TCS Daily

Capitalism is Not the Cause of Housing, Subprime Turmoil

By John E. Tamny - August 24, 2007 12:00 AM

Though they clashed on the inputs necessary for economic growth, John Maynard Keynes and Ludwig Von Mises had very similar views on the economic impact of falling currency values. In his Tract on Monetary Reform, Keynes wrote that when money is losing value, the "practice of borrowing from banks is extended beyond what is normal" with tangible commodities such as gold, art and real estate the regular beneficiaries of monetary mischief. Von Mises was more succinct in Human Action, noting that there is a "flight to the real" in times of inflation.

Greedy capitalists are increasingly blamed for the moderation of real estate prices that has led to the subprime meltdown, but a more realistic culprit is our own Federal Reserve. Dollar mismanagement there drove lenders and individual consumers into the housing market; both understandably chasing the rising returns that always result when the unit of account (in our case, the dollar) is cascading downward. History has once again repeated itself.

Though home prices continue to rise according to the broadest statistics offered by the Office of Federal Housing Enterprise Oversight (OFHEO), the big annual gains of 2001-2006 have vanished in a way that has imperiled the marginal homeowner. Amidst the aforementioned boom, it was easy for the latter to regularly refinance home loans given the desire of lenders to chase the performance of an asset class aided by the "money illusion" wrought by a currency rapidly losing value.

Gold, the single best market indicator of a currency's true value, hit a high of $740 in the summer of 2006, and its 12 percent fall since then neatly foretold the troubles borrowers and lenders are experiencing today. With property no longer bolstered by a falling dollar, the pullback of lenders from the housing market became more certain.

Interestingly, there's a broad consensus today that the Fed's switch in bias towards rising interest rates in June of 2004 tells the tale of the present problems. History suggests otherwise. Rather than a market driven by low nominal rates of interest, the single best indicator of housing's health is the price of gold given its useful measure as the best proxy for the dollar.

Indeed, in the aftermath of President Richard Nixon's 1971 decision to leave the gold standard, housing, according to Rice University historian Allen Matusow, "emerged as the most dynamic sector" in the U.S. economy. Importantly, with the dollar having lost credibility absent its gold definition, the former went into freefall while the latter skyrocketed. That interest rates were rising at the time did not detract from the shine that the falling dollar brought to property.

Moving ahead to the Carter years, George Gilder wrote in Wealth and Poverty that, "America's middle class was doing better in the housing market than all of the shrewdest investors in the financial and capital markets of the world." While the prime rate rose from 6 to 19 percent during the time in question, housing was not deterred given the stunning rise of gold from $150 to an all-time high of $892 in February of 1980. The weak dollar once again propelled nominal housing returns skyward, and served as a "middle-class hedge" amidst the dollar's rout.

Since 2001, the tragedy that was 9/11, Sarbanes-Oxley and a renewed protectionist sentiment in Washington were all dollar negatives such that gold rose 56 percent from mid-summer of '01 to May of 2004. Then the Fed began raising rates in June of 2004; the 425 basis points of hikes occurring alongside a further 87 percent rise of gold against the dollar. Not surprisingly, real estate emerged yet again as the ultimate hedge in times of dollar weakness. From 2001 to 2005, the Bloomberg/REIT Index rose 19.1 percent while the S&P 500 fell 3.2 percent.

Interest rate levels, when it came to home prices, were yet again a sideshow. Indeed, James Grant of the Interest-Rate Observer has written that prior to the recent property moderation, the three major bear property markets occurred in 1974-75, 1980-82, and 1990-92. It should be noted that interest rates were falling amidst all three of the aforementioned downturns.

Looked at in today's light, the dollar's 12 percent rise versus gold began in late summer of 2006 when the Fed chose to end its pattern of rate increases. Counter-intuitive as it may seem, history shows that rate increases work against dollar strength, so it was in fact the Fed's pause that has arguably done the most damage to the housing and subprime markets. Continued rate-hiking would have taken the dollar down further, while driving housing returns higher.

