A recent report from the Federal Reserve Bank of New York examines the role of speculators in driving the housing bubble. Setting aside the fact that almost everyone who bought a house was “speculating” to some degree, the researchers focus on those who were buying homes they did not intend to live in.

Some have already tried to paint this study as proving the government had little to do with the housing crisis. To their credit, the study’s authors do not go that far. Others, Mark Thoma for instance, show no such constraint:

“This is pretty far away from the (false) story that Republicans tell about the crisis being caused by the government forcing banks to make loans to unqualified borrowers.”

Of course, I’m sure that even Thoma knows that he’s set up a straw-man. Does anyone really believe that the Community Reinvestment Act and the Government Sponsored Enterprises housing goals were the only factors behind the crisis? Perhaps if the New York Fed really wanted to understand the crisis, it should look in the mirror.  It would seem reasonable to me that three years of a negative real federal funds rate might have had some impact on the housing market, particularly in encouraging speculators. After all, the Fed was basically paying people to take money.

None of this takes away from the role that Fannie and Freddie played in the housing market. For mortgages they purchased directly, Freddie’s investor share increased from three percent in 2003 to seven percent in 2007. And this ignores the massive volume of private label mortgage backed securities purchased by Fannie and Freddie. I think its reasonable to believe some of those were investor loans. In addition, the FBI has reported that the most frequent form of mortgage fraud has been borrowers stating the loan was for a primary residence when it was not.  But then it would be impolite of me to suggest we actually prosecute borrowers who committed fraud.

As I argued over two years ago, the relatively high percentage of foreclosures that are driven by pure speculators should make us question the many efforts to slow or stop the foreclosure process. If so many of these foreclosures are speculators, then why do we continue to protect them from losing the homes? They gambled, they lost. It’s time to move on and let the markets continue to adjust.

Now, one can continue to blame private sector actors for following the perverse incentives created by government. After all, the banks didn’t have to make the loans and the borrowers didn’t have to take the money. But it should be the primary objective of public policy to get the incentives correct. It should by now be crystal clear that all of the massive speculation in the housing market didn’t “just happen”—it was the result of massive government distortions in our housing and financial markets.

It Was those Bad Speculators That Drove the Housing Bubble…. is a post from Cato @ Liberty - Cato Institute Blog

The words “bipartisan” and “commission” usually send a chill down my spine. I felt such a chill when I learned that the Bipartisan Policy Center (BPC) had formed a Housing Commission to “address the long-term challenges facing a struggling housing sector.” My initial reaction was confirmed when I read that it would be chaired by former government officials and politicians of the establishment type:

• Christopher “Kit” Bond – former U.S. senator (R-MO)
• Henry Cisneros – Housing and Urban Development (HUD) secretary under President Bill Clinton
• Mel Martinez – former U.S. senator (R-FL) and HUD secretary under President George W. Bush
• George Mitchell – former Senate majority leader (D-ME) and BPC co-founder

The most disturbing name is Henry Cisneros. Policies implemented by Cisneros’s HUD helped lead to the housing bubble and bust (see this section on Cisneros from a Cato essay on HUD Scandals). What’s next, Dick Cheney on a hunting safety commission?

Christopher “Kit” Bond, former appropriator and proud porker, hangs himself with his statement on the BPC’s website:

Since serving as Missouri’s Governor, and then as a United States Senator, I have worked to be an advocate for improving public housing and advancing community development. Some of my proudest achievements are helping shape housing policy and programs in homelessness, rural housing, public housing, HOPE VI, and affordable housing. None of these successes would have been possible without strong partners on the other side of the aisle.

In fact, my fellow Commission Co-Chair, and former HUD Secretary, Henry Cisneros and I, were referred to in a 1996 Wall Street Journal article as the ‘Odd Couple’ of federal housing policy – a moniker I still wear as a badge of honor. Though it was a different time in our nation’s history, Henry and I were then – as we are now – committed to coming together to address long-ignored problems with immense implications.

The federal government’s abysmal record on housing (see these Cato essays here for more) is a poster child for government failure. But not only does Bond consider his support for these programs to be among his “proudest” achievements, he actually states that collaborating with Cisneros back in the 1990s is a “badge of honor.”

I’m not sure what Mel Martinez has going for him on housing policy other than that his relatively short tenure as HUD secretary under Bush wasn’t marred by scandal like his successor’s, Alphonso Jackson. At least Martinez acknowledges that the Bush administration continued the Clinton administration’s misplaced emphasis on expanding homeownership.

