Wise Men Say
By Amit Singh | Sunday, March 8th, 2009 | Policy“The laws of gravity cannot be held responsible for people falling in love” –Albert Einstein
Whether you call it a Bailout, Stimulus Package or the War on Reality, the government is struggling to figure out what to do about the economic crisis. The MSM, Dems and many GOP are saying that since the Free Market has failed us that only the Govt can save us now. What they fail to recognize is that the Free Market is working just fine and it is Government Intervention that has failed us and it is Limited Govt that will save us. Many blame deregulation for the housing crisis when in fact it was precisely due to the govt with incentives through Fannie Mae and Freddie Mac coupled with the threat of ACORN lawsuits related to CRA and finally a touch of easy credit available by the Federal Reserve enticing investors who made no downpayments on their properties to simply walk away with foreclosures reducing the value of all the neighboring properties. Of course it is much easier to say “greed” caused the crisis than large govt programs designed to give credit to those who could and should not have qualified.
The politicians want a painless recovery and are willing to “save” millions of jobs deemed strategic by a few bureaucrats. But predictably that is not working either given the last unemployment numbers which are up to 8.1%. So what is the remedy? I would focus on making the US a better environment for businesses, both large and small, because it is not sustainable to grow the size of govt at the expense of the private sector. Fostering private sector growth can include eliminating the corporate income tax, which Jim Gilmore correctly pointed out would be cheaper than the stimulus, and modifying Sarbanes-Oxley so it is not so expensive for businesses to perform their accounting. But part of less regulation is also strongly enforcing the few rules you do have. The Madoffs of the world need to go to “pound them in the @$$” prisons not white collar resorts for a few short years.
Falsely accusing the Free Market to justify increased govt involvement is simply the wrong direction. We need to understand the Free Market for what it is including its innovative abilities through competition and constructive destruction and how govt intervention either through the Fed or large govt programs is the true culprit for our current woes.
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22 Responses to "Wise Men Say"
I can’t find where i read this but ill paraphrase.
Just a thought experiment. Lets assume that over the last year or so the government reacted to our economic crisis with laissez-faire policies. Then lets assume that the unemployment rate, the stock market and GDP all stood where exactly they are today. What percentage of Americans do you suppose would NOT then conclude based on this that our reaction to the crisis failed and that free markets were the cause for the situation getting worse? Can anyone honestly say more then 10%? So why after a year of massive government interventions, which at the very least have been ineffective, do we still call for even more intervention?
“Government intervention creates unintended consequences that lead to calls for further intervention, and so on into a destructive spiral of more and more government control.”
-Ludwig Von Mises
They don’t want us to prosper. The greatest folly one could do is believe that they believe what comes from their mouths. The more power we have over our lives, the less they have over us. Think its time some people try to delve into the study of the sociology of knowledge. I say this as someone who got “gentlemen’s Ds” in classes like finance and accounting but somehow was able to see that Yahoo stock wasn’t worth 300 dollars and that the housing market was going to fall when everyone else was telling me that I was crazy and should buy a house then, If a dummy like me can figure this stuff out, they know damn well what they’re doing. If we didn’t have crises what would we need them for?
To begin, your presntation of the facts, while standard GOP propaganda, are simply wrong.
Fannie Mae and Freddie Mac were not central to the housing crisis – fact is, even if we take your assertions as true (which in themselves are questionable) they fail on the simple basis that these organizations weren’t large enough to create the mess our nation currently enjoys. Did they participate, absolutely. But, the problem was much bigger than Fannie or Freddie, the problem was a system whereby anyone with a Mortgage License could put anything on to an application to get an unqualfied person qualified – and then system move those mortgages along off company A’s books by selling them. Which was easy to do because the credit rating agencies violated their own principles of accounting to rate bundled mortgages – which should have rated junk status – AAA. Then these now AAA rated securities were sold around the world. Hence today trillions of dollars in bad debt owned by banks from Dubai to Shanghai.
