Can Government Fix the Over-Built Housing Market?By Thomas E. BrewtonWhy did we get a massive over-building of single family homes and a  plethora of bad mortgage loans?Responding to Liberals' Wall Street Pirouette www.thomasbrewton.com/index.php/weblog/ a reader wrote, among other  observations:I was right with you until..."the huge overproduction of housing would not haveoccurred."What "over-production"?Remember: supply, demand and price balance except whereforce or fraud intervene, in a theoretical environment ofscarcity. So, how do you precisely define"over-production" or "over-supply" or "surplus" or"shortage"?My explanation:Bottom line: the crash of the housing industry, the subprime mortgage  meltdown, and the securitized debt disintegration that threaten the  financial community originated with the Federal Reserve.  In the  extended period during the 1990s and into recent times, Fed Chairman  Alan Greenspan kept interest rates artificially low by flooding the  market with excess money.  Chairman Bernanke, who believes that the  Depression was caused by the government's failure to spend enough, is  carrying on that destructive policy.The Fed's current emergency actions may temporarily bail out Wall  Street, but they will only impede and prolong the workout in the  housing industry.  Continuing inflationary expansion of the money  supply will keep us at square one, with unqualified buyers who will  have no equity in the properties they aim to buy using mortgage loans  which their incomes are insufficient to service.The interpretative problem originates in Keynesian macroeconomics,  part of the religious dogma of liberal-progressives.  Keynesians  assume that aggregate demand and aggregate supply for the economy as  a whole are single "things" that can be reduced to one supply-and- demand graph.  This is an oversimplification that masks a huge  complexity of demand and supply factors, along with widely differing  time scales of production.Keynesians' oversimplification leads them to the assumption that, if  aggregate demand is less than aggregate supply, then the government  has only to put more fiat dollars into consumers' hands to increase  consumption and to re-energize economic production and employment.What in fact occurs is that additional artificial-money handouts from  the government simply drive up prices, prolonging and aggravating the  distress.Instead, government needs to butt out and let normal market processes  take place.  Wage rates, housing prices, and housing inventories need  to fall as fast as possible in order to clear the market.  Once  inflation fears are quelled by restricting the money supply and new  lower costs and prices enable buyers to qualify for sound mortgage  loans, the housing industry can rebound on a profitable basis.I find the Austrian economic school version, as I understand it, a  more reliable analytical tool than Keynesian doctrine.Ludwig von Mises, Friedrich Hayek, et al focused upon the lengthy  time scale that applies to production of capital goods (which  includes all the intermediary steps from raw materials to  manufacturing the machinery and tools for production) that are  necessary for the production of goods for immediate consumption.Monetary manipulation by the Fed sends misleading signals to the very  large part of the economy that is involved in long-cycle production  of capital goods.  Excess expansion of the money supply leads capital  goods producers to over expand their investments in production  capacity to meet an illusionary, credit-based consumer demand.   Additionally, the artificially low, Fed-managed interest rates make  investment in capital projects appear to be profitable, though they  may be uneconomic at free-market interest rates.Capital goods producers, in our present case, are home builders and  building materials suppliers.  They are parts in a long time-scale of  production that cannot possibly respond to short-term government  consumer handouts or to the Fed's low interest policies implemented  by expanding the money supply.Homebuilding, in most jurisdictions, is a very lengthy process,  commencing with locating developable sites, demographic analysis,  securing options on the land, drawing up site preparation and  building plans, getting them approved by local authorities (usually  with months or years of lawsuits and other community action opposed  to any new development), and finally obtaining land financing,  construction loans from banks, and arranging packages of permanent  mortgage financing for home buyers when the finished product  eventually hits the market.It is not unusual for builders of multiple homes on large sites to  have two to five years of time, effort, and money invested before  they see a dime of income.  In most cases, their profit on a  development deal is realized only at the back end, after several  years of building homes, when all the original capital investment and  land acquisition financing has been paid off.That is why real estate, and to some extent all capital goods  production, is such a boom-and-bust business.  Once having embarked  on a large project, the developer can't just stop it or put it on  hold, because the interest meter is always running on his land loans  and construction financing.Misunderstanding the nature of the problem, Congressional liberals  aim to end recessions by churning out an endless array of government  spending programs, and the Fed accommodates them with a flood of money.That over-expansion of the money supply and, in the early stages, the  artificially low interest rates for loans make developers think that  consumers have sufficient real savings to buy their products and that  the projects will be profitable.  Remember that developers must make  multi-year spreadsheet projections of costs and revenues to determine  the economic feasibility of a project and to persuade lenders and  equity investors to finance it.  And their spreadsheet projections  must employ assumptions about interest rates.The result is commencement of long-term projects that lead to  oversupply of finished goods several years later.Whenever we experience economic shocks such as the current subprime  meltdown, the natural, though misguided, tendency is to search for a  villain, somebody or some institution whose malfeasance caused the  problem.In fact, such shocks are inherent in the Fed's creation of excess  money supply and artificially low interest rates.   Once the dollar  begins falling in foreign exchange markets and inflation worries  begin to take hold, the Fed has to slow down creation of money in an  effort to keep inflation within its policy limits and to fix interest  rates at what its bureaucrats have selected as the appropriate level  of market interest rates.  When the Fed begins to change course, the  game is up.Deals that appeared several years earlier to be profitable no longer  are when inflation drives up production costs and selling prices.   But the capital goods capacity expansion and finished goods  oversupply are already in the pipeline.Thomas E. Brewton is a staff writer for the New Media Alliance, Inc.  The New Media Alliance is a non-profit (501c3) national coalition of  writers, journalists and grass-roots media outlets.His weblog is THE VIEW FROM 1776http://www.thomasbrewton.com/Email comments to viewfrom1776@thomasbrewton.com