price bubble and bust of 2002–09 was a very different experience.
During the bubble phase of residential real estate prices, a large and even growing share of the population became inebriated by the “wealth effects” of improving household balance sheets. Clearly, homebuilders, contractors and subcontractors, and all the employees of the mortgage-origination companies who financed the construction and purchase of houses, condos, and beach cottages enjoyed improving lifestyles. Less obvious were the gains to the retailers and other vendors of furnishings, appliances, and decorations for both the newly constructed dwellings and all the remodeled and renovated residences motivated by rising market values. Furthermore, even the manufacture and sale of vehicles, boats, and private aircraft experienced the temporary prosperity fostered by misguided central bank policies intended to “create jobs” and “spend our way to prosperity.”
One of several flaws in such a theory was the abundant opportunity for low-cost refinancing of mortgage debt as house prices rose — together with “non-recourse” in the event of default on home mortgages — which gave rise to the phenomenon known as “my house is my ATM.” Mortgage originators were eager, and sometimes aggressive, when offering homeowners opportunities to frequently get new and larger loans in order to pay off old loans, and generate lots of extra cash that could be spent immediately on anything desired.
These “mortgage-equity-withdrawals” — or M.E.W.s — produced from $3.5–5.0 trillion of ready cash between 2002 and mid-2008. The upside of such an enormous cash flow to households was a sharp increase in consumer spending from a historic average of 65 percent of national income to more than 70 percent when the bubble imploded. That was a 5 percentage-point increase in the consumption share of a $14 trillion economy. At the peak, almost 10 percent of consumer spending was financed by M.E.W.s, not by wages and salaries earned by households.
Of course, some of the M.E.W.s were reinvested in houses in the form of new kitchens, etc., and some was used as down payment on vacation homes and other investments. The bulk, however, was spent on everything from new furnishings and appliances to new cars and boats, as well as luxury consumption services such as ocean cruises.
The abrupt end of the potential for M.E.W.s in the summer of 2008 meant an unavoidable drop in household consumption spending and the consequent bankruptcy of retailers and manufacturers of everything from motor vehicles to household electronics (Circuit City), to kitchen and bathroom goods (Linen ’n Things). No amount of monetary and fiscal pump-priming stimulus by government could have prevented this massive hangover following years of binge money and credit creation by both monetary authorities and federal government–sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac.
In a regime of sound money — the nation’s monetary standard defined by specie and anchored in quantity, such as the U.S. dollar in the pre-1914 gold standard — lenders would not have extended enormous M.E.W.s on very generous terms to the fortunate homeowners who saw their own and their neighbors’ homes shoot up in market value during the inflating stage of a housing bubble. In a sound money regime, market interest rates cannot be artificially held down, so increased credit demands for one purpose must compete with other uses of credit. Only in a discretionary fiat money regime is it possible to augment the available supply of loanable funds — through expansion of the central bank’s balance sheet.
Regrettably, the global financial crisis of 2008–09 has been followed by enormous expansion of central bank balance sheets in futile efforts to maintain the consumption share of national income at the bubble level. Interest rates around the world have been suppressed at levels well below historic experience, and stock market valuations have soared. This bubble-nomics creates the “healthy glow of a fever” in the early stages of serious illness. There can be no soft landing from another binge on easy money and credit.