In the Financial Times, Lawrence Summers writes,
The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending.
Specifically, Summers wants the spending and borrowing directed back into housing.
Keynesians have a hard time looking at the long term (or the medium term for that matter). It is true that the last boom economy was fueled by the rapidly expanding housing sector. The investment in this sector, however, was misdirected because of the Federal Reserve’s loose monetary policy. While developers built houses far out in the suburbs that no one wanted, people took out no down payment, adjustable rate mortgages to buy overpriced homes they couldn’t afford. So when the Fed finally began to tighten its monetary policy in 2006, the frantic overbuilding stopped, housing prices tumbled, construction companies folded, people ended up owing more on their mortgages than their houses were worth, and financial companies invested in mortgage securities collapsed. It would be possible to bring back the boom by repeating the policies of the early 2000′s, but then you would also recreate the bust a few years in the future. The one is inextricable linked to the other.
In the midst of the recession that followed the collapse of the NASDAQ bubble, Paul Krugman wrote,
To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.
It turns out, Greenspan did just that. And here we are today. Washington is already trying to re-inflate the housing bubble through bailouts, fiscal “stimulus,” and Bernanke’s program of “quantitative easing” (money printing). If they continue to do so and follow any of Summers’ advice, they will eventually succeed. Which will spell disaster a few years down the road.