It’s become popular for the current crowd in Congress to try and find a scapegoat to blame for the sub-prime real estate loan meltdown. You should forget the lack of proper risk analysis of securitized loan packages by the bond rating agencies. Also ignore the lack of standards in making decent loans by the banks and mortgage brokers. With all that cheap money sloshing around just waiting to be lent what would you expect?
In the desire to help our liberal colleagues solve this painful problem, it is necessary to trace this particular history back to its roots.
Several decades ago, an extraordinarily popular BBC/PBS series was presented by the science writer James Burke. He called it Connections, and the first series’ 7 episodes neatly tied together dozens of historic inventions — like gunpowder and the telegraph — which have brought us the modern world of thermonuclear devices and the internet.
We can easily do the same thing with Herman Hollerith and his amazing invention, the computer punch card.
Dr. Hollerith was a mathematician in the 1880’s who had been hired by the US government to automate the 1890 census. The prior census had taken nearly a decade to complete, and the process was still being done by walk-about census takers using quill pen and paper.
Dr. Hollerith was familiar with the Jacquard loom, an 18th century invention which had automated the weaving of fabrics. The Jacquard system used a series of wooden boards with holes punched into them at strategic locations. As these wooden boards, which were looped together with a series of cords, passed through the loom, wooden pegs or fingers would fit into the holes and cause the machinery to duplicate the weaving pattern.
Hollerith used the idea of Charles Babbage and his punch-card driven mechanical tabulator to create his prototype “punch card”. The new punch card was cut from a thick piece of paper to be the same size as the 1887 dollar bill. There was originally room for just 24 columns of data, but each column could be punched in 12 different positions using a round hole punch. Hollerith selected the dollar bill size of 3.25 by 7.375 inches for his cards because he used the Treasury Department boxes as containers.
One column was used for the person’s sex, another two for their age, and so on. And two were reserved for the year: 90 would mean 1890, 00 would mean 1900.
By the 1950’s, modern computers and the Cobol and Fortran programming languages had codified the date field to two digits. Programmers were aware that there might be a problem around the turn of the next century, in the year 2000. But that was half a century away, and everyone would be long gone by then, and surely the problem would be fixed.
By 1995, US industry had awoken to its worst nightmare.
By 1998 it was in full panic mode. Hundreds of billions of dollars were being spend by the Fortune 1000 companies to repair the global network of computers — all of which were keyed to 2 digit years — and which tests had shown would lock up and stop functioning at the stroke of midnight, 1999.
No electricity, no dial-tone, no water or sewage, no banking or airline service was projected by scores of computer experts. Years of IT budgets were spent in a few months. Internet routers were scrapped and new equipment, new operating systems, and new programs had to be written to eliminate what came to be known as the Y2K bug. An explosion in growth in the high tech computer and telecoms fields was the result.
Technology stocks doubled then tripled. Some went up by 1000%.
The Fed was concerned, if not frightened. Y2K could potentially lock up the entire financial system of the United States, if not the world. By the closing weeks of 1999, it was excessively pumping hundreds of billions of newly printed dollars into ATM machines nationwide, and truckloads of currency were shipped to the 12 regional Federal Reserve Banks.
Almost overnight, the M1 money supply shot through the roof.
By February, 2000, it was clear that the worst was over. The bullet had been dodged. And the Fed began to pull back its oversupply of money that was no longer needed.
The money supply shrunk just as fast as it had been expanded during the crisis. By the summer, however, it became clear that something was deeply troubling in the high tech field. All the predicted new spending on high technology had already been taken from future corporate and government budgets. It had all been spend several years before. The order books dried up. Companies began to lay off thousands of people. The stock market tanked, and the famous “dot com” bubble collapsed.
Now a new panic was felt at the Fed. And when 911 happened, the panic became compounded. As the economy began to sag, the Fed needed to act to stimulate it back into activity. It did so by progressively lowering its interest rates month after month for almost two years, until the cost to borrow money for prime lenders was only 1% — way below the annual inflation rate.
The result, coupled with the Bush tax cut and immediate infusion of tax rebates, kick-started the economy into overdrive. The US bounced from a sure recession to a sure boom — and the boom was driven by cheap money flowing into both the stock market and the housing sector. With so much money available and begging to be lent, banks were eager to issue mortgages to anyone who barely qualified — and many who didn’t.
“Don’t ask, don’t tell” loans (known as “no docs” — no proof of income, no tax returns needed) exploded. Super cheap ARMS — in particular short term teaser rate loans that would reset their interest rates upwards in two or three years hence, beginning around 2007 — jumped from 5% to 75% of loans issued in some markets.
The result is evident today. We’re in a real mess. And the end is not yet in sight. As the baby boomers begin to retire in earnest and cash out their market investments, coupled with a desire to downsize their “McMansions”, the real estate market could continue to unwind for years. Serious property readjustment in previous bubbles (ala Japan, South America, the UK) has seen values drop by 15% to 30% or more.
If there is a moral to this story, it is that the Fed over-reacted in the fall of 1999 and again in the fall of 2001. The market whipsaw was the result. But what was the Fed to do? After all, that is its job, to control the nation’s money supply by increasing or decreasing the amount of fiat money in circulation and to set the interest rates that the banking system charges lenders.
Turning over this most important of the free market’s products — the creation and supply of money — to the government-controlled monopoly of the Federal Reserve Board back in 1913 may yet turn out to be the most profoundly disastrous policy decision that the Congress has ever made in a long line of foolish experiments with socialism and government manipulation of the free market.
As a property owner, I hope that my analysis is wrong. Massive future inflation may yet bail out the home owner’s nominal loss valuation. Time will tell. Anyway, you can tell Congress that it’s all Herman Hollerith’s fault.