As for George Mitchell, his claim to federal housing policy fame is that he authored the creation of the Low-Income Housing Tax Credit. Here’s what a Cato essay on public housing has to say about the LIHTC:

Another response to the failure of traditional public housing has been the creation of the Low Income Housing Tax Credit in 1986, which currently subsidizes construction or rehabilitation of roughly 70,000 units of low-income housing each year. This is another failed attempt to manipulate markets, and it has a variety of negative effects. For one thing, the structure of the tax credit program encourages the location of projects in particularly low-income areas, thus exacerbating the concentration of poverty in cities, just as traditional public housing did. Also, the method of allocating tax credits to the states results in many subsidies going to areas of the country where few housing affordability problems exist.

Further, the projects built under the LIHTC program have income caps for tenants, which create the same disincentive effects for personal advancement that traditional welfare programs do. Finally, the program essentially functions as a subsidy program for developers. Economists Edward Glaeser and Joseph Gyourko argue that developers effectively pocket the $4 billion or so in annual federal tax credits, while the rents in buildings constructed under the program are generally no lower than they would have been in the absence of the program.

In a nutshell: an establishment commission is planning to “reform the nation’s housing policy by crafting a package of realistic and actionable policy recommendations” for the Beltway establishment’s consideration. Hold onto your wallets, taxpayers.

Uh-Oh: Bipartisan Housing Commission Announced is a post from Cato @ Liberty - Cato Institute Blog

The Washington Post is reporting that President Obama has assigned his staff with the task of designing a new set of government guarantees behind the U.S. mortgage market. Although as the Post also reports the “approach could even preserve Fannie Mae and Freddie Mac.” That’s correct. Despite their role in driving the housing bubble and the already $160 billion in taxpayer losses, President Obama appears to be considering just putting the same failed system in place. Of course, we’ll be promised that it will all work better this time.

Perhaps most offensive is that the Post reports that Obama “officials don’t want to punish the thousands of Fannie and Freddie employees who have specialized knowledge about the mortgage market.” Seriously? What about the many blameless employees of AIG, Lehman Brothers, or Bear Stearns? Or New Century for that matter. Did the janitors and receptionists at those firms really cause the crisis? The truth is that the employees of Fannie and Freddie have been lining their pockets at the expense of the taxpayer for years. What the Administration is really saying is that they wouldn’t want all the political operatives at these favored firms to lose their perks. After all, Obama officials will need somewhere to land after 2012 and Goldman Sachs has only so many slots.

What’s most depressing is that you can’t say Obama hasn’t been given the facts. As the Post makes clear, his economic advisers spelled out the case against massive subsidies for the mortgage market. Austan Goolsbee, chair of Obama’s Council of Economic Advisers, points out: by subsidizing mortgage investments, the government drives capital away from other types of investments. If Obama truly wants to help the middle and working class, then he’d want capital to flow into investments that increase labor productivity, which is the ultimate source of wage growth.  Running up asset prices, like houses, does not make us wealthier in the long run.

But then what should I expect. The President has already entered campaign mode. It would be nice to see the economics win over the politics. But it looks like such a thing will have to wait for another administration.

No Hope or Change When it Comes to Fannie Mae is a post from Cato @ Liberty - Cato Institute Blog

The House of Representatives is scheduled this week, as early as today, to consider an extension and “reform” of the National Flood Insurance Program (NFIP), administered by FEMA. Since Hurricane Katrina in 2005, the NFIP has been about $18 billion in the hole. And this is from a program that only collects around $2 billion a year in premiums, which barely covers losses and expenses in a normal year. So make no mistake, the NFIP is still on course to cost the taxpayer billions more in the future.

Even before Katrina, the Congressional Budget Office estimated that the NFIP was receiving a subsidy of close to a billion dollars a year. Under CBO’s optimistic projections, the House’s reform bill would increase NFIP revenues by about $4 billion over the next ten years, making only a small dent in the program’s current deficit.

The projected cost savings could potentially be lost by the expansion of the NFIP in the House bill. Yes, you read that correctly. Despite being deep in debt, the House is proposing to expand the coverage, and hence the risk, underwritten by the NFIP. For instance, the reform bill adds coverage for living expenses and “business interruption expenses,” as well as increasing the coverage limit from $350,000 (250k for structure and 100k for contents) to about $520,000 per home.

