Thursday, 9 August 2012

The Subprime Crisis

In a recent article in The Quarterly Journal of Austrian Economics titled "The Subprime Crisis" Andrian Ravier and Peter Lewin analyse and explain the causes of the subprime crisis (housing bubble) in the U.S. and state "that we should concentrate our attention on the Fed’s monetary policy and pressures on the banking system received from the U.S. government for flexible lending". They conclude that it should be no surprise if the US economy fall into a new cycle in the coming years, suggesting that the recovery following the subprime crisis might be W-shaped (rather than V-shaped).

In short, the authors assert the following:

  1. The subprime crisis is not an isolated incident
  2. The Fed intentionally replaced the dot-com bubble with a housing bubble
  3. That Greenspan-Bernanke was wrong by asserting the crisis was not rooted in the politics of the institution they lead (but was rather a "global phenomenon")
  4. That the popular explanation that blames the deregulation of markets as  cause of the crisis is unfounded
  5. The housing bubble started between 2001 and 2004 and could not have persisted unless the Fed kept interests rates low.
  6. Real capital value has been destroyed in the process
  7. Bernanke could have avoided micro-engineering and the favouritism and moral hazard that implies
  8. The fiscal deficits the federal and state governments have (and are) accumulating (in tandem with the expansionary policies of the Fed) have not delivered the promised employment increases.
Another interesting point they make is that when a recovery indeed begins, it will be difficult for the Fed to prevent an "explosive increase in M1" when the money multiplier (which have been very low following the onset of the subprime crisis) returns to normal. It is likely then that inflation will also be high.

Their findings about inflation looming in the U.S suggest it is prudent to stay clear of investing in assets that are negatively correlated with inflation, e.g. U.S. government bonds.

Here's the full article (as published on the Ludwig von Mises Institute website) which is worth reading in detail.

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