It is great to be invited back here on campus, back to the AU Libertarians, it's an organization
that's been around a long time now and very active and one of the coolest student organizations
on campus.
And I want to salute you all for a lot of the great work that you've been doing the
last year or so.
My topic tonight is the housing, whoo, it was the housing bubble, yeah, the housing
And what's going on in the housing market and why are they tearing down all of Auburn
to build game day condominiums for people who are only coming to campus like six days
a year?
It's kind of very strange.
Auburn, I've been here for 24 years and Auburn sort of has changed a little bit over time
But it's changed a lot in the last few years, and a lot of the landmark institutions of
Auburn are no longer with us, and in a few cases that's probably a good thing, but we've
gone through this period of rapid change, and it's not just here in Auburn, it's all
across the country.
All across the country there's basically been a housing bubble.
It's different as you go from city to city, from county to county, from state to state
in terms of what the manifestations of that bubble is, but it's all over the country.
I just read a story today about a brain surgeon in Miami, Florida.
This brain surgeon paid $3.6 million for an option to buy 100 acres of land that he was
going to build houses on.
So that means he's paying $36,000 per acre just for the right to buy the property.
So he hadn't even bought it with $3.6 million.
And he decided not to exercise that option when it came due.
So he just basically, $3.6 million evaporates for him.
So it's happening all over the country.
In Auburn, across the country, California, Florida, New England.
The Theory of Money and Credit
to explain exactly why these things happen and what are the results and ultimately what are the consequences that result from these kind of bubbles.
So first of all, what is a bubble? Well, it's basically asset prices increasing by a very extensive degree.
There are three types of factors that are involved in any kind of bubble.
Before I get into those factors though, I want to say something about the nature and significance of this type of talk because it's a little unusual for this group.
Usually it's about politics, it's about the drug war, it's about the war in Iraq, it's all that kind of stuff.
economics is really not the forte of what goes on around here but I want to
tell you that the what causes the housing bubble is more important to us
than the war on drugs or the war on Iraq is as important as those things are to
our economy to our lives to our civil liberties and so on this is more
is more important than all of that combined. This is going to ultimately be about the standard
of liberty in this country. So it's something that libertarians should hear and as a matter
of fact it's the most important thing that libertarians should hear. So when we look
at the housing bubble, there's three basic factors that go into a bubble. There are real
Real factors, real economic factors, there are psychological factors, and then there
is the Federal Reserve.
Real factors with housing are things like, for example, tax breaks that you get on residential
housing.
You get to write it off on your taxes, there's now an exemption on capital gains that you
can get on houses, so that people are interested in investing in real estate because it has
has these tax advantages, and there are other real factors like population growth.
And then there are psychological factors that develop over time, the type of speculation
that goes on where people who are otherwise unconnected to the housing market start investing
in housing, that they already have their own house, but they're buying additional houses
for the simple reason of trying to resell them.
The term there is called flipping houses, where you buy them and then you resell them
at a higher price in a very short period of time.
It's very similar to the stock traders of the late 1990s, the day traders, who would
buy stocks in the morning and sell them at night and make a profit during the day, and
that's what they would live on.
And that's what these house flippers were living on until recently, where they would
to buy a house or a condominium and then resell it for a big profit.
And finally there's the Federal Reserve, the easy monetary policy, the easy credit policy
of the Federal Reserve in terms of generating the housing bubble itself.
They did the same thing for the tech stocks in the late 1990s that they've been doing
in recent years, funneling credit into the housing market.
I'm going to talk a little bit about that, but basically it involves reducing the interest rate on mortgages.
If you reduce the interest rate on mortgages, it reduces your payment and makes it easier to buy housing.
This increases the overall amount of credit that goes into the economy, so that there are more loans available through banks and other financial corporations than there otherwise would be.
It's easy to get a loan when the Federal Reserve is keeping the interest rate down and increasing the supply of money and credit.
And if there's more credit that's going into the economy artificially from the Fed, that means that lending standards at the banks have to decline.
They have to make it easier for people to qualify for a loan in order to give more loans away.
Giveaway. You've only got so many good customers and if you've got extra credit to give away then you have to take progressively people with worse credit ratings. The upshot of this is that the Federal Reserve policy creates bad investments. You give more money away to people with poor credit and ultimately you're going to find that bad investments are being made and we're finding that out in today's marketplace.
There's a website called foreclosure.com where you can go look at the houses that have been foreclosed or where they've gone into bankruptcy in a particular area.
