Reflating the Bubble?

The Fed has decided to extend, at least through early next year, its program of purchasing mortgage-backed securities. The Wall Street Journal reports:

“The Fed’s action signals its belief that the economy, while in recovery, remains fragile and that housing, which has seen some improvement in recent months, has only started to pull out of its slump.”

What is the objective of their action? When will they know they have succeeded? Almost everyone admits that there was a housing bubble or, as I prefer to say, a misdirection of resources into the housing industry due to excessively low interest rates and other government programs designed to stimulate the housing sector.

But now, again from the Wall Street Journal:

“Mainly because of heavy government intervention in the mortgage market, interest rates remain near their lowest levels in decades. Rates on 30-year fixed-rate conforming mortgages currently average 5.24%, down from a recent peak of 5.81% in June but up from the year’s low of 4.84% in late April, according to HSH Associates, in Pompton Plains, N.J.”

This intervention is good, even though the previous one caused the bubble, presumably because “the housing market has not fully recovered.” What is full recovery? Business as usual? What is that?

The article continues:

“With so many empty houses sitting on the market, some builders say they still have no way to make a profit with new construction.”Why build new when people can go out and buy for less than it cost?” says Mark Connal, vice president of realty at Michael Crews Development, a developer and builder in Escondido, Calif.”

If the Fed defines full recovery as when it is profitable to build new homes, it has not grasped the fact that the housing sector is over-expanded. The point of losses or potential losses is to curtail the use of resources in this field. (If the Fed is claiming that the market is over-reacting in its curtailment of resources into housing, how do they know that? What is their standard?)

Thus, once again everything we know from microeconomics falls to the wayside in the Name of the Stimulus.

As if it were not enough that the Keynesians have fallen victim to this idea, the usually excellent Jeff Miron seems to think that the problem of reflating the bubble is mainly political, rather than economic. Of course, it is perfectly possible to interpret the Fed’s actions here as giving into the political pressure of the housing interests (real estate, construction unions, etc.), I do not think that is what he has in mind. Miron seems to think that the Fed can retrench at the first sign of inflation. But increases in the aggregate price level weren’t the problem in the first place. The housing bubble took place without “inflation.”

I just “love” macroeconomics.

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