Regardless, the real point of your piece is the nature of our relationship to capitalism going forward; in my opinion, and that of many economists, the free market is uncivilized without regulation. It is no different than Hobbes’ opinion that without human civilazation and structure life would be nasty, brutish and short. Human beings are a flawed lot, given free reign their greed, their excesses and their lack of care for their fellow human beings will destroy all that others have worked for – it is only with the civilizing effects of government and the law that we may enjoy the fruits of capitalism. As Cicero wrote, we are slaves to the law so that we may live free – simply put, capitalism is merely a reflection of we human beings who practice capitalism and without sufficient law to guide and moderate it, we may not live free – and the markets may not move freely.
That said, I would argue on your side that we would not need government interference, regulations and laws – if human beings acted morally, with a sense of ethics. Sadly human beings are not worthy of the trust you place in us as the last ten years have demonstrated; there is no moral compass on Wall Street, and moreover, such a compass is more often than not lacking in business transactions. So long as humans are lacking a sense of ethical behavior, the noble ideal of capitalism you would defend will remain an ideal – one which needs to be tempered by laws and regulations.
The funny thing, Mark, is that it was government who encouraged mortgages to people who previously couldn’t afford them or qualify for them. You argue that some government guidance is needed, but acting like the mortgage crisis was a free-market phenomenon is silly.
The free market wouldn’t have allowed these people to get mortgages. They’d be bad risks and the private sector would’ve stayed far away from them.
Government told them to make homeowners out of them. They did, on the idea that even if they couldn’t afford the house, they’d build up quick equity and either re-fi or move to a new house. Aided by yuppie house flippers who rode the market for the upticks, the entire fiasco collapsed.
But make no mistake. It was government’s prodding to make everyone a homeowner that started this mess.
“Sadly human beings are not worthy of the trust you place in us as the last ten years have demonstrated; there is no moral compass on Wall Street, and moreover, such a compass is more often than not lacking in business transactions. So long as humans are lacking a sense of ethical behavior, the noble ideal of capitalism you would defend will remain an ideal – one which needs to be tempered by laws and regulations.”
Government is composed of human beings, is it not? Why do these human being earn your trust? Are they not flawed too? In a free market I can choose who to associate with and who not to, with government I submit to the will of the majority. You mentioned a whole lot of fancy philosophers in your post, let me throw one in. It was either Socrates or Plato that said that “good decisions are found in knowledge not numbers.” I am not a big fan of being collectively punished for bad decisions of numbers.
Just to clarify, even your hard core believers in the Free Market system believe in law and regulation.
The purpose of government is to, “Protect the Individual from Force and from Fraud.” What we have seen here is caused by a lack thereof not because of it.
The government is forcing by threat of legal sanction mortgage companies to invest in hopless causes, sometimes on the basis of political correctness, sometimes as Brian pointed out, the hope that a demonstrated financial failure will gain enough equity and turn their way around.
We also see failures being rewarded by bailouts. We in essence see the rewarding of stupidity and criminality. If the government will bail you out what does that tell those with restraint that are hurting a little but, not bankrupt due to GOOD decisions? It tells them that they are morons for not overspending and taking bad gambles. After all, you’re missing out on all that free government money.
What does the car bailouts tell the taxpayers? Some select groups can engage in suicidal financial strategies and contracts and the taxpayers will be left with the bill and lots of people will lose their jobs.
You’re right we do need laws. We need the government to protect us from force and fraud. What we don’t need is to have government reward fraud with bailouts. What we don’t need is the government forcing entities to enter into obligations that will bankrupt them. Not only has the government NOT done it’s job, it has acted counter to it.
Who will be the next group that is “Too Big To Fail”? We have already trained corporate executives to expect government reward for failure.
mark,
You misunderstand the role of Fannie and Freddie. Maybe that is because most political critiques about all this confuse this problem by placing primary blame on the CRA and other measures that forced affordable housing. Though these did in fact have a role, they were only a small piece of the equation and I wish the conservative talking heads would stop pinning this all on acorn and the community reinvestment act. These were not the primary problem.
Underlying everything was that we had an asset bubble, just like the tech stock bubble, and just like the stock bubble of the 1920s. This was not caused by subprime loans. Most subprime loans were originated from 2005 to 2007, well after the bubble was ongoing, which started ramping up around 2000 to 2001. The subprime part of this was only the last phase of the buildup, when not enough people could afford conventional loans anymore, so the market created more subprime loans to further accommodate the expansion of mortgages.