Returning to Keynes and Von Mises, the former wrote that capitalism "presumes a stable measuring-rod of value, and cannot be efficient - perhaps cannot survive - without one." Von Mises more succinctly pointed to the "mal-investment" that results when money is unstable. The Fed's failure to the right the dollar's fall for most of this decade, similar to its previous failure in the '70s, led to excessive lending towards the housing market that drove prices higher.

With the Fed expected to begin cutting rates in September, history says that the dollar and equities will rally, while housing will underperform to an even greater degree. Regarding the continued subprime fallout that will result from Fed ease, it will be easy to blame aggressive lenders and overeager borrowers. Capitalism is always an easy target that can't talk back. But if we're realistic, we should look no further than a Fed lacking any commitment to maintaining a stable dollar defined in the constant that is gold.

John Tamny is the editor of RealClearMarkets, a website that will be launching soon. He can be reached at



No Subject
talk about conspiricy - the fed knows this and does it anyway - who is benefiting? follow the money.

Mises was rigth and there is another factors hear..
Over regulation of growth in due to slow counties growth policies etc. have kept building slower than otherwise woudl have been. Thus as people could aford more becuase of falling interest rates, more money went into higher prices and less into more housing than otherwise would have been.

Another conspiracy nut...
...maybe the Fed is just incompetant?


Who's blaming "capitalism?"
Who's even talking about 'greedy capitalists?'

I've heard criticism of hedge fund operators or speculators or subprime loan operators, and specific criticism of specific abuses. Some people are saying some regulations need to be tightened because they invited abuse. I donn't hear anyone saying private property is the problem or the issue.
couldn't whatever point is being made be made without bringing irrelevant associations into the mix?

Ike and Ike
I'm pretty sure that the author means capitalists as a synonym for 'hedge fund operators, 'speculators' or 'sub-prime loan operators.'
A case in point is the lack of 'specific criticism of specific abuses,' yet lingering general assumptions that there were some.

What are regulations?
Control of private property.

If 'investors' are foolishly throw their money at people who are not qualified to repay the loan, and if other 'trust' the ratings on the those loans, the investors deserved to loose their money.

If someone who makes $1000/mo 'qualifies' for a $300k mortgage, what is he out if he defaults?

capitalism cause
Indeed, left wingers do blame capitalists for the recent turmoil. And the author correctly shows that its the FED itself that is the creator of the problem, just like they were in the 20s when they created the big depression, as correctly predicted by the same v.Hayek and the Austrian SChool of economics at the time. It's amusing when guys say that gold is some useless relic from primitive times....but it's just a coincidence that it costs so many dollars to buy an ounce of it. The gold kept its value, the money lost its because the stupid organ of the government, the FED printed too much.

same difference
But where's the bottom line? As long as it seemed that the damage was limited to the actors themselves - the hedge fund investors, speculators, etc; nobody was really throwing around blame.

Now, as it suddenly appears that the unraveling may have much broader ramifications and affect all kinds of people not involved, sure, questions are being asked. And should be. But they aren't questions about "capitalism."

And as far a specific abuses, we are getting some pretty detailed reports of outright lies. for example:

?One area where regulators are paying closer attention is advertising that promises tantalizingly low payments without clearly disclosing the myriad strings that accompany the debts. It is a tactic that has been widely used — and, critics say, abused — by lenders trying to lure new customers.

Mortgage lenders have spent more than $3 billion since 2000 on advertising on television, on radio and in print, said Nielsen Monitor-Plus, which tracks ad spending.

That figure does not include direct mail and Internet advertising, which are increasingly popular vehicles for the industry. Nielsen/NetRatings estimates that mortgage companies spent $378 million in the first six months of this year on Internet display ads, and many companies also buy search advertising., a site owned by the credit agency Experian that funnels borrowers to mortgage lenders, has become a prolific advertiser on the Web with its impossible-to-miss ads that feature dancing cowboys and a video of a woman jumping and screaming with joy, presumably after being approved for a loan.

The Federal Trade Commission and attorneys general in states like Ohio and New York are looking into the ads as part of more comprehensive reviews of lending practices during the housing boom. In June, federal banking regulators ranked advertising as one of three areas where mortgage lenders need to be more judicious...."

