Posted by Anthony Gregory on 11/23/09 12:49 PM   [Newer: Pat Boone: Bring Our Troops Home Now!] [Older: Projected Nat'l Debt Interest: More than War, Education, Energy Combined]

Last year, I thought and hoped they wouldn't be able to do it. Alas, Robert Higgs writes:

Since the summer of 2008, the U.S. Treasury and the Fed have initiated a welter of new spending, lending, and subsidizing programs ostensibly aimed at steming the recession that began early in that year and deepened quickly in its last quarter and in the first quarter of 2009. Among the most notable of these programs have been attempts to prop up the real estate market and the residential construction industry, where the Fed’s easy-money policies in the first half of the present decade induced lenders to make millions of mortgage loans to home buyers who would not have qualified for such loans if traditional underwriting standards had been applied.

 During the housing bubble, however, with congressional backers goading Fanny Mae, Freddie Mac, and other lenders, caution was thrown to the wind, and loans were extended to home buyers who had little more than a pulse as a qualification. People who believed that real estate prices would never fall did not worry much about the great volume of dicy credit being extended to house buyers – for the moment everybody seemed to be getting rich effortlessly with little or no risk. However, people who believed that real estate prices would never fall were fools, and when the Fed began to back away from its easy-money policy and interest rates began to rise, real estate prices began to fall, mortgage delinquencies and foreclosures began to rise, and before long the entire house of cards began to collapse: house prices dropped drastically, as did the pyramid of financial derivatives built atop the mountain of mortgage loans, and in quick succession some of the world’s largest banks and other financial-services companies went belly up. Some, including Fannie, Freddie, and AIG, were taken over by the government or the Fed; hundreds of others were bailed out, at least for the time being.

A sensible person, surveying all of this wreakage and pondering how such a debacle might be avoided in the future, certainly would have concluded that the government should cease and desist from artifically spurring the real estate market by subverting traditional underwriting standards for mortgage loans. Those standards include, for example, a substantial down payment, usually 20 percent, and well-documented sources of income sufficient to permit the buyer to service the loan, usually a steady job or substantial assets.

During the crisis since mid-2008, however, the government has not done what a sensible person would have concluded it should do. Indeed, it has done the opposite. Rather than terminating the government policies that had encouraged the foolish behavior of real estate buyers, sellers, and lenders – foolishness that lay at the heart of the artificial boom that went bust during the past two years – the government has undertaken to continue and even to compound the selfsame policies that in large part caused our present economic troubles. For example, Fannie and Freddie, now effectively government owned and operated firms, continue to extend loans as if promising borrowers were superabundant.

Moreover, the Federal Housing Administration, a government agency created in 1934 to insure conventional mortgage loans, has greatly expanded the volume of its business, and according to a recent report in the New York Times, the FHA “is underwriting loans at quadruple the rate of three years ago even as its reserves to cover defaults are dwindling.” The Mortgage Bankers Association affirmed on November 19 that “more than one in six F.H.A. borrowers was behind on payments.” The FHA has backed 37 percent of all residential mortage loans made in 2009. Reporter Patrice Hill observes that “these loans are exposing taxpayers to the same kinds of soaring default rates and losses that brought down Fannie Mae and Freddie Mac as well as destroyed many banks and the private market for mortgage loans.”

Read the rest. This is most unsettling. For what happens when the chickens come home to roost? What happens when the laws of economics reassert themselves in the form of a more dramatic, painful correction? The summer/fall of 2008 will look like a cakewalk. What goes up most come down. Throw it up higher, and it will only fall harder.

Posted 11/23/09 5:28 PM larry101 New York, NY

"Rather than terminating the government policies that had encouraged the foolish behavior of real estate buyers, sellers, and lenders" And what policies would they be? The government policy under Bush that eliminated leverage caps at investment banks? The government policy under Clinton that eliminated Glass-Steagal? The government policy that ignored warnings of massive fraud by appraisers?

Posted 11/23/09 7:18 PM Anthony Gregory Berkeley, CA

How about the government policy of underwriting a large percentage of the bad mortgages, promising to bail out financial institutions, and pumping easy credit into the housing sector early on in this decade? That's what we're talking about. BTW, Ron Paul opposed the change to Glass-Steagal, because it wasn't true deregulation, but an increase in moral hazard: http://www.lewrockwell.com/blog/lewrw/archives/023595.html As for the other two things you mentioned, they couldn't compare to the effect of all the interventionist policies I mentioned above.

Posted 11/25/09 09:33 AM MichaelBarry Sebring, FL

No bubble in history has ever successfully been reinflated. The market always wins. It always triumphs over intervention of every kind, and every asset migrates to its true value. There is not enough capital available to indefinitely sustain any bubble. This is why we are looking not at a recession, but at a depression. Consumption in the United States cannot be subsidized indefinitely. Production in China cannot be subsidized indefinitely. We are looking at the beginnings of the structural collapse of the world economy.

Posted 11/25/09 6:45 PM Glenn Cumming, GA

Thanks for pointing out this article to us, Anthony. Robert Higgs is a favorite of mine and his economic analysis always makes sense to me. While reading, the phrase "ethics of money production" kept coming to my mind(the title of a book by Hulsmann). Don't know why, I've never read it.