Planning Foreclosures

Samuel Staley's picture
 As the economy continues to lumber through the most protracted period of recession since the early 1980s, the financial sector has received the brunt of the blame. It's been easy for the planning profession to distance themselves from what seem at first to be macroeconomic trends. That view, however, is becoming increasingly difficult to uphold.  New data compiled by USA Today (March 5, 2009) suggests that geography, and planning, may have had a role to play in triggering our nation's problems. USA Today reporters found more than half of the foreclosures last year were concentrated in just 35 counties. These counties housed 20% of the nation's population and were concentrated in just a hand full of states: California, Florida, Nevada, and Arizona. These counties also clustered within the states around places like the San Francisco Bay Area, Southern California (Los Angeles), Las Vegas, the Florida coasts, and Phoenix. 

These counties "were the epicenter of a wave of foreclosures that have left leading banks teetering and magnified the nation's economic problems," the reporters write. "The foreclosures in these counties started a ripple effect that led to the collapse of the financial system."

 Notably, these metro areas are also known for high housing costs. "A few of the 35 counties leading the foreclosure boom are in already-distressed areas around Detroit and Cleveland," reports USA  Today. "But most are clustered in places such as Southern California, Las Vegas, Phoenix, South Florida and Washington, where home values shot up dramatically in the first half of the decade, then began to crumble." What makes these metro areas particularly high cost? It's simply supply and demand. These counties were mostly areas where housing demand outstripped the ability to supply it fast enough to meet rising demand. The result was a market imbalance that drove housing prices well beyond the reach of the typical household. In Los Angeles, for example, housing supply lagged demand by nearly two to one during the early part of this decade. The median housing price climbed to nearly 10 times the median household income. The fall of the housing market was inevitable under these conditions, and, indeed, the bubble burst.  

The fact housing imbalance and affordability issues were geographically concentrated begs a larger question for the planning community: To what extent did growth management laws contribute to this imbalance? Planning critics Wendell Cox and Randal O'Toole have made this point from the outset. At first their criticisms were easy to dismiss. The recession was national in scope, exotic financial instruments seemed to be the culprit, and the housing markets in the affordable industrial Midwest and Northeast also suffered severely. Geography didn't seem to play that big of a role.

The USA Today article, however, combined with data already compiled by Cox and O'Toole, and about three decades of academic research showing restrictive growth controls increase the price of housing, suggests this thesis is worth another look. Indeed, my quantitative analysis of the effect of statewide growth controls on housing affordability in Washington State and Florida (and recently updated for Florida), suggests that statewide growth management requirements alone might add up to 20% to the cost of housing. (That was enough to reverse trends toward affordability in Florida before the growth management act was implemented.)

The correlation is not perfect, but it's a lot closer than many in the planning profession may think and the strength of these relationships warrant a re-evaluation of the role growth management laws play in restricting housing supply and contributing to local and regional housing bubbles.

Sam Staley is Associate Director of the DeVoe L. Moore Center at Florida State University in Tallahassee.



Prices in the metro areas

Prices in the metro areas currently suffering from the most foreclosures were driven by speculative demand, as opposed to owner-occupiers looking for a primary residence. Historically low interest rates and financial innovations, combined with the conventional wisdom that house prices never go down, created powerful adaptive expectations among investors, who continued to bid up prices in what amounted to a massive ponzi scheme. Supply, as measured by single-family home starts did increase to unprecedent levels nationally (I don't have metro data but I'd wager, based on anecdotal evidence, that most of this additional supply occurred in the bubbly markets). Feeding additional supply into this type of market, ironically, would have probably increased prices further, thus magnifying losses on the way down and increasing the number of empty homes.

The other piece of evidence that doesn't seem to reconcile with the constrained-supply theory is the path of the price-to-rent ratio during the bubble. If the problem really was tight supply, then people simply looking for a place to live would have bid up rents right along with prices. Yet in Miami and LA, price to rent increased from 1.0 in both cities in 1997 to 2.25 and 2.5, respectively, by the beginning of 2006. The only way you can explain this is through investor expectations of additional price increases. Arguing that we should have paved over more farmland for single-family homes to meet this demand is like saying the Dutch should have converted their staple crop acreage to tulips.

Before anyone disparages me

Before anyone disparages me for being anti-free market, let me briefly add that most of the time prices do provide effective signals to producers, consumers, and investors. But for a number of reasons the price mechanism totally broke down, leading to a massive over-allocation of labor and capital to homebuilding.

No disparaging

I'm a "free-market" guy, but I'll be the first to tell anyone that while markets are rational and efficient in the long term, they are sometimes temporarily irrational and occasionally fail. That doesn't mean we throw the baby out with the bathwater, it just means we re-assess and try to move forward a better way. Also, we can't ignore the "government failures" involved as well.

First, to your point about rents vs. home prices. It is possible for divergence here in the supply-constrained theory. The major complaint from some folks was that housing such as rental multifamily was getting approved, but detached single family homes weren't. Neverthless, rental vacancies did go quite low in some hot markets, but as you point out, the rent vs. price ratio went out of whack. Why? This leads to my second point: loose, plentiful, cheap debt capital. All the crazy exotic mortgages distorted the for sale market. Why was it a distortion, to some degree? Monetary policy and the Federal Reserve. House prices are not included the CPI because it was thought that the structural components were included and that would be double counting. However, think about the number one component of housing that went up the most in price: land. Land prices turned ridiculous in the boom (construction costs went up, but not by much in comparison as the commodity boom was a little later). Greenspan ignored all the evidence that housing/land prices were hyperinflating and just looked at the modest CPI and lowered FF rates or kept them steady at very low rates. Since he kept the short end of the yield curve so low, new buyers found out they could get much lower rates if they did short term loans or ARMs. After that, bubble psychology took over and everybody saw their neighbor using their house like a leverged day-trade margin account. The mortgage lenders/brokers were willing participants and the MBS buyers loved it because they thought they were getting high rated bonds with low default risk. The problem there? The rating agencies didn't want to lose business by rating anything non-investment grade much like appraisers overvaluing homes to get repeat business. It keeps everyone happy. Everyone asks "where were the regulators in all of this?" Well, those two private regulators blew it for everyone and no we must ask ourselves if this is a legitimate private or government function.


I actually think the price mechanism worked perfectly here... it's just that the our central bank (which is responsible for centrally planning the price of our money) held interest rates too low for too long. Everybody else (lenders, borrowers, buyers, sellers, Fannie/Freddie, USG) responded perfectly rationally to a situation where debt was essentially free.... they leveraged the bejeesus outta themselves. Once can afford to bid up the price of a house/company/automobile/commodity if you can just borrow more to cover the difference and pay that debt back in inflated dollars via artificially low interest rates. Unfortunately, this rational action within unsustainable market parameters just manifested itself in a real estate bubble, just as it manifested itself previously in a tech bubble, just as it manifested itself previously in the "Asian Tiger economies" bubble, just as...etc.