When I first looked at that website, there were like 36 houses in Auburn that were either foreclosed or in bankruptcy.
And that was after Thanksgiving, so it was like early December when I checked that.
Today, when I checked it, there were 74. So the number has basically doubled in a month and a half.
So more people are unable to make their payments.
There are 400 houses in foreclosure or bankruptcy in Lee County.
And there are 18,000 houses under foreclosure or bankruptcy in the state of Alabama
and 1.4 million in the United States.
There's a lot of people who haven't been able to make their payments and they're going personal bankruptcy or the house is being foreclosed by the bank that made the loan.
So there are too many houses being built. The houses have tended to be very expensive, very large, the wrong type of housing, sometimes in the wrong location or even the type of construction that's been done on these houses.
There's a lot of bad investment, in part, in terms of the construction companies themselves.
They've bought a lot of equipment, they've bought a lot of land and things of that nature that they've invested in, and now they can't sell houses.
And they've stopped, in many cases, stopped building houses.
And in the recent quarter, the last three months, the major home builders in the country,
The top six or seven companies that build homes all over the United States wrote down one and a half billion dollars of losses on the land that they bought prospectively to build houses on.
So the Fed has created this easy monetary policy and interest rates were as low as 1% there for a while, 2004, 2005.
and now we're seeing many many more of these investments that were made in that
period of time turning out to be bad investments. We have some more federal
government intervention here as well in the form of Fannie Mae and Freddie Mac
and some of these other government sponsored corporations and they have the
They have a nice purpose of making it easier for people to get a home mortgage.
And so they're in the business of making more mortgage money available to banks.
And essentially what they do is they buy the loans from banks.
The banks have made their money.
They buy these loans, package them up and sell them to Wall Street
as a big $50 million chunks of home mortgages.
So that the people who buy these things are protected against things like foreclosure and bankruptcy.
The American taxpayer is not protected, but the buyers of these securities are.
So the number one point, and the most important point you want to take away from this,
is that it's really the government that's causing these economic bubbles to appear in our economy.
It's the Federal Reserve's easy money credit, easy credit policy, and it's the Fannie Mays and Freddie Macs that have reduced the credit quality of the loans that are being made out there and creating a big tax liability for taxpayers.
It's not the marketplace. You do see people in the market who are speculating, but it's not the marketplace itself.
In the absence of the Federal Reserve, in the absence of this easy credit policy and insured losses, the marketplace wouldn't get out of whack the way it has in the last couple of years with the housing market, the real estate market.
It wouldn't have gotten out of whack with the tech stock bubble of the late 1990s.
in the 90s, there's automatic corrective mechanisms in the marketplace and with all this easy
government credit coming into play, ultimately the money is going to be misused, abused and
creating bad investments.
You may not remember, but the Enron crisis with the Enron company was basically a case
where banks were giving Enron all of this money, lending them all this money without
not even checking into their credit. They were just giving it away and Enron was taking
it in and using it in many cases for some stupid things. So the results, the results
here are not pretty. First of all, it creates too much debt in the economy. The American
consumer right now has an all-time record personal debt to the tune of about, well it's
It's over $12 trillion of debt that the American public owes to banks and financing companies
for auto loans and all the rest.
They've taken on way too much debt.
The results are ultimately going to be a lot of bankruptcy, personal bankruptcy, business
bankruptcy and unemployment.
Right now we've only seen the tip of the iceberg, I suppose, in terms of unemployment in the
construction industry itself.
We're told in the business press day after day that it's not spreading, it's going to take care of itself.
By the next few months, this housing bubble will be all over.
I think it's all going to be all over too, but in a much more negative way.
Ultimately, this could bring on a recession.
And for those who don't know the cause and effect of all this,
it also brings a kind of psychological injury to people who have been forced into bankruptcy,
who have lost their homes, who have lost their jobs, because they see that the system is
not working.
Okay, the system, their society that they're living in, they haven't done anything wrong,
they were playing by the rules, they were going to work, they bought a home, and yet
they end up with bankruptcy, they end up losing their home, maybe their job, the system just
isn't fair.
And in a sense, it isn't.
There's this big game going on in Washington D.C. behind the scenes of manipulating money
and credit, and they don't really have any idea about any of that.
They just see the system is failing and what do they naturally call for?
What's the first thing they're going to call for?
More government intervention, exactly.
They're going to want help.
They're going to want bailouts.
They're going to want subsidies.
To give you a little magnitude of the problem, the amount of real estate loans in the U.S.