Such a massive expansion of coverage would likely drive out the existing providers of excess flood insurance coverage. And yes, you also read that correctly: there are a handful of insurers that offer private flood insurance. There is absolutely no reason that the private market could not offer flood insurance. Yes, rates might go up for the highest risk properties, but they would likely go down for others (and clearly reduce costs to the taxpayer). And given the high administrative costs of the NFIP (about 30 percent of premiums go directly to private insurance companies to help run it), it is likely that a completely private system of flood insurance would be cheaper.

In the aftermath of the housing bubble and its extreme costs to the taxpayer, we should eliminate the vast array of subsidies for housing construction, including the NFIP. If there’s one thing we should have learned, the underpricing of risk can have disastrous results.

Put Federal Flood Insurance Out of Its Misery is a post from Cato @ Liberty - Cato Institute Blog

In the 2006 and 2008 election cycles, Republican candidates for Congress tried to save their bacon by running against immigration. In 2010, according to the Wall Street Journal this morning, a number of Democrats are trying to save their seats by running against trade. I predict the Democratic tactic will be as fruitless as the Republican effort before it.

Democratic incumbents have been running TV ads accusing their Republican challengers of favoring trade agreements, outsourcing, and tax breaks for U.S. companies that invest abroad. The charges are wrong on substance, as I address at length in my 2009 Cato book Mad about Trade: Why Main Street America Should Embrace Globalization, but running against trade has not proven to be a vote getter, either.

It is difficult to find a presidential or congressional election anywhere that has turned on trade. While most voters have an opinion on trade, the issue tends to rank down the list of top concerns, far behind the economy, jobs, and, in this election cycle, government spending and debt.

Demonizing trade is an especially odd campaign tactic in 2010. The recession of 2008-09 was not caused by trade, but by the bursting of the housing bubble. As the economy slowly recovers, trade has been one of the bright spots, with a healthy increase in exports fueling a revival of the closely watched manufacturing sector, as my Cato colleague Dan Ikenson blogged a few days ago.

Democrats running against trade should remember that the “Clinton economy” of the 1990s that they often speak nostalgically of restoring was built in significant part on the passage of major trade agreements and a robust expansion of trade.

Democrats Turn on Trade in Desperation is a post from Cato @ Liberty - Cato Institute Blog

A couple of weeks ago, David Boaz discussed the Old Testament story in which the people of Israel ask Samuel for a king to rule over them. God’s instructions to Samuel can be summed up as “tell them to be careful of what you wish for.” David brought up the passage in the context of civil liberties, but the story’s lesson also applies to economic liberties.

Over the past eighty years, the public has become conditioned in times of crisis to turn to their rulers and demand that they “do something.” That the rulers had a hand in the crisis is all too often either unrecognized or it’s a secondary concern. As Robert Higgs demonstrated in his seminal book, Crisis and Leviathan, the rulers will willingly oblige the public and, in the process, come away with more power and control than they had prior to the crisis. Unfortunately, the rulers’ enhanced authority begets more crises in the future.

The latest chapter in this story is the economic downturn. Many of the “seeds” for the recession were planted by government. Regardless, the average citizen reflexively looked toward Washington to quickly fix the economy. The public’s limited patience meshes well with policymakers who are naturally inclined to operate on a short-term horizon (i.e., the next election). Therefore, policymakers responded with quick-fix measures with almost no regard to the long-term consequences.

The long-term economic problems caused by massive deficit spending and mounting debt are the most obvious. But as two stories in the news show, short-term measures implemented by policymakers to “fix” the economy have also introduced unwelcome economic distortions.

First, following the expiration of the federal homebuyer tax credit, home sales have fallen off the cliff. The Christian Science Monitor asks: was the homebuyer tax credit the “scam of the century?” The program was riddled with fraud, some folks who were induced to purchase a house are already underwater or are headed in that direction, and the billions of dollars spent on the program did zilch for the long-term health of the housing market.

When one looks at ultimate beneficiaries of the tax credit, it’s easy to see why the CSM calls it a “scam:”

[I]n trying to fully understand why the government undertook such a useless and poorly calculated program, it’s important to recognize those who truly walk away from this policy in better standing.

Realtors, home builders and mortgage bankers… some of the most notable culprits of the housing bubble years… all walk away cleanly skimming the proceeds coming from the transactions of an estimated 2 million temporarily stimulated home purchases.

