Money Creation by Commercial Banks : The house price bubble

There was an interesting bit BBC Radio 4 this morning - a discussion with Karl Case who, with Robert Shiller developed an index for comparing repeat sales of the same homes in an effort to study home pricing trends, the Case-Shiller index.

The news is that today, the index has just gone slightly positive following an incredible period in which house prices had plummeted in the USA since the peak of the housing bubble in 2007. I extracted the graph from a press article, and you can see it here. You can see that year on year prices increases reached an unbelievable 16% at the peak, before dropping by up to 20% in 2009.

What amazed me was Karl Case's statement that the banks had pumped $10 trillion in new credit into the housing market between 2000 and 2005, and that because of the crash, $6 trillion of that value has simply disappeared in smoke. That's $10 trillion dollars that the banks just created out of thin air.

$10 trillion dollars! That is what happens when the money creation process is put in the hands of commercial banks. They create money for buying the same houses over and over again, causing a totally insane cycle of inflation that eventually ends with a crash.

I simply cannot believe that there is any reasonable way of keeping this sort of insane money creation under control unless the the money creation mechanism is changed fundamentally. If all money creation was done by central banks who would then allow governments to spend the money into the economy (or pay off debt), then such problems would be a thing of the past.