What can be done to prevent another bubble

[youngdan]

Time for straight talk. Thr real estate bubble here had one major cause. There were too many people with nothing to lose. The buyer had nothing to lose because he was getting a mortage of 120% in some cases. The bank had nothing to lose on any mortage as they were bundled and sold on. Fannie Mae an d Freddy mac had nothing to lose because they could issue trillions of bonds to get the money to buy the bundles as they were seen to have government backing. The people who bought the Fannie bonds had nothing to lose because in the end the government did cover the bonds. All the agents in between obviously had nothing to lose.

The ball got rolling when Carter signed into law the Act which mandated that 42% of loans be given to subprime borrowers to combat what was known as redlining.

This could have been avoided had the bank suffered for writing a mortage that everyone knew would never be paid.

The biggest joke is the FDIC insurance. Why should anyone not deposit into a shaky bank paying the extra 1% when you don't give a bollox whether it fails or not.

Now we have the bailouts and everyone is scared. It is a great comedy as everyone looks to the likes of Lenehan to gaurantee billions. They still will not waken up Tuesday when they are told that there is a 15 billion shortfall.

Then of couse there are those you say Ireland will borrow 10 billion. These are a lost cause

[Fr. Hank Tree]

Why don't they look attractive?

Try the One Minute Case for the Austrian Business Cycle Theory for a quick rundown of how central banks cause booms and busts.

I have a question for you 20000miles - lets say the monkeys are all dead, what happens if Cruesoe has a family and friends and they all start fishing and saving like him and use up all the rocks on the island? They continue to produce fish but their supply of rocks has maxed out, what then?

[20000miles]

The one-minute part of the title is misleading. The model: doesn't include (e.g.) inflation in the Robinson Crusoe analogy, doesn't accurately represent actual capital investment, cuts corners in giving explanations.

How Robinson's rocks represent money is not explained, nor is the suggestion that Central Banks are mischievous monkeys.

The bloody thing was not a complete waste of time, because it was mildly amusing, but it falls far short of anything that legitimately sells anything worth having.

Inflation is included - inflation is correctly defined as an increase in the money supply. Notice that prices can't inflate they can only rise and fall.

The One Minute case is far more cogent than Krugman's babysitters example of why central banks should print more money.

There's a whole load of proper articles on Mises.org about the crisis. Alternatively you could read one of the Austrian school tomes like Money, Bank Credit and Business Cycles, or Mises' Human Action.

But there's no surer and simpler way of untangling cause and effect than this:

1. The Federal Reserve cut interest rates to as low as 1% so that after inflation we had negative interest rates.




2. As a result, mortgage rates fell to an all time low.



3. Low rates caused borrowing and lending to explode, particularly in real estate. For example, commercial banks more than doubled the amount of real-estate loans they made.



4. All these low interest loans had to be extended to people with worse credit ratings and this increased the demand for homes and other real-estate assets.

The result:

The biggest housing bubble of all time.



Source: http://mises.org/story/3130

[Fr. Hank Tree]

20000miles could you or any of the other gold standard people answer my question - if a banknote is merely representative of certain quantity of gold, what happens when the world population increases, more goods and services are being produced, more trade is taking place, yet there is no corresponding increase in the number of banknotes because the gold supply is finite?

[20000miles]

The interest rate was set too low. No argument there.

There's a long way between that and to conclude that the central banks shouldn't set any interest rate at all.

Excellent. So we've established the free market was not to blame for the giant bubble and the recession that is now here to correct it.

Perhaps we should move away from the system we have now, and try free market capitalism for a change.

20th century monetary policy has given us the worst recessions, horrendous hyperinflations, and rising prices for the past 40 years. Time to change how things are done.

Let the interest rate be set by the valuations of countless economic actors instead of a few white men in suits in a large marble building.

Unless you advocate that prices for all goods should be centrally fixed...

[20000miles]

20000miles could you or any of the other gold standard people answer my question - if a banknote is merely representative of certain quantity of gold, what happens when the world population increases, more goods and services are being produced, more trade is taking place, yet there is no corresponding increase in the number of banknotes because the gold supply is finite?

Hank,
gold is mined at about 1-2% per year. That's perfectly acceptable. That being said, the gold or silver standard is not without it's faults and is not the silver bullet solution.

Now here's my question:

As governments have the power to create money out of thin air, what stops them from debasing the currency they are meant to be protecting?

[Fr. Hank Tree]

Hank,
gold is mined at about 1-2% per year. That's perfectly acceptable. That being said, the gold or silver standard is not without it's faults and is not the silver bullet solution.

Now here's my question:

As governments have the power to create money out of thin air, what stops them from debasing the currency they are meant to be protecting?

Preaching to the converted on this point, i agree that central banks clumsily distort the money markets by arbitrarily fixing prices and increasing the supply disproportionately to any increase in trade.

My problem is with the solution. How do you have a self-regulating currency that automatically increases in supply in accordance with productivity and trade?

[20000miles]

Preaching to the converted on this point, i agree that central banks clumsily distort the money markets by arbitrarily fixing prices and increasing the supply disproportionately to any increase in trade.

My problem is with the solution. How do you have a self-regulating currency that automatically increases in supply in accordance with productivity and trade?

If you have another solution I'd like to hear it.

But the way I think of it is that money has no mystical properties that sets it apart from any other commodities. You create goods, then 'purchase' money, then 'sell' money for other goods.

The supply of money does increase as time goes on. But the most important thing IMO is that the market has chosen gold and silver. Problems only begin when you are told by the State what you can/cannot accept as money. The last 100 years has shown us this.

Something like a 100% gold dollar/ gold standard isn't perfect, but it is superior to the current system. And if the government gets out of our way then the market might just find an even more superior means of exchange.

[Fr. Hank Tree]

If you have another solution I'd like to hear it.

I've literally just come up with a solution - how about backing money by energy? Energy is a measurable commodity, is practical (easily stored and transferred) but is also infinite yet requiring work to be gernerated: methinks some sort of wacky green solution lies therein. Give me a few days to work it out.

[patslatt]

A few years ago,a Moscow mafia gangster offered millions to a fund manager to manage with a proviso attached. If the fund manager lost significant money,the mafia would murder him. The fund manager declined the business.

That's one solution to risk management.

Another solution is education. All bankers should be required to study the history of banking crises in capitalism's business cycles,especially the banking crisis of the Great Depression.