It should come as no surprise that these were the very same industry groups that worked tirelessly lobbying to enact this failed policy… it was a simple exchange… your tax dollars to their wallets.

Second, we go from “scam of the century” to the “the dumbest program ever.” The latter refers to the “Cash for Clunkers” program, which Chris Edwards submitted for nomination in August 2009. Chris cited numerous problems with the program, including that “Low-income families, who tend to buy used cars, were harmed because the clunkers program will push up used car prices.”

A senior editor at Edmunds.com tells a reporter from WIOD news radio in Miami that used-car prices are way up (h/t Radley Balko):

If buying a used car is among your cost-cutting measures… be prepared to pay up to 30-percent more than you did last year.

It is a simple case of supply and demand.

Trouble is … there are fewer used cars.

The cash-for-clunkers program took a bunch off the market.

Plus, Edmunds Senior Editor Bill Visnick says 5-million fewer new cars were sold last year…which pares down the used car supply even more.

As Radley sarcastically notes, you can’t blame those supposedly selfish limited government types for this one:

[W]e have a government program whose stated aim was to shore up huge, failed corporations by giving public money to mostly upper-income people that in the end will penalize low and middle-income people. But remember folks, it’s the libertarians—who opposed C4C—who are greedy corporatists who hate the poor.

There could be a silver lining in the cloud if more Americans start to realize that asking policymakers to quickly fix problems that government policies helped foster isn’t much different than asking the arsonist to put out the fire.

Government’s Unwelcome Economic Distortions is a post from Cato @ Liberty - Cato Institute Blog

In a recent speech to real estate interests, former Clinton HUD secretary Henry Cisneros preposterously claimed that the recent housing meltdown “occurred not out of a governmental push, but out of a hijacking of the homeownership process by some unscrupulous interests.”

The only criticisms Cisneros could muster for the government’s housing policies over the past 20 years were that regulations weren’t tough enough and it should have focused more on rental subsidies.

The reality is that Cisneros-era HUD regulations and policies directly contributed to the housing bubble and subsequent burst as a Cato essay on HUD scandals illustrates:

• Cisneros’s HUD pursued legal action against mortgage lenders who supposedly declined higher percentages of loans for minorities than whites. As a result of such political pressure, lenders begin lowering their lending standards.

• On Cisneros’s watch, the Community Reinvestment Act was used to pressure lenders into making more loans to moderate-income borrowers by allowing regulators to deny merger approvals for banks with low CRA ratings. The result was that banks began issuing more loans to otherwise uncreditworthy borrowers, while purchasing more CRA mortgage-backed securities. More importantly, these lax standards quickly spread to prime and subprime mortgage markets.

• The Clinton administration’s National Homeownership Strategy, prepared under Cisneros’s direction, advocated “financing strategies, fueled by creativity and resources of the public and private sectors, to help homebuyers that lack cash to buy a home or income to make the payments.” In other words, his policies encouraged the behavior that he now calls “unscrupulous.”

• Cisneros’s HUD also put Fannie Mae and Freddie Mac under constant pressure to facilitate more lending to “underserved” markets. It was under Cisneros’s direction that HUD agreed to allow Fannie and Freddie credit toward its “affordable housing” targets by buying subprime mortgages. Fannie and Freddie are now under government conservatorship and will cost taxpayers hundreds of billions of dollars.

Cisneros now serves as the executive chairman of an institutional investment company focused on urban real estate. Might that explain why Cisneros is now a fan of subsidizing rental housing?

“Unscrupulous” would be a good word to describe the millions of dollars Cisneros has made in the real estate industry following his exit from government.

From the Cato essay:

In 2001, Cisneros joined the board of Fannie Mae’s biggest client: the now notorious Countrywide Financial, the company that was center stage in the subprime lending scandals of recent years. When the housing bubble was inflating, Countrywide and KB took full advantage of the liberalized lending standards fueled by Cisneros’s HUD. In addition to the money he received as a KB director, Cisneros’s company, in which he held a 65 percent stake, received $1.24 million in consulting fees from KB in 2002.

When Cisneros stepped down from Countrywide’s board in 2007, he called it a “well-managed company” and said that he had “enormous confidence” in its leadership. Clearly, those statements were baloney—Cisneros was trying to escape before the crash. Just days before his resignation, Countrywide announced a $1.2 billion loss, and reported that a third of its borrowers were late on mortgage payments. According to SEC records, Cisneros’s position at Countrywide had earned him a $360,000 salary in 2006 and $5 million in stock sales since 2001.

