Prices and Crisis II

Prices do something that nothing else can. They convey information about what people actually want. More than that, they convey those signals in a way that allows thousands upon thousands of activities to be coordinated to produce those things.

For example, most of us want a house. We may want a large one, a small one, one in town, or one outside of town. Sometimes, we just want a hamburger. Either one, a house or a hamburger, is impossible for us to produce ourselves. Prices signal to other people what we want.

Here’s the neat trick, though. No one person makes a house, or even a hamburger. Even if I were to build my own house, I would need all the things necessary to put it together. An act as simple as grilling a burger requires the same coordination. Chances are, you don’t even know the people who grew the wheat for the bun, slaughtered the cow, or manufactured the siding for your house.

Left alone, the pricing system does an astoundingly good job of getting people what they want. Burgers cost less than houses because they are worth less to most people most of the time. They also require the participation of fewer people to make. Working within the constraints of their own budgets, people allot their money toward purchases according to their relative value. Taken all together, an unconstrained economy makes all of us infinitely better off than we would be making all this stuff ourselves. It does so by rewarding the people who work to satisfy the needs of others.

Our current crisis has been blamed on the free market. Baloney. Our economy has not ever been truly free, though thankfully it has been mostly free. That is, until recently. For example, why is the housing market so goofed up? People who want to sell can’t because they are underwater on the loan. People who want to buy can’t because other people can’t sell. People who want to stay in their homes can’t because the second mortgage they took out can’t be rolled over, something that would normally be a no-brainer. All these people want something perfectly reasonable, yet are precluded from acting on those desires–all courtesy of government intervention.

In the 90’s, certain folks decided it would be a good idea to help Americans own homes. On the face of it, not a bad idea. Or was it? Before that, people could buy homes only if they saved enough to put 20% down. Now there is nothing magical about 20% It just happens to be the amount that banks had found historically made for solid loans. People who could save that much tended to be good borrowers. Banks had good reason to insist on these kinds of requirements–they had to eat the bad loans.

Enter Fannie Mae and Freddie Mac. These were at first private enterprises, kind of. I say “kind of” because in the murky waters of public-private “partnerships” it is hard to tell which is which. Such was the case with the Big F’s. Though not explicitly stated by anyone, there was a strong suggestion that the government (read you and me) would guarantee any loans these entities made. Simultaneously, they were encouraged to make more loans to traditionally unqualified buyers. Fannie especially loved this and lobbied vigorously for a nod and a wink to loan more and more money to questionable clients–like people who could barely afford the pen they signed with.

The price of these loans, which translates to the interest rate, was lower than it would have been had there not been an implicit government guarantee. And here is where the pricing mechanism started to wreak havoc. Cheaper loans meant more buyers, which put upward pressure on the prices of homes. Easier and easier terms put more people in the market who could not pay the loans back. “Regular” banks tried to compete with Fannie and Freddie and also made questionable loans. Banks tried to hide the bad debt by bundling them and selling them as securities. When there were more leaks in the dike than fingers to plug them, the whole thing crashed.

Sadly, it will continue to crash for years because no one wants to let prices go back down to where the free market says they should be. In order for the market to clear, all the foreclosures and bankruptcies need to be processed, people who have the resources need to buy homes at their “correct” prices and start the process all over again-without interference. Painful? You bet, but not nearly as painful as the alternative.

You see, in the end, markets always win. We can continue the charade of buoying up housing prices for only so long. Eventually, a crash much worse than the one we just saw will lay us all low. The longer we wait, the worse the crash will be. Sadly, it is not just housing, but healthcare, education, and a host of entitlements promised by the government that distort prices. Whenever prices are manipulated in this way, the myriad producers of anything subsidized or otherwise influenced by intervention are given false information. They build homes that no one can legitimately buy, conduct medical tests that patients don’t need, and create layer upon layer of useless education administrators.

No plan currently offered by anyone in politics will help, with the possible exceptions of Ron Paul and Gary Johnson, who both advocate a stringent libertarianism. Unfortunately, even their approaches cannot prevent the pain we have all signed up for over the last twenty-something years. Countless people have now been working for years in professions that are either not needed or should be completely revamped. Countless others are doing nothing or are underemployed because bureaucrats make it difficult to start a new business. Getting market signals back to working appropriately in an unmolested economy will take years, if not decades.

In the meantime, what do you and I do? Prepare for a bloodbath. Search every corner of your soul for the strength and courage to create something good for others. It may be as complex as writing a book or as simple as cutting hair. It may be as lofty as creating a company that employs thousands or as humble as a basement business. Whatever it is, make sure you are someone who has something to offer. You may have to sell it on the black market, but you will at least have something to sell. Trust me, while everyone else retreats into hopelessness, you’ll be able to command a handsome price for your efforts.



About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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3 Responses to Prices and Crisis II

  1. Diane Benjamin says:

    Have you been listening to Glenn Beck? lol


  2. Dick Richards says:

    I forwarded the advice in the last paragraph to my daughters.


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