Dear Mises Forums members,
Below is my take on the Austrian Business Cycle Theory. I hope you find it useful.
Stages
1. Money Supply Increase causes a general
2. Credit Supply Increase, which causes a general
3. Interest Rate Decrease, which causes a general
4. Longer Term Investment Increase, which causes a general
5. (a) Demand for Labor Increase and (b) Demand for Capital Goods Increase, which cause a general
6. (a) Wage Rate Increase and (b) Capital Goods Price Increase, the first of which causes a general
7. Credit Demand Increase, which causes a general
8. Interest Rate Increase, which, along with 5(b), causes a general
9. Longer Term Investment Decrease back to normal
There is nothing inherently circular about this progressive response to artificial credit expansion. The theory might even be called the Austrian Business Blip Theory (ABBT) were it not for the government's recurrent interventions into the markets for money and credit.
Causal Explanations
1-2. The money supply increase in the present system is in the form of bank money. This bank money is made available as new and additional credit.
2-3. The interest rate is the price of credit. Increases in supply cause decreases in price. Therefore, a general increase in the supply of credit will cause a general decrease in interest rates.
3-4. The lower the interest rate, the more viable are longer term projects funded by investment borrowing.
4-5. Longer term production processes generally require more labor and goods than shorter term production processes.
5-6. Wage rates are the price of labor. Increases in demand cause increases in price. Therefore, a general increase in the demand for labor will cause a general increase in wage rates.
6-7. This is my own either new or independently formulated contribution. I've been avidly reading works and listening to lectures to try to understand the ABCT. It was tough at first, partially because I was trying to foist up price inflation as the dominant element in my understanding of it. It only started making sense when I let that drop and read and listened more carefully; this led me to realize that what the theory was chiefly concerned with was not price inflation but artificial credit expansion and its temporary effect on the interest rate.
Then it all started to click, but still only incompletely. In expositions of the theory, the explanation of the boom phase generally made sense to me, but things would always get muddy concerning how the boom became a bust. Often the explanation would focus on why the bust was, according to capital theory, inevitable, with Hayekian triangles, and Bohm-Bawerkian insights into what the interest rate represents. I in no way doubt the veracity of these analyses, but too often the concrete human motivations and actions that actually embody the turn from boom to bust was left out. Even when those concrete motivations and actions were present, the causal links didn't quite make sense to me. For example, I would often read that workers, after getting their raises in stage 6, would (a.) go out and spend their additional money, and that would bring their savings and consumption back to their normal ratio according to their time preference and that this led to (b.) not enough savings being available to see all the long term projects in stage 4 to their completion. But in everything I've read or listened to, it's never been explained (at least for my understanding) exactly how (a.) leads to (b.). Again, I in no way doubted that it does happen; it seems theoretically necessary. But how?
Then, motivated by the recent post asking for a concise explanation of the ABCT, I started trying to construct the above step-by-step explication. I tried to make it as clear and direct as possible. But, I kept getting stuck at stage 7. I kept asking myself, "what is the bridge from 6 to 8?" Then I thought, "stage 8 is just the opposite of stage 3. Just as an increase in the supply of credit brought about lower interest rates, higher interest rates must come about from either a decrease in the supply of credit or an increase in the demand for credit." Then it finally hit me: the savings-to-consumption ratio is indeed essentially what determines the interest rate, but not immediately so. The concrete human action that embodies the reestablishment of the normal savings--to-consumption ratio is more borrowing. People generally have an income-to-debt ratio they're comfortable with, according to their time preference. If they get a raise, they don't suddenly become more thrifty than before; so they borrow more, generally in proportion to the increase in their wages.
7-8. This increased demand for credit then raises the interest rate, which causes, along with the increased capital goods prices (6b),...
8-9. the long-term projects from stage 4 to no longer be profitable. Boom gives way to bust.
Regarding the 6-7 analysis, I know I could very well be wrong. Or I could be right and silly at the same time, if that was what ABCT scholars were saying all along, and I was just dull to it. In any case, I thought I'd share my thought processes with you, my fellow travelers, who are also trying to teach themselves economics (and political philosophy, history, etc.) as best they can.
I would very much like to hear any comments and corrections you would like to offer.
Sincerely,
Daniel J. Sanchez
Austrian Theory of the Business Cycle in 9 steps (Soliciting comments)
Wrong. What you're describing is a credit cycle. It implies that all the government needs to do is to keep interest rates low. During a boom/bust cycle, the fundamental changes are not in interest rates, but in the productive structure of the economy.
