When asked about the recent bankruptcy of the City of San Bernardino, California Governor Jerry Brown had this to say: “We have to realize this country has been dealt a very heavy blow: trillions and trillions of dollars in the wealth of America has been destroyed by very powerful people, some of whom have never been punished.”
Let’s see what sense we can make of this. “Wealth of America” presumably means real assets: homes, businesses, land, etc. Taken literally, this makes no sense. Where are the smoldering ruins? The financial crisis did a lot of damage but little or no physical damage. What did happen is that malinvestments were revealed. Tracts of houses built in places like the California Central Valley on the presumption that home values could never decline were left empty or unfinished. Wealth was indeed destroyed: not tangible wealth but wealth in the sense of people’s expectations of ever-rising future house prices.
The housing crash was a necessary if painful cleanup of the damage done by policies that created the boom in the first place. What were those policies? A rough summary:
- Government policies aimed at expanding homeownership. Loans to marginal buyers were encouraged by government-sponsored entities, particularly Fannie Mae and Freddie Mac.
- Low interest rates engineered by the Greenspan Fed during 2001-2005.
- Tax deductions for mortgage interest.
- And yes, private greed. Institutions like Countrywide were churning out low-doc loans, no-doc loans, neg-am loans and God knows what else in defiance of common sense. They were, of course, responding to incentives as a dog would respond to a piece of meat left on the kitchen counter. But they are not dogs and should have known better.
Now, what about those trillions and trillions? Indeed, total real (inflation-adjusted) household wealth has fallen by more than a trillion in the last few years – all the way back to 2005 levels. In other words, a lot of illusory “wealth” that was the result of the government-created boom has been taken off the books. Painful? Sure, you can no longr refi and take cash out for a vacation. Your house is no longer an ATM. We’ve sobered up and that’s good.
It’s so easy for a politician like Brown to spout sound-bite demagoguery and get away with it. The majority of voters, full of nonsense fed to them by public mis-education, lap it up. The truth is often complicated and ill-suited to sound bites. That’s why economics can be both frustrating and satisfying. Personally, I find it satisfying to try to understand the truth and convey it in class or in a blog. I urge bright young people to consider economics as a career and consider people like GMU professor and prolific writer Don Boudreaux as a role model.