Therefore, anyone who creates a model for the purpose of describing what happened needs to give an explanation for why the housing bubble happened in the first place. Anyone who tried to create a thesis of the current problem without adressing this fact should immediately be dismissed. Blaming this on a lack of regulation associated with subprime loans does account for the asset bubble. There was no significant change in the regulatory structure over the past decade and in addition independent brokers who securitize mortgages have always existed. Plus, as stated earlier, these subprime loans were the last phase of the buildup, not the root cause. So why did this crisis happen now? Why not years ago? Why has a housing bubble like this never occurred before, when the same lack of regulation was present then also? Blaming this on a lack of regulation is like pouring gasoline on one side of a duplex, lighting a match and then blaming the fact that the other side burned down on the fact that the firewall wasn’t strong enough. Sure, maybe this would have mitigated it somewhat, but its not the root cause of the problem. Don’t light the match in the first place.
This is what happend. Fannie and Freddie are huge. They either own directly or guarantee mortgages that they then resell to investors totaling about 60 percent of the entire mortgage market. We are talking trillions of dollars. Over the last decade, two major things occurred. During and particularly following the tech bubble and its bursting in 2000-2001, the Fed conducted very easy monetary policies. Interest rates fell to record lows, to a negative inflation adjusted rate, and kept it there for years. Another way of looking at this is the money supply as measured by M2 grew at double digit rates for about a decade. What this meant is that there was a huge amount of cheap money available to be lent out, which incentivised more borrowing and leveraging. When the cost of acquiring more funds is low, banks and other financial institutions are incentivized to use it and make loans that otherwise would have not been profitable. In this case, most of these loans ended up occurring in housing, because at the same time of this easy monetary policy, Fannie and Freddie where increasing their leverage my multiples. When they failed their leverage ratios were about 33 to 1, compared to the bank average of 10 to 1. That means the two GSE’s were over three times bigger than banks as a percent of capital. Because these two institutions are so big, that meant literally trillions of dollars in increased mortgage loans. Because the profits were privatized and losses socialized, the natural market regulatory incentives did not function. Investors were willing to channel this cheap money from the fed into housing finance because of this perverse framework. Compounding the problem was that Fannie and Freddie’s mandated “affordable housing” portfolio requirement was upped by the Clinton and Bush administrations from about 15% in the mid 90s to about 45% by the time they failed.
It is this fed/ GSE dynamic which was the primary mover of the bubble. Then once the bubble began to take off, other market participants then jumped on board with “irrational exuberance” with investors, lenders, home buyers, etc all thinking it would never end. This crisis was not the result of “deregulation” (which there wasn’t any. Anyone who makes this claim, I challange them to find me what was deregulated and why that is relivant) or even a lack of regulation. It was the result of central planners at the Fed messing up the efficient price of money (interest rates), so that an efficient market price was never realized in order to allocate capital correctly, mixed with perverse incentives and mandates related to the GSE’s that were the mechanism for channeling this over abundance of money into housing in particular. Far from being a failure of the free market, this was a failure of a planned economy. Unfortunately, the failures of market interventions almost always create calls for even more market interventions. We will only make more problems down the road as we intervene further.
“Government intervention creates unintended consequences that lead to calls for further intervention, and so on into a destructive spiral of more and more government control.”
-Ludwig Von Mises
BK – I see you are buying in/ selling the propaganda. Perhaps you need so badly to believe in the innocence of the system that you are willing to lie to yourself/ others to defend it?
You wrote:
The free market wouldn’t have allowed these people to get mortgages. They’d be bad risks and the private sector would’ve stayed far away from them.
Yet, that is EXACTLY what the free market did. The free market made this work by simply not being responsible for the mortgages they were approving. Banks (WaMu may have been the worst offender), Mortgage Brokers, etc were engaged in terrible practices because they would then move the mortgages along to investors around the world on the belief that when Moodys and the other credit rating agencies (which were receiving legal kick-backs) would not rate an investment AAA if it was actually junk – which it was. Moreover, NO ONE forced anyone to make these loans, to rate them improperly or to buy them as investments – this all happened on the market.