Please note that I am definitely not arguing that all the lying, greed and excess that went along with the boom and bust was right, or even acceptable... i just think that if you take a step back and look at what happened, the price mechanism did work, in that it sent the correct signals to consumers and entreprenuers about the risk/reward factors of the current market conditions. Now that the current market conditions were being manipulated (in my opinion) is a different story.

Let me clarify: The price

Let me clarify: The price mechanism worked to the extent that it responded to the distortions - from the Fed, from a poor regulatory structure, from the adaptive (as opposed to rational) expectations of investors - that were fed to it. In that sense, it works to simply reflect the psychology of buyers and sellers today, regardless of whether that behavior is wise for the medium or long term health of the economy. But I like to think that the price mechanism - especially with regards to capital assets - is supposed to give meaningful signals to how the economy should allocate its resources over time. In fact that's supposed to be one of the major appeals of capitalism over, say communism. So, for example, if the high price of homes in the Nevada desert makes it "rational" for builders to build out 100,000 lots, but then 2 years later the price collapses and they are all vacant, I think in we can agree that the price mechanism failed to allocate labor and capital to their best use. So whether or not you think the price mechanism "worked" depends on what you think its supposed to accomplish to begin with.


"But I like to think that the price mechanism - especially with regards to capital assets - is supposed to give meaningful signals to how the economy should allocate its resources over time."

Agreed wholeheartedly, and that is exactly how it should work... I just think that Fed is manipulating the price system (via the money supply and interest rates) for the benefit of Uncle Sam and the resulting bubbles and pain are the natural consequence of that activity (also, I think the Fed is not purposefully doing harm, just that these are the unintended consequences of its actions... although a strong case could be made against that as well).

A Joke...right?

Mr. Staley states that growth management had a role in creating the housing bubble, and then notes that Phoenix, Las Vegas and Inland CA have been hit the hardest with housing deflation.

Phoenix, Vegas and Riverside have growth management policies? These three metros added more greenfield single family residential units than the rest of the nation combined in the past 10 years. In fact, these three metros have some of the most liberal land use regulations in the nation.

Phoenix, Vegas and Riverside

Phoenix, Vegas and Riverside were only booming because retiring and up and coming middle class Californians were fleeing coastal california's ever-increasingly unaffordable housing markets... add in a (large) dose of speculation and boom... housing bubble. So, yes, in fact "growth management" did have a role in Phoenix, Vegas and Riverside... it was just SF/LA/SD's growth management. The pattern holds true in the Bay Area as exurbs like Antioch, Brentwood and Central Valley towns like Stockton and Tracy boomed (and then busted) far more than the "core" Bay Area because retiring and up and coming middle class folks were priced out of the "core" areas.

retiring and up and coming

retiring and up and coming middle class Californians were fleeing coastal california's ever-increasingly unaffordable housing markets

Your comment seems to suggest that housing price appreciation in Phx/Riverside/Vegas have been driven by supply/demand fundamentals. Which is wrong.

The huge price increases in these markets were driven almost entirely by investors, not by an influx of residents fleeing from the coast.


No, I am saying that "growth management" policies did in fact contribute to the huge boom/bust of Phoenix, Vegas and Riverside... just not the "growth management" policies of those cities, but the policies of coastal CA. A simple glance at the respective population growth of those three areas over the past decade would indicate that it couldn't entirely be the fault of investors/speculators (not that they didn't contribute, as in fact they did so with abandon). Plus, the "bubble" real estate wealth generated by coastal CA was the main source of investor/speculator money in those markets... so one could argue that again, "growth management" policies of coastal CA did in fact fuel the bubble in Phoenix, Vegas and Riverside in another way as well (if one were to believe that only investors/specualtors drove the prices).

Markets like Phx have a

Markets like Phx have a multi-year backlog of of housing inventory on the market, and prices continue to be much lower than Coastal, CA. The latest data show Phoenix losing population -

How has growth management on the coast contributed to the bust in these markets? By your logic, Phoenix, Riverside and Vegas should still be growing since they are more affordable now than during the bubble and prior to it.

These markets have, and have had, a surplus of housing - as perhaps 20% or more of homes purchased at the peak were investor-owned. Seems like the reverse would be more accurate - that a lack of growth management in the bubble markets contributed to the bust, as their supply far exceeds demand.

Other side of the coin

Yeah, Phoenix, Vegas and Riverside overbuilt in response to the housing bubble. Would they have built nearly as much if coastal CA was affordable to live in for the majority of folks? Not a chance. Do think that if coastal CA was affordable so many people would have moved to Phoenix, Vegas and Riverside? I don't think one could have happened without the other.

Despite prices being ddown 20% in SF, LA and SD, the majority of the population in those areas still cannot afford the median priced home... so at least, once the wreckage clears, Phx, Vgs and Rvrsd will have some cheap housing for their residents if their economies get back on track (in new, non-housing related ventures hopefully).

Bubbles And Regulation

Speculative bubbles have appeared through history, and they don't usually result from regulation. The dutch tulip bubble was not caused by government limiting the supply of tulips, and the tech bubble of the 1990s was not caused by government limiting the supply of tech companies.

Excessive government regulation was one contributing factor in higher housing pricies, as zoning limited supply. As a smart growth advocate, I am a big supporter of loosening zoning and allowing higher densities in already developed urban areas to moderate housing prices.

Inadequate government regulation was a much bigger contributing factor in causing this bubble, as the government did not regulate mortgage-based derivatives and the companies that insured them to reduce risk. Alan Greenspan himself (the old Ayn Rand fan) has said that he was wrong to believe that the market would regulate itself and avoid risk, and that there should have been more government regulation.

There are many honest free-market advocates who admit that this bubble shows we need more regulation of the riskiest financial instruments.

There are also many less-than-perfectly-honest free-market advocates who work for think-tanks and who are paid to blame everything on too much government regulation - regardless of the facts.

Charles Siegel

One Needed Regulation

For most insurance policies, insurance companies are required to put money in reserve, in case they have to pay on policies.

Credit-default swaps were a new financial instrument that were essentially insurance on mortgage-based derivatives. Because they were new, they were not regulated, so there was no requirement to put money in reserve to back them.

This lack of regulation allowed AIG to issue huge quantities of credit-default swaps. Because AIG had a AAA rating, the mortgage-based derivatives it insured also got a AAA rating.

These derivatives are the toxic assets that the banks are now stuck with. If there had been a regulation requiring a money reserve to back credit-default swaps, far fewer of these toxic assets would have been created, and there would have been more viable insurance to back those that failed.

