Zach McDade recently posted explaining the housing bubble and how it has helped shred the broader financial system. I wanted to note two trigger factors obscured by his general statement: “the market decided that we had built too many houses.” Here they are:
1. Suburban housing values fell, causing people to default on mortgages, precisely because demand for new subdivisions slackened. This happened at exactly the same time as energy prices spiked (both home energy use and transportation are higher in the suburbs), and America saw its first net flow of people from the suburbs to the cities since the 1950s. Decoded: the energy crisis => the change in suburban-urban land use value => the housing crisis
2. Low-income urbanites started defaulting on mortgages or rent payments as the cost of fuel, energy, and food rose. Food prices rose due to A. rising energy prices increasing input costs and B. crop failure due to adverse weather in several food-producing areas (US Midwest, East Africa, India, Australia) globally reducing supply. Decoded: the food crisis (itself caused by the energy and climate crises) + the energy crisis itself => rising cost of living for poor => the housing crisis.
So what does this have anything to do with me, the career I’ll be trying to start when I graduate in 10 months, or the stimulus package?
Mr. McDade did an excellent job in detailing with what went wrong and caused this current economic crisis, and we should focus immediately on focusing the current crisis. The best route would be to detoxify the banks and to buy up their assets – the primary goal of fixing up the economy should be to fix the credit system, which is currently rather dysfunctional due to the various poorly-made loans.
However, we are having a lack of focus on solving the economic crisis from across the aisle, for both Republicans and Democrats. Much of this is due to rampant populism that has once again reared its ugly head and prevented Congress from taking the necessary steps to fix the economy, as many Americans seem more interested in punishing the various banks and their executives than in taking the necessary steps to actually fix the economy, as shown through the current AIG Bonus controversy, where various Congressmen and the American people bemoaned the idea of paying the dues of a company that has been virtually nationalized. Furthermore, we are seeing hints of protectionism appearing once again, best demonstrated with the current spending bill which contains a provision that terminates a project allowing 97 Mexican trucks on American highways as specified under NAFTA. While it may feel good to attack the “greedy” banks and their “corrupt” executives, it is not a productive path, and will unfortunately lead to disaster as the economy continues to muddle along in its current stupor.
This post is for those who still feel they couldn’t quite answer the question, “What went wrong with our economy?” It looks at one aspect of the problem, subprime lending.
The economy essentially has two levels – the real and the nominal. The real level is the production of real (actual) goods and services. The nominal level is the one that concerns money – its creation, use and exchange. (To help connect nominal with money, remember that money comes in denominations.)
The real level and the nominal level interact, of course, whenever you use money to buy a real good or service. So, to sum, the two different levels of the economy are distinct, but connected. (In other words, the economy could operate with only the real level; we would just exchange goods and services for other goods and services – a barter economy.)
So, what went wrong? To answer that, remember that there is one primary way to make money on the nominal level – that is, to make money with money: Lending. If you have money that someone else wants, you lend it to her for a fee. Say you want to buy a home. You go to the bank, take out a loan, agree to pay it back, plus interest, and this exchange is entirely on the nominal level.