Cisneros Rewriting HUD History is a post from Cato @ Liberty - Cato Institute Blog

Today begins the televised political theatre that Barney Frank has been waiting months for:  the first public meeting of the House and Senate conferees on the two financial regulation bills.  While there are a handful of important differences between the House and Senate bills, these differences are overshadowed by what the bills have in common.  The most important, and tragic, commonality is that both bills ignore the real causes of the financial crisis and focus on convenient political targets.

As our financial system was brought to its knees by an exploding housing bubble, fueled by government mandates and distortions, one would think, just maybe, that Congress would roll back these distortions.  Despite their role in contributing to the crisis and the size of their bailout, however, neither bill barely mentions Fannie Mae and Freddie Mac.   Except, of course, to continue their favored and privileged status, such as their exemption from a proposed new “consumer protection” agency.  What we really need is a new “taxpayer protection” agency.

Nor will either bill change the government’s meddling in what is probably the most important price in the economy:  the interest rate.  Given the overwhelming evidence that loose monetary policy was a direct cause of the housing bubble, one might expect Congress to spend time and effort preventing the Fed from creating another bubble.  Not only does Congress ignore the issue, the Senate won’t even allow GAO to look at the Fed’s conduct of monetary policy.

Instead of spending the next few weeks gazing into the camera, Congress should stop and gaze into the mirror.  This was a crisis conceived and born in Washington DC.  The Rayburn building serving as the proverbial back-seat of the housing bubble.

Congress Begins Conference on Financial Regulation is a post from Cato @ Liberty - Cato Institute Blog

Several commentators have reacted to Senator McConnell’s floor statement regarding the Dodd bill as a defense of “doing nothing”.  And accordingly argue that such a position would be, in the words of Simon Johnson, both dangerous and irresponsible.  This familiar canard is based upon the oft repeated assertion that the failure of Lehman proved that we cannot simply let large financial companies enter bankruptcy.

The simple, but important, fact is that we have no idea what would have happened had we let AIG and Bear go into bankruptcy proceedings.  Nor do we know what would have happened if Lehman had been saved.  Macroeconomics does not have the luxury of running natural experiments to determine the impact of a corporate failure.   Scholars have an obligation to accurately reflect the uncertainties in the debate.  Those that assert Lehman proved anything, are being at best disingenuous, and at worst, dishonest.

Let us, however, put forth a few things we do know:

1. We know none of Lehman’s counterparties failed as a result of Lehman’s failures.  Just as we know none of AIG”s counterparties would have failed if they did not get 100 cents on the dollar from their CDS positions.  So where exactly is the proof of contagion?
2. We know we had a nasty housing bubble.  We were going to lose millions of jobs in construction and real estate regardless of what we did.  We knew financial institutions heavily invested in housing would suffer.  How exactly would saving Lehman have prevented any of that?

The debate over ending bailouts and too-big-to-fail will not progress, we will not learn a thing, if we let simple, empty assertion pass as fact.  Much of the public remains angry at Washington because those responsible, such as Bernanke and Geithner, have never laid out a believable or plausible narrative for the bailouts.  It always comes back to “panic.”  If we are ever to hope to return to being a country governed by the rule of law, rather than the whims of men, then we need a lot more of an explanation than “panic.”

Lehman’s Failure Taught Us Nothing is a post from Cato @ Liberty - Cato Institute Blog

• Cato experts will live-blog Obama’s State of the Union Address tonight. Join in, submit questions, and watch the speech right here on Cato@Liberty at 9:00 PM EST.

• A quick, ten-point libertarian State of the Union Address.

• One “Great Canard”: Federal Reserve Chairman Ben Bernanke argues that the Fed’s monetary policy was not responsible for the U.S. housing bubble.

• About that non-discretionary spending…

• Podcast: “Obama’s Fiscal Right Fake” featuring Chris Edwards.

Wednesday Links is a post from Cato @ Liberty - Cato Institute Blog

The Federal Housing Administration will reportedly announce more stringent lending requirements and higher borrowing fees. The move comes in response to growing concerns that rising losses on mortgages it insures will require a taxpayer bailout. Although any credit tightening is welcome, the agency will not propose an increase in the minimum downpayment, currently 3.5 percent. (Borrowers with credit scores below 580 will be required to put down a minimum of 10 percent, but most FHA lenders already require a 620 minimum score.)