An increase in the money supply does not cause a crisis. If the money supply increased equally across all sectors of the economy, there would not be any malinvestment, only price inflation.
What does cause a crisis is a decrease of the interest rate without an increase in the supply of savings. This decrease in the interest rate has to be funded by having new credit created. This funds special high cost projects. It funds the purchase of machinery, land, factories, houses, apartment buildings, vehicles, and other capital and durable consumer goods. In Austrian terms, durable consumer goods and capital goods are called "higher order goods." This increase in the purchase of higher order goods stimulates the production of said goods. Companies which produce these goods experience higher profits, attract more investors, hire more workers, and raise wages. In essence, they buy up resources which would be used by lower order industries. However, since people's time preferences have not changed or have changed very little, they will consume more than they did before, thereby reallocating their money to lower order industries. These lower order industries (e.g. retail) then experience higher profits and are able to attract more investors, pay higher wages, hire more workers, and bid away resources from higher order industries. This causes higher order industries to be less and less profitable, forcing them to lower wages and/or lay off workers while returning less profits to their investors. Lower profits means less consumption, which then means lower profits for lower order industries which produce consumption (lower order) goods. These lower order industries are then forced to continue the cycle by lowering wages, laying off workers, and returning less profits to their investors. Unemployment increases and consumption falls while the malinvestments made during the boom are liquidated and credit contracts.
Political Atheists Blog
wilderness, thanks so much for taking the time to tackle this.
wilderness:I don't know if malinvestment is to be explicitly considered in the ABCT or not.
At least according to "classical" ABCT it is:
Projects which would not have been thought "profitable" if the rate of interest had not been influenced by the manipulations of the banks, and which, therefore, would not have been undertaken, are nevertheless found "profitable" and can be initiated....
If... the banks decided to halt the expansion of credit in time to prevent the collapse of the currency and if a brake is thus put on the boom, it will quickly be seen that the false impression of "profitability" created by the credit expansion has led to unjustified investments.
(From Mises' "Austrian Theory of the Trade Cycle" Essay)
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wilderness:The malinvestment becomes a drag on individual businesses especially if they grow so large it begins to outweigh what real money (assets or currency) a business actually has to offer in the form of payments on its obligations. For instance, the investment firms, AIG and crowd, over-invested or promised obligatiosn in payments that they could not deliver upon. As long as the market was bringing money into these firms, then the money going out could be equally met. Yet once their overhead became so large they could no longer meet their expanses, then a problem.
There are two distinct forms of bubblelicious malinvestment that the above formulation talks about: (1) the malinvestment from shorter-term to longer-term production processes, and (2) asset bubbles. The overhead you're talking about is increased longer-term investment (my "4a"). Firms will only voluntarily take on more overhead if they think it will eventually pay off. In the case of firms whose profits are not based on the asset bubble, the increased overhead IS the bubble. But the overhead reaching a critical point is not what pops the bubble, except only indirectly. It is only after the chain of events I outline leads to an interest rate hike that the increased overhead becomes unsustainable. It is the interest rate hike that pops their bubble. In the case of firms whose profits were based primarily on the asset bubble, it is not the overhead that is the problem: it's the calamitous drop of the asset prices. These two problems are distinct, but interrelated.
wilderness:These firms sold CD's and insurance (credit-swaps) on these CD's (mortgage investments) and as long as the prices of houses went up, then people made virtual money on these virtual investments. They look good for a portfolio to show worth of a company, but if they were actually paid out in currency, a run on these investments to have them cashed in, the firms promised more than they actually had to give back if investors wanted currency instead of CD's, their credit-swap, etc...
AIG was the one buying, not selling, mortgage-backed securities. Buying an MBS is basically taking over as lender for portions of a bunch of home loans. So as an owner of MBSs, AIG was basically in the home loan business. MBS's aren't bank notes, so the only thing analogous to a run on them would be if everybody started wanting to sell them, and stopped wanting to buy them on the market. This would drive down the value of AIG's MBSs. But that wouldn't really matter if home borrowers continued making their payments. AIG would still be getting a steady stream of principal and interest payments. In fact, they would gleefully buy up even more of the underpriced MBSs. So it's not a problem of people "cashing out", per se. The problem is that the MBSs stopped giving AIG a steady stream of principal and interest payments, because home borrowers weren't making their mortgage payments. Of course if the rest of the market cashes out before AIG does (as really happened), then AIG has a problem, because they'll be forced to sell at a loss, or we'll be forced to bail them out (as really happened). You could say the investments and the money were virtual for the economy as a whole. But the MBSs weren't virtual investments for AIG. And the income they earned and the price they got weren't virtual either. They were real, but risky. If AIG had cashed out in time, somebody else would have been left holding the bag.
