 Originally Posted by Spartiate
In capitalism, every once in a while there is a sector of the economy that booms. Stocks and prices become inflated past their intrinsic value as investors rush to get a piece of the action. This creates a positive feedback loop known as an economic bubble. Sometimes economic growth is so fast and so promising that investors use unsecured assets, or basically funds they can't back up, this is a speculative bubble.
In any case, bubbles eventually burst as prices and stocks sharply drop back closer to their intrinsic value, ending in a stock market crash and recession. This is what happened to the US housing market in the 2000s, the IT bubble in the late 1990s and pretty much the whole market before the Great Depression. It is a natural cycle in capitalism and can be prevented by state regulation.
Au contraire.
 Originally Posted by Housing
The story is told with great persuasive clarity in The Housing Boom and Bust (Basic Book, $25) by economist Thomas Sowell, who is a long-time senior research fellow at the Hoover Institution on the campus of Stanford University.
Sowell explains that the Federal government began a huge regulatory push to create "affordable housing" in the 1990s, under the presumption that the cost of acquiring a home was out of reach for a growing number of American families.
However, he shows that in general average American incomes were keeping up with or even exceeding the cost of buying a home in most of the U.S. The only problem areas were in places like California, where regulations on land development and home building were making land scarcer and more costly to buy.
Prominent Democratic and Republican members of Congress and both President Clinton and President Bush put pressure on lending institutions to lower their credit rating standards; reduce the minimum down payment requirements (in a growing number of cases, to zero); and introduce short-term flexible monthly payment methods that would only increase later on.
Often under the intimation of bank and mortgage market regulators, financial institutions greatly increased their lending to targeted socio-economic groups that were less credit worthy due to fears that they might otherwise be hit with anti-discrimination law suits. As Sowell points out, the tragedy of forcing banks to make home loans to people really not financially able to bear the costs of a house once times turned even moderately bad, is that foreclosure rates are highest for this segment of the population.
Two major vehicles for the growth of this unsustainable housing bubble were the semi-governmental agencies, Fannie Mae and Freddie Mac. Congress and the White House pressured both agencies to extend loan guarantees or buy up the mortgages of these credits unworthy borrowers, until finally before the housing crash last year these two agencies held or guaranteed around fifty percent of all the home loans in America.
The irresponsibility of Fannie Mae and Freddie Mac, and those in Congress who pressured them to go out on this limb has been shown by their formal take over by the government and the huge sums of taxpayer's money that it has cost to maintain their solvency.
What also fed this housing market frenzy, Sowell explains, was the monetary policy of the Federal Reserve. In 2003 and 2004, the central bank kept interest rates artificially at historically low levels. Indeed, when adjusted for inflation, for part of the time interest rates were zero or negative. Mortgage rates were pushed down to barely two or three percent in real terms.
If there is a lesson to be learned from the facts of the housing crisis, it is that its cause has been misguided and intrusive regulations and political pressures, and not any inherent weakness or instability in a market economy.
 Originally Posted by IT
We understand the cycle as described by Mises and Hayek to be an ideal type, which more or less explains particular cycles. Praxeologically speaking, we can say that maintaining an artificial interest rate, like all price-fixing, will have unintended consequences that the price fixer can do little to control. But the particular consequences always involve particular historical circumstances.
We believe the events comprising the dot-com boom and bust can be illuminated by tracing the Cantillon effects as new money made its way from the Federal Reserve, through the banking system, and finally to the dot-com startups.
This liquidity led them to bid up the price of capital goods that were complementary to their business plans. As those prices rose, it became clear that many of their plans were not feasible. Broad-based price indices, such as the CPI and the PPI, mask such important phenomena as the steeply rising prices for web programmers, Silicon Valley real estate, and Internet domain names—precisely the effects predicted and explained by ABCT [Austrian Business Cycle Theory].
Consumer behavior during the period shows that, much as Mises (1998, p. 567) described, artificial booms are characterized by both malinvestment and over-consumption. In addition to the stock market bubble, the period in question saw increasing consumer leverage, a booming housing market, increasing debt-to-equity ratios, and lower down payments on homes.