This economy hit $1 trillion in November of 1994.
In November of 2002, it hit $2 trillion, and in May of 2006, it hit $3 trillion.
Over that same time, total debt by consumers was $5 trillion in 1994, $7.5 trillion in
2002, and an amazing 12 plus trillion in May 2006. And this is all at a time when the
personal savings rate in the U.S., the amount of our paychecks that we don't spend and
that we leave in the bank is hit zero. And actually we've had a couple of months where
it's been negative. So the Americans are spending everything they have and then some. As a matter
As a matter of fact, a lot of Americans have used this easy credit to take money out of their house, so say for example they've been paying on a mortgage for 10 or 15 years and they've built up a lot of equity because they've been paying down the mortgage, well they just go to the bank and refinance, take out $100,000 and spend it on a boat, motorcycle, RV, game day condo, all of a sudden you've got $100,000 of cash
Payments Lower, seems like a great deal. So the debt has increased tremendously. The money
supply that's created by the Federal Reserve has also increased very rapidly in recent
years. If we go back to a time when we had a, when our monetary system was based loosely
on gold and silver from like the 1960s, when our monetary system was still on basically
The money supply increased at about 5% per year on average.
From 1971 to 1984, after we had gone off of the gold standard initially, the money supply
increased at an average of 8% per year.
And since 1984, when we sort of deregulated the money supply, the money supply has been
increasing at over 10% per year.
So we start out in 1959 with a money supply of 150 billion dollars.
Today the money supply exceeds 7 trillion dollars.
That doesn't make us any better off.
It's just pieces of paper and we just have a lot more of them now.
We might think of ourselves as a lot richer, but ultimately it's an illusion.
Prices have just gone up.
In 1959, you could buy a gallon of gas for like 12 cents a gallon.
To give you some idea about the magnitude of how many houses have been created,
the normal number of housing starts or housing construction in the U.S. is about 1 million houses per year.
Maybe 1 to 1.1 million houses per year is the number that we need in terms of population growth and income growth and that sort of thing.
For the last four years, housing starts and construction have been between 1.5 and 1.8 million houses.
So basically we have about three million extra houses out there.
Does anybody know anybody who owns more than one house? Yeah.
Well that's the type of thing that we've gotten into in the U.S. and there's nothing wrong with owning more than one house.
It's great, but it's become pervasive in our economy that people owning, you know, a house here, a gameday condominium there, a beach house, a house in the mountains and so on.
So there's been this big ballooning of the housing stock. In the last couple of months, housing construction has come back down to normal levels, about 1.1 million.
As I said, the Federal Reserve is basically all responsible for this in terms of reducing
the interest rate down to 1%.
That's the interest rate that it charges, banks charge to one another and basically
they can get money from the Federal Reserve at 1%.
You can't get 1%, I can't get 1%, but the big banks can get that low interest credit.
They've since raised those rates, of course, to about five percent.
I want to give you a little insight into exactly how they do this, and I'm not going to go
into the technical details.
When I teach money in banking, I spend the whole course on this, and they still don't
get it.
So, it's kind of confusing.
Let me just give it a try here, how the Federal Reserve creates credit.
Let's see what the Federal Reserve does, is it buys U.S. government bonds from banks.
You know, how does that increase the money supply?
Well, if the bank sells bonds and gets money in return, then it can make that money available for loans.
And this is how they keep interest rates low.
If they buy a bunch of government bonds, inject a bunch of money into the economy,
When that helps keep down interest rates.
Now how does the Fed buy these bonds?
This is where it gets interesting.
They open an account for the bank at the Federal Reserve.
And then they put a deposit in that account.
Say the Fed buys a million dollars from your bank.
It puts a million dollars in your account at the Fed.
Banks have to hold a certain amount of reserves by law.
So they use that money at the Fed as part of their reserves and they take their reserves at the bank and they lend them out.
Does that make sense?
The interesting thing about this is that the Fed doesn't actually put money into an account.
They just enter it on the computer.
So there's no actual money the Fed is actually giving these banks.
It's just an electronic entry.
So it would be like saying, okay, you give me all of your bonds and I'll make this little
account for you in my bank and we'll just pretend.
And that's what they do.
They pretend there's no money, the money is in effect is ejected from the banks into the
economy through an electronic bookkeeping at the Fed.
And it works real well for the Fed.
They've got hundreds of billions of dollars of government bonds and they earn the interest
on the Internet.
And then that's where they get their money to spend.
