To Beat the Bust, Burn Houses Down?
July 6, 2012
Economist Milton Friedman once famously quipped that price deflation can be fought by "dropping money out of a helicopter."
That, for an economist who normally advocated a small expansion of the money supply as the right way to grow an economy, was about as radical as you could get in fighting sluggish.
Or a case where, like now, interest rates are near zero, housing prices are in a six-year decline and the Federal Reserve seems to be running out of options to stimulate the nation's fiscal condition.
What, instead, if you burn houses down?
Here is a not-so-widely recalled observation by a governor of the Federal Reserve system in 2002.
"If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets."
Those "private assets" could and have been taken to mean houses. In lieu of tax cuts or other stimulus, the government could increase spending on current goods and services by, in effect, taking overstock out of the picture.
The governor was Ben S. Bernanke, speaking in November 2002 at the National Economists Club in Washington, D.C., on how to prevent deflation from happening here.
Now he is the Fed chairman. And this is what Curtis Arledge, the chief executive officer of BNY Mellon Investment Management calls the "buy houses and burn them down" policy.
The tactic, if invoked, would do two things, he said last week at the company's headquarters 55 floors above Grand Central Terminal in New York:
"When you buy a house, you inject money into the system. The person you buy it from gets liquidity. And, the second thing you do, is obviously deal with the supply and demand dynamics,'' he said.
You end the overhang. Instead of the nation slowly working its way out of its overleveraged, overbuilt state, you speed back to the starting point of health. Build houses-only as needed-and let the inhabitants spend on the goods needed to fill them and the services needed to maintain them.
"Now, you know, some people think that's crazy,'' he said. But one of them is not Fed chairman Bernanke, he said. Or, his predecessor Alan Greenspan.
"You may remember in 'Too Big to Fail' [the book] and in October 2011e again, former Chairman Alan Greenspan actually talked about the idea that the Fed thought the most effective thing they could do was to buy houses and burn them down,'' Arledge said.
But for Bernanke, burning houses down, by Arledge's reckoning, is a seventh and last option in, at the same time, stimulating growth and fighting back the deflation that occurs when an economy is so sick that demand for goods and services shrivel.
The seven steps that Bernanke laid out in his 2002 speech and the steps he's taken so far from that playback go like this, in Arledge's count:
1. Expand the balance sheet. The nation's money supply now stands at $2.9 trillion, according to BNY Mellon. More than $2 trillion of that has been added since the eruption of the housing-led credit crisis that erupted in September 2008.
2. Extend the duration of assets and liabilities held on the balance sheet. On June 20, the Fed for instance launched a $267 billion extension of its Operation Twist, plan to underpin the still-fragile U.S. economy. Under that Twist, the Fed would sell medium-length bonds that are coming due and use the proceeds to buy longer-term bonds, such as 10-year Treasuries.
3. Jawbone. Verbally try to convince the market that rates will stay low. In January, Bernanke pledged to keep interest rates low through at least late 2014. That was an extension of a previous pledge to keep rates low through the middle of 2013.
4. Cap yields. "You just say, we're going to be an unlimited buyer of Treasuries or you say, we're going to buy all of them at 1%,'' said Arledge. "So you just say the 10-year Treasury note is going to yield 1% and we will buy all of them so that they yield that.''
5. Grease the wheels. Make low or even zero interest loans to banks. Extend credit to companies and real estate firms. If that doesn't work, suck up other loans on the nation's books. The Fed, in effect, becomes a manager of credit markets, "because this is your financial system and it's not working,'' Arledge said.