Maybe our free-market think-tanks believe that we should deregulate the entire insurance industry by eliminating the requirement that they have money in reserve to back their insurance policies. Then the entire insurance industry could become as toxic as the credit-default swaps have been.

for more details, see

Charles Siegel

CDS regulation

Charles, I agree with much of what you have said above as long as more regulation means more transparency and better bond rating. CDS themselves, are not toxic assets. We allow all types of bond insurance, which in itself, is not bad. I would suggest this: First, eliminate the mark-to-market rule so when we let AIG fail, the swap purchasers would not have to fully mark down an asset that was never meant to be traded on a daily basis (so why force them to price it that way). Also, why not set up an insurance fund, similar to brokerage SIPC insurance, funded by financial institutions, to compensate those who lose money on swaps so when they do go bad, we don't have to prop up the bond insurer (AIG) or compensate the CDS buyers since it will create a ripple effect. If we regulate swaps as securities (bonds), then we just need to focus on fixing the broken bond rating process.

At Least The Reason Foundation Has Nerve

CP, I don't know enough about finance to be able to say whether it is better to have a capital reserve requirement (as I suggested earlier) or mandatory contributions to an insurance fund (as you suggest here). One way or another, there should be regulations requiring some sort of contribution to stand behind insurance

I think we also need regulations requiring Wall Street bonuses to be paid out in the form of stock grants that vest over 5 or 10 years, rather than in the form of cash, so our financial wizards have some incentive to think about the long-term health of their companies, rather than raking in multi-million dollar bonuses for a few years and pocketing all that money when the house-of-cards collapses.

But I have to admit that the Reason Foundation has nerve. At this time, when the overwhelming majority of economists (and even Alan Greenspan) are saying that we need more regulation to avoid similar speculative bubbles and crashes, the Reason Foundation has the effrontery to say that we need less regulation.

Discretion is the better part of valor, and the Reason Foundation would probably do better to lay low for a couple of years and then, after this crash is history, go back to repeating their usual party line.

Charles Siegel

Reason and Corporate Governance

I think Reason is generally pretty reasonable, no pun intended. Quite honestly, if we had less government in many areas as they have suggested in the past, we would probably be in a lot better shape right now. The law of unintended consequences gets us into more trouble than almost anyone can imagine. That being said, I would like to see some sort of insurance program so one set of bad decisions by one company can't take down the entire financial system. Economicaly, you might look at it as AIG is creating a negative externality by serving as the dumbest counterparty known to man. We should let them fail, but we feel we can't because of the enormous wealth destruction and chain reaction it would create.

As for your statement about bonuses: to me, that is a whole other issue about corporate governance which I also have a problem with. I have no problem with how companies want to compensate their employees. But, the corporate governance system was set up so shareholders could truly be represented by the Board of Directors, who oversee management. The problem now is that the Board members are so distanced from shareholders - they are like one in the same with management. Fix that incorporation and governance issue and we won't have to worry about more fair compensation structures. Carl Icahn, of all people, has some interesting beliefs about this.

Unintended Consequences

"The law of unintended consequences gets us into more trouble than almost anyone can imagine."

True, but it applies to the unintended consequences of private, market-based decisions as well as the unintendended consequences of government policies. Eg, global warming is an unintended consequence of private decisions to use the cheapest fuels possible.

About corporate governance: I doubt if it is possible for shareholders to take as active a part in corporate governance now as they did a century ago, because corporations are much larger and deal with issues that are more technically complex; eg, there are lots of MBA financial wizards coming up with financial instruments that most people can't understand.

Charles Siegel

Speaking of unintended consequences and execuitve comp limits

The funny thing is the recent explosion in stock options is a unintended direct result of a Clinton-sponsored 1993 law to limit executive pay to $1,000,000 in annual salary. Boards just started giving options as they weren't "salary" in terms of compensation. I wish I could have found a more in depth article, but here is one from the LA Times saying as much:

Re: Bubbles and Regulation

I'll argue the case that we don't need more regulation (and I don't even work for a think tank). The first question I have, in regards to your the paragraph, is what wasn't regulated about mortgage-based derivatives and the companies that insured them? Insurance, banks and securities are already heavily regulated by the government (and aside from some outright government-controlled insustries like health-care and education they are some of the most regulated industries). Mortgage-backed securities and credit-default swaps, in and or themselves, are just bonds and derivative contracts. Nothing is inherently wrong with them other than lots of supposedly smart folks made huge speculative bets that housing prices would never go down (and lost those bets). In regards to the AIG example below, AIG made the same speculative bet, and was dumb enough to misprice the risk and not hedge, or reserve, against potential losses on their bet. I can sense the answer here..."because they weren't required to by any regulatory agency". Granted, that is true, but, even in the article you cited, AIG was able to game both the SEC and international financial rules to its own advantage (just look at how it helped banks manipulate their capital ratios) while supposedly being regulated, so even if it was regulated...would it have made any difference? I'd say no...just look at Lehman and Bear, which were also "regulated". AIG made some very bad business decisions, and instead of being forced to reckon with those decisions (through failure), it is being bailed out by the taxpayers.

I could easily just as argue that, although heavily regulated, AIG was still allowed to do what it did... so why have more regulation when the current regulations in palce didn't work at all? The ratings companies that gave AIG and AAA rating are government-chartered monopolies that have missed every major financial blow-up since who knows when. Regulating a reserve requirement for CDS, even if there was one AIG would have found a way around it (as, arguably, CDOs, mortgage-backed securities and CDS are all ways around older capital regulatory requirements put in place after the S&L crisis). So I would argue that more rules are exacly the opposite of what is needed, which is getting the government out of socializing business losses via the taxpayer. Instead of failure, crappy institutions get subsidies and more rules to follow, which leads to figuring out ways around the rules to generate further profits for themselves (and their regulators...jsut look at how many government folks trade their insider knowwledge for fat paychecks after a government stint) and then, when the inevitable failure happens, they are "too big to fail" and must be bailed out via the taxpayers... moral hazard at its finest.

I don't think we will agree, but at least thought I'd give it a shot as I believe there is a very credible argument for less regulation.

What Wasn't Regulated

"what wasn't regulated about mortgage-based derivatives and the companies that insured them?"

As I say below, credit-default swaps used to insure mortgage-based derivatives were not required to have a capital reserve, as other forms of insurance are.

"AIG made some very bad business decisions, and instead of being forced to reckon with those decisions (through failure), it is being bailed out by the taxpayers."

The entire financial system swallowed so many of those AIG insured derivatives that, if AIG hadn't been bailed out, the financial system would have collapsed, and we would now be in something like the Great Depression. Herbert Hoover also didn't believe in bailing out the financial industry.