Yesterday, the Wall Street Journal noted that “home builders are worried” the FHA would propose raising the minimum downpayment. The CEO of a Texas builder said it would be a “game changer,” meaning that it would hinder the nascent housing recovery. However, other industry observers believe otherwise:

In markets where home values are still falling, buyers who put little money down could see their equity wiped out quickly. The FHA is “just manufacturing more upside-down homeowners by the truckload in Arizona, California, and Nevada,” says Brett Barry, a Phoenix real-estate agent who specializes in selling foreclosed homes.

FHA commissioner David Stevens counters that inhibiting lending by increasing downpayment requirements would “perpetuate” price declines. But falling prices are a painful, but necessary, correction needed to bring the housing market back into equilibrium. Government interventions in the wake of the housing bubble’s burst have created an artificial cushion. Thus, any alleged housing recovery could prove illusory when the cushion is removed. In addition, the longer the government tries to prop up the housing market, the greater the economic distortions and risk to taxpayers.

The article cites the example of a 42-year-old air-conditioning repairman who just bought a house with the FHA minimum 3.5 percent downpayment. To meet the requirement he had to borrow part of the money from his father-in-law, which he then repaid with the $8,000 first time homebuyer tax credit. He now has a $1,466 monthly mortgage payment on a $50,000 salary. Factoring in utilities and other homeownership costs, it’s not inconceivable that half of his pre-tax salary will be devoted to just his home. Is it any wonder the FHA is experiencing large default rates?

FHA’s New Stringent Standards is a post from Cato @ Liberty - Cato Institute Blog

David Leonhardt’s column today in the New York Times, in reaction to Ben Bernanke’s recent speech at the American Economic Association meetings, asks an important question:

If the Federal Reserve failed to detect the housing bubble when it occurred, why should we entrust it with that role in the future?

But he doesn’t follow the logic of his question far enough and instead embraces a financial equivalent of the National Transportation Safety Board, as if technical solutions exist and could be implemented if politics got out of the way.

In our recent Policy Analysis, Jagadeesh Gokhale and I examine a more complete list of technical and political problems that stand in the way of asset bubble management. Can bubbles be detected using scientific techniques (econometric models) with little controversy? We argue no.

Would stopping bubbles involve the simple implementation of a technical solution such as raising interest rates, or would they instead involve trade-offs with other policy goals? We argue the latter.

Even if bubbles could be detected easily with no controversy and policy solutions involved no tradeoffs, could the Fed maintain political support by stopping booms if the benefits of such a policy (preventing busts after financial bubbles burst) were never observed? We argue no.

And finally, even if all the previous problems were solved, how would raising interest rates reduce the supply of capital to housing markets given that a rate increase would increase the supply of capital to the United States and interest rates for both long-term and short-term housing loans have become decoupled from federal funds rates?

Our reasoning, like Bernanke’s, suggests that the events of 2008 were not the result of “bad” monetary policy. However, we believe that granting additional regulatory authority to the Fed will not prevent similar episodes because of the technical and political difficulties we describe in our paper.

Popping Bubbles is a post from Cato @ Liberty - Cato Institute Blog

For American workers and families trying to get ahead, the decade just behind us was a stinker. As a front-page Washington Post story over the long weekend summarized:

For most of the past 70 years, the U.S. economy has grown at a steady clip, generating perpetually higher incomes and wealth for American households. But since 2000, the story is starkly different. …

According to the story, the Aughts (2000-09) were the first decade since World War Two with no net job creation, and the first in which median household income was actually lower at the end than at the beginning.

It won’t be long before critics of trade will try to blame the poor economic performance on trade agreements and globalization. This has been a standard line of attack, and I address it at length in my new Cato book, Mad about Trade: Why Main Street America Should Embrace Globalization. For now, just a few quick-hit observations:

The two recessions that book-ended the past decade were both “Made in the USA.” The first was triggered by the popping of the dot-com bubble, the second by the bursting of the housing bubble. Trade was not the cause of either recession. In fact, trade and globalization were charging ahead full steam in the 1990s, when everybody agreed the economy was doing well.

