Saturday, September 20, 2008

Deregulation Fails American Financial Markets; Crowd Psychology Dominates

A generation of financial policy based on deregulation has passed away. The Reagan era supply-siders who created huge budget deficits and who de-regulated industry after industry are waking up discredited. Another generation of financial pros will grow up with this as the signature event of their time. 

Everyone who said that we should have known better is wrong. The housing market crumble followed by the mortgage loan crash was unforeseeable except in hindsight. This is because the "markets" are not so knowledgeable as the financial theorists proclaim. They are big crowds subject to crowd psychology. The premium that goes to independent action is sometimes delayed by decades.

Having said that, this type of market crash and buyout will never happen again. That is because the hundreds of thousands of financial acolytes are learning a lesson this week.

Second, housing assets were too expensive at a time when personal incomes were not growing fast enough. The housing bubble was puffed up with cheap money, and just a little monetary deflation caused the bubble to shrivel.  Blame can be cast at supply side policies slighted the middle class for slight faster short term growth. 

The buy-out will speed the healing of the market. It probably will be paid for in ten years of increased inflation. Inflation is the real cure for the house price problem. I don't think a central banker will every utter that sentence because the Fed cannot be seen to be encouraging inflation. On the other hand, buying 500 billion in bonds will certainly inflate the money supply and the economy. This will cause new lows for the dollar.