Charles Siegel

Fair Enough

Yes, credit-default swaps used to insure mortgage-based derivatives were not required to have a capital reserve. The problem is that this one regulation isn't what is being called for by most people... many are calling for the reversal of the Clinton-era financial services deregulations as well as further government oversight of everything else related to the financial services industry (I think you mention more rules governing corporate bonuses below) as an overreaction to the current government-induced bubble popping. I doubt simply requiring one, perhaps smart, regulation above is what the politicians will settle for, and a bunch of half-baked regulations thought up in a supposed "crisis" will definitely cause more long-run harm than good.

On, your second point... seriously, you think Hoover did nothing? I wish he had done nothing, but his activism actually set the stage for FDR to come in and make the Great Depression Great (on another note, is it me, or is Obama doing the exact same thing Bush did, more financial services bailouts and exonomic stimulus... does anyone remember the $185 billion of so tax rebate stimulus Bush pushed through last April... did it even work?) Anyhoo... I don't buy the line that the financial system would have collapsed if AIG hadn't been bailed out (remember, mushroom clouds in America if we don't invade Iraq). The CDS market actually handled the Lehman bankruptcy quite well (as Lehman was a huge counterparty on CDS). Would an AIG bankruptcy be painful, sure.... would everything collapse? No way, if anything we'd reach a market clearing point for mortgage-backed securities much faster as the folks holding them wouldn't keep holding them at higher than expected valuations in expectation of a government bailout. Once those folks are on their own, they's figure out ssome realisitic valuations pretty fast. Some of the big banks might go bankrupt and their shareholders and bondholders would be wiped out... but that's much more preferable than wiping out our taxpaying grandchildren because the USG is too afraid to let a large compaany fail.

Regulation and Enforcement

In the regulation v. deregulation debate, people have lost sight of the role of enforcement. One of the problems I have with the de regulate everything crowd is that when they fail ( their explanation:entrenched bureaucracies; my explanation: much of the public likes the security of regulations) they instead turn to gutting the enforcement mechanisms. In regards to California, CEQA imposes onerous demands on planning new developments, but the enforcement is all after the fact, and based on the back and forth of litigation in the courts. Since people have been convinced that all government is bad, but they still want the good aspects of long-term planning, they shoot down any creation of a planning enforcement branch, and instead rely on NIMBY lawsuits.

Back to the point

Getting lost in the financial debate has resulted in this thread swaying away from the initial argument - credit markets aside, growth management law play a role in restricting housing supply and contribute to local and regional housing bubbles.

I think that this argument misses a major issue: growth management laws are NOT negotiable - they are essential to the future well-being of our communities. Once that assumption is accepted, the argument must move away from whether or not we should have growth management, but HOW can we make growth management policies work so that they DON'T contribute to unaffordable housing.

I think Charles makes an important point, that zoning in almost all of the country's cities needs to be re-evaluated on a major scale. Allowing more density is not only important for housing affordability, but for the healthy function of local economies and provision of municipal services. "Going local" is becoming a huge movement, but even a large community of single-family residences can hardly support more than the standard "chains." After spending a few years studying land use law, I believe this country needs to shake itself of the single-family worshipping attitude and recognize that - to take a quote from The Watchmen - "the American dream came true. Look around you. This is it." And it can't go on any longer, or you can expect Cormac McCarthy's vision of our future in "The Road" to come true (I know, a bit drastic, but you get the point).

Correlation studies DO NOT WORK when studying the complex web of interrelated issues that compose the urban fabric. Many factors affect both the supply and demand of housing in an area, and growth management laws happen to be ONE of the actors in that equation.

Michael Lewyn's picture

hey, wait a minute

Staley writes that "statewide growth management requirements alone might add up to 20% to the cost of housing."

I am perfectly prepared to assume for the sake of argument that this statement is factually correct. But even assuming this is the case, housing prices in "bubble" markets increased by a lot more than 20% over the past decade. And the places with the strictest growth management (Washington, Oregon) are not the places with the most serious foreclosure problems.

Two Issues Behind Housing Prices

Michael is right. There are clearly two separate issues involved.

Housing prices were driven up to some extent by growth management laws (though the right-wing is wrong to blame this on the smart-growth movement, which wants higher densities in some locations). But this is not the cause of the current financial crisis.

Housing prices were driven up to a much greater extent by banks writing subprime mortgages, financial wizards securitizing these subprime mortgages, and insurers without enough capital creating credit-default swaps to insure these securities. This is the cause of the current financial crisis: the financial system created all the toxic assets, and the taxpayers are now bailing them out.

Of course, the Reason Foundation is in business to criticize government regulation, not to criticize the banks and insurance companies - which is why it has such a distorted, one-sided view of the current crisis.

Charles Siegel

Not that one-sided

"Housing prices were driven up to a much greater extent by banks writing subprime mortgages, financial wizards securitizing these subprime mortgages, and insurers without enough capital creating credit-default swaps to insure these securities. This is the cause of the current financial crisis: the financial system created all the toxic assets, and the taxpayers are now bailing them out."

Banks, financial models and insurers did not buy houses.... people did. Regular folks got caught up in an irrational market bubble and bid up housing prices because they thought that those prices would never fall. Banks, financial models (I can't really call them wizards as history is proving there was nothing wizardly about assuming that a housing carsh couldn't happen) and insurers simply jumped on the bandwagon providing folks with the means to borrow way more than they should have. The question is why would these supposedly smart folks get caught up in this... greed? Yes, partly... but also because these risks were being subsidized by good ole' Uncle Sam. Subprime mortgages... the Community Reinvestment Act mandates that banks make subprime mortgages that they wouldn't otherwise make. Securitization, Fannie Mae and Freddie Mac (basically nationalized lenders) own more than half the mortgages in the US and are the biggest securitizers of mortgages (including subprime)... plus, they were the ones that lowered their lending standards (no down payments, higher leverage, etc.) during the boom - and they drive the market (as you tend to when you control over 50% and are the USG). CDS, Fannie and Freddie led the way in accepting and selling CDS backed mortgage security bonds. Both of these governmental organizations have leverage ratios that make Wall Street investment banks (at least former investment banks as they don't really exist anymore) look downright conservative. Uncle Sam was basically directly subsidizing the risk of the "financial system" by buying up or guaranteeing all the "toxic assets". Many economists and politicians were arguing about the inherent risk of these entities even in the 90s... except that Fannie and Freddie take a large amount of their profits (produced by their government guarantee) and recycle them as donations to their political benefactors to stay in business (Barney Frank being the main one). Along with AIG, these two entities are the largest recepients of bailout funds. I am not saying the bankers were greedy, or deserve special treatment (as it was actually enjoyable to watch wall st. fall off), but to focus on them is to ignore the 800 lbs. gorilla of Uncle Sam's rather large role in this whole mess.

