How Malinvestment Poisons the Entire Economy

Our Fed-fueled lottery-ticket economy will unravel with a vengeance in the years ahead.

Malinvestment–the systemic consequence of the Federal Reserve’s policies of near-zero interest rates and abundant credit–doesn’t just inflate destruction asset bubbles: it poisons productive assets and the entire economy.

Malinvestments arise when credit is cheap and abundant, as it costs speculators very little to borrow money for gambles, and they can in essence buy lottery tickets in the asset bubble of the day without having any skin in the game, i.e. without having to put any of their own money at risk.

The classic example in the previous housing bubble were speculators who bought houses with no-down, no-document low-interest “liar loans”: with no money down and a modest interest-only mortgage payments, speculators could buy a lottery ticket in the housing mania for almost nothing, and maintain their gamble for a very modest monthly sum. Given the potential for an enormous gain should the gambler find a greater fool to buy the house in a few months, this was an entirely rational and indeed attractive bet.

Today’s asset bubbles in stocks, junk bonds, housing, art, bat guano futures, etc. are being driven by the Federal Reserve, which has replaced the nuisance of no-document liar loans with unlimited liquidity for bankers, financiers and insiders.The super-wealthy and corporate cronies can borrow as much nearly free money as they want from the Fed, without even bothering with qualifying for the credit.

When credit-money is nearly free and abundant, it becomes rational to buy lottery tickets in every asset class that is soaring in a Fed-fueled frenzy of “don’t fight the Fed” euphoria.

Longtime correspondent Joe H. explains how such perverse incentives to malinvest millions of dollars in asset-bubble lottery tickets poisons not just the market’s ability to discover price but the entire economy:

Something that often gets overlooked in the abstract discussions of malinvestment are the potentially productive assets that get captured in the malinvestment.

There are 80 acres directly east of me that were subdivided into 12 lots. That happened about 6 year ago at the peak of the housing boom. Three of the lots sold. One additional lot was in process when the bottom fell out and never went to closing.

My neighbor to the south and west raises cattle. He has more head of cattle than he has land to feed them.

He approached the speculators and asked if he could fence and graze the unsold 60 acres of land until it sold.

They told him to pound sand. If he wanted the property he could spend the $10,000 an acre: the full asking price.

A full grown calf (1200 lbs) might go for $2000 at auction….but that is still not enough to support that kind of price. Further, there is no guarantee those prices will continue into the future. My neighbor said, “No thank-you.”

The owners of the property can afford to play hardball because it costs them so little to service the debt. There is little incentive for them to activate the frozen resources in productive ways. Consequently resources that could be growing beef (or potatoes or corn or green onions) are being withheld from production.

And beef averages $5.30 a pound.

How much labor is tied up in similar locked-up ventures?

How much concrete, and copper, and petroleum derived products are trapped?

Locked up and not producing, not being reallocated to a higher value process…. because it costs virtually nothing to hold on to last week’s lottery ticket in the hope that the holder will be able to redeem it in some future drawing.

Thank you, Joe, for explaining how malinvestment poisons productive investments and the entire economy. Issuing lottery tickets to the asset bubble du jour is the Fed’s core policy, and the unintended consequences of the Fed-fueled lottery-ticket economy will come home to roost with a vengeance in the years ahead.

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  • Riggs Degenova

    Real lottery tickets, or the lottery, is taxation on the middle and the poor. Borrower, investor or speculator, are these the same things? Let us inject honesty into our semantics when cutting and pasting our pablum essays. The crony capitalists had the housing-asset backed currency that they wanted, but because some of them got burned badly by more enlightened capitalists, the whining and revisions, and the propaganda continues :

    1. The Fed will lead us to some form of Revelations or preferably something out of Leviticus 2. Keynes is stealing the money that we..umm..”earned” 3. fancy lad Krugman is sooo wrong, since the universe revolves around this economist 4. the po’ or uneducated folk tried to immorally get high on the hog. (always need to keep a lucrative eye on those people) 5. Hate government like a Bircher since we’re suddenly been evicted from the entitled ruling class. 6. All of a sudden fairness, the rule of law seems to be important (We’ve had our ‘Murcian Capitalist ox gored, man that is awful) 7. Meat is goin’ up 8. Wheat, grains are evil, because meat. 9. guns

  • marki

    The gearing that the speculators have is still deadly. for an investment bank, say Goldman Sachs to be able to buy positions in gold – massive positions – on a few percent margin with the clearing house, only entices them to manipulate markets – keep buying to support the price..or keep selling to deflate it. The double or nothing mentality allows for many close shaves leading to the conceit of invulnerability – until the MELTDOWN. Even the Bank of England played that game till Soros flushed it out.
    By using various scenarios some positions up some down the appearance of stability is maintained under a stress test,… so long as the cards dont align to all down for one party….because that party’s collapse then empties the clearing house and of the other parties new vulnerabilities emerge and massive failures align..

  • kimyo

    speculators could buy a lottery ticket in
    the housing mania for almost nothing, and maintain their gamble for a
    very modest monthly sum

    this ignores the mortgage brokers forging documents to sell adjustable rate mortgages to ‘anyone with a pulse’. their commissions and bonuses are the true ‘perverse incentive’.

    there would never have been a housing bubble with 20% down/income verified mortgages.