By Dan Beaulieu
Rebutting: How to Stabilize the Housing Market by Lawrence Summers
I find it hard to understand how someone could ever subscribe to the ideology of treating the illness with what caused it. Lawrence it seems you've spent a great deal of time with a magnifying glass to the situation, when all one needs to do is take a step back and look at the entire picture. The business cycle.
Essentially, what your advocating is exactly what Alan Greenspan did in 2000 to combat the collapse of the Dot-Com bubble, which itself was formed using your approach of high risk investing. Micromanaging the situation through Keynesian models will only result in redundancy.. To properly stabilize the economy we must understand how we arrived at our current crisis; we must understand the business cycle.
Bubbles form when the Federal Reserve lowers interest rates below the natural levels of a market, it influences expansion of investments well beyond sustainable levels. This distorts the signals that business uses to assess risk. These distortions then lead businesses to believe that consumers have the savings to back up their investments. However, artificially low (below market) interest rates don’t generate new wealth to make good on investments. So when the bubble pops these fallacies are realized in lost investments.
The great bubble was largely attributed to the bad policies of Alan Greenspan who was the chairman of the Federal Reserve from 1987 until 2006. Greenspan intervened in the recession that should’ve followed the dot-com bubble. Instead of accepting the natural recession that should have occurred in 2001, the Fed began expanding the Housing Market. This didn’t negate the previous bubble; it merely stalled it by creating a bigger bubble. The Fed arrogantly continued its efforts to stop recession through low interest rates and actual interest rates fell below historical averages. At that point the Fed had abandoned all monetary rules in attempts to prop the market.
Alan Greenspan slashed the federal fund targets from 6.5% in January of 2001 all the way down to 1% by June 2003. He fixed the rates at an artificial low of 1% for a full year, which encouraged more bad investments and caused a massive expansion of the bubble. Then, by June of 2006, Greenspan had raised it back to 5.25%, a move that popped the bubble and unleashed the havoc of three overdue recessions.
Treating the problem with the problem is exactly what got us into our financial crisis; microeconomics, Keynesianism and the Federal Reserve abusing our elastic money supply. To "fix" the housing market we need to stop setting the stage for bad investments and when the business cycle begins to decline, as it must, let it. Furthermore, in order to insure we never experience this magnitude of economic downfall again we must get back to a sound money and limit, if not dismantle, the Federal Reserve.