Most of the energy of political work is devoted to correcting the effects of mismanagement of government. - Milton Friedman
By now you have heard about the blinding success of the economy-saving program "Cash for Clunkers;" the awesomely complex program through which you may (or may not) be eligible for a government funded rebate for the purchase of a new car. It is so complex that the FAQ section of the government site dedicated to the management of the program spans 19 pages and 5300 words.
But what did you expect?
Over the past week you would be hard pressed to find a media source that has covered the topic in a tone short of elation; a Bloomberg article cited Ford's best month of sales in 2 years as due to "Cash for Clunkers." But, when the chorus of advocates are as deafening as they now are we must take pause and consider the outcome of government stimuli.
Let us forget for the moment that this is a blatant example of re-distribution of wealth.
In late 2009, our economy was dramatically impeded by the paired conundrums of a full fledged financial crisis brought about partially by a housing crisis. This pairing is referred to as a "black swan" by some in the financial community because of the extreme unlikelihood and unpredictability of two crisis meeting at the same time.
If fact, it might have been easier to predict the downturn than the followers of "black swan" theory would allow. Mean regression theory states (loosely) that if an occurrence or observation of a variable is measured at an extreme (or trends away) from the mean (or average) the next observation will tend to be closer to the mean.
Armed with "Mean Regression Theory" let us critically evaluate the history of government intervention into the free market -- in particular the housing market -- that enjoyed all around support; "The Community Reinvestment Act of 1977." The "Community Reinvestment Act" mandated that all F.D.I.C. insured banks give more loans to lower income households (or less credit worthy borrowers). The act was significantly broadened by Clinton in 1993.
In his memoir "My Life," Bill Clinton states;
"One of the most effective things we did was to reform the regulations governing financial institutions under the 1977 Community Reinvestment act. The law required federally insured lenders to make an extra effort to give loans to low and modest income borrowers.... After the changes we made between 1993-2000, banks would offer more than $800 billion in (loans) to borrowers covered by the law. A staggering figure that amounted to well over 90% of all loans made in the 23 years of (the act)."
Before the Community Investment Act was amended in 1993, the rate of home ownership was always near 64%.
You might argue that it was this amendment that caused the significant increase in demand that artificially drove up the value of homes, nudging us towards the current housing crisis.
The simple laws of supply and demand tell us that if there are more buyers in the market place competing for the same number of houses than the home prices will increase. This is exactly what happened.
In this chart, the mean is the inflation rate. Under normal market conditions, home prices rise in step with inflation because a house is a merely a composition of lumber and other raw materials and because the inflation rate takes housing costs into consideration. Notice that the deviation from the inflation rate starts about the time of the original act and takes off after President Clinton spurs the act forward.
In the above graphs we can note a significant "progression" or deviation from the mean. It would have been logical to assume that at some point these increases would reverse, or regress to the mean.
While there are many variables that led to the economic crisis that we are still mired in, had the government not acted to artificially increase housing demand through the Community Reinvestment Act, the crisis would not have been nearly as deep.
In all things, and especially government intervention into the free market, we must remember the law of unintended consequences. There can be no doubt that the "Cash for Clunkers" program is artificially increasing demand, which will in turn cause the auto manufactures to increase output. Certainly these manufacturers are not good at predicting consumer demand (as we've seen this year) and will stall. As before, the government will ignore the lessons of the past and plant the seeds for another future crisis.
Brent Stransky and Andrew Foy, MD are co-authors of the new book, "The Young Conservative's Field Guide." The book will be available in stores and on-line September 8th. They can be contacted through their website at www.aHardRight.com.