And so they have so much money, they don't know what to do with all of it.
They make like 60 billion dollars a year.
And they have elaborate offices, huge buildings, unbelievable security.
If you're ever, if we're ever in a nuclear war and you work at the Fed, you'll be okay.
Nuclear proof shelters, great paying jobs, just all sorts of resources.
resources. As a matter of fact, they don't come anywhere close to spending all of the money they take and they give some of it back to the government.
It's the only governmental agency that actually makes a profit. So that's the whole trick. It's just an electronic bookkeeping entry at the Fed.
The government bonds come off the table and artificial credit is injected into the economy and ultimately, if they do enough of it, they're going to cause bad investments
So what's going to happen with the housing bubble?
Well, the truth be known, we really don't know exactly what's going to happen.
One of the points about Austrian economics and the Mises Institute is that we can't actually accurately forecast the economy.
We can't predict with precision over and over and over again what's going to happen in the economy.
There are way too many variables, too many economic variables, too many political variables,
too many geopolitical things like war and terrorism to make accurate predictions.
So we can't tell for sure, but we can have some pretty good ideas.
Some people believe we are at the beginning of the end of the housing bubble.
They think that the worst is over and that after a few months all of the excess inventory
is going to be worked out and that housing will start to regenerate itself and that it's
not going to lead to a recession.
So there's some very optimistic people out there, but unfortunately these are the same
people who denied that there ever was a housing bubble starting in the first place.
So if we look at government economists, real estate industry economists, the Wall Street
Bulls, who were interested in selling you shares in these companies.
They all think that things are really turning around already.
It's just unfortunate they're the same ones who denied that there was ever a housing bubble
in the first place.
Alan Greenspan, who was the chairman of the Fed before he left office, he said there is
He is not, definitely, there's definitely not a housing bubble.
And he went to outline various reasons why there could not be a national housing bubble.
And then right before he left office, he said that there was apparently some frothiness in the real estate market.
Nice coffee analogy.
Then, when he got out of office, his first speech, which I think he made like $100,000,
he said that the housing bubble was over.
He said it was over, he'd been denying all along that it existed, and then all of a sudden
he gets out of office, first thing he does he says, well, you know, it's over with.
So these are all the same people who did not predict the housing bubble in the first place
in a place who denied its actual existence right through the whole bubble when it seemed
to a lot of people that there were tremendous excesses in the economy.
My brother moved out to Napa Valley, one of the most expensive real estate markets in
the country.
He bought a house for $250,000.
He described it as the worst house in Napa County.
It was 782 square feet of a house on a major highway.
Four years later, he sold it for a half a million dollars.
And there's stuff like that going on all across the country.
There are other people such as myself who think we are only at the end of the beginning.
We're not at the beginning of the end.
We're just at the end of the beginning of the housing bubble.
And this would include the Austrian economist, basically.
There were a few other people who predicted the housing bubble in advance, but basically
the people who predicted it in print from the same school of economic thought as myself.
I just noticed today, for example, that the homeowner vacancy rates in the U.S., this
This is single-family houses, condominiums and multi-family units.
Homeowner vacancy rates, these are houses that are owned by somebody who is not currently living there, hit an all-time high.
The statistics go back for decades and the homeowner vacancy rates for single-family houses were about 1%, on average.
So they might be 0.5, 0.6, 0.7, 0.11, 0.12, and the series goes for years and years and years and then all of a sudden the last couple of years straight up and it's more than doubled in the last year.
21 sub-prime lenders. These are companies that make loans to people who do not have good credit.
Subprime. So I would be, you know, a prime person to sell a mortgage to, you guys would be subprime.
Okay? 21 such companies have closed, ceased operations since December 1st. So none of them
closed for like the last six or seven years, and now 21 have closed in about 70 days. Another thing
The thing that has yet to really happen in this economy is that a lot of people who have taken out loans refinance their house with the use of creative financing with teaser rates.
A teaser rate is, for example, you take a mortgage loan and you only have to pay 2.9% interest for the first six months and then it goes up to the real rate.
The credit card, well they only charge you 1.9% interest, and then six months later it's 12.9 or 16.9.
So a lot of people have financed their house that way, and they only really qualified at the 2.9% level.
They really don't have the money to pay for the mortgage payment on a real interest rate.
They also have a lot of people on variable rate loans and those loans, the rates on those loans are going to be increasing because interest rates have increased since they first took out their loan.