Plus, besides the above, most economists have concluded that it was low interest rates that drove the real estate bubble. Guess who controls interest rates.... Uncle Sam via the Federal Reserve. Here's a piece where Greenspan admits that it was interest rates that caused the bubble but argues that the fed couldn't control the long-term rates as they were influenced by Asian savers:

And here's the counter-arguments implicating Greenspan and the Fed and exonerating Asian savers:

There was definitely a convergence in events that led to the current financial crisis and the people who speculated on houses, the banks that abetted them and the government policies that subsidized them all share a large role.

I agree with Ricardo on this point

See my comment below on the impact of monetary policy as well. Those institutions that Charles' mentions didn't choose to "overpay" for a house, though they did choose to accomodate the buyer by "overlending" and yes Fannie and Freddie were the main culprits there which is why they are in conservatorship. Fannie and Freddie could have been cut loose long ago from their Congressional Charters. In fact, several members of Congress tried to do exactly that. Sadly, certain members of the Banking Committee were well compensated to maintain the status quo. That staus quo allowed both GSEs access to cheaper capital becase investors long assumed either would be backed by the Treasury, though it was never explicitly stated.

Bottom line is that there is lots of blame to go around and pretty much everyone who is at fault is getting bailed out or ignored. Banks and homeowners and insurers get billions (trillions combined) and the realtors, unscrupulous mortgage brokers, joke bond raters, and trash appraisers get a free pass.

I don't think the Reason Foundation is as far off as you might think, Charles. Public policy interventions in various forms of mostly well intentioned monetary policy, growth management, subprime loan encouragement, government sponsored loan buyers have all contributed greatly to the mess we are in right now. Blaming "Wall Street" is always popular because nobody wants to look in the mirror at the mistakes they have made, especially your average American and their elected official. In reality, politicians love this because some of them can create "problems" that others must "solve" thereby providing them sufficient re-election fodder for their constituents. It's a great time to hate the "free market", but the only thing this situation has demonstrated is that people and their elected officials like free markets when the outcome benefits them and then seek socialized losses when the market produces an outcome they don't like. Nobody of satisfactory economic intelllect ever said "free markets" work that way. I guess there is no atheist in a foxhole...except the Reason Foundation and others like them.

Michael Lewyn's picture

some interesting stories on point

How HUD encouraged Fannie Mae etc to take on subprime loans:

On the other hand, if you want examples of how the free market really did encourage unsavory loans, just google "predatory lending" - a rather perjorative name for a wide variety of business practices by lenders, some fraudulent, some slightly unsavory, and all very risky. There was quite a bit of controversy over such practices, and should also have noticed that (contrary to some suggestions above) lenders did not need to be pressured by government to engage in predatory lending- they happily did it all by themselves!

Federal bureaucrats actually tried to prevent states from combating such practices:

Bubbles Then And Now

There is truth to what you say, Ricardo: the financial system is made up of both public and private institutions, and both are bound to contribute to any major fluctuations.

But the fact that this public/private financial system sometimes fails doesn't imply that cutting back on the public sector would make things better.

In fact, there have been bubbles and crashes ever since the Tulip bubble and the Mississippi bubble. In nineteenth century America, there was no federal reserve bank, no government bailouts, and businesses were allowed to fail as a result of their own business decisions, but there was a regular business cycle of booms and "panics" (as they called recessions or depressions back then, indicating how people felt during them).

If letting businesses fail rather than bailing them out didn't prevent the continuing series of "panics" in the nineteenth century, why would letting businesses fail today do any better? This thread includes lots of attempts to fix the blame for the latest crisis, but it includes no evidence at all that a deregulated economy would do any better at avoiding crises.

It seems clear to most economists that we are better off with the Federal Reserve Bank at least trying to moderate the business cycle by raising interest rates during the boom periods and lowering them during the bust - even if it cannot always succeed fully. So said Milton Friedman, who was not known as a wild-eyed socialist.

It also seems clear that we are better off having the federal government trying to avoid the worst suffering with an occasional bailout. If all those businesses were allowed to fail, the people who made the bad business decisions would not suffer the most: they have lots of money stashed away, and they would remain comfortable. The people who would suffer most would be low-level employees who didn't make the bad decisions, who don't have resources, and who would lose their jobs at a time of high unemployment. Your view of economics seems to ignore the suffering of those people.

Ricardo, I am curious: I get the impression that you want to eliminate the Fed. Is that right? If so, would you substitute a gold standard, or what you would base the currency on? CP, how about you? Would you abolish the Fed?

Charles Siegel

Michael Lewyn's picture

Bad Fed. Bad, Bad, Bad Fed.

Charles wrote- "It seems clear to most economists that we are better off with the Federal Reserve Bank at least trying to moderate the business cycle by raising interest rates during the boom periods and lowering them during the bust - even if it cannot always succeed fully."

I agree that when the Fed does its job, we are better off. Unfortunately, over the last decade the Fed never bothered to control the boom - with the results that the bust has been unnecessarily severe.

I'm not sure whether any alternatives to the Fed would be any better, though.

The Federal Reserve System

I guess it is as good as anything, in terms of a system. There were ways to manipulate things when we were on the gold standard too. My complaint is on the policy, not so much the system. One of the primary purposes of the Fed is to moderate the economy which I would also assume to mean detect threats to moderation and at least debate action on them. As I stated below, I think Greenspan and the other FOMC members focused too much on just the CPI and PPI data and ignored growing anecdotal and other hard evidence that wasn't being captured by his economic data sets. I recall Greenspan kept saying that "there has never been a national fall in housing prices" as if there is never a first time for anything. I also recall thinking - yes, but there has never been a doubling of prices in most places in 2-4 years, 100%-105% LTV loans, IO mortgages, negative amo mortgages, people flipping homes in a few months and in some cases, flipping new homes they had just made reservations on that they never really purchased or ever lived in. This wasn't a secret. The Fed really can't control long rates which is the metric that long term loans are based. Those are market-determined. But, they could have shut the Discount window, raised their target Fed Funds rate, and sold Treasuries. We can't pin everything on them, but the Fed is one of many guilty parties. Thus, it makes one wonder whether they are so reactive that they contribute as much to boom and bust as they prevent it (e.g. will all of the money and credit exapnsion now lead to high inflation in 3 years?). As you said though Charles, asset price bubbles have long formed and they all have one thing in common: the psychology of greed by speculators. In this case, the speculators were home buyers. I just don't think it's good public policy to bail them out - through fiscal or monetary policy.

Failures Of The Fed

"One of the primary purposes of the Fed is to moderate the economy which I would also assume to mean detect threats to moderation and at least debate action on them."

This suggests that the Fed contributed to this bubble by having too much faith in the market and not regulating enough. In fact, Alan Greenspan has admitted that he was wrong to believe that the market was self-policing and would avoid risk on its own.

"In this case, the speculators were home buyers."

The speculators were the home buyers who took the mortgages - and also the banks that wrote the mortgages and the insurance companies that insured them.

