Belmont Club

The Trouble With Tulips

Barney Frank’s disquisition on why you couldn’t have a housing bubble because “houses ain’t tulips” provides a remarkable insight into his thought process and its limitations.  In a C-Span video Frank argued that overpriced housing was fundamentally different from historical bubbles, such as the one in tulips because houses had an intrinsic value which flowers did not.

I do want to address this thing about the bubble. I think the bubble is an entirely inappropriate metaphor. Let me just be very clear, houses ain’t tulips. Houses today even with the drop in housing prices are more valuable than tulips were however many years ago when we had the tulip business … bubbles in history haven’t been cases of irrational exuberance. They have been cases of exuberant irrationality. And there really is a distinction. Irrational exuberance means you get a little carried away with something that is basically a good thing. But exuberant irrationality is when you start thinking that tulips or some of those dumb ideas on the internet when there were some of those things that nobody in their right mind wanted to buy, those were excessive.

Considering that Frank was about to become the Financial Services Committee Chairman it was an extraordinary assertion. Economic bubbles happen every time there’s a disconnection between price and value at “high volumes”. It is the disconnection and the volumes involved which makes the bubble. Because the role of different commodities changes in history, bubbles are about different things, but are bubbles just the same. But it’s the price distortion that matters. Historically the worst bubbles arose from financial instruments, which Frank was supposed be on the lookout for. The argument that mortgages were not flowers was irrelevance bordering on intellectual dereliction.

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Once the role of price in resource allocation had been banished from his mind then housing, like a bubble itself, was free to float in his conception unmoored from anything but politics. It ceased to be a commodity that was to be allocated by market pricing. Instead it became a “benefit” to distribute to constituents and Barney Frank was determined to do the distributing. He went on to say:

We weren’t doing anything for Fannie Mae and Freddie Mac. The issue for me was housing. We were doing something for housing. And I agreed with those who argued that because of the markets’ perceptions, Fannie Mae and Freddie Mac got this great benefit to be able to borrow money cheaply yet the benefit was not being adequately returned to the public. There were two things you could have done about that. You could have reduced the benefit. You could have cut back on their ability to borrow as cheaply or you could leave that benefit in place and distribute it more fairly. That’s what we chose to do with the affordable housing fund.

Embedded in this argument is the dim realization that housing was being misallocated; that Fannie Mae and Freddie Mac were receiving a subsidy that enabled them to provide housing more cheaply than it really cost. But this didn’t bother Barney. It was just fine by him so long as this misallocation was passed as subsidy to the ‘public’. He said, “you could have cut back on their ability to borrow as cheaply or you could leave that benefit in place and distribute it more fairly. That’s what we chose to do with the affordable housing fund.” Here was something for nothing, or at least something from people who could ‘afford it’ and therefore it could be safely passed on.

It was an income transfer from the half of American society that paid taxes to the other half that didn’t. Except that it didn’t take the form of a tax. It was nothing so overt. Instead it assumed the guise of a guarantee that allowed Fannie and Freddie access to cheap money, putting the taxpayer on the hook in case things went bad. It was hidden contingent tax. And what do you know? Despite Barney Frank’s assurances that “houses ain’t tulips”, history proved not for the first time, that housing bubbles can in fact exist.  And now the taxpayers are on the hook, in part from his misjudgment.

Because bubbles had happened before, and not just to tulips, the risk of a bubble was a known unknown. But for Barney Frank it was an unknown unknown. Or perhaps it was something worse: it was the known known that wasn’t so.

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