August 20, 2007 by Tom Armstrong.

Hayek on our current situation in the housing market:

One cause, he said, was increases in the money supply by the central bank. Such increases, he argued in Prices and Production, would drive down interest rates, making credit artificially cheap. Businessmen [and individuals] would then make capital investments that they would not have made had they understood that they were getting a distorted price signal from the credit market. But capital investments, noted Hayek, are not homogeneous. Long-term investments are more sensitive to interest rates than short-term ones, just as long-term bonds are more interest-sensitive than Treasury bills. Therefore, he concluded, artificially low interest rates not only cause investment to be artificially high, but also cause “malinvestment”—too much investment in long-term projects relative to short-term ones (consider the investment in housing). He argued that the boom must turn into a bust. Hayek saw the bust as a healthy and necessary readjustment. The way to avoid the busts, he argued, was to avoid the booms that caused them.

Above taken from Hayek bio here.

Or, as Brian Wesbury, chief economist for First Trust Portfolios, put it today in the WSJ:

Even though many, including Alan Greenspan, continue to argue that the excessively easy monetary policy of 2001-2004 was necessary, it was this policy stance that caused the problems we face today. The current financial market stress is a result of absurdly low interest rates in the past, not high interest rates today.

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August 20, 2007 by Tom Armstrong.

Good op-ed today here. Notable:

Consider the case of Countrywide, which finances nearly one in every five home mortgages, almost all of them to “prime” borrowers, rather than the riskier “subprime” sort. Despite that commanding position, Countrywide’s stock price has been halved since the start of this year. In fact, it’s fallen so much that you could buy the entire firm for less than it would cost to buy its assets: It’s as though the market were valuing a piggy bank at less than the value of the coins it held.

I am, it should be known, considering a purchase of CFC at current prices, at least some calls.

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August 20, 2007 by Tom Armstrong.

Opinion in today’s journal begins:

Blaming monetary policy for economic and financial market turmoil is a time honored tradition. Maybe the most famous bashing was in 1896 when William Jennings Bryan, an original populist, ranted against hard money and for inflation: “. . . we shall answer their demands for a gold standard by saying to them, you shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold.”

Monetary policy makes an easy scapegoat because printing money (like drinking a cup of coffee) is an easy way to give an economy a temporary boost. But if what ails the economy or markets was not caused by tight money in the first place, a temporary boost will not help. It may cover up the symptoms temporarily, but in the end it does not solve the underlying issue (a lack of sleep).

In fact, easy money always leads to greater problems down the road — either rising inflation, or a reduced sensitivity to risk, as markets come to expect rate cuts to bail them out.

Lately, modern-day William Jennings Bryans have been loudly calling on the Fed to cut interest rates and inject cash into the banking system. They believe more money would stop financial markets from seizing up any further.

This would make sense if money was already tight — or to put it another way, if a lack of liquidity was the real issue. But trades are clearing, banks are well capitalized, commercial and industrial loans are growing, credit-worthy borrowers are getting mortgages, and the economy is still expanding.

…

What can help is more certainty. Tax cuts, or at least a promise not to raise taxes, and immunity — or at least a safe harbor from criminal prosecution for above-board institutions in the mortgage business — could help loosen up a rigid market in a more permanent way than sending out the helicopters to dump cash in the marketplace.

Read it all here.

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