I guess my question was very vague. Let me be more specific.
When people talk about causes, they can mean a few different things. For example, if someone is crossing the street at a walk signal, and is hit by a drunk driver, we tend to say that the drunk driver caused the accident. The accident could have been prevented if the pedestrian had been more careful, perhaps, but he was generally justified in crossing at a walk signal. The driver, on the other hand, was doing something unexpected and dangerous. So in this sort of situation, we can point to a cause.
Then again, there are other accidents where there is no single cause. If you ask what caused Chernobyl, you could answer that it was caused by bad reactor design; or by failing to follow safety protocols; or by running a dangerous experiment; and, from what I've read about the accident, all of these explanations would be somewhat correct. All of these actions were reckless, and the absence of any one of them could have prevented the accident. So with Chernobyl, there are many independent factors which collide in an unpredictable way to create a catastrophe.
Yet again, there are systems like the weather. If you want to know why it's raining, you can point to particular things that happened recently - like moisture moving in from the pacific or what have you. Each event that occurs has some proximate causes. But overall, the weather is chaotic and unpredictable. There's not really any way to analyze it into overall causes - the best we can do, long term, is the ultimate forecase of the 'hippy dippy weatherman': 'the weather will continue to change, on and off, for a long, long time'
So, for me, right now, the economy is pretty much like the weather. There are highs and lows, and each one has its particular characteristics, but I can't see an overall system to it. I'd love to have a level of understanding where it is more like the driving accident: I could point to the particular asshole who caused the mess. If that's not possible, I'd at least like to have a Chernobyl level of understanding, where I have some sense of what mistakes were made.
So anyway, I guess I've read some pieces of the story from a few different sources, and they all give a fairly plausible story of how A preceded B, and ~A would have prevented B. Some of these are: deregulation, low interest rates, government interference in the housing market, bad modeling of risk on the part of finance firms and credit agencies, capitalism itself. I have a little bit of an understanding of each of these stories. But I'm still confused over which of these could be considered independent causes. For example, if the financiers somehow needed to find a place to put their money, then it may have been a consequence that they came up with risk models which drastically underestimated the risk of certain products.
So, what I'd like to know is, how did low interest rates lead specifically to this housing-led finance bubble? Were the other factors coincidental, or forced?
I hadn't ever heard that borrowing was actually below the rate of inflation - so that's very interesting to me. But then, why didn't the bankers just borrow money and put it into treasury bonds or the stock market? Why build up this house of cards with subprime mortgages and mortgage-backed securities and whatever else?
Thanks for taking the time to answer my questions. I'll also look into Schiff later (I don't really like video, but I'll see if my library has one of his books).
I find the recent financial trouble really fascinating, partly because so much of it was predictable, and partly because I'm not certain that it was avoidable.
Let's rewind the clock. IIRC, in 2000-2001 we had the dot-com crash and its various effects on the economy, but there was a relatively fast recovery, partly due to low interest rates. Low interest rates in and of themselves didn't directly affect consumers' habits, but they did have a powerful indirect effect in the form of easy credit.
This easy credit prompted the poor and lower middle classes to overextend themselves. They took the opportunity to buy consumer products they couldn't technically afford, in the form of new cars, electronics, furnishings, etc., and that in turn caused a brief period of economic boom.
But, one of the interesting things about the poor and lower middle classes is -- despite another article on HN this morning -- they're always on the lookout for a way out of their situation. Especially anything that looks like a "cheap" solution.
The housing market. The combination of cheap credit -- with lenders practically falling over themselves to hand out loans to individuals that didn't qualify on paper for the loans -- along with the mentality of the lower socio-economic classes that housing was suddenly "a good investment" -- because prices were going up, up, up and nobody at the time believed they could ever fall -- caused a housing gold rush.
In places like the Bay Area, a lot of the available land for new housing is party far removed from everything else. This is the classic suburban housing model, and it's also going to be factor.
Because, things actually were going pretty great for about a year or two. If your credit was shaky for any reason, you couldn't afford to move or buy a house, but hey, everyone else is happy. And, remarkably, the price of basic goods and services didn't seem to change much during that period -- just the price of housing, which exploded.
And then, in a perceptibly short period of about a year or so, gas prices went through the roof. (I still don't understand why that happened, but it was timed nicely with the war in Iraq.)
What happens if you're running down a hill as fast as you can, and then you try to make a slight course correction? There's a pretty good chance that you eat pavement, and that's what started to happen.
