–Why the real estate collapse?

An alternative to popular faith
        Why did we endure a real estate collapse? (Some call it a bubble.) There is a difference between a boom and a bubble. A bubble is a boom that gets pricked. So first, why did we have the boom?
        The price of any commodity, including real estate, is based on supply and demand. The question is, why did demand for real estate rise faster than the supply for more than 60 years, then suddenly fall?
        Fed haters will tell you the reasons for the collapse were low interest rates and lack of federal credit supervision. I suggest this is somewhere between overly simplistic and just plain wrong. There were many reasons for the boom, and several for the collapse:
        As for the boom, one reason may be that too many people believed unaffordable housing was affordable. The ongoing idea was: Buy a house you really can’t support today, but rely on your future income growth to make it affordable tomorrow. The notion that tomorrow’s income increase will cover today’s unaffordable expenses might sound familiar. It’s a first cousin to a Ponzi scheme, and it’s what many young couples subscribed to.
        Add to that the “safe,” insured profits lenders made, and there was strong encouragement on the credit side.
        Add to that the ridiculous tax law that gave advantages to owners, but not to renters. This was part of the governments historical efforts to help everyone own a home and live the American dream.
        Add to that the history of home value growth since WWII. Experience said, owning real estate was a “sure” way to make money. Think tulip bulbs.
        Add to that the notion that poor minorities should not be prevented from buying houses (Remember Jesse Jackson’s criticisms of the banks for redlining certain neighborhoods). A bank that refused a loan could be accused of racism. This created an influx of “entitled” home owners who not only could not afford their houses today, but never would be able to afford those houses.
        Add to that population growth that in itself increased demand.
        Add to that foreign investors, who saw the U.S. real estate boom as a great place to invest money.
        Add to that the introduction of condominiums, which made renting financially less prudent than owning.
        So there were plenty of reasons for the 60+ years boom. But then, what turned this boom into a pricked bubble? The tipping point may have been the reduced federal deficit growth rate which exacerbated all of the above factors. Because the real estate boom was a long-running Ponzi scheme, it depended on continuing increases in money flow. Ask Bernie Madoff’s investors.
        Yes, low interest rates may have had some recent effect by making property seem more affordable, but this real estate boom had continued for 60+ years, through low rates and high rates.
        Yes, lax supervision of lenders and insurers made everyone feel “bullet proof” when it came to risk. But trying to point at interest rates and supervision as the only factors making for the housing bubble, seems to miss the point.
        If you’re looking for a one-word description of what could have burst the bubble after all these years, that word may be “leverage.” Real estate was purchased with mortgage leverage. These mortgages then were leveraged by being bundled with many mortgages, that leverage being a version of the law of large numbers. (The failure of a small and predictable number of mortgages is distributed harmlessly over a large number of mortgages.)
        The next layer of leverage came from the belief that such organizations as Fannie Mae and Freddie Mac really were government sponsored, and so were absolutely safe.
        An additional layer of leverage was insurance, which fundamentally is a leveraged product (A small number of failures is distributed harmlessly over a large number of insureds.)
        Still one more layer of leverage was added when massive futures trading of insurance was adding to the mix.
        Ultimately, the leverage became so great, that a few billion dollars of real estate supported many trillions of investment. Every change in real estate supply and demand became magnified exponentially.
        In 2004, Federal Debt held by private investors increased 14% from the previous year. Subsequent annual increases declined to about 4% in 2007. The government pumped money into the economy too slowly to support a real estate demand that depended on faster growth.
        Those whose investments relied on greater growth in real estate values, began to feel a pinch, and the massively leveraged house of cards swayed more and more until it tumbled down.
        Previous reductions in federal debt growth almost always had led to recessions, but now the leverage was too great for just a small recession. After a series of smaller economic earthquakes, each caused by reduced deficit growth, this was (as they say in California) the big one.
        In short, the real estate bubble didn’t grow and burst because of something that happened recently. It grew and burst because of many policies that, beginning with the end of WWII, built leverage higher and higher, until a cause that previously had warned us with a series of small recessions, now collapsed into a big recession.
        This leaves us with the question, what has the government now done to reduce the fundamental cause of the bubble burst, leverage? The government has added money. Adding money does provide a temporary solution, but to prevent future bubble bursts, the government also must reduce the various sources of leverage.
        Requiring larger down payments, eliminating the sale of bundled mortgages, eliminating underfunded insurance and eliminating futures trading of mortgages, might be worthwhile for discussion.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

