Economic Answers Way off the Mark

by Karl Williams

Another neoclassical excuse-maker has just hit the airwaves, claiming to identify the causes of the GFC and even hailing Alan Greenspan as the prophet who was ignored as the GFC loomed! Once again, the fact that our economic system allows land speculation – with the promise of never-ending capital gains – to spiral into gigantic bubbles that are doomed to burst, is ignored. We’re now told that there’s little wrong with our boom-bust cycles if only the government wouldn’t meddle and nationalize or bail out the big lending institutions.

Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance written by economists Viral V. Acharya, Matthew Richardson, Stijn Van Nieuwerburgh and Lawrence J. White is the name of this superficial commentary on the GFC, claiming to be a groundbreaking analysis.

While property speculators and spruikers, banking executives hell-bent on bonuses based on quarterly loan figures, and neoclassical think-tanks holding sacred outright “property rights” over land and natural resources are quietly ignored, the real culprit, we’re told, is the US government which stepped into the smoking ruins the former had created to try to restore stability and confidence. More specifically, the authors lay the blame squarely on US government housing policy in bailing out the two mortgage giants, Freddie Mac and Fannie Mae.

The timing of the authors’ purported mega-disaster? – one week before the failure of Lehmann Brothers in late 2008, when Freddie and Fannie were put into ‘conservatorship’ by the US government. Meanwhile, as geoists know too well, the US property bubble had been expanding for years to record unsustainable levels, puffed up by the failure of tax policy to collect virtually any of the unearned increment in the socially-created land values. Such policies give the green light to investors to speculate in property, and this speculation pushes up prices further which induces new entrants to jump onto what they are told is a never-ending gravy train of capital gains. In the early years of the bubble these beliefs are self-fulfilling but, like the law of gravity, bubbles can only be inflated so much. In the end, rental returns are not enough to cover the interest payments on inflated prices and, once the hope of capital gains dims, the smart guys rush for the door and the stampede of sellers soon follows. If this phenomenon hadn’t occurred before (it actually occurs with remarkable regularity – about every 18 years), we could excuse policy-makers and perhaps even these very undistinguished authors.

The authors overlook the distant origins of the GFC, although they actually mention how US housing finance changed dramatically from 1992, when lenders were given ‘affordable housing’ mandates by the US government that were explicitly designed to extend credit to those least able to finance a mortgage. Completely in the thrall of their neoclassical indoctrination, the authors fail to see how easy credit actually boosts the price of property, with new potential buyers bidding up prices. Our Australian government is guilty of a similar oversight in the way its First Home Owners Grant has merely inflated property prices.

The easy target that the authors do identify is high-risk mortgage lending, but if the economic rent from land were collected for the public purse (enabling tax relief on honest work) then land prices could simply not spiral into dizzying heights (the full reasons for this can’t be explained here, for reasons of brevity).

The authors note the knock-on effects outside the borders of the US (which is true enough), but fail to note how other nations had their own property bubbles whose collapses were set off by the panic of the US situation. All in all, this work is a fine example of Economicus Superficialis 101.