Sunday, March 22, 2009

Sound advice on the economy

By definition, winners of the Sveriges Riksbank Prize have made a lasting contribution to our understanding of economics. Some (but not all) continue to increase public understanding of economics long after they have been recognized.

This weekend, the WSJ interviewed 1992 winner Gary Becker, who is known for his understanding of labor markets. The title of the piece: “Now Is No Time to Give Up on Markets.”

He firmly rejects the popular (and populist) “wisdom” that the meltdown was caused by not enough government:

Mr. Becker sees the finger prints of big government all over today's economic woes. When I ask him about the sources of the mania in housing prices, the first culprit he names is the Fed. Low interest rates, he says, were "partly, maybe mainly, due to the Fed's policy of keeping [its] interest rates very low during 2002-2004." A second reason rates were low was the "high savings rates primarily from Asia and also from the rest of the world."

"People debate the relative importance of the two and I don't think we know exactly," Mr. Becker admits. But what is clear is that "when you have low interest rates, any long-lived assets tend to go up in price because they are based upon returns accruing over many years. When interest rates are low you don't discount these returns very much and you get high asset prices."

On top of that, Mr. Becker says, there were government policies aimed at "extending the scope of homeownership in the United States to low-credit, low-income families." This was done through "the Community Reinvestment Act in the '70s and then Fannie Mae and Freddie Mac later on" and it put many unqualified borrowers into the mix.

The third effect, Mr. Becker says, was the "bubble mentality." By this "I mean that much of the additional lending and borrowing was based on expectations that prices would continue to rise at rates we now recognize, and should have recognized then, were unsustainable."
He also argues — as many of us have — that efforts (by both Bush and Obama) to prop up the housing market today are merely delaying the necessary correction to set prices to a realistic level. (Full disclosure: I am long California real estate.)

He has other valuable comments about taxes, “too big to fail” banks, stimulus and the accuracy of studies claiming a multiplier effect for government spending. I commend the entire piece to anyone who cares about turning around the economy for long-term growth.

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