In my column dated February 18, 2010, I explained that the housing crisis in the United States that confronted FDR in 1932 primarily was a consequence of deflation, of a massive decline in the general price level and nominal incomes over the period 1929-1932, and not a manifestation of a relative decline in the housing market. Those who entered the housing market during the period 1921 to 1927, unlike those who entered the stock market, had not, for the most part, ignored the underlying real value of the housing stock and gambled on making quick gains by entering and exiting a housing market fueled by bubble mentalities. The real price of housing held up extremely well throughout the Great Depression. The investments were basically prudent and sound.
The problem was maintaining mortgage commitments fixed in 1929 prices at incomes that had collapsed to reflect the 1932 CPI. The problem was that some 25 per cent of mortgage-holders had lost their jobs in an environment where, for the most part, women were excluded from the labor market. The problem was that when mortgages came up for refinancing (and in the 1930s most mortgages were of 5 year duration) existing lenders had been bankrupted and the cost of credit intermediation was extremely high if available on any terms.
In such circumstances, the foreclosure rate soared, because of deflation, not because of house buyer error and/or greed. In January 1934, some 43.8 per cent of all urban, owner-occupied homes on which there was a first mortgage were in default. Among the delinquent loans, the average duration of that delinquency was 15 months. Among homes with a second or third mortgage, 54.4 per cent were in default, and the average duration of that delinquency was 18 months. Thus, at the beginning of 1934, approximately one-half of all urban houses with an outstanding mortgage were in default. For comparison, in the fourth quarter of 2007, 3.6 per cent of all US residential mortgages and some 20 per cent of all adjustable-rate subprime mortgages (unheard of in 1934) had been delinquent for at least 90 days. The difference is major and unmistakable.
When FDR intervened to limit the magnitude of the home-ownership crisis, there was no prior experience of the corruption and political manipulation that is endemic in such large-scale institutional interventions. FDR for the most part believed in the myth of omniscient and impartial government that dominated economics and political science until the public choice revolution in the late 1950s. He had no real perception of the depths of depravity and chicanery that would manifest themselves in the activities of the monsters that he created: the Federal Home Loan Bank System (FHLB), the Home Owners’ Loan Corporation (HOLC), the Federal Housing Administration (FHA), the Federal Savings and Loan Insurance Corporation (FSLIC), and the Federal National Mortgage Corporation (FNMA).
As taxpayers were to discover over succeeding decades, the long-term cost of the house-market support mechanisms put in place by FDR would be extremely high. The policy of house-market intervention would prove utterly irresistible to politicians and presidents of all stripes, would indeed bring about the financial crisis of 2008 and the ensuing economic contraction (Rowley and Smith, Economic Contractions in the United States: A Failure of Government, September 2009, www.amazon.com).
As Nathanael Smith and I outline in our book, the United States house market problem that manifested itself in late 2006 and ultimately brought the world economy to its knees, was a problem of a very different nature. The problem in this instance was the product of contemptible greed and selfishness, on the part of politicians and presidents who craved every last vote and campaign contribution from housing market participants, on the part of the banks, financial institutions and government agencies that knowingly promoted a house price bubble of immense proportions, and on the part of all those households that played musical chairs through the bubble, expecting to enter and to exit the housing market, to move upwards from apartments to mini-mansions on janitorial salaries and unemployment benefits, and to take their high-risk gains before the music stopped.
By 2009, Obama and his administration knew full well the level of depravity and corruption that accompanies large-scale interventions in the housing market. The evidence from the savings and loans fiasco of the 1980s and the promotion of subprime lending to indigent households during the noughty years, was staring his administration in the face. In 2009, deflation was not the problem, but rather a significant relative over-pricing of the housing stock in the United States.
The solution was obvious: allow the market to adjust through private intermediation within the mortgage market, through orderly foreclosures, and through bankruptcy, the mechanisms of market adjustment that had evolved over many decades. The four million additional households that had moved, in many instances unjustifiably, from renting to home-ownership, or from modest to spectacular home-ownership, between 2004 and 2008, for the most part, would have to return to their previous, affordable stations in life; and would do so quickly in the absence of government intervention.
Instead, Obama has followed the flawed FDR trail, as is his instinct in all matters political. In consequence, housing market adjustments have been blunted and delayed, and a massive burden of toxic assets weighs down not just the private financial markets, but the Federal Reserve itself, putting at serious risk the international reserve status of the US dollar. Of course, by this ill-judged emulation of FDR’s policies, Obama has placed his own administration into serious jeopardy, jeopardy of policy paralysis until 2012, and of political oblivion thereafter. He has imposed intolerable long-term burdens on US taxpayers, as the Tea Party revolution is already demonstrating. Inevitably, and justifiably, he will pay a very high political price for this extremely serious error of political judgment.