There is also the temptation to extrapolate short and medium trends into a long-term decline in living standards. As the Post reporter Neil Irwin rightly noted,

The miserable economic track record is, in part, a quirk of timing. The 1990s ended near the top of a stock market and investment bubble. Three months after champagne corks popped to celebrate the dawn of the year 2000, the market turned south, a recession soon following. The decade finished near the trough of a severe recession.

The U.S. economy has endured equally long stretches of poor performance in the past. For example, the Dow Jones Industrial Average was actually lower in 1982 as it was in 1966—16 years stuck in neutral. Real median household income was lower in 1983 than it was in 1969—14 years of no net gains. Yet the economy recovered and scaled new heights.

During difficult economic times, trade helps us weather the storm by offering lower prices and more choice to consumers struggling to make ends meet. When domestic demand sags, U.S. companies can find customers and profits in more robust markets abroad. Foreign investment in the United States helps to keep interest rates down, keeping more Americans in their homes and keeping credit markets open.

Our policy makers will only make our economy worse if they reach for the snake oil of higher trade barriers.

Trade Not to Blame for a ‘Lost Decade’ is a post from Cato @ Liberty - Cato Institute Blog

• Helping out the “Wall Street fat cats:” Bankers are responding to the incentives generated by the economic policies of the Treasury and the Federal Reserve.

• How charter schools can save states big education dollars.

• Doug Bandow:  “Congress has spent the country blind, inflated a disastrous housing bubble, subsidized every special interest with a letterhead and lobbyist, and created a wasteful, incompetent bureaucracy that fills Washington. But now, legislators want to take a break from all their good work and save college football.”

• In case you missed it last week, watch Cato’s Jerry Taylor on the premier episode of Stossel.

• Podcast: “Urban Planners Romanticize Immobility“

Thursday Links is a post from Cato @ Liberty - Cato Institute Blog

• A few questions for Ben Bernanke: “Perhaps the most important question Bernanke should answer is: how will he re-build and maintain an independent Fed?”

• Before considering Bernanke’s role in containing the financial crisis, Congress should investigate the role of Fed policy in allowing the housing bubble to grow.

• Prepare to pay more: Today, an average insurance policy can cost about $2,985 for an individual or $6,328 for a family.  Under the Senate bill, those premiums will increase to $5,800 for an individual worker and $15,200 for a family plan by 2016.

• Why the White House “jobs summit” is unnecessary.

• Made on Earth: How global economic integration renders trade policy obsolete.

• Podcast: “ObamaCare the Budget Buster.” More, here.

Thursday Links is a post from Cato @ Liberty - Cato Institute Blog

• A glimmer of hope for libertarian public policy in the age of Obama: The War on Drugs may be slowly winding down. “The prospects for reform are better than they’ve been in decades.”

• An overview of religious liberty around the world. Doug Bandow: “Martyrdom did not disappear with imperial Rome.”

• All eyes on India: Party crashers aside, Indian Prime Minister Manmohan Singh’s visit to the U.S. was an important event.

• Patrick J. Michaels on “ClimateGate.” More, here.

• The insanity of housing subsidies: “If you’re thinking to yourself that this is the sort of government-induced behavior that helped create the housing bubble, go to the head of the class.”

• Podcast: “Judicial Takings at SCOTUS“

Tuesday Links is a post from Cato @ Liberty - Cato Institute Blog

Many commentators have argued that if the Federal Reserve had followed a stricter monetary policy earlier this decade when the housing bubble was forming, and if Congress had not deregulated banking but had imposed tighter financial standards, the housing boom and bust—and the subsequent financial crisis and recession—would have been averted.

In a new study, Cato scholars Jagadeesh Gokhale and Peter Van Doren investigate those claims and dispute them.

New Paper: Would a Stricter Fed Policy and Financial Regulation Have Averted the Financial Crisis? is a post from Cato @ Liberty - Cato Institute Blog

• Bush-era surveillance powers are set to expire at the end of this year. Julian Sanchez explores the efforts to revise the PATRIOT Act.

• More on the medical professionals who aided in acts of torture.

• Doug Bandow: Ireland is holding a second referendum on the Lisbon Treaty on Friday. If the Irish say yes, the European Union will be stronger. But will anyone notice?

• How urban planners caused the housing bubble.

• The aftermath of  “Cash for Clunkers” hits automakers. Looks like it just might have been the “dumbest program ever” after all.