–The cost of ignorance

An alternative to popular faith
Ignorance is expensive. Government ignorance is especially costly.
Here is just one of many, many projects prevented because of Congressional ignorance about money and federal finances. It may not be as immediately harmful as the lack of universal health care, a fully funded Social Security and the elimination of an expensive, byzantine tax system; it’s a terrible shame, nevertheless:

Cost-cutting NASA eyes three cheap space missions

WASHINGTON (AFP) – NASA has named low-cost missions to Venus, the moon and an asteroid on a shortlist to become its latest space adventure, as the US agency faces astronomical political pressure to cut costs.
        The proposed probes — to the surface of Venus, the moon and to bring back a piece of a primitive asteroid — must all come with a price tag of less than 650 million dollars, a fraction of the cost of manned space flight.
        The agency, in a statement Tuesday, said the winner of the competition will be announced in mid-2011, with the project to launch by the end of 2018.
        NASA has faced growing pressure to cut its budget as the US government’s debt soars and as the United States buckles under the deepest economic crisis since the Great Depression of the 1930s.
        The agency has also seen dwindling political support, with its White House and congressional paymasters reluctant to fund the type of expensive manned space exploration that saw the agency put 12 men on the moon.
        A plan to return humans to the moon by 2020 came under withering criticism from a panel tasked by US President Barack Obama to look into the future of space exploration, as the project’s initial budget of 28 billion dollars exploded past 44 billion.
        Against this backdrop, the agency is asking scientists to come up with low-cost ideas to further space exploration.
        One project led by the University of Colorado’s Larry Esposito would send a explorer to Earth’s sister planet, Venus.
        The explorer would descend through the carbon dioxide-rich Venusian atmosphere, landing on the planet’s surface in the hope of gathering evidence that could explain why it is so different from Earth, despite being close in size and space.
        A second project would place a lander on the moon’s southern pole, collecting rocks that are thought to come from the lunar core, offering an insight into how the moon and Earth developed.
        Another project would travel to an asteroid to snatch around two ounces (56 grams) of material before returning the payload to Earth for extensive tests.
        The winner will be the third in NASA’s cost-saving New Frontiers program, which was launched in 2006.
        The first mission will fly by Pluto and its moon Charon in 2015 and then a target in the Kuiper belt, at the outer reaches of the Solar System.
        “These three proposals provide the best science value among eight submitted to NASA this year,” said NASA’s Ed Weiler.
        “These are projects that inspire and excite young scientists, engineers and the public.”

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

–How the federal budget really works

An alternative to popular faith

A parable about the Fed budget:

We shall call him “Mr. Fed.” He has an unruly daughter named “Taxpay,” whom he wishes to encourage toward goodness, while teaching her basic budgeting. So Mr. Fed tapes two sheets of paper to the refrigerator.

One sheet is titled “Taxpay Savings.” The other sheet is titled “Deficit Scoresheet.” Each day when Taxpay is good, Mr. Fed will draw a checkmark on her Savings sheet, and because he is teaching her double-entry accounting, he also will draw a checkmark on his Deficit Scoresheet.

Taxpay wants these checkmarks, because Mr. Fed will allow her to use them to buy things like staying up late or having friends for a sleepover. She trusts Mr. Fed to exchange these goods and services for checkmarks (In some quarters this trust is known as “full faith and credit.”) Also, if she is bad, Mr. Fed will tax her, so she needs checkmarks to pay any “bad girl” taxes she might incur.

All of the first week, little Taxpay is good, so by the end of the week she has accumulated 7 checkmarks on her Savings sheet. Similarly, Mr. Fed has drawn 7 checkmarks on his Deficit Scoresheet.

The system works so well, Mr. Fed tells Taxpay that from now on, he will give her 2 checkmarks for every day she is good, which of course requires that he also draw 2 checkmarks on his Deficit Scoresheet.

