By VERNON L. SMITH
The joint housing and mortgage-market crisis once again reminds us that all financial implosions stem from the same cause: borrowing short and lending long without enough equity to weather periodic storms in the gap between.
But this bubble was different. Besides being fueled by housing purchases and repackaged loans, each with inadequate equity -- doubling down with other people's money -- at the end of the capital-gains rainbow was the right to take up to $500,000 of profit, tax free.
Thank you President Bill Clinton for your 1997 action, applauded by the banks, the realtors and all citizens in search of half-millionaire status from an investment they could understand and self deceptively believe to be low risk; thank you for fueling the mother of all housing bubbles; thank you for enabling so many of us who bought second or third homes, and homes before construction began, which we then sold to someone else who dreamed of riches from owning homes long enough to sell to another fool.
Once again, try as we might and in spite of our political rhetoric, we have failed to help the poor in applauding government action intended to help ourselves.
The consumption binge is now over, and there is more than enough blame and souring loans to spread around. Congress, if its members can stop squabbling, wants desperately to sanctify it all with actions sure to launch at some future date the grandmother of all housing and mortgage-market bubbles. This august body has long forgotten that it set the stage for housing bubbles by creating those implicitly taxpayer-backed agencies, Fannie Mae and Freddie Mac, as housing lenders of last resort.
Financial market innovators who invented securitization as a mechanism for creating a liquid national market for mortgages are now criticized for having caused an "agency problem." This is jargon for management not having good incentives to provide investors with "truth in packaging" of the underlying economic risk. But what does truth matter at the height of a bubble? These critics would solve the agency problem with more government regulation. Excuse me, but does not the political process have the biggest agency problem of all?
The Federal Reserve, with a default-risk tiger by the tail, feels handcuffed by its accountability and responsibility for avoiding a cascade of defaults in the highest quality obligations, as well as the bad investments seeking an asymmetric tax-free profit. Shades of Long Term Capital, the Savings and Loan crisis, and heyday of the myth of Portfolio Insurance -- historical cases of borrowing short to lend for what may turn out to be longer than expected. They are all conditioned on the existence of liquidity for sellers that can dry up with frightening speed.
Consequently we have the "independent" Fed being driven by market forces to accommodate the long-evident and glaringly least-defensible features of the housing/mortgage markets. Moreover, the moment the Fed abandoned its stance against inflation, the dollar, gold, oil and commodity prices signaled inflation, and now two months later consumer prices have confirmed the signal.
More daring than the action to exempt real estate from the capital gains tax -- and in lasting service to the poor -- would have been actions allowing capital gains on all assets to go tax free, provided that the capital was reinvested -- i.e., not consumed, and yes, good citizens, housing counts as consumption.
Unlike the latest housing bubble, the stock market "excesses" of the 1990s financed thousands of new ventures, some of which found innovative ways to manage the proliferation of new technologies. The result: astonishing, long-term increases in productivity still evident in the most recent quarter.
Adam Smith in his "The Theory of Moral Sentiments" (1759) saw the subtle truth that consumption by the rich has little effect on the welfare of the poor. That's because the income of the rich is largely invested in the tools and knowledge of production, which provide future long-term value for everyone: "The rich only select from the heap what is most precious and agreeable . . . though they mean only their own conveniency . . . [and] . . . the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements."
Expenditures on housing construction are not "improvements" yielding increased productivity and future new wealth to be divided with the poor. They are more akin to satisfying government-subsidized vanity.
Mr. Smith, a professor of law and economics at George Mason University, is the 2002 Nobel Laureate in economics.
Минувшую неделю VERNON L. SMITH - опять же в WSJ - продолжил (после годичной паузы) рассуждения на все ту же растущей актуальности тему:
There's No Easy Way Out of the Bubble
Treasury doesn't know much about running a 'reverse auction.'
But the bulge was not precipitated by general stock-market excesses nor by an economy-wide bubble-crash. The excesses were focused in the housing and related financial markets -- banks, mortgage, and insurance companies -- starting in 1998 and accelerating to 2006. This created the mother of all housing bubbles.
True, the crash has been exacerbated by the increase in oil prices, up from a mere $12 a barrel in 1998, to $90 in January 2008, then a spike to $147 in July. But the economy has rolled tolerably well under that punch, and it does not pose the systemic risk of the housing debacle.
Housing is one-third of all U.S. wealth, totaling $19.4 trillion in the second quarter of 2008, according to the Federal Reserve. Almost all of the mortgage debt on those assets will be paid. Only a subset of homes funded recently with low down payments at unsustainable prices are at risk. All of you who rent -- a respectable American tradition -- can look forward to buying more cheaply in the future. Take your time.
The housing disaster-in-motion was widely reported, complete with warnings, before the crash. But every word fell on deaf ears, because bubbles are never about reason, cool calculation and courageous politicians willing to risk defeat.
By 2005 Alan Greenspan and others were warning that Fannie Mae and Freddie Mac had become seriously undercapitalized and had persistently over-accumulated high risk mortgage paper. That paper was created by an industry reluctant to hold its own brainchild, but which responded to home buyers chasing an appreciating capital asset driven by their own ebullient expectations.
Moreover all parties have long believed that the obligations of Fan and Fred were backed by the Treasury's deep pockets -- that's you and me who pay taxes.
We need to minimize systemic and taxpayer risk. Fortunately the two are entwined. Serve the needs of the former and you protect the taxpayer.
Why is this crash a classic?
- A "liquidity crisis." In every market, there is ultimately only one source of liquidity: buyers. And this is what central bankers hope to see return when they speak euphemistically of "restoring confidence."
