How to Avoid the Next Housing Bubble

October 17, 2008 • Commentary
This article appeared in the Los Angeles Times on October 17, 2008.

I must admit that the last month has been a miserable time for people like me who support economic liberty. The politicians in Washington approved a massively expensive $700‐​billion bailout. The Treasury Department, after first proposing a goofy plan to buy bad assets for either too much (to line the pockets of financial institutions) or too little (to supposedly make a profit for taxpayers), has now decided to coerce banks into accepting partial government ownership. Combined with a similarly inept $300‐​billion housing bailout earlier this year, politicians are displaying their typical ability to make a bad situation even worse.

But the ultimate insult to injury is that the financial crisis is largely a result of other government mistakes. As I explained in a column on Tuesday, the current turmoil is the result of the housing bubble, and the housing bubble can be traced to three misguided policies.

  • Easy money from the Federal Reserve: Egged on by politicians who think artificially low interest rates somehow are good for growth, the Federal Reserve flooded the economy with excess liquidity earlier this decade. That extra money had to go someplace, either by bidding up consumer prices or bidding up asset prices. For reasons I’ll explain soon, the funds got channeled into the housing market.
  • A corrupt system of subsidies from Fannie Mae and Freddie Mac: As I explained in my Thursday counterpoint, these two infamous government‐​sponsored enterprises used their favored status to dramatically expand the size and scope of their activities, making the bubble even bigger and increasing systemic risk.
  • Government‐​mandated lending to borrowers with bad credit: A number of policies, ranging from the Community Reinvestment Act to so‐​called affordable‐​housing quotas imposed on Fannie and Freddie, either extorted or lured lenders into giving mortgages to people who were ill‐​prepared for the responsibilities of homeownership.

The only piece of good news in the “perfect storm” of bad policy is that policymakers now have a road map to avoid disastrous housing bubbles in the future. If politicians want a stronger economy (or, to be more accurate, if they want a stronger economy more than they want to curry favor with special‐​interest groups), they should get rid of the policies that caused today’s mess.

That means abolishing Fannie and Freddie, which hopefully should be easy now that they’ve gone bankrupt and have stopped giving campaign contributions. It also means repealing the Community Reinvestment Act and other “affordable‐​housing” mandates. Luring people into homes they cannot afford is bad for banks and bad for poor people.

But why stop there? To protect taxpayers as well as the economy, the entire Department of Housing and Urban Development should be shut down. And, just to be on the safe side, the building should be razed and the ground covered with a foot of salt to prevent it from springing back to life and haunting future taxpayers. As I explained in a Monday post, housing is not a legitimate role for the federal government.

Fixing monetary policy is a more challenging task, particularly since a stable, zero‐​inflation policy requires the Federal Reserve to accurately gauge both the supply of money and the demand for money. But one no‐​brainer step would be to repeal the Humphrey‐​Hawkins Act, which saddles the Fed with an impossible dual mandate of price stability and macroeconomic fine‐​tuning. Europeans generally are not role models for economic policy, but we could learn at least one lesson from them, because the European Central Bank is responsible for price stability and nothing else.

The key goal, in all cases, is to reduce the amount of damage that government imposes on the economy. There is a reason the United States is more prosperous than France, and that is because the burden of government is smaller. But this is also a reason Hong Kong grows so much faster than America. It has a limited government, similar to what our founding fathers envisioned. Rather than become more like France, maybe it’s time for the United States to become more like Hong Kong.

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