This is no problem for Mr. Fed who has plenty of pencils to draw checkmarks. But it outrages a visiting busybody named “Debthawk,” who asks Taxpay the nonsensical question, “Who is going to give Mr. Fed checkmarks to reduce the number of checkmarks on his Scoresheet?”

Puzzled, little Taxpay asks, “Huh? Why does Mr. Fed’s Deficit Scoresheet need to be reduced? It’s just a scoresheet for accounting purposes. The checkmarks don’t cost Mr. Fed anything. They are free, backed by nothing. They merely are arbitrary symbols that Mr. Fed can draw in unlimited quantities. They are exactly like the dollars the federal government produces, now that we are off the gold standard – arbitrary symbols, free and backed by nothing other than full faith and credit.”

Taxpay is pretty smart for a little girl, obviously smarter than Debthawk, who keeps insisting that one day Taxpay’s children and grandchildren will have to give Mr. Fed checkmarks to offset those on the Deficit sheet. Debthawk calls this “inter-generational transfer.”

In short, Debthawk wants a “balanced budget,” aka “deficit neutral” which means every time Mr. Fed gives Taxpay a checkmark, she should give it back. Think about the sense of that.

The first day of the next week, Taxpay is bad, so Mr. Fed taxes her. He erases a checkmark on her Savings sheet, and also erases a checkmark on his Deficit Scoresheet, reducing the Deficit Score to 6 checkmarks. Debthawk is thrilled, failing to notice the reduction on Taxpay’s Savings sheet.

Taxpay then decides to spend all her remaining checkmarks for permission to have a dozen friends at a sleepover. Mr. Fed erases all her Savings checkmarks and simultaneously erases all the checks on his Deficit Scoresheet. At first elated to see the Deficit Scoresheet having no checkmarks, Debthawk belatedly realizes that Taxpay now has no checkmarks left to pay for future goods and services. This puts everyone into a Great Depression, at which time Debthawk says, “I always knew that in emergencies like this one, Mr. Fed would have to add to his Deficit Scoresheet so Taxpay would have checkmarks.” (Of course he did.)

But, the minute Mr. Fed started to give Taxpay more checkmarks, Debthawk again complained about there being too many checkmarks in the Deficit Scoresheet. Poor little Taxpay. Debthawk wants to take away her precious checkmarks, and because his mind is closed, she can’t seem to convince him that is unnecessary.

And that is the way the federal budget really works.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com

Faith is belief without evidence. Science is belief from evidence.

–The federal deficit debate

An alternative to popular faith

THE WELL-KNOWN, ANTI-DEFICIT POSITION
A federal surplus is more prudent than a federal deficit

