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Conservatives Miss The Cause Of The Economic Crisis

The Conservative mantra of the day blames the current financial crisis on the government’s over-regulation of an otherwise sound banking system. They want you to believe that the crisis stems from an intrusive government forcing lending standards lower by government fiat, namely the CRA. While the government is at fault here, the government's intervention in the banking system is only a component of a much larger problem - consumer debt.

Not all debt is the same. In economic terms, investment debt is unpredictable because the impact really depends upon the success of the underlying investment. Consumer debt on the other hand is very predictable. It pushes demand forward getting consumers to buy today what they would normally wait to buy. When we express future demand today, we pull revenue streams forward, thereby overstating present revenue.

In the microcosm of housing, the government and financial systems enabled people to borrow more and at a lower rate than ever before.  This pulled demand as well as revenue forward as people wanted more housing.  The builder, unfortunately, didn't think that his revenue was overstated, and neither did the banker who started lending on looser and looser terms. To them, the boom would never end. So the builder, in turn leveraged his wealth, buying things from people who found themselves suddenly richer. Those people in turn leveraged their wealth, and so on and so forth, until the economy was brimming with imaginary wealth entirely built upon imaginary revenue.

The problem is that at some point there isn’t enough future demand to pull forward. We hit that point in 2007. Housing demand for 2007, 2008, and 2009 had been depleted, having largely been filled in 2004, 2005, and 2006. There was no cheaper capital to pull into the game of low interest rates. In fact, we were experience the opposite as interest rates on variable notes reset higher, forcing the housing crisis. Higher rates forced people to sell at the exact same time that demand was falling. This was the housing crisis.

In the net, the problem wasn’t the marginal poor person buying a house that he couldn’t afford. The problem was the near-rich person who bought the swimming pool for the house that he couldn’t afford. It was people spending imaginary wealth, borrowed from bankers who imagined growing revenue streams. Having worked in banking for 20 years, I can assure you that the government didn’t force bankers to make bad loans any more than the zoo keepers force lions to eat red meat. The government simply lowered interest rates below the rate of inflation and stood back to watch economic gravity take hold.

The government is almost entirely responsible for this mess, but we as a nation need at least blame the right people, and learn the right lesson. Failing to assign the blame for economic bubbles is the reason that so many politicians try to create them.