Thursday, March 25, 2010

What If the DOT.COM Bubble Burst Today

As I read the news reports about a new government effort to help the 6 million people whose homes are in foreclosure, I reminisced about how the government handled another bursting bubble a decade ago.  Back in the 90’s, as the internet exploded into every fabric of our lives, a couple of people would band together to create a website and then offer their startup company’s stock.  Investors poured money into these internet cottage industries.  With tons of cash, these companies, with no real business plan would hire employees, buy buildings and equipment, and buy nice things for themselves.  As the investment cash ran out and the company did not actually make money, this bubble, the lifted the stock market to new heights, burst.  The companies began to fold like dominoes.  Investors were ruined, and unemployment rose.    George Bush, for all of his faults, inherited this mess from the previous administration, not that Bill Clinton had anything to do with it.   George, in his first year as President, assessed the situation and realized that the economy needed a real sustained stimulus, not just an infusion of cash that would end.  So, he passed sweeping tax cuts on income, investments, and estates.  The result was a booming economy and very low unemployment for the next 7 years.
Now let’s contrast this approach to the housing bubble.  During the ladder part of the Bush administration, government owned Freddie and Fannie Mae were under instruction to expand home ownership so that more minorities could own homes.   So, the cycle of sub-prime mortgages began.  What happened is that banks, with the backing of Freddie and Fanny, abandoned all sense when it came to extending loans to perspective buyers, buyers that should never have been loaned to.  For example, a home across the street from my house was for sale.  Because it is twice the size as every other house in the neighborhood, it was also for sale for twice that value.  A family bought the home with a payment that was more than twice my own, while bringing in quite a bit less than me in income.  The payment was well over half of their income ( I know because they told me as they moved out).   So, not only did the buyer enter into a disaster, so to did the bank that extended the loan.  Needless to say, in August of 2008, the home was foreclosed on and the house has sat vacant ever since.  All over the country, people snatched up real estate at an over inflated rate, and as these expensive properties came due, the owners defaulted.  The market was flooded with over-priced homes and nobody wanted to build a new home. 
So, instead of allowing the market to correct itself as was done with the bubble, Obama decided to try to prevent the foreclosures from happening with a relief package.  Essentially, it is like seeing a drug addict try to quit, and when you see them violently shake, you decide that what they need is maybe one last hit.  Of course, once that hit wears off, they convulse once again.  Similarly, as the initial package just delayed the inevitable, Obama is once again offering another hit.  Obama’s drug is just as addictive, it is called government aide, and like a good dealer, he wants you hooked.  It’s also like coming to the end of a bad book.  Instead of being able to read the last chapter and move on to a new book, Obama keeps writing more and equally bad chapters for you to read.  The best thing that happened out of the bust was that it was allowed to happen.  Investors learned their lesson and the economy rebounded.  Let’s do the same with the housing bubble.

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