Now you're right that they did sell credit-default swaps, and that these were basically insurance policies. AIG's counterparties paid them a steady stream of premium's as long as certain loans (especially home loans) didn't go into default. But if they did default, AIG would have to pay their counterparties large sums (as really happened). Again, here the problem of the "run" isn't really the underlying problem; if everyone flocked out of CDSs, but the underlying loans didn't default, and the counterparties kept paying their premiums, AIG would still be sitting pretty. The underlying problem is not the run: it's the underlying default.
wilderness:Well the Wall Street firms did promise more than they actually had in currency to pay out. Once the investors realize that a lot of people invested especially in these virtuals of CD's and credit-swaps and they also realized these firms could never pay out all the money to all the investors, then there are runs on these virtual accounts (the assets) in the Wall Street firms. No investor wants to be left holding nothing due to a firm going under. It's the same idea as a run on the bank. The Wall Street investment firms promised more than they had.
Regarding investment banks, they took the savings of other people (not so much their own money, like AIG did) and used them to buy MBSs FOR the investors. Just as with AIG's MBSs, the real problem is if the mortgage payments stop coming in, and the MBS value falls as a result. MBSs don't have a face value, like a bank note, so it's not a matter of the investment clients rushing in to get their money "out" of the investment bank before the investment bank runs out. The investment clients get their money "out" of whoever will buy the MBSs they want to unload, not the investment bank itself. The investment bank is just the middle man.
Thanks again.
krazy kaju:An increase in the money supply does not cause a crisis. If the money supply increased equally across all sectors of the economy, there would not be any malinvestment, only price inflation.
Indeed, that's why I wrote this:
The money supply increase in the present system is in the form of bank money. This bank money is made available as new and additional credit.
I know the ABCT is not about David Hume's "Angel Gabriel Scenario", which you describe.
krazy kaju: In Austrian terms, durable consumer goods and capital goods are called "higher order goods."
Consumer goods are, by definition, not higher order, at least not according to Rothbard in MES...
The means to satisfy man’s wants are called goods. These goods are all the objects of economizing action.Such goods may all be classified in either of two categories: (a) they are immediately and directly serviceable in the satisfaction of the actor’s wants, or (b) they may be transformable into directly serviceable goods only at some point in the future—i.e., are indirectly serviceable means. The former are called consumption goods or consumers’ goods or goods of the first order. The latter are called producers’ goods or factors of production or goods of higher order.
... and Mises in Human Action...
Economic goods which in themselves are fitted to satisfy human wants directly and whose serviceableness does not depend on the cooperation of other economic goods, are called consumers' goods or goods of the first order. Means which can satisfy wants only indirectly when complemented by cooperation of other goods are called producers' goods or factors of production or goods of a remoter or higher order.
Since the structure-of-production-only take on the theory doesn't involve consumer goods, it doesn't seem to explain housing bubbles.
Regarding lower interest rates inducing the purchase of more truly higher order goods, that is exactly what I meant when I wrote,
4. (a) Longer Term Investment Increase, and, aided by 2(b), a (b) Sharp Demand for Particular Assets Increase, the first of which causes a general
"Longer Term Investment" implies a lengthening of the chain of production; that is, adding more links (more higher order goods). I didn't want to write that out, because I thought it would be obvious, and I wanted to keep it from getting any more complicated than it already was.
krazy kaju:However, since people's time preferences have not changed or have changed very little, they will consume more than they did before, thereby reallocating their money to lower order industries. These lower order industries (e.g. retail) then experience higher profits and are able to attract more investors, pay higher wages, hire more workers, and bid away resources from higher order industries. This causes higher order industries to be less and less profitable, forcing them to lower wages and/or lay off workers while returning less profits to their investors.
It seems to me that the increase in spending of wage earners would play itself out mostly in price inflation, not in a dramatic shift in the structure of production. Industries that make goods of the first order (retail) get higher profits. They use those higher profits to bid up prices of goods of the second order, giving the industries that produce them higher profits. Those industries in turn use their higher profits to bid up prices of goods of the third order and so on.
