Wisdom of Sound Economics

I was re-reading the first economics book I ever read this evening, and I came across a particularly insightful paragraph that I want to share, if for no other reason than to marvel at the beauty of sound logic and sound economic reasoning. Notice, I say sound economic reasoning instead of sound economic calculation or prediction; I am not a believer that a system of literally hundreds of billions of independent actions carried out by billions of actors can be modeled via any extensive calculus.

So, without delay here is the insightful paragraph I mentioned for your amazement and enjoyment!

"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 eventually to 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 the 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."

- Henry Hazlitt, Economics in One Lesson, 1946, Chapter VI, Credit Diverts Production.

Notice, Hazlitt's paragraph could easily have been written today to describe exactly what would happen say, after the Federal Reserve sets the federal funds rate to 1.0%, then Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac provide (mandated by law) loans in large amounts to people who might have had some difficulty qualifying for a traditional private mortgage. The loans would possibly take the form of Adjustable Rate Mortgages (ARMs) with little or no down payment required, among other forms. The ARM rates were derived directly from the federal funds rate, and consequently would be awfully low because of this fact.

This type of mortgage (ARM with little or no down payment) has been implicated as a prominent factor in our recent housing boom and bust. Amazing how sound economics can generally get the story straight, eh? And from 60 years before hand, no less. The paragraph describes very well the upshot of the current situation (where we have many millions of unsold homes on the market in America, and prices still artificially high in many areas as people caught up in the malinvestment are trying to sell at an acceptable level before losing all the capital they have invested). It should sound about right to anyone who bought a house over the last few years in many places, faced with out-sized pricing for even the most modest dwelling, and potential large losses if they have been forced to sell due to unexpected circumstances such as a job loss or relocation.

In the meantime, the taxpayers are forced via taxation to pay for this in the form of subsidized low interest mortgages, tax incentives for home buyers based on the American Reinvestment and Recovery Act, and as well the implicit guarantee of nearly 65% of all mortgages through GSEs Fannie Mae and Freddie Mac. And, I will only briefly mention that the FED also works to keep interest rates artificially low through its purchase of Mortgage Backed Securities (MBSs) - packages of bad loans on banks' books which the FED is now buying to the tune of $500 billion to help clear the way for more new low-interest loans!

This short quoted paragraph is so surprising to me because with simple deductive reasoning Hazlitt explains in a nutshell the economic debacle we currently face in America, in clear language that mostly anyone could understand with some thought, including many children I know. This simple eloquence is not something we will likely ever hear from the likes of Ben Bernanke as he tries to defend his actions as Chairman of the Federal Reserve. Hazlitt was a student of the Austrian School of Economics, and refuted in a weighty tome the writings of John Maynard Keynes - the fellow who provided the groundbreaking intellectual patchwork and background in favor of heavy public deficit spending as a replacement for so-called inadequate demand from the private sector around the world in his treatise 'The General Theory of Employment, Interest and Money" (1936).

Keynes' writing was not meant to be understood by the layman and indeed was written with the intent to convince the economists of the day. Keynes himself noted this in the preface to his famous book. I would welcome a description of the fundamentals of Keynesian doctrine that can be put forth in as simple and eloquent a manner as Hazlitt's remarks on the effects of government-sponsored mortgages, that were as convincing. It seems in order to reach the maximum number of individuals and also groups in society this would be a worthy goal. Sadly, I've looked very hard for such a description and have yet to find it. I am a logical person, and the appeal of the Austrian Business Cycle Theory and of economists such as Hazlitt and Ludwig von Mises is that the thought processes prescribed simply make sense in a logical way. I must admit, I have decided that I cannot and do not believe in the system Keynes prescribes, since it makes no logical sense to me whatsoever. But, I can be hopeful for the most concise and well-stated version of those ideas in order that I more and more fully understand the position I have taken, as well as that of the alternate viewpoint.

I will close with the thought that it is also simply impossible for me to take seriously a man who thought it would be reasonable for people to have a job digging up bank notes buried in bottles by the government. Don't believe me? Look it up. Keynes thought that it wouldn't be best, but it would be better than nothing in the face of political or practical pressures. To me, that is just so much nonsense.