All other sources of liquidity are stop gaps, bridges, band aids, and now a duct-tape bailout. Every seller in dire need of a buyer is in a liquidity crisis, even if he is a gainfully employed homeowner whose job security requires a move, or a fundamentally solvent bank, holding secured mortgage paper, but in need of immediate cash. Both now find that yesterday's buyers are in hiding.
A sale is always an "expectations equilibrium" -- a buyer only accepts a seller's instrument (agrees to a sale) if she believes that others will also accept it. Disequilibrium bubble-crash principles have been intensively studied in laboratory environments for over two decades (see Jerry Bishop's article in The Wall Street Journal on my work in this field "Stock Market Experiment Suggests Inevitability of Booms and Busts," Nov. 17, 1987).
- During a bubble buyers are everywhere. Then, suddenly, they disappear, waiting, watching, delaying, reluctant to buy assets that others might not. That buyers will disappear in a bubble is predictable, what is never predictable is the timing. In his 1933 inaugural address, President Franklin Roosevelt said "the only thing we have to fear is fear itself." Yes, but the return of fearful buyers is just as unpredictable as the timing of their disappearance. And only the most arrogant will pretend to know what public policies will restore buyer "confidence."
- Cash is not scarce. Cash is just justifiably hard to loosen, and this makes it king. There are only three kinds of buyers in a downside housing/mortgage or equities market: those who buy too soon; the few who roll an 11 at the bottom; and those who are too spooked to buy until well after the crisis is over, if ever. Warren Buffet may be either too soon or about right. If he is too soon, it won't be his first time. The point is that no one can know.
Starting in 2007, the Fed under Ben Bernanke, did all the right things expected of a central banker facing liquidity problems in the finance/housing sector. He even risked inflation by making it easy for banks to borrow from each other and the Fed. (The dollar did temporarily fall as commodities spiked upward.) But the action failed to solve the problem.
The early evidence came when Countrywide crashed and burned last year. But as English economist Sir Dennis Robertson would have put it over 60 years ago, the Fed was "pushing on a string" that only buyers can pull. Further deterioration set in, and nothing terrorizes a central banker more.
Enter a bipartisan Keynesian-inspired Congress and administration, who authorized Treasury to write large numbers of small checks as part of a "stimulus" package to many people who do not pay taxes. People spent the money at Wal-Mart. Much of it went to China (which recycled it into U.S. bonds). And we saw a blip in retail sales that just delayed the inevitable.
So Mr. Bernanke took the only action left: He got Treasury Secretary Henry Paulson into the action. Better two scared leaders at the top than one. They went to Congress.
And the result was the House's "Emergency Economic Stabilization Act of 2008," a bureaucratic nightmare that fails to use auction markets in a way that will minimize both taxpayer and systemic risk. The key flawed provision states "The [Treasury] Secretary is authorized to purchase, and make and fund commitments to purchase, troubled assets from any financial institution as are determined by the Secretary."
Excuse me, did I read "any?"
The Senate spelled it out more clearly: "troubled assets are not limited to mortgage related assets but could include auto loans, credit card debt, student loans or any other paper related to commercial loans."
"Any other paper?" Heaven help us! Fortunately, Mr. Paulson still has some good sense. But no wonder the bailout bill is authorized at $700 billion. For a little perspective, consider that in August, MarketWatch reported that there are 4.67 million existing homes for sale, at a median price of $212,400 for a total of just under a trillion dollars. With a 30% loan, Treasury could buy them all.
Auction designers should immediately note that we are talking about a market with one buyer and many sellers of a hodge-podge of items. The mechanism that will be used is a "reverse auction" -- with sellers competitively submitting asking prices to sell Treasury a heterogeneous mix of good, some sour, apples and oranges whose content is better known to sellers than the Treasury.
Treasury expertise is in auctioning Treasury securities of a given maturity to multiple competing buyers: say $10 billion worth of six-month bills, or two-year notes. In either case every bill (or note) is identical to every other one. The only uncertainty is the final clearing price and Treasury is assured that it will get the best price.
Treasury has no expertise in this ridiculous new venture. (Auction houses such as Christie's and Sotheby's have no problem with heterogeneous items. They auction them singly or in small assemblies to multiple buyers, who assess the items and make bids that reflect best estimates of true value.)
Treasury action should focus on providing capital to individual banks and mortgage companies in return for debt, convertible bonds and equity and warrants to be negotiated. This is dangerous enough for the taxpayer, but here Mr. Paulson has previous experience. (The model was demonstrated recently when Treasury and the FDIC assisted J.P. Morgan's takeover of Washington Mutual.) Then let companies do any necessary piecemeal paper asset auctions, while Treasury holds managers accountable. This is feasible at least, if hardly risk-free for taxpayers.
This procedure will confront financial systemic risk, and allow prices to emerge competitively that will encourage the all important return of bargain hunting buyers.
Would the procedure work? I don't know. But it does focus on the knowledge that markets are capable of bringing to the table. The bailout does not.
To the extent that the bailout shores up existing home prices and its paper, it delays the inevitable. It does not assure the early return of buyers. Look at the course of home prices since 1987 in the nearby chart. Do you think the price decline has run its course since it turned the corner in 2006, then plummeted in 2007-2008?
Shoring up prices to prevent a further debasement of overly generous loans is not designed to bring back buyers of homes and mortgage paper. But there is good news: homes, stocks, crude oil, copper, corn, soy beans, wheat, lumber and even ethanol are now cheaper.
Mr. Smith, a professor of economics and law at Chapman University, received the Nobel Prize in economics in 2002.
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