Consumer Debt

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The Bubble Economy and Credit Expansion

Credit expansion is what was responsible for both the stock market and the real estate bubbles. Since its establishment in 1913 and certainly since the expansion of its powers in World War I, responsibility for credit expansion itself has rested with the Federal Reserve System. The Fed is the source of new and additional reserves for the banking system and determines how much in checking deposits the reserves can support. It has the power to inaugurate and sustain booms and to cut them short. It launched and sustained the stock market and real estate bubbles. It had the power to avoid both of these bubbles and then to stop them at any time. It chose to launch and sustain them rather than to avoid or stop them.

To be responsible for a bubble and its aftermath is to be responsible for a mass illusion of wealth, accompanied by the misdirection of investment, overconsumption, and loss of capital, and the poverty and suffering of millions that follows. This is what can be traced to the doorstep of the Federal Reserve System and those in charge of it...

The real estate bubble, like the stock market bubble before it, was caused by credit expansion. The credit expansion was instigated and sustained by the Federal Reserve System, which could have aborted it at any time but chose not to. As a result, the Federal Reserve System and those in charge of it at during the real estate bubble bear responsibility for major harm to tens of millions of Americans...

The conclusion to be drawn is that the housing bubble was indeed the product of credit expansion, not a "saving glut."

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My thoughts: George Reisman at his best.

Credit Crisis and Free Markets

Q. But hasn’t the current crisis discredited “free markets”?

The history of markets is one of periodic crises (especially financial crises) and recoveries, including major episodes of creative destruction, but with steady positive long run growth despite severe fluctuations around the trend. The huge fallibility of human actors makes the case for markets stronger, not weaker. The market itself triggers the corrective actions by both public and private actors when these actors do stupid things, like give too many mortgages to people who were not creditworthy and then try to cover it up with fancy securitization. The collapse of financial markets was a severe wake up call to change this stupid behavior; creative destruction is wiping out firms that made huge mistakes (despite some well-publicized cases of individual CEOs getting bonuses despite their stupid actions). New firms or restructured firms will not make the same mistakes (even if they find new mistakes to cause some new crisis). Since we recovered from all the previous crises of capitalism, it seems likely we will recover from this one. A knee-jerk rejection of markets (especially in poor countries) will likely postpone rather than accelerate the recovery.

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10% Growth is Not a Credit Crunch

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No Credit Crunch?

Business and Credit

None of the small business owners I know depend upon easy credit to make their payroll. When things get to the point where you need to borrow to pay your employees, the end is near. Most small businesses fail in the first few years, in large part because business is not easy, it is hard. Not everyone is good at it. But it is an essential part of free trade and the market economy that businesses fail, so that new, better ones can arise in their place.

Few small businesses depend upon easy credit. Banks are generally reluctant to lend to small businesses, with good reason. Most small businesses are funded by owner's savings. Sometimes start-up money comes from loans by parents or friends. While I can understand that small businesses involved in building houses might profit from easy credit, the market is sending unmistakable signals that there are too many houses that are too expensive. Flooding the system with still more easy credit can't be the cure, it is the problem.

There's no denying that life is easier with easy credit, at least until the bill comes due. But there is an alternative: savings. Before my firm hires a new employee, we save enough to buy the equipment they will need, and to pay their salary for the weeks or months it will take to train them. Those savings come from our profits.

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Cartoon: The Dow and Credit Markets