The turn that came in 2000 triggered the liquidation of boom-inspired
malinvestments. The Federal Reserve attempted to engineer a “soft landing” with a moderate tightening of credit conditions. We suggest that was a problematic solution. The large buildup in consumer debt that since has helped to maintain housing prices and consumer spending has cast an ominous shadow over the prospects for a smooth recovery.
 Originally Posted by The Great Depression
What triggered the crisis?
Fischer explained it was a combination of Marxian crisis theory and Keynesian under-consumption theory: "People who wanted to consume all did not have the means, and the people who had the means could not consume all. Hence our reduced purchasing power."
What needs to be done? "Divide and redivide profits," he said. "That is the way out." There should be "provision for a perfectly equal division of surplus value in years to come"; we should eliminate "the profit of the capital owner" and create "socialism."
Hazlitt responded by showing Fischer's figures on surplus value to be based on a "fallacy of selection." Fischer had picked base years (1899 and 1929) with a purpose in mind and then confused anomalies with a general trend. Two can play this game, and Hazlitt showed that labor's product can be said to have been increasing relative to output by picking other years (1869 and 1921).
Moreover, Hazlitt asked, why if labor's decreasing share of profits is the cause, how do we explain economic recoveries during the same period in question? How can we explain. using this reasoning, why the crisis did not come sooner?
As Hazlitt said, Marx's theory "makes it difficult to explain why we are not always in a crisis, and impossible to explain how we ever surmount one." On that basis, he dismissed the broader implication that the 1929 crash represented anything like a long-running trend in the structural basis of the economy.
But what if Fischer were right, that labor really was earning a smaller return relative to capital? Hazlitt noted this would not necessarily mean that people are being exploited. It could just mean the volume of capital in industry was increasing at a greater rate than that of labor, which indicates increasingly efficient technology. If so, that might lend weight to the expectations of the classical economists that labor would own more capital as productivity increased. For example, the number of stockholders increased dramatically during the 1920s.
Having dispensed with Fischer's sweeping Marxian theory, he argued that the best period to examine from an economic point of view was the time "between the last crisis and the present one—the period, say, from 1922 to 1929." In this period one notices that the prices and output of capital and labor in the industrial sector were growing out of proportion to the agricultural sector. That may not have any significance to the cause of the crisis, but it brings into question the idea of economy-wide exploitation of labor.
Having exploded Fischer's data and economic theory, he went on to speculate on an alternative. There was no visible free-market theory on why the U.S. was in crisis. But Hazlitt knew from his reading of history of the trouble that comes with an overactive and indebted government. He knew the secret to the crash resided with these problems.
A stable market order, he said, requires an atmosphere free of shocks, or at least a government that allows the economy to correct once those shocks had occurred. The war had artificially inflated the prices of commodities and they needed to correct downward to a more realistic level. He argued the crisis of 1929 was that downward correction.
"But the focus of this collapse," he wrote, "was aggravated enormously by the whole series of post-war policies." Among these he listed the "vicious Treaty of Versailles," the "disorganization caused by reparations and war debts," the "preposterous tariff barriers thrown up everywhere," the abandonment of the gold standard and the adoption of the "gold-exchange standard," and "reckless lending to foreign countries.
Most importantly, he blamed the "artificial cheap-money policy pursued both in England and America, leading here to a colossal real-estate and stock-market speculation under the benign encouragement of Messrs. Coolidge and Mellon." This malinvestment, caused by inflationary policies, created distortions in the capital stock which called for correction.
Later Hazlitt would conclude that malinvestment was the central problem, not only in the Great Depression, but in all business cycles. He did so under the influence of Ludwig von Mises, whom he met about a decade later. Together they advocated the gold standard as a policy, and the "Austrian" theory of the business cycle. The theory, developed by Mises, points to the way markets coordinate plans over time and the way central bank money and credit expansion disrupts those plans.
One such patently absurd recommendation in Fischer's essay, according to Hazlitt, was his call for high new taxes on capital. This measure "would violently aggravate the catastrophe," Hazlitt said, by causing business to take another downturn that would make the 1929 crash look trivial. An increase in wages would be undesirable as well, Hazlitt said, because that would cause their cost to business to increase and lead to even more unemployment. In order to make the economy recover, he said, we need more private capital, not less, and that means letting markets work.
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