Abstract

The Austrian theory of the business cycle provides a necessary but not sufficient framework for understanding the intertemporal discoordination that caused the housing boom and bust and the financial crisis of 2008. Artificially low interest rates after 2001, caused by central bank expansionary policy, encouraged long-term loans, and housing policy and institutions, especially Fannie Mae and Freddie Mac, channeled those funds into the real estate market. The ensuing boom facilitated the growth of exotic financial instruments premised on rising housing prices, all of which crashed when the intertemporal discoordination became clear. Once in a bust, Austrian economics, supplemented by public-choice theory and other parts of Virginia political economy, rejects expansionary fiscal and monetary policy as appropriate responses. Only market discovery processes in a sound monetary framework can reallocate the malinvestments of the boom.