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
That is the popular faith.* But, a large economy has more money than does a small economy. Therefore, a growing economy requires a growing supply of money. Federal deficit spending is the prime source of that money. All six recessions, since the end of the gold standard (1971), have been introduced with a surplus or a reduction in deficit growth. All six were cured with an increase in deficit growth. When we have insufficient money growth we have recessions or depressions. The Great Depression immediately followed years of surpluses, and ultimately was cured with deficits.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Large deficits are unsustainable. The interest payments alone will grow to a point where they occupy the entire federal budget.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Unlike you, me, cities, states and corporations, the federal government uniquely has the power to create unlimited amounts of money, a power it gave itself in 1971. To service a deficit of any size, including interest payments, the government merely creates money ad hoc, by crediting the bank accounts of creditors.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
We cannot keep borrowing forever. Foreign nations will refuse to keep lending us money to support our profligate ways.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The government does not need foreign nations to lend us money. The federal government borrows by creating unlimited amounts of T-securities from thin air, backed only by full faith and credit, then selling them for the money it previously created. The government just as easily and safely could create money from thin air, also backed by full faith and credit. This would eliminate the borrowing step as well as all concerns about debt. Federal borrowing is a relic of the gold standard days.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
The fact that the government borrows is prima facie evidence that the government needs to borrow.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Federal borrowing is a relic of the gold standard years, when the government did not have the unlimited ability to create money. Today, borrowing has zero advantages over direct money creation, and many disadvantages, not the least of which is the mistaken belief
federal debts are a problem.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Federal deficits increase the money supply, which reduces the value of money and causes inflation.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The value of money is based on both supply and demand. Increasing the demand for money prevents/cures inflation. Demand is determined by risk and reward. The reward for owning money is its utility as an exchange vehicle and interest rates. To fight inflation, the government increases the reward by raising interest rates. Since 1971, there has been no relationship between inflation and federal deficits.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Raising interest rates to fight inflation will hurt business and the economy.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Since 1971, there has been no relationship between interest rates and economic growth. Low rates have not stimulated (as Greenspan and Bernanke have learned); high rates have not inhibited. The reason: For every borrower there is a lender. What helps one, hurts the other. It’s zero sum. For example, high rates help holders of CDs, bonds, T-securities. Also, changes in interest rates represent minuscule changes in business costs. Additionally, high rates have had a slightly stimulative effect, because they’ve forced the federal government to pump more interest money into the economy.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Our children and grandchildren will pay for today’s deficits through higher taxes in the future.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The government pays its debts by marking a credit in the bank accounts of its creditors, and marking a debit in its own balance sheets. No physical money changes hands. The government can do this endlessly. It does not use tax money to pay its bills. When taxes are received, the government debits the payers’ bank accounts and credits its own balance sheets. Effectively, the tax money is destroyed. The government has no vault or fund of money. It merely makes electronic notations. That is why today’s taxpayers do not pay for the massive Reagan deficits. There is no historical relationship between tax rates and federal deficits.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
There is no such thing as a free lunch. One day, someone will have to pay for today’s federal spending.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Federal money is, in fact, a free lunch to the federal government. It pays its bills by crediting vendors’ bank accounts. This costs the government nothing other than a few electrons sent to the banks’ records. Nothing collateralizes our money other than full faith and credit.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
When the debt exceeds the value of all government assets, the government will be bankrupt.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Federal assets, such as the Grand Canyon and Washington Monument do not collateralize our money. As a holder of U.S. bonds, China is a creditor to the government, but China cannot lay claim to such federal assets as Lake Michigan or the Supreme Court building. China’s collateral is the U.S. government’s full faith and credit, nothing more.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
I have to pay my bills and be careful with my borrowing. Otherwise I will go bankrupt. The government is you and me. It must do the same as we do.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The government is not you and me. It collects taxes; we pay taxes. It can create money at will; we cannot. As a sovereign nation, with the unlimited ability to create money, America cannot go bankrupt. The belief that the government is the same as its citizens gives rise to the myths about deficits.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
As our population ages, and more people collect Social Security, the program will go bankrupt unless taxes are increased or benefits decreased.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Social security is a federal agency, much like the Department of Defense, Congress, the Supreme Court and 100+ other federal agencies. No federal agency ever has or ever will go bankrupt, simply because the federal government itself, having the unlimited power to create money, cannot go bankrupt.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Technically, the government already is bankrupt, since it doesn’t have the money to pay all its debts, and must rely on future tax collections.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
The government has no money, yet doesn’t rely on tax collections. It pays its debts merely by changing the numbers in its creditors bank accounts. The government acts like a football scoreboard. When a team scores a touchdown, the scoreboard “owes” it six points. No one asks, “Where is the scoreboard going to get six points?” This is explained in detail at http://www.moslereconomics.com/2009/12/10/7-deadly-innocent-frauds/
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Many countries – Germany, Italy, Brazil et al – have suffered from hyper-inflation caused by excessive money printing.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
Each instance of hyper-inflation has been caused by unique circumstances, but generally, hyper-inflations have been caused by governments not addressing the root causes of their inflations. They mistakenly printed more money in response to inflation. This exacerbated modest inflations into hyper-inflations.
–//–
THE WELL-KNOWN, ANTI-DEFICIT POSITION
Most prominent economists believe the deficit and debt are too large.

THE LITTLE-KNOWN, PRO-DEFICIT POSITION
That is exactly the way scientific progress is made. The vast majority of prominent scientists have a belief. Then a minority (sometimes just one person) proposes a new hypothesis, which at first is denounced. Eventually the vast majority begins to change its mind, and the new hypothesis becomes the majority. Then the process repeats.

*Faith is belief without evidence. Science is belief from evidence.

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