Charles Siegel

You are correct.

I think I would, in fact, eliminate the federal reserve. Besides this financial crisis, the Fed made the Great Depression "Great" (Ben Bernacke even apologized for it upon his appointment), the Fed was responsible for the "stagflation" crisis of the 70s as the Fed is the source of inflation (and is still responsible for all inflation) and can be blamed for several other smaller crises (the 1981 recession as Paul Volcker - Fed Chairman - pushed the interest rates sky high to break Fed caused inflation, the asian financial crisis of the 90s and possibley the tech bubble). I think there are several books and articles that can make a stronger case than I for the Fed's failures. So, if the Federal Reserve system is supposed to moderate the booms and busts and doesn't do it very well, or even tends to exascerbate samller crises into larger ones, should it even exist? I say no. In theory, as Friedman and many others point out, it should work, but in practice it does not seem to (the unfortunate fallability of man). There is also the idea that empowering one individual (or committee as the cas may be) with so much power (as the Fed chairman is arguable more powerful than the president) is just a bad idea - as the fed chairman not only dictates our monetray policy, but by virtue of the dollar being the reserve currency, dictates the monetary policy of much of the world (there are some strong economic colonialism arguments here that I don't necessarily agree with, but they are out there).

As to what I would replace the Fed with, I'd argue for a return to a true gold standard (full convertability of paper to gold), an end to legal tender laws (i.e. end the USGs monopoly on printing money) and an end to fractional reserve banking. Now as radical as this might sound, prior to the establishment of the federal reserve, this was exactly the lay of the land in the US (with the exception of the illegaility of fractional reserve banking), so it has been done before. You are correct that there were booms and busts during this system, and there would be booms and busts in any system going forward... unfortunately I don't think those things can be eliminated (although that is the intent of ending fractional reserve banking - Austrian business cycle theory claiming that booms and busts are a result of credit expansion, which really can't happen at 100% reserve banking). I am still doing some studying up, but it seems to me that the previous financial panics of the 1800s were no where as severe (or as long) many of our modern day depressions under the Fed (the Great Depression being the most notable, but stagflation, early 80s, the two in 70s, and wherever this one ends up being). My thoughts are, if cyclical downfalls are going to happen, I'd rather them just happen than have a central planning authority around that has the potential to make it even worse (and coordinating that bad policy with other central banks around the world to spread the disaster worldwide - as may yet happen here) (and has a history of making it worse). Plus, as the Fed creates inflation (because inflation is solely a monetary phenomenon) a return to a gold standard would actually induce slight deflation (as was the norm in the US until 1913 - the year the Fed began). Deflation favors savers and production, and would help put an end to our countries over-reliance on consumer consumption, debt and FIRE (finance, insurance, real estate) based economic growth. Ron Paul even has an End the Fed bill in place that is much in line wwith my thoughts above (of course it has not gone anywhere).

While I often sound like a cold-hearted free-marketer when I talk about businesses failing (and being left to fail) (ok, it's because I am), I too think the government should help the people hit by the fall out with things like jobless benefits and unemployment insurance, but not by propping up failed businesses and shareholders. Helping bad businesses is plain outright theft from the populace, and it prevents the failed capital investments from being recycled back into more productive uses. Helping workers affected by any busts is a different story.

100% Reserve Banking

My impression is that the business cycle was worse during the nineteenth century than during the post-war period, but that is just an impression. If you find any hard data, I would like to see it.

I do not understand your call for an end to fractional reserve banking, and if you have any links explaining it, I would like to see them. My first take is that 100% reserve banking would make it impossible for banks to recycle any savings as loans (since 100% of savings would have to be kept as reserves), which would cause inadequate aggregate demand, which would mean that there would always be a severe depression. But I would like to see more explanation.

Charles Siegel

Re: 100% Reserve Banking

I have gotten a different impression through my various readings, but it is also just an impression. One of the main thoughts I have regarding the 1800s, despite the panics, is that money experienced a long, slow deflationary trend (except in times of war) until the early 1800s. This meant that a penny saved was actually a penny earned (the common man did not have to speculate his retirement future on the specualtive stock market because inflation wasn't eating away his savings), and therefore, despite the occasional speculative panics (and of course, the much tougher standard of living) individuals weren't always part of the rate race and could live so long as they took care of their material needs. I actuallly think we've discussed this before on a different thread (about the currently degraded quality of life and the decreasing earnings of the middle class - or just look at the 50s compared to today... only one person needed to work... now you need both partners to work their butts off and many times, in places like SF (where I live) that's barely enough to afford a home or raise a family - and no, I am not advocating bringing back slavery or the sexism that accompanied the 1800s and 1950s as they are mutually inclusive of the economic issues). Anyways, I do not have any hard data at the moment but will be happy to provide it should I come across some in my extracurrivular reading.

I think a good link in general is this six part series on Ludwig von Mises, an older economist who's theory on money and credit are integral to understanding what is happening today (and what happened in the past... including the banking panics of the 1800s):

I am still reading the original books to see if I agree with the author's summation, but it actually seems to be a pretty good summary. Also, note that while the summary is good, the rest of the site is filled lots of libertarian and anarcho-capitalist rhetoric and I am definitely not warranting my complete belief in that.

I have not found any good links for you on 100% reserve banking (at least that explain it well) yet, but again, will provide if I find them. Nor, have I yet been fully swayed by the arguments for it and against fractional reseve banking... but if you buy the theories above on money and credit it inherently makes sense (sidenote, apparently the economists who produced the Chicago Plan for Roosevelt in the 30s to help combat the depression recommended 100% reserve banking among many other ideas for banking regualtions... and it was not adopted while other parts of the plan were). But the idea is as you have stated above, that the bank could not lend out more money than it had on deposit (preventing credit expansion, which is the cause of all financial/asset bubbles... even those in the 1800s by private banks - as the government does not have a monopoly on credit expansion). In terms of your savings account, that money wouldn't be available for lending, but something like a CD would (as you have lent the bank your money for a fixed period of time so they can lend it out in and in return pay you interest)... so you'd have to seperate out types of deposits. The only difference is that the bank could only lend $1 for every $1 you give them.... not $10 like they can today with a federally-mandated 10% reserve requirement... the thought being that banks would unable to artifically expand the money supply via credit and therefore, would be unable to create asset bubbles. Again, I am still working on this one due to my thoughts that banks in a truly free market would be much more prudent in the reserve ratios if the fed wasn't there to specifically back them up during a run (i.e. when the depositors know you f-upped your business and want their money back) (but then again a run would not really be a problem with 100% reserves). I think that lending would definitely still be possible, but rates would likely be higher (as they should be) and there probably would be an overall reduction in the amount of credit available (but perhaps not, aand would that necessarily be a bad thing given how debt-reliant America has become?),

True statements, but I'm skeptical

I understand what you are saying and many Austrian School economists (Staley being one) have advocated a return to the gold standard and an elimination of fractional reserve banking which essentially allows creation/destruction of capital. In theory, the concept has some merit, but I believe it was Nixon who basically ended the gold standard when he refused to give gold for USD to France and some other countries. The situation is not too different from what we have now: a huge national debt and a lot of foreign creditors who are uneasy that we will essentially devalue our currency by printing money (electronically or not). Their dollar reserves would not fare well and since they are usually held in US Treasuries, it's a double dinger since interest rates will probably go way up severly devaluing their bond holdings. Asking for a gold trade now is virtually impossible since we aren't on that standard and maybe that has something to do with most politicians resistance to not wanting to return to that: accountability. Now, we can just print money or "create" it with the Fed.