Sorry Brian, the free market failed completely because we made it too free. For the same reasons we need criminal laws to keep humans from raping, murdering and stealing, we need laws and regulation to keep the captialist system – which is nothing more than the sum of its flawed human parts – from stealing, as happened over the past 10 years.
To deny this is to deny the opportunity to learn how to prevent it from happening again.
Mark, if you insist on seeing everything as propaganda, collusion and conspiracy, go live on a freakin’ island with your “Who shot JFK” books.
Mark, the goovernment pushed loans on mortage companies that were bad. In that case the government, the regulators, was part of the problem not the solution. They did not enforce EXISTING laws and regulations. Fraud and misrepresentation are still big no-nos unless the govt. is part and parcel to what is going on.
Yea, EJ made good points about the money supply contributing to cheap money for banks and the temptation to use it. However, that does not excuse mortgage companies just because the Fed and the govt. made something easier to do by manipulating money supply. Then again, the government does not get to ignore current law and standards in order to declare the system broke and nationalize it later. The govt. is not entitled to punish prudent companies and tax payers for not going broke.
One point EJ left out was the why the money supply was jacked up and government spending gone wild. All this stimulating gets to the point of addiction and becomes its own problem. “Stimulating” becomes the way of dealing with real life economic turns and is a false escape from prudent budgeting.
Existing laws should be enforced. Legal action against those that commit fraud and misrepresent should be encouraged. Companies that fail should go bankrupt. What do you say to companies like BB&T that complained about the bailouts. They get punished for being solvent and forced to compete against companies that should have perished.
The government, the regulators did not crack down on misrepresentation of qualifications. The government did everything to encourage bubble growth and tried to reinflate it with intervention. Ever hooked on that stimulating. That shot of coffee in Bush’s first term was what the doctored ordered. Unfortunately, we’ve moved on to cocaine versions of “stimulating”.
If the government did its job, the free market would have punished the reckless behavior and reward the prudent with larger market share. People would have faced legal action and possibly jail. When you get to be “too big to fail” other entities realize that they are also “too big to fail”.
Who will be Amerca’s Next Too Big To Fail?
Who wins the next corporate welfare prize? Wait……you democrats are against corporate welfare right? Or is it just that you have a different preference for who gets that corporate welfare?
In addition to the points that EJ made, localities are also to be blamed for hyper inflated property values. All that stimulating and demand for property yielded associated higher property taxes. Your local governments had big time incentives to keep the bubble going and encourage false growth. They ran with it. Most cities did not bank some of that surplus and refunded precious little back to the taxpayer. They spent credit they didn’t deserve.
I’m starting to become a big fan of Ej’s posts.
Mark, I think you completely missed the point of my post. the Free Market does not make guarantees that everyone will become rich. rather it is a chaotic system where ideas are tested in a variety of methods. some fail, some succeed. the resources used by the failures are reallocated for new ideas or to augment successful ones. the Free Market is not perfect but neither is Nature and trying to affect it causes all those serious problems like Global Warming, etc
Britt Howard,
“However, that does not excuse mortgage companies just because the Fed and the govt. made something easier to do by manipulating money supply. ”
I agree with you and that’s one of the reasons why I don’t support bailouts in general. Many institutions avoided these bad loans and therefore have remained relatively unscathed. They should be the ones that get to grow now in the wake of failed bad institutions.
However, market participants can not be expected to be benevolent; you can only expect them to react to incentives given to them. A market worked because it incentivizes good behavior and punished bad. When this incentive structure is manipulated by government, it no longer works the way it is supposed to.
