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by Eric Englund
Without
bank credit expansion, supply and demand tend to be equilibrated
through the free price system, and no cumulative booms or
busts can then develop.
~
Murray Rothbard
In my
two decades as a surety bond underwriter, I have seen financial
fads come and go. One aspect of my job entails analyzing personal
financial statements, and I most certainly have seen scores
of them. Along the way, I have been able to discern distinct
patterns in the financial behavior of people. What is so striking
to me is the herd-like behavior of human beings – many of
whom seem to be easily swayed by the marketing blitzes of
Wall Street brokerage houses, banks, and other financial services
companies. As Ludwig von Mises stated in his magnum opus Human
Action:
Common
man does not speculate about the great problems. With regard
to them he relies upon other people’s authority, he behaves
as "every decent fellow must behave," he is like a sheep
in the herd. It is precisely this intellectual inertia that
characterizes a man as a common man. Yet the common man
does choose. He chooses to adopt traditional patterns or
patterns adopted by other people because he is convinced
that this procedure is best fitted to achieve his own welfare.
And he is ready to change his ideology and consequently
his mode of action whenever he becomes convinced that this
would better serve his own interests.
Unfortunately,
the common American does not understand he is being manipulated
and impoverished by the Federal Reserve. When money is no
longer real (i.e. fiat currency vs. gold and silver), then
people may come to believe in the surreal, and a hyperreality
emerges. In particular, during the reign of Alan Greenspan,
money and credit – created out of thin air – rained upon Americans
as if to assure us that crop failures and misfortune had been
banished from U.S. soil. Hence, we came to live in a world
of plenty where one may become wealthy by simply purchasing
a house – with lots of borrowed money – and by "investing"
in stocks for the long run. What a dream it is to become wealthy
without effort. This mass delusion is only one step away from
collectively believing that cotton candy is a cash crop. Alas,
Americans will soon discover that housing values don’t grow
to the sky and that heavy mortgage debt leads to a harvest
of financial despair. The Austrian theory of the trade cycle
will be validated yet again.
So here’s
a quick trip down memory lane. Early in my underwriting career,
cash and savings were king. Accordingly, this frame of mind
was reflected in personal financial statements. As
the 80s rolled on, Americans bought into the pop culture that
is Wall Street. Without fail, I saw people cash in CDs and
purchase mutual funds. Peter Lynch, indeed, popularized such
"investment" vehicles for long-term wealth creation.
Then John Bogle flaunted the low-expense-ratio S&P 500
Index Fund as the wisest way to build a substantial retirement
nest egg. And who can forget the dot.com and telecom crazes
of the late 90s? Americans envisioned themselves retiring
to Easy Street based upon owning shares of Amazon.com and
Global Crossing. Lastly, let’s not forget the Wall Street
darling known as Enron. This company’s common stock was going
to make each of its shareholders wealthy. So why aren’t Americans
taking early retirement, en masse, to lives of luxury? Where
is all the wealth promised by Wall Street?
To date,
I can’t say that I have seen a single individual become wealthy
by investing in the "products" promoted by Wall
Street. From the results I have witnessed, Wall Street preys
upon the economic illiteracy of Americans and does a most
efficient job of transferring wealth from the masses to the
bank accounts of the Wall Street – mostly Ivy League – elites.
Over the years, a familiar pattern has emerged: Wall Street
brokerage houses make their recommendations, the sheeple get
fleeced, and I bear witness to a clustering of human financial
error as reflected in the personal financial statements that
I survey daily. For the most part, such financial errors have
not been devastating, but were merely temporary misadventures
on the part of misguided individuals.
As a
quick aside, yes, I have seen some individuals become wealthy.
Yet such wealth emerged by way of starting up and maintaining
successful businesses. Such entrepreneurs, typically, maintain
strong personal liquidity and keep debt loads at reasonable
levels.
Nothing,
however, could have prepared me for the horrors I have witnessed
the past few years. Because of the housing bubble, as engineered
by the Federal Reserve, Americans are now drowning in mortgage
debt while naďvely believing that living in a house is the
path to wealth creation via long-term capital appreciation.
Thus I am just going to come out and say it: countless American
homeowners are already insolvent and simply don’t know it;
and many of them continue to make ends meet by borrowing against
credit cards and ever-shrinking home equity.