The thing about the gold standard, if it would not be fractional...As I understand it, would not the total value of all gold have to equal world GDP? It's not even close right now. The total value of all gold is about $4 trillion and even the US GDP is what, $12 trilion? Now add in the rest of the world. So, it goes back to your point about the monetary system adding years and years of inflation. Going back to this standard would have to greatly increase the value of gold and greatly deflate all other asset classes, correct?

One possibility: keep the central bank and just raise the reserve requirement which is something the Fed does from time to time. Of course, they tend to keep it quite low - about 20% ish I think. My point being, it's not entirely about the system, it's about the policy implementation. If we're politically able to handle a very severe recession, we would probably determine that we should not be expansionary right now, and that we just accept some significant deflation no matter how painful since the market is just correcting for the enormous unmeasured inflation the last 8 years or so. But, no, we would rather print money, encourage more overleveraging, more spending, more borrowing, and do everything we can to return to what every normal soul considers to be an unsustainable 2006. Go figure.

Links On Elimination of Fractional Reserve

"many Austrian School economists (Staley being one) have advocated a return to the gold standard and an elimination of fractional reserve banking."

CP or Staley, I would appreciate links explaining this, if you have any. It makes so little sense to me that I must need to learn more about it.

"As I understand it, would not the total value of all gold have to equal world GDP?"

With 100% reserve and a gold standard, the total value of the world's gold would have to equal the world's Money Supply. Multiply the Money Supply by the Rate Of Circulation of Money to get the GWP.

Charles Siegel

Gold standard argument-link

Charles, here is a fresh piece on the gold standard refuting (or trying to) an article supporting not returning to the gold standard. This is from an economist at the libertarian Ludwig Van Mises Institute. He has many good points as we have already discussed, but also points out one failing I believe I mentioned which is that the gold standard could be manipulated as well.

Gold Standard vs 100% Reserve

Thanks for the link, but those are familiar arguments about the gold standard.

It is 100% reserve banking that I am not familiar with, that doesn't make any sense at all to me, and that I am looking for links about.

Charles Siegel

Skeptical is a Good Thing

Exactly, the gold standard holds governments accountable for their spending... that is why governments and their central banks do not like it (that is why Europe dropped it during WWI, the US dropped it during the depression and finally severed all ties to it via Nixon... ironically enough, that is also the main argument against it... that it is too rigid - i.e. makes it too hard for the government to manipulate the currency). I, after what I can see today, think that's a good thing as Uncle Sam is working overtime to protect its own behind and basically punish the heck out of everyday Americans (and other world citizens as well since they buy our debt to make their own currencies stable... via exactly as you describe in your last paragraph above).

There are several interesting books out how to return to the gold standard, Murray Rothbard's "What Have They Done To Our Money" has one take on it I believe (it is on my to-do reading list so I cannot go into detail about it). I'll have to look more into your thoughts about what might actually happen but your point is well taken.

Unfortunately the Fed is a political entity despite the rhetoric of its impartiality; an entity that is simply too powerful and unaccountable for the common good of everyday americans. It also has a history of being wrong more than it has been right... so i think it would just be better to kill it than to have other policitians force the Fed to raise the reserve requirement (which they won't do as the USG needs the fed to help inflate away its debt).

100% Reserve, Deflation, And Happiness

"[with 100% reserve requirement] the bank could only lend $1 for every $1 you give them.... not $10 like they can today with a federally-mandated 10% reserve"

My understanding is that, with a 10% reserve requirement, they can lend $9 for each $1 deposited, with a 50% reserve requirement, they can lend $1 for each $1 deposited, and with a 100% reserve requirement, they could lend $0 for each $1 deposited.

"[Deflation] meant that a penny saved was actually a penny earned (the common man did not have to speculate his retirement future on the specualtive stock market because inflation wasn't eating away his savings), and therefore, despite the occasional speculative panics (and of course, the much tougher standard of living) individuals weren't always part of the rate race and could live so long as they took care of their material needs."

The conventional wisdom is that deflation discourages investment, because investors have to borrow in current dollars and pay it back in more valuable dollars.

The deflation that followed the civil war was very harmful to the common man, because people who bought farms after the civil war had to pay off their mortgages in more valuable dollars. This led to William Jennings Bryan's famous "cross of gold" speech. Likewise, with deflation, you would be paying off the mortgage on your house in more valuable dollars over the next 20 years or so.

Most people in the 19th century worked long hours and had a very low standard of living. Look at the tenements in the Lower East Side, and consider that people had to work 10 or 12 hours a day, six days a week, to pay the rent for those apartments. And they had to spend almost all of their income on absolute necessities like food and rent. Per capita national income today is more than 5 times what it was in 1900.

"or just look at the 50s compared to today... only one person needed to work... now you need both partners to work their butts off"

Even in the 1950s, per capita income was less than half of what it is today. The average new house in 1950 was only half the size of the average house today. The average American drove about one-third as much in the 1950s as today.

Both partners are working their butts off to support a standard of living that is much more expensive than the 1950 standard of living, but that does not provide more satisfaction.

This is not a question of inflation or deflation. It is a question of how much is enough - how much people need to consume to live a good life. International comparisons of self-reported happiness show that consuming more does not increase happiness after you reach per capita income that is about one-half the current American level.

Beyond that level, it is (in your words) a rat race.

Charles Siegel

Michael Lewyn's picture

Hey wait a minute...

"This is not a question of inflation or deflation. It is a question of how much is enough - how much people need to consume to live a good life. International comparisons of self-reported happiness show that consuming more does not increase happiness after you reach per capita income that is about one-half the current American level."

Evidence for this assertion, please?

Evidence About Happiness

There are lots of studies of self-reported happiness, beginning with Richard Easterlin's a couple of decades ago.

I ran into it most recently in Gus Speth's book The Bridge at the Edge of the World (which I happened to see yesterday in the bookstore), which has a scatter graph of these findings. Unfortunately, Amazon's Look In This Book doesn't seem to be working for this book, or I would add a link to the scatter graph.

I guess that before that, the last time I saw it was a few months ago in Bill McKibben's Deep Economy. But as I say, it goes back decades to Easterlin, and has been confirmed by many follow-up surveys of self-reported happiness. (I believe that, out of all the surveys that have been done, only one did not have this finding.)

We who know about city planning should understand this finding. We know that Americans drive twice as much now as in the 1960s, but consuming twice as much transportation does not make us twice as happy. If anything, it makes us less happy.

Charles Siegel

Michael Lewyn's picture

Here's one survey

Suggests that most of the happiest countries are First World countries that are roughly as affluent as the US (though there are a few outliers) - suggesting that a massive drop in GNP probably wouldn't make us particularly happy.

The One Contrarian On Happiness

As I said above: "I believe that, out of all the surveys that have been done, only one did not have this finding."
This is the one, and he is challenging the consensus.

His map is not as clear as a scattergraph. You should check out the scattergraph in Speth, which shows clearly that subjective well-being levels off at about half the level of US per capita national income.
When I get Speth's book, I will check the footnote and tell you the survey he is using as a source.

Charles Siegel

More on Banking

Sorry for the belated response. The reserve requirement is simply a leverage ratio of total assets (loans in the case of banks) to total reserve capital (it has a specific definition). So in your example above, for every $10 dollars in loans banks have to keep $1 in reserves (10% reserve requirement), at a 50% reserve requirement, for every $2 in loans they have to keep $1 in reserves aand at a 100% reserve requirement for every $1 in loans they have to keep $1 in reserves.

As far as deflation goes... just think about new cars. They are an extremely deflationary asset (they lose something like 20% of value the second you drive them off the lot), but people still buy new cars anyways. Or in turn, think about the 1800s... there was plenty of investment going on there, all the while accompanied by mild deflation. Investments work in both inflationary and deflationary scenarios (not hyper inflation or both those scenarios really mess thing up), there are just different assumptions on the ROI calculations (you just can't assume inflationary appreciation).... but any cash flow generated is then more valuable in the future. Deflation is actually much more advantageous for savers than debtors, as inflation is essentially a hidden tax on savers. Banks and debtors love inflation (and Uncle Sam is the biggest debtor in the world... so inflation is really in the USGs bests interests... but that may not mean it is in the interests of individual americans). The post-civil war deflation comment is interesting in that it actually followed a huge inflationary period brought about by the USGs use of the printing press to pay for the civil war... either way it proves that the government can easily harm the common man thorugh monetary policy (as I believe they are today). The only difference is that the gold-standard actually holds governments accountable (when they screw up monteray wise, one can notice the immediate effects, ala Mr. Bryan). Whereas today, the Fed is insiduously devaluing the USD which is harming both individual americans and much of the world population (because they buy our debt) and only a few people notice what they are actually doing. I vote for accountability as it is really scary how much power the Fed has over our lives (and scary that no one really realizes it).

As far as consumption goes, I agree with you... but look at the incentives built around consumption in this country... what happens to savers? If you simply hold onto money you are taxed via inflation (you actually lose money by simply holding onto it). Then what, you are actually forced to speculate on the stock and bonds markets to actually even hold onto the value of your savings (then you get taxed on any earnings via captal you have to take more risk to get the same return that you would otherwise get tax free). It's easier just to spend it on something that provides value now than save for something in the future (and since borrowing is still essentialy free it pays to spend even more now because you can pay it back in cheaper dollars in the future anyways...sometimes you can even write off the interest as a tax deduction). Plus, if you screw up and bite off more than you can chew... the government will likely bail you out anyhow... so the perfectly rational decision is to consume (I am kidding about the bailout part, but not the rest). I don't think it really has anything to do with happiness, consumption is simply the rational choice (and that can be traced directly to monetary policy).

Saving and Happiness

"for every $10 dollars in loans banks have to keep $1 in reserves (10% reserve requirement), at a 50% reserve requirement, for every $2 in loans they have to keep $1 in reserves."

Reserves cover both savings and loans (not just loans). Thus, if there is a 50% reserve requirement, for every $1 of savings, the bank can make $1 in loans (not $2 in loans): 50 cents of that $1 in savings is the reserve for the $1 in savings, and 50 cents for the $1 loan. (The reserves are for total deposits, and both savings and loans are deposits.)

Likewise, with a 100% reserve requirement, they would not be able to make any loans based on savings. They would have to keep it all as a reserve for the savings. It seems to me that there would be a permanent depresssion because they could not make loans based on savings.

"As far as consumption goes, I agree with you... but look at the incentives built around consumption in this country... what happens to savers?"

If you agree with me about consumption, then you should see that much more than savings is involved. I said that international comparisons generally show that increased income/consumption does not increase happiness beyond about 50% of the US per capita income. We could not channel that entire 50% into savings without causing a massive depression: about 10% is a healthy savings rate.

So what should we do with the other 40%? I think we should take much of it in the form of free time rather than in the form of income.

In the Netherlands, workers have the right to choose how many hours they work. As a result, the average worker there works only 75% as many hours as the average worker in the US. They also earn about 75% as much, and they can get by on less money because they live in rowhouses rather than sprawl suburbs and they bicycle rather than driving as their main form of transportation.

I think they are better off than Americans because they live this way. Californians wouldn't be complaining about having to work their butts off to afford a house if we lived this way. Instead, we would have free time for our families and our own interests. We would be much healthier because of reduced stress and more exercise.

And we would be doing much less to cause global warming and other global environmental problems.

Again, this has little or nothing to do with inflation, savings, and monetary policy. It is a question of of how much we produce and consume, and according to basic market economic theory, this should be determined by individual choices about the value of more income vs. more free time. On this subject, you might want to read a 4-page white paper I just published named "Compulsory Consumption," which is at

Charles Siegel

Ricardo, you don't know what

Ricardo, you don't know what you're talking about. Charles is correct. A 100% reserve requirement means that banks could not loan out deposits: they have to keep 100 cents of every dollars worth of deposit in their vault. As for your suggestion that the Federal Reserve be done away with, I suggest you look at swings in the interbank lending market prior to the Fed conducting open market operations and since ( While we don't have GDP data going back that far, it's not hard to imagine the impact that the extreme interest rate volatility of the 19th century had on output.

Time Preference

No, it's all about matching time preferences. What you say is true only if you think in terms of savings and checking accounts. One cannot redeem CDs at any time... all the bank has to do is match maturities and walla... 100% reserve banking. For longer periods banks can use bonds to match the time preferences of depositors and lenders... not an impossible task by any means.

The data you present makes sense... when one has a central planning agency in charge of interest rates and the money supply that is set up to foster interbank lending it is going to be much less volatile. It's great for banks, but is it great for the economy as whole or individuals over time? I am thinking no... is it great for bankers and debtors (the USG being the largest of such), most definitely yes.


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