1. Interest Rates, Caffeine and Fuzzy Signals: Intervention and Recession
Nikolai G. Wenzel, Ph.D.
Broadwell College of Business & Economics
Fayetteville State University

2. Overview Initially a housing bubble …then a financial crisis
…and now an economic recession
What happened
Overinvestment in the housing market
Risky investments… and risky loans
But HOW could it possibly happen? And WHAT NOW?

3. Outline Theory A Contrarian History of the Crisis of 2008
III. Prospects for Recovery
Conclusion

4. I(1). Theory: The Dynamics of Intervention
Intervention in one market leads to intervention in other markets
Intervention as distortion of price signals
Examples: milk, medical services, etc.
First proposed by Ludwig von Mises

5. I(2). I, Pencil Specific Lessons: General Lessons:
“not a single person on the face of the earth knows how to make me”
Inputs from multiple countries… and multiple skills
A pencil is made by millions of people who have never met…
…and don’t care about each other – or pencils!
General Lessons:
Markets = cooperation without coercion
Knowledge is dispersed; markets make use of “local knowledge of time and place”
Price mechanism communicates limited knowledge and coordinates interests

6. I(3). Moral Hazard
If you’re protected from the consequences of risk… you’ll engage in riskier behavior
Examples include:
Insurance
Antilock brakes
Airbags and seatbelts

7. II(1). Housing and Monetary Policy
The Federal Reserves controls the money supply A higher supply means lower price of money… or the Fed can simply lower “the” interest rate The interest rate is simply the price of money The money market then effects the market for loans

8. II(2). Housing and Monetary Policy
2001 (January): 6% 2003 (January): 1% 2005 (January): 1.25% By 2006: 5.25% Cheaper money = more loans More loans = increased demand/prices

9. II(3). Housing and Fuzzy Signals
Caffeine versus sleep The evil leprechaun TA Crossing a desert in a bus: speed or AC?

10. II(4). Housing and Fuzzy Signals
Interest rates reflected Fed policy… …but not the real price of money! Artificially low prices meant overinvestment… …followed by a necessary crash!

11. So… why did all that easy money end up in housing?

12. II(5). Housing and Regulatory Policy
Specific background
Bush, Clinton and the ownership society
Home ownership 64% to 69%, 1990s to 2000s
General background
Federal govt support of housing since New Deal
Federal govt support of housing since 1970s

13. II(6). Housing and Regulatory Policy
The Federal Housing Administration (FHA)
Lower downpayment requirements
Incentive to spend more (ΔD)
Freddie Mac and Fannie Mae
Federal insurance on housing loans
Moral hazard and downward-sloping demand
Private profit… backed by taxpayers

14. II(7). Concluding the History
Remember the theory:
Dynamics of intervention
Institutions and information
Institutions and incentives
Artificially cheap money:
Downward-sloping demand
Massive quantity increase (housing bubble)
Overborrowing, overbuying, new financial instruments
Moral hazard and regulatory policy
Overinvestment in housing, generally
Overpurchasing, specifically
Bailouts: privatize profit, socialize risk (more moral hazard!)
The housing bubble… and the bursting bubble
Unsustainable… like a caffeine high
Feeding frenzy… and irresponsible behavior

15. III(1). Long Run Production and Recovery
In sum, my concern is not so much about short-run macroeconomic conditions
Questions about long run:
Economy’s productive capacity, given regulatory environment
Regime uncertainty

16. III(2). Regime Uncertainty
Higher taxes during a recession?
Fundamental regulatory change?
Health insurance, energy, unions
Property rights and regulation:
TARP and executive pay caps
Chrysler bondholders
Govt management
Who gets a bailout?
Lehman Brothers, AIG, Bear Stearns…

17. III(3). More Fed Shenanigans

18. Conclusion 1. Dynamics of Intervention
Was this really a market crisis?
What’s next?
Always difficult to predict future, anyway
Especially difficult with regime uncertainty
Optimism about American spirit

19. Feedback and comments welcome. nikolaiwenzel@gmail.com
Thank you!
Feedback and comments welcome.