These are people who barely fit in to their loan in the first place because when the housing bubble was in full swing and everybody was desperate to get a house and were just willing to do anything,
they were basically lying to the loan officers about their ability to pay.
and the loan officers were doing anything they could possibly do to make that loan go through
because they would just resell it to somebody else. They were just interested in the commission.
So all of these teaser rates and variable rates and creative financing, all of this is set, reset.
In other words, the payment that you have to make on your mortgage is going to change this year.
I think it's up to a trillion dollars of loans are set to reset during the year 2007.
And finally, another piece of disturbing information I think in terms of the housing bubble and
how it might pan out and how long it might last is the case of Japan.
Japan had a stock market bubble during the 1980s.
The stock market there increased by four or five hundred percent.
And then at the end of the late 1980s, the market crashed and in Japan it's basically
been at about half the level it reached in 1990.
Since that time, since 1991, real estate prices in Japan have been declining.
Since 1991, real estate prices in Japan have been declining.
They didn't go down and then come back up.
And they've been going down for 15 years.
Hopefully our situation won't be anything like that.
Their central bank rushed in to save everybody with very, very low rates of interest so that
the problems in their economy never worked themselves out, and they still have it.
But that gives you some idea of how long and how lingering those problems can last.
In Japan, at the height of their bubble, banks were making mortgages for 100 years, so you
get 100 years to pay back the loan.
What's up with that?
I mean, the Japanese live a long time, but not 100 years.
Yeah.
Yeah, I don't think you're going to get one.
Yes. Yeah, they hand their property down from one generation to another, which is all fine
and good, but their monetary policy stinks. Culture, good. Central bank, bad. And I think
that's where I want to end up on is the important message about central banking that most libertarians
never hear and need to hear, because it is the central bank of a country that is the
The Central Banks emerged in this world at the end of the 1600s. We didn't have central banking. We had gold and silver coins and very little banking at all.
And that's how the West developed on a strong monetary system. Central Banks came along at the end of the 1600s and the big states, France and England, emerged.
States that could go deeply into debt. They could borrow money because they had these central banks that everybody could bail them out.
And so they borrowed a lot of money, they spent a lot of money, wars and colonies and slave companies and all sorts of really nasty, dirty things.
They built up huge national debts, they increased taxes on the population, literally centuries of war, all on the backs of these central banks.
And basically the central banks is a way in which politicians can get a hold of a lot more resources in order to give it to themselves and give it to their friends.
These wars and these colonies and things that they engaged in in the 1700s and 1800s, they did nothing for the average citizen.
They only ended up suppressing the economy, raising taxes, building a huge national debt that had to be paid off.
If you don't have these central banks and you're on a gold standard, nations can't engage in those types of things.
They don't have the financial flexibility that a central bank allows them.
As I explained to you about what the Fed does nowadays, this little switcheroo where money is given to certain sectors of the economy like Wall Street, like the banks, the stock markets, construction.
Few sectors of the economy get all this money that ultimately is made up of thin air.
It doesn't really benefit the average ordinary citizen, the average ordinary worker is taking
advantage of all of this.
We get a larger national debt, we get heavier taxes and we don't even know that it's going
out because we have no idea what exactly the central bank is doing to us.
They seem to be our friend, they cut interest rates but actually they're not our friend
and they're responsible, they make it possible for the warfare state, they make it possible
The Federal Reserve is essential for nations to do stupid things like the war on drugs or fight the war in Iraq.
You know, that's all easily papered over.
It's going to cost us $2 trillion. Well, we'll just borrow the money.
And nobody is going to find out about it because the Fed is going to keep interest rates low while we're borrowing all this money.
So it really is important. It really is the key to big government.
And if we can stop the central bank and if we can get back on
and Honest Monetary Policy, like the gold standard, then we can limit big government.
It is the most, the gold standard is the most effective limit on big government and on the bad behavior of government.
Irresponsible government is an automatic check on the ability for big government to go rampaging around and acting irresponsibly.
It also helps clear up, a good monetary system helps clear up these problems, these booms and crashes and periods in our economy
where people feel like they've been disenfranchised or they've been taken advantage of and that they can't no longer trust the system
because in fact the system is geared against them.
A gold standard system is a system where everybody knows what's going on, everybody, you can see the physical solid gold and silver coins
and there's no counterfeiting there's no playing behind the scenes and taking
advantage of people so we always need to remember that we need to fight the
battles of the drug war and the war in Iraq and all the stupid programs that
the government does but we always have to remember that we're not going to be
able to stop big government until we can stop the power of central banks thank you
very much