One of the sad things about government involvement with anything is that it makes enemies out of people who have no reason to quarrel on a free-market. Take the question of worker compensation. I don’t care what wages other people freely negotiate with their employers, and it’s none of my business. I interact with people everyday who earn various wages; I don’t know, and I don’t care to know what they earn.
Enter government. We often have debates about whether or not public school teachers, for example, are over or underpaid. This is not something any of us are qualified to determine, just as we’re not qualified to decide whether a chemist or an engineer should be paid more. That’s up to the market, which is nothing more than the revealed preferences of millions of freely acting people. But when government takes our money by force (taxation) and decides to spend it we (rightly) feel that we should have some say over the spending, since we are part of a representative government. Hence debates over teacher and other government employee compensation, which tend to divide otherwise amicable parties.
The extent of such debates grows everytime government does. Earlier today I posted a graph illustrating how much employees of the big three make compared to other workers. I didn’t post it because I think I know what wages they deserve, or that I should be deciding who gets what. I never would’ve noticed or posted anything about their wages if they were simply operating privately in the free-market. When they decided to seek my tax dollars however, they became a target for my (and everyone else’s) critique of their business model, spending, compensation, etc.
I have no interest in getting into debates over what wages anyone should be paid. Nor do I have an interest in having my money taken and given to certain businesses, industries, workers or professions against my will. Until the latter stops, it is sadly legitimate to engage in the former.