The over-extended poor and lower middle classes had by this time used much of their available credit, and they were doing fine, unless the day-to-day cost of living changed much. Thing is, many of them had nice homes that were a 30 minute commute from work, and many of them had nice, huge vehicles. Both of those turned into the perfect storm of a price sensitivity on gas.
The first stumble happened in the car market. The distinctly American SUV, which had been considered invincible, suddenly started to see a slow-down in sales. A slow-down of anything in a bubble economy makes people nervous, but there didn't seem to be a very noticeable reaction from any major groups.
But, the price of gas stayed fairly relentlessly high, and significant numbers of people started to fall slightly behind on their credit card payments. This led to effect number 2: a very slight downward change in consumer spending.
The really neat effect though was on housing. Seemingly overnight, nobody wanted to move farther away from work. Houses started to stay on the market longer, but the prices didn't drop, at first. Thing is, too many of the people trying to sell were doing so because they themselves were overextended in credit, and they were trying to get some of that free equity out of their home that everyone had promised them.
Realtors at the time were still naively optimistic though, so they -- nearly to a one -- encouraged their sellers to stick to their price and wait it out.
The net effect was precisely what most people had considered impossible: the housing market stalled, and then crashed.
The lower socio-economic classes by now were really beat up financially, so even when the price of gas fell again, they just weren't spending money anymore. A huge number of people got soaked on their home purchases, seeing decades of savings evaporate seemingly overnight.
The big financiers and creditors then ran into trouble, and we all know the rest.
I think that the price of gas was the metaphorical straw that broke our economy's back, but I also think that the trends at the time were totally unsustainable and doomed to failure eventually. I also see how people are so willing to blame low interest rates and cheap credit (two sides of the same coin), but the thing is, those also resulted in the rapid growth of economy. What few people want to admit is that a healthy modern economy absolutely depends on the lower socio-economic classes spending money; the more they spend, the better off everyone else is. Maybe someday our economy won't work that way, but for now, it does.
Without those low interest rates, it's just as likely that we would have seen a long period of stagnation coming out of the dot-com crash. Whether that would have been intrinsically better or worse for us is way over my head.
When people talk about causes, they can mean a few different things. For example, if someone is crossing the street at a walk signal, and is hit by a drunk driver, we tend to say that the drunk driver caused the accident. The accident could have been prevented if the pedestrian had been more careful, perhaps, but he was generally justified in crossing at a walk signal. The driver, on the other hand, was doing something unexpected and dangerous. So in this sort of situation, we can point to a cause.
Then again, there are other accidents where there is no single cause. If you ask what caused Chernobyl, you could answer that it was caused by bad reactor design; or by failing to follow safety protocols; or by running a dangerous experiment; and, from what I've read about the accident, all of these explanations would be somewhat correct. All of these actions were reckless, and the absence of any one of them could have prevented the accident. So with Chernobyl, there are many independent factors which collide in an unpredictable way to create a catastrophe.
Yet again, there are systems like the weather. If you want to know why it's raining, you can point to particular things that happened recently - like moisture moving in from the pacific or what have you. Each event that occurs has some proximate causes. But overall, the weather is chaotic and unpredictable. There's not really any way to analyze it into overall causes - the best we can do, long term, is the ultimate forecase of the 'hippy dippy weatherman': 'the weather will continue to change, on and off, for a long, long time'
So, for me, right now, the economy is pretty much like the weather. There are highs and lows, and each one has its particular characteristics, but I can't see an overall system to it. I'd love to have a level of understanding where it is more like the driving accident: I could point to the particular asshole who caused the mess. If that's not possible, I'd at least like to have a Chernobyl level of understanding, where I have some sense of what mistakes were made.
So anyway, I guess I've read some pieces of the story from a few different sources, and they all give a fairly plausible story of how A preceded B, and ~A would have prevented B. Some of these are: deregulation, low interest rates, government interference in the housing market, bad modeling of risk on the part of finance firms and credit agencies, capitalism itself. I have a little bit of an understanding of each of these stories. But I'm still confused over which of these could be considered independent causes. For example, if the financiers somehow needed to find a place to put their money, then it may have been a consequence that they came up with risk models which drastically underestimated the risk of certain products.
So, what I'd like to know is, how did low interest rates lead specifically to this housing-led finance bubble? Were the other factors coincidental, or forced?
I hadn't ever heard that borrowing was actually below the rate of inflation - so that's very interesting to me. But then, why didn't the bankers just borrow money and put it into treasury bonds or the stock market? Why build up this house of cards with subprime mortgages and mortgage-backed securities and whatever else?
Thanks for taking the time to answer my questions. I'll also look into Schiff later (I don't really like video, but I'll see if my library has one of his books).