Let's say the increased spending of wage-earners gives Wal-Mart higher profits, but not the company that makes the wheels for the toy cars that it sells. Wal-Mart and the Toy Wheel Company both go onto the brick market. Wal-Mart's enhanced purchasing power bids up the price of the bricks. The Toy Wheel Company must pay more for the bricks than it otherwise would have, so it does indeed take a hit. But Wal-Mart takes hits too. First of all, it's not the only retailer that has more purchasing power. So Rite-Aid and Target also bid for the bricks, and the price of bricks rises for retailers too. Of course, considering only this much, they are still much better off than the higher order producers, because the latter don't have the higher profits of the former... YET. I say yet, because Target is not only in the market for bricks with its enhanced purchasing power. It's also in the market for toy cars, as are Toys R Us, Costco, Walgreens, and lots of other retailers who've experienced the same boom as Wal-Mart. So the prices of toy cars get bid up. The toy car companies, flush with profits, then bid up prices on toy wheels. And the poor old Toy Wheel Company eventually gets its higher profits too. Of course they get it later, which means the process does benefit the lower order producers more. But it doesn't seem to be enough of a shift in fortunes to completely explain such a calamitous bust.
Do you think that people, after getting raises, tend to borrow more in absolute terms? For example let's say a spendthrift who always borrows up to the hilt gets a raise. Wouldn't he then borrow up to his new, higher hilt? If so, then wouldn't this create an upward pressure on interest rates? And if so, wouldn't an increased interest rate make production processes which were just barely viable under a previous lower interest rate no longer viable?
I know a sustainable economy is at bottom about there being enough savings to see through the production processes. I just think that the way that fact expresses itself is through the interest rate. If society's average time preference was actually higher, and therefore the wage earners, after getting a raise didn't borrow more, then the interest rate would stay low, justified by the increased savings, and the longer-term investment projects would see fruition. But in the case of artificial credit expansion inducing the interest rate lower, the time preference is most likely not higher. And this will express itself when the interest rates go back up to normal.
I've postulated that the reason why the housing bubble popped was because the homebuyers could not afford their payments. When the homebuyers made their calculations, to see if they could afford the house, they didn't account for such a huge rise in their cost of living (such as, the price of gasoline, food, education, energy, and so on, although not including the mortgage).
To paraphrase Marc Faber: We're all doomed, but that doesn't mean that we can't make money in the process. Rabbi Lapin: "Let's make bricks!" Stephan Kinsella: "Say you and I both want to make a German chocolate cake."
Daniel:I've postulated that the reason why the housing bubble popped was because the homebuyers could not afford their payments. When the homebuyers made their calculations, to see if they could afford the house, they didn't account for such a huge rise in their cost of living (such as, the price of gasoline, food, education, energy, and so on, although not including the mortgage).
I postulated that very same thing a while ago too. But I don't think rise in the cost-of-living was accelerating any more when the bubble burst than it was in the thick of it. The continuous rise in the cost-of-living was fine as long as it was out-paced by the continuous rise in the value of their homes (plus the rise in wages).
I don't think it's a coincidence that the Fed finally started allowing the interest rate to rise around the same time as the housing bubble started to pop. Money was reasserting its value as a means of saving. So the value of houses started to revert to reflect demand for it as a consumption good, without the premium it had as an optimal means of long-term savings.
Daniel J. Sanchez: krazy kaju: In Austrian terms, durable consumer goods and capital goods are called "higher order goods." Consumer goods are, by definition, not higher order, at least not according to Rothbard in MES... The means to satisfy man’s wants are called goods. These goods are all the objects of economizing action.Such goods may all be classified in either of two categories: (a) they are immediately and directly serviceable in the satisfaction of the actor’s wants, or (b) they may be transformable into directly serviceable goods only at some point in the future—i.e., are indirectly serviceable means. The former are called consumption goods or consumers’ goods or goods of the first order. The latter are called producers’ goods or factors of production or goods of higher order. ... and Mises in Human Action... Economic goods which in themselves are fitted to satisfy human wants directly and whose serviceableness does not depend on the cooperation of other economic goods, are called consumers' goods or goods of the first order. Means which can satisfy wants only indirectly when complemented by cooperation of other goods are called producers' goods or factors of production or goods of a remoter or higher order. Since the structure-of-production-only take on the theory doesn't involve consumer goods, it doesn't seem to explain housing bubbles.