• Podcast: “Three Felonies a Day“

Weekend Links is a post from Cato @ Liberty - Cato Institute Blog

This past week witnessed continued debate in congressional committees over changes to our financial regulatory system.  Perhaps catching the most attention was Fed Chairman Ben Bernanke’s appearance before House Financial Services. 

Sadly missing from all the noise this week was any discussion over reforming those entities at the center of the housing bubble and mortgage meltdown:  Fannie Mae and Freddie Mac.

While many, including Bernanke, have identified the “global savings glut” as a prime force behind the historically low interest rates that drove the housing bubble, often missed in this analysis is the critical role played by Fannie and Freddie as channels of that savings glut.  After all, the Chinese Central Bank was not plowing its reserves into Countrywide stock; it was putting hundreds of billions of its dollar reserves into Fannie and Freddie debt.  Fannie and Freddie were the vehicle that carried excess world savings into the United States.

Had this massive flow of global capital been invested in productive activities, or even just prime mortgages, it is unlikely tha we would have seen such a large housing bubble.  Instead, what did Fannie and Freddie do with its Chinese funds?  It invested those funds in the subprime mortgage market.  At the height of the bubble, Fannie and Freddie purchased over 40 percent of private-label subprime mortgage-backed securities.  Fannie and Freddie also used those funds to lower the underwriting standards of the “prime” whole mortgages it purchased, turning much of the Alt-A and subprime market into what looked to the world like prime mortgages.

Given the massive leverage (at one point Freddie was leveraged 200 to 1) and shoddy credit quality of mortgages on their books, why were the Chinese and other investors so willing to trust their money to Fannie and Freddie?  Because they were continually told by U.S. officials that their losses would be covered.  At the end of the day, Fannie and Freddie were not bailed out in order to save our housing market; they were bailed out in order to protect the Chinese Central Bank from taking any losses on its Fannie/Freddie investments.  Adding insult to injury is the fact that the Chinese accumulated these large dollar holdings in order to suppress the value of their currency, enabling Chinese products to be more competitive with American-made products.

While foreign investors have been willing to put considerable money into Wall Street, without the implied guarantees of Fannie and Freddie, trillions of dollars of global capital flows would not have been funneled into the U.S. subprime mortgage market.  As Washington seems intent on continuing to mortgage America’s future to the Chinese, that at minimum it seems that fixing Fannie and Freddie might help insure that something more productive is done with that borrowing.

Fixing Fannie Is Essential is a post from Cato @ Liberty - Cato Institute Blog

The core of Keynesian economic policy is that the government must come in and replace reductions in private sector demand with public sector demand, therefore bringing overall demand back to its previous level.  One of the many flaws in this thinking is in assuming that the previous level of demand was “correct” and getting us back to that level is the appropriate policy response.

Take the example of the housing market and the government response.  The primary response of Republicans in Washington has been to offer tax credits and other incentives to replace the drop in demand for housing.  Witness Senator Johnny Isakson’s  recent comments on why we need to extend the $8,000 homebuyer tax credit: “If you take that kind of business out of what’s already a very weak housing market, you do nothing but protract and extend the recession.”

This analysis could not be more wrong.  The tax credit largely acts to keep housing prices from falling further.  However, that is how markets are supposed to clear in an environment of excess supply.  If there’s too much housing, the way to address that is to allow housing prices to fall, which attracts buyers back into the market.

We should also recognize that the tax credit does not help the buyer, it helps the seller, by allowing the seller to charge that much more for the price of the home.

Perhaps the worst impact of the policy is that it encourages the continued building of homes, only adding to the over-supply, which itself will “protract and extend the recession.”  Witness the recent news that housing starts in the US just hit a nine month high.  While these levels are still low in historic terms, and housing inventories are declining, we still have an excess of housing.  The damage done by creating a false floor to housing prices is that builders don’t respond to inventory, they respond to prices, and as long as there is a positive gap between prices and construction costs, builders will build.  The tax credit only serves to widen that gap between prices and construction costs.

Back to Keynes: the central flaw in the thinking behind the tax credit proposal is its assumption that we need to re-inflate the housing bubble.  The previous level of housing demand, from say 2003 to 2006, was not driven by fundamentals; we had a bubble.  There will be a correction in the housing market.  Our choices are to either take that correction quickly and move on, or to prolong that correction, maybe even make it worse, by trying to create a false floor to the market.

Republicans Just as Guilty of Flawed Keynesian Thinking is a post from Cato @ Liberty - Cato Institute Blog