It is
commonplace for me to see married couples with mortgage-debt-to-income
ratios that are wildly askew. The hyperreality conjured by
the Federal Reserve’s relentless inflation of the money supply
is characterized by a populace which believes that a permanent
plateau of prosperity has been attained. This is the boom
phase of the trade cycle. A mindset, correspondingly, arises
in which people have absolutely no fear of debt. After all,
the Federal Reserve has the economy under control. Debt, in
fact, is embraced as a means to lever up one’s return on investment.
When
the bust phase of the trade cycle materializes – and followers
of Austrian economics know it will, eventually – then the
real horror show will unfold. Let’s face it: highly leveraged
Americans have little to no chance of ever paying back their
enormous mortgage debts. All it will take is for a husband
or a wife to lose a job, or for interest rates to go higher,
in order for mortgage debt to become unmanageable. In the
bust phase, mortgage defaults will become a deluge.
Earlier,
I mentioned that the Federal Reserve "engineered"
America’s housing bubble. To be sure, there are those who
deny a housing bubble exists. Hence, such deniers argue there
is no correlation between aggressive growth in M3 and the
spectacular rise in housing prices across the United States
– as if the Federal Reserve’s pounding down of interest rates
occurred in a vacuum. To this I respond with a quote from
page 1 of a September 2005 study sponsored by the Board
of Governors of the Federal Reserve System titled House
Prices and Monetary Policy: A Cross-Country Study.
Here is the smoking-gun quote: "Like other asset prices,
house prices are influenced by interest rates, and in some
countries, the housing market is a key channel of monetary
policy transmission."
With
the bursting of the NASDAQ bubble signaling that the U.S.
was heading into a recession – not to mention the shock of
9/11 – the Federal Reserve took desperate measures by goosing
the money supply and driving the Fed Funds rate down to 1%.
These monetary central planners knew that housing demand was
very much interest rate sensitive, and they were counting
upon the opiate of easy credit, at remarkably low interest
rates, to stimulate the "animal spirits" of Americans
in order to set the housing market ablaze. The Federal Reserve’s
central plan worked. Uncle Sam’s economy was rekindled as
trillions of dollars were loaned into existence via the housing
market – the Fed’s monetary transmission mechanism. Therefore,
America’s housing bubble did not emerge spontaneously in a
bona fide manner. Rather, it is a debt-laden financial monster
created by the mad doctors populating the Federal
Reserve.
As surely
as night follows day, a credit-induced boom is followed by
a bust. Moreover, only the Austrian theory of the trade cycle
provides the intellectual framework allowing one to understand
the boom-bust cycle. Before delving a bit further into this
theory, there are a couple of things to keep in mind. First
of all, as premeditated by the Federal Reserve, the housing
boom was credit-induced. Secondly, America’s savings rate
is near zero, so savings-induced growth cannot explain the
housing boom. What we will find, as elucidated by Roger Garrison,
is that central banking is at the epicenter of the boom-bust
cycle. Dr. Garrison provides the following explanation in
the Mises Institute’s remarkable book The
Austrian Theory of the Trade Cycle:
The
Austrian theory of the business cycle emerges straightforwardly
from a simple comparison of savings-induced growth, which
is sustainable, with a credit-induced boom, which is not.
An increase in saving by individuals and a credit expansion
orchestrated by the central bank set into motion market
processes whose initial allocational effects on the economy's
capital structure are similar. But the ultimate consequences
of the two processes stand in stark contrast: Saving gets
us genuine growth; credit expansion gets us boom and bust.
Assuredly,
the housing boom is destined to bust just as the NASDAQ bubble
did – anecdotal evidence
is already pointing toward this end. When the NASDAQ bubble
did burst, I saw the liquidity of many Americans diminish
significantly. Yet the housing bubble is vastly different
and the financial pattern is unmistakable. Trillions of dollars
of mortgage debt came into existence in a very compressed
timeframe – in less than five years. Consequently, over the
last three years, I have never seen so many dangerously-leveraged
personal financial statements in my entire underwriting career.
This
mortgage-debt bubble, as engendered by the Federal Reserve,
is leading millions of Americans to financial ruin. This may
become the most calamitous clustering of financial error in
U.S. history. If anything positive comes out of this economic
mess, perhaps it will be the demise of the Federal Reserve
itself. Regrettably, the Fed’s failure will have come at an
enormous price, including the possibility of volatile social
unrest.
A terrifying
thought it is.
April
22, 2006
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