Durable Consumer good = part immediately serviceable good + part indirectly serviceable good
The latter requires additional time, the complementary good. A TV, a house, car, etc. are goods that continuously mature into present goods. Their future services are, subjectively speaking, capital goods. Often the more a durable a consumer good, the farther into the future its services will acrue, so that for all intents and purposes it may be called an increasingly higher order good.
De Soto treats this in his book and Hayek spends a lot of time on it in "The Pure Theory of Capital".
Houses, etc., are all explained by the ABCT.
And BTW, none of the above quotes by M & R contradict this. They would certainly agree.
edward_1313: Durable Consumer good = part immediately serviceable good + part indirectly serviceable good The latter requires additional time, the complementary good. A TV, a house, car, etc. are goods that continuously mature into present goods. Their future services are, subjectively speaking, capital goods. Often the more a durable a consumer good, the farther into the future its services will acrue, so that for all intents and purposes it may be called an increasingly higher order good.
Ah, that makes sense. Thank you.
However, it's hard to imagine the housing bubble fitting the picture of producers investing heavily in higher order goods, only to have factors of production bid away from them later. This would mean home owners invested too heavily in the capital good of "house-which-will-mature-into-a-house-in-the-future". Were the factors of production of this process bid away from homeowners, thereby reducing their profits and making the production process non-viable? But once the house is built, the only complementary factors of production necessary for turning the house into a future-house are time and maintenance expenses. Obviously time can't be "bid away", so did housing prices collapse because the homeowners suddenly couldn't afford the basic upkeep of their homes anymore (minimal roofing requirements, etc)? That seems extremely unlikely.
Daniel J. Sanchez: wilderness:These firms sold CD's and insurance (credit-swaps) on these CD's (mortgage investments) and as long as the prices of houses went up, then people made virtual money on these virtual investments. They look good for a portfolio to show worth of a company, but if they were actually paid out in currency, a run on these investments to have them cashed in, the firms promised more than they actually had to give back if investors wanted currency instead of CD's, their credit-swap, etc... AIG was the one buying, not selling, mortgage-backed securities. Buying an MBS is basically taking over as lender for portions of a bunch of home loans. So as an owner of MBSs, AIG was basically in the home loan business. MBS's aren't bank notes, so the only thing analogous to a run on them would be if everybody started wanting to sell them, and stopped wanting to buy them on the market. This would drive down the value of AIG's MBSs. But that wouldn't really matter if home borrowers continued making their payments. AIG would still be getting a steady stream of principal and interest payments. In fact, they would gleefully buy up even more of the underpriced MBSs. So it's not a problem of people "cashing out", per se. The problem is that the MBSs stopped giving AIG a steady stream of principal and interest payments, because home borrowers weren't making their mortgage payments.
AIG was the one buying, not selling, mortgage-backed securities. Buying an MBS is basically taking over as lender for portions of a bunch of home loans. So as an owner of MBSs, AIG was basically in the home loan business. MBS's aren't bank notes, so the only thing analogous to a run on them would be if everybody started wanting to sell them, and stopped wanting to buy them on the market. This would drive down the value of AIG's MBSs. But that wouldn't really matter if home borrowers continued making their payments. AIG would still be getting a steady stream of principal and interest payments. In fact, they would gleefully buy up even more of the underpriced MBSs. So it's not a problem of people "cashing out", per se. The problem is that the MBSs stopped giving AIG a steady stream of principal and interest payments, because home borrowers weren't making their mortgage payments.
Right. That's what I was getting to. And homeowners are not just people that will live in the houses. Also contractors build homes without a buyer to move in. Houses by were I live have been built in a housing development by contractors. They have been for sale for well over 6 months now without buyers. These are also houses kin to those seen torn down in California in that one thread here in the forum. I don't know if the contractors or banks own those houses that are up for sale still. One would think contractors couldn't possibly make monthly mortgage payments on numerous houses they built for months at a time.
Daniel J. Sanchez: Of course if the rest of the market cashes out before AIG does (as really happened), then AIG has a problem, because they'll be forced to sell at a loss, or we'll be forced to bail them out (as really happened).
Of course if the rest of the market cashes out before AIG does (as really happened), then AIG has a problem, because they'll be forced to sell at a loss, or we'll be forced to bail them out (as really happened).
Frannie and Freddie involvement too.
Daniel J. Sanchez: You could say the investments and the money were virtual for the economy as a whole. But the MBSs weren't virtual investments for AIG. And the income they earned and the price they got weren't virtual either. They were real, but risky. If AIG had cashed out in time, somebody else would have been left holding the bag.
You could say the investments and the money were virtual for the economy as a whole. But the MBSs weren't virtual investments for AIG. And the income they earned and the price they got weren't virtual either. They were real, but risky. If AIG had cashed out in time, somebody else would have been left holding the bag.
When I say virtual, I mean real, but I'm saying these types of monies are not hard currencies not even U.S. fiat dollars. They are probably even virtual in the sense they are data bits in a computer cause nobody has the actual cash to put in hand or pocket that these investment firms were dealing with.
Daniel J. Sanchez: Now you're right that they did sell credit-default swaps, and that these were basically insurance policies. AIG's counterparties paid them a steady stream of premium's as long as certain loans (especially home loans) didn't go into default. But if they did default, AIG would have to pay their counterparties large sums (as really happened). Again, here the problem of the "run" isn't really the underlying problem; if everyone flocked out of CDSs, but the underlying loans didn't default, and the counterparties kept paying their premiums, AIG would still be sitting pretty. The underlying problem is not the run: it's the underlying default.
"Mortgage backed securities can be considered to have been in the tens of trillions, if Credit Default Swaps are taken into account."
Thus the "run" I'm referring to is the default occurs and now all these people/investors now want their money. But when obligations and promises on payments to investors are in the tens of trillions no investment firm actually had this money. Just like banks don't actually have all the money they loan out. I'm not saying these are the same type of runs, they are different, but as in all confidence scenarios in economic institutions if they promise to pay more than they have then a run and collapse before all payments to investors is paid out will occur. Thus the government stepped in saying "To big to fail". Also the money reached into the trillions due to the same pool of houses could be speculated upon numerous times. I don't know if this was on CDS or MBS or some other form of Wall Street game.
Daniel J. Sanchez: wilderness:Well the Wall Street firms did promise more than they actually had in currency to pay out. Once the investors realize that a lot of people invested especially in these virtuals of CD's and credit-swaps and they also realized these firms could never pay out all the money to all the investors, then there are runs on these virtual accounts (the assets) in the Wall Street firms. No investor wants to be left holding nothing due to a firm going under. It's the same idea as a run on the bank. The Wall Street investment firms promised more than they had. Regarding investment banks, they took the savings of other people (not so much their own money, like AIG did) and used them to buy MBSs FOR the investors. Just as with AIG's MBSs, the real problem is if the mortgage payments stop coming in, and the MBS value falls as a result. MBSs don't have a face value, like a bank note, so it's not a matter of the investment clients rushing in to get their money "out" of the investment bank before the investment bank runs out. The investment clients get their money "out" of whoever will buy the MBSs they want to unload, not the investment bank itself. The investment bank is just the middle man.
Ah, I see. So a buyer is needed. But then the CDS come into play. And they reached into the trillions. So if an investor had enough CDS coverage, then they could get their money back that way. But the investment firms themselves would need to unload these or fail. But somebody invested and would lose money. The investment firms being the biggest losers. Yet a big loser like Lehman Brothers brought in big wins for AIG cause AIG bet against Lehman Brothers. I believe Goldman Sachs did the same. Yet AIG swelled so big the government won't be able to even keep up with providing zombie assistance. Fiat, the Italian car company, gets subsidized from the Italian government and is trying to get billions of subsidies over a 2-3 year period from Berlin too as part of this take-over deal of Chrysler. So through the back door of Chrysler U.S. government will be bailing it out which trickles to Fiat with gets bailouts currently from Italian government and trying to get some from German government.
Daniel J. Sanchez:However, it's hard to imagine the housing bubble fitting the picture of producers investing heavily in higher order goods, only to have factors of production bid away from them later. This would mean home owners invested too heavily in the capital good of "house-which-will-mature-into-a-house-in-the-future". Were the factors of production of this process bid away from homeowners, thereby reducing their profits and making the production process non-viable? But once the house is built, the only complementary factors of production necessary for turning the house into a future-house are time and maintenance expenses. Obviously time can't be "bid away", so did housing prices collapse because the homeowners suddenly couldn't afford the basic upkeep of their homes anymore (minimal roofing requirements, etc)? That seems extremely unlikely.
They couldn't afford the most basic maintenance requirement - paying the note. The price of interest rose, and those with ARM's could no longer afford them.
The construction companies, and all their beneficiaries, also have a production process that is not in line with consumer desires. Here's a good explanation by Mish in attempt to call out Krugman's Keynesian nonsense.
Check my blog, if you're a loser
Speaking of the human action role in this. This in today's news. Housing permits hitting record low.