The Housing Bubble in One Lesson

Yesterday I was at Borders and I picked up the book Economics in One Lesson. It's by Henry Hazlitt and the basic idea of the book is that there are a number of fallacies which have plagued much of economic thinking throughout the years. These in turn leads to misguided and harmful governmental policies. I should say that the book was written in 1946, and fortunately I believe some of the fallacies discussed have been accounted for in more modern Economics texts. However, the book is in no way irrelevant. I think many of the fallacies still are believed today by much of the general public. These fallacies are sold as truths everyday by politicians. Later I would like to post Hazlitt's lesson as well as what he says makes a good economist and a bad economist. But right now I want to quote some passages from chapter six, Credit Diverts Production. Here he explains how the government makes bad loans (a contributing factor to our current financial mess). He also goes on to point out the often overlooked fact that the money used for these bad loans could have been used somewhere else:

There is a decisive difference between the loans supplied by private lenders and the loans supplied by a government agency. Each private lender risks his own funds. (A banker, it is true, risks the funds of others that have been entrusted to him; but if money is lost he must either make good out of his own funds or be forced out of business.) When people risk their own funds they are usually careful in their investigations to determine the adequacy of the assets pledged and the business acumen and honesty of the borrower.

If the government operated by the same strict standards, there would be no good argument for its entering the field at all. Why do precisely what private agencies already do? But the government almost invariably operates by different standards. The whole argument for its entering the lending business, in fact, is that it will make loans to people who could not get them from private lenders. This is only another way of saying that the government lenders will take risks with other people's money (the taxpayers') that private lenders will not take with their own money. Sometimes, in fact, apologists will freely acknowledge that the percentage of losses will be higher on these government loans than on private loans.

And now my favorite part. Later in the chapter Hazlitt explains (in a simplified manner) our housing bubble 60 years before it happens. If you are familiar with Fannie Mae and Freddie Mac the accuracy will be chilling:

The case against government-guaranteed loans and mortgages to private businesses and persons is almost as strong as, though less obvious than, the case against direct government loans and mortgages. The advocates of government-guaranteed mortgages also forget that what is being lent is ultimately real capital, which is limited in supply, and that they are helping identified [recipient] B at the expense of some unidentified [recipient] A. Government-guaranteed home mortgages, especially when a negligible down payment or no down payment whatever is required, inevitably mean more bad loans than otherwise. They force the general taxpayer to subsidize the bad risks and to defray the losses. They encourage people to "buy" houses that they cannot really afford. They tend to eventually bring about an oversupply of houses as compared with other things. They temporarily overstimulate building, raise the cost of building for everybody (including the buyers of the homes with guaranteed mortgages), and may mislead the building industry into an eventually costly overexpansion. In brief, in the long run they do not increase overall national production but encourage malinvestment.

More on all this later. But in the interest of keeping posts at a somewhat readable length, that's it for now.