But it isnt even all about benevolence. Prices are a market signal. Any given price tells all producers and consumers in a given market at what level they should do such things receptively. When the Fed and Fannie/ Freddie made mortgage funding cheap, it makes a lot more mortgages profitable then otherwise would be. So a bank which normally would have only made mortgages at say 7 percent, was now willing to make them at say 5 percent. And at 5 percent, in turn, many more home buyers were willing to by at this lower price price, which means more housing demand. Will more housing demand, house prices go up. So the messed up artificial money pricing incentivized over home buying and over home construction. But because this was a fake and not true market price based on underlying supply and demand fundamentals, it had to come to a an end. The fed started raising interest rates in 2005 and brought it back up to a normal range by 2007 in order to fight inflation. It is not a coincidence that 2005 to 2007 (as the fed increased mortgage prices) was the time when almost all of the subprime loans were made. Due to the bubble created in prior years, people could no longer afford mortgages that were conventional at these higher home prices and now more normal interest rates. So subprime loans were created. And subprime loans are fine as long as home prices keep going up. Homeowners can just refinance and in the worst case scenario if the borrower does default, the bank can foreclose and recover all the money. The problem is, home prices popped with the increased fed interest rates. Now subprime borrowers could not refinance with negative equity and banks could not recoup their money via foreclosure. It’s much like the stock crash of the 1920′s. Many investors borrowed heavily on margin. This works fine as long as stock prices keep going up. It doesnt work if prices go down and that’s what created the first wave of financial institution failures in 1930. Had there not been margin borrowing, yes less institutions would have failed, but there still would have been the bubble bursting causing a bad recession. Same thing here. Even if subprime loans were not here (presumable blocked by regulation, but thats easy to look backward rather then knowing ahead of time what regulation is needed), yes there would have been less financial shocks but the bubble still would have popped causing a recession.
So my point in the end is, this is all about a bubble and how a bubble messes up expectations that cause misalignment of resources. The bubble in turn was created because the pricing structure underlying these assets was manipulated by the Fed and Fannie/ Freddie, which distorted resource allocation creating an unsustainable bubble. Market intervention messed up the very self regulating principles of the market. Anyone who is trying to describe our mess has to be able to explain why the bubble happened in the first place. If anyone’s explanation can not account for this, then they do not have a valid hypothesis. The bubble came before subprime loans which in turn came before the crash. This is what frustrates me is that virtually no one in the media or public debate is dealing with this. And like i said before, i am tired of free market defenders/ conservative talking heads trying to blame all this on ACORN and the CRA. This was a factor in making bad loans. The government incentivized it and even mandated it in many cases. But subprime loans were only the last phase of the buildup, not the root cause.
PS: Im glad you’re beginning to like my responses.
EJ, I’m amazed. you must finally be using spell checker!
to build on your point of fixing prices, the govt restrictions on foreclosures and short selling falls into the same category of artificially propping up prices. without foreclosures, housing prices were artificially high and those who could afford the fair market value were unable to purchase a home. and short selling is another way to correct the market by letting those who are willing to do the research bet against bad companies. it was basically short selling that identified Enron’s house of cards not govt regulation which had basically allowed it. again, the govt intervention is distorting the free market and making things worse
Amit -
On this point we agree, the free market is the best way to get ideas into the marketplace, expand the economy and grow wealth; where we disagree is on the need for government regulation. I argue that the free market is no different than any other human endeavor, tainted with the same greed, corruption and, if you will, original sin, of all humans. You believe that the market will correct itself when confronted with such challenges.
Where I believe you will agree with me is that yes, I believe that the market will correct itself – when all the facts are known to all participants. The problem that has developed is that no one, not even the most educated insiders have the knowledge to make the market work – too much information is hidden (Enron, Madoff, Bank of America, Bear Sterns, Merrill Lynch, etc), and as such your idealized vision of a market free from governmental interference can exist only as that – an ideal.
BK – there is such a thing as truth, and on this issue you are lining up with the UFO-types/ 15% of Americans who believe that Rush is their messiah.
Mark, I just talked to some people on a UFO, and they’re amazed you’ve gone this long without mentioning George W. Bush.
They’re also get tickled when you debate yourself. You say “the market will correct itself” but argued the exact opposite for the entire thread.
Go back into a corner, decide on a position, and then come back and play.
I thought this would be a great opportunity to talk about how wonderful Sarah Palin is.
Oh,……hold on. I must report to the mother ship for an emergency conference.
Britt, they were asking about you. Where ya been?
Bk – I leave the playing with yourself to you
Mark, are you still having sexual thoughts about me. I thought you would’ve gotten over that when you got “married”
Once again you’re confusing your fantasy world with the real one. You’ve really got to stay on your meds.
Mark, your wife says hi.
This is cheap and uncalled for. I don’t condone or find this line of banter amusing for this blog.
Let’s keep it to arguments and not personal attacks.
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