Regulations are part of capitalism
And regulations that limit use of private property are not ipso-facto socialism, despite extremist libertarian rhetoric.

For example: do you think these investigtions should be stopped?

The Federal Trade Commission and attorneys general in states like Ohio and New York are looking into the ads as part of more comprehensive reviews of lending practices during the housing boom. In June, federal banking regulators ranked advertising as one of three areas where mortgage lenders need to be more judicious.

The Ohio attorney general, Marc Dann, said his staff was investigating direct-mail advertising that appears to be a solicitation from a homeowner’s bank or from the federal government. Many ads appear to aim at low-income and minority neighborhoods. Mr. Dann said his office has sent letters asking 30 lenders to substantiate their claims..

As the mortgage market shrinks and defaults rise, he said, lenders “are becoming more desperate, and consumers are becoming more desperate.”

Consumer advocates say many ads are at best misleading and at worst steer consumers into risky loans with promises of low introductory rates that do not make clear that they could pay significantly more in a few months or years....


Bought a house lately?
How long did it take to sign all the documents?

Every one of those is the result of some government regulation.

Obviously they are not effective since every year more are added to the stack.

The most effective regulations are market regulations. If it requires lenders to go bankrupt or for borrowers to to go bankrupt, all were volunteers, all signed all sorts of disclaimers that they did not read, let them go bankrupt and start over.

So I guess we'd better get rid of some of those government documents like deeds
I mean, why can't people just trust each other on things like who owns property without the government sticking in its big nose.

But I'll tell you what: I'll sell you a house and you won't have to sign a thing. Just hand over lots of cash. Sure, a year later, I'll say you own it, even though you don't have title.

>The most effective regulations are market regulations. If it requires lenders to go bankrupt or for borrowers to to go bankrupt, all were volunteers, all signed all sorts of disclaimers that they did not read, let them go bankrupt and start over.

What's this 'bankrupt?' thing? Some kind of government regulation that lets people get out of paying what they owe? What's wrong with debtors prison, or just being able to seize the children of creditors as hostages. That's the market solution. Should we go back to it?

Absolutely. Stop these investigations as they have nothing to do with the issue.
The issue is lenders can buy cash at lower (Fed rates) than the market will charge. So they lend this out at market rates and keep the money. That is all fun and dandy until the borrowers over borrow and then the house crashes in.

This has nothing to do with the lenders who in an environment of lowering dollar values are behaving PERFECTLY rationally by lending it realizing that the borrowers have to pay back less in the future.

All of these investigations are attempts by the regulators themselves to cast blame for the mess on the actors who are stuck with their regulations in the first place.

Nothing to do with what issue? You mean fraud is just an ordinary business practice?
Nobody's talking about reconfiguring the entire system. Some investigations into particular suspicious advertising and marketing practices. Investigating these is a threat to capitalism??

If a robust basket of investment vehicles, all surrogate storehouses of value, exist, then the health of any one item in the basket must be measured against the entire basket, and not one of the discrete others. Herein lies the absuridity of the present article.

Capitalism survives robustly because capital seeks its highest and best use, even relying on the creativity of men to invent new vehicles for its use where the existing ones don't serve the utility of expansion under the prevailing circumstances.

RE: capitalism cause
Left wingers blame capitalists when they stub their toe against a table leg.

One amusing example. I was watching a news show some time ago where a STATE OWNED sugar plant in the Dominican Republic was using Hatians for slave labor. The commentator blamed and I quote: "Capitalism and the profit motive."

A deed is not a regulation.
A deed is document agreed to by both parties describing the property. No government agency is REQUIRED for a deed.
In many locations a title COMPANY verifies the title history and INSURES the title. The government only keeps track of the deeds.

OK, so lets stop recording deeds
just a needless expense that puts more money in hands of those government thugs.

>In many locations a title COMPANY verifies the title history and INSURES the title. The government only keeps track of the deeds.

Sure. And how would they do this without a single agree-upon repository for documents?

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