One of the theories behind U.S. monetary policy is that if we make money easier to get (low taxes and low interest rates) people will invest in activity that drives productivity. Business will expand, new business will open, more jobs and economic growth will follow. The problem with this theory is that it is not absolute. Investment does flow into productivity, but investment also flows into speculation. The technology and real estate bubbles are perfect examples. Speculation drives false productivity, where the value of assets rose based upon perceived value versus actual productivity.
While Alan Greenspan and Ben Bernanke were driving down interest rates to avoid inflation HGTV was airing The Big Flip eight times a week. Funny how the word "flip" showed up in both the tech and housing bubbles. Here is how HGTV promotes the show:
Our renovators, Paul Peic and Kye Husbands, are taking on the challenge of fixing and flipping as many houses as they can in just 12 months. Or lose their minds and shirts trying. Paul and Kye are experienced entrepreneurs who will try anything once, but neither one of them has ever flipped houses before. They say it's not a problem. They're convinced they have what it takes not only to be successful... but really, really rich. The investment, the sweat equity and any ups or downs are all theirs. Can it be done? They think so.
HGTV's peers were all in the game, with competing shows including Flip this House and Flip that House. There is a big difference between a VC that can afford to spend $500 million on 10 start-ups in hopes that one ends up worth $5 billion and people putting all of their savings into real estate and tech stocks. Most venture capital firms aren't investing with their own money. Investing is what a VC does for a living, and the good VCs bring assets to the companies they invest in that make those companies better.
The investor who overextends to invest in properties in Southern Florida is working in a completely different environment. Let's say he put $1.5 million down to buy 20 properties for an average price of $500,000. That gives him $10 million in mortgage liability and $100,000 a month in mortgage payments. He is investing his own money. No one property is going to "make it big" and suddenly be worth $50 million to offset losses elsewhere. And if he can't cover the mortgage payments he has to start selling off property, regardless of the market conditions. The is a real scenario. I rented a house from someone in exactly this situation. The day after we went home from our vacation in Disney World the bank foreclosed on all of his properties.
This kind of speculation happened across the country in both larger and smaller scales. I don't have an answer; the solution is not obvious. I'm all for lowering taxes and trimming government spend. And I am not against low interest rates. I do think that when you use terms like "irrational exuberance" and "froth" to describe market conditions perhaps driving down interest rates, on its own, isn't the best course of action. Once again, I'm not in a position to say where those interest rates should be, but our policy makers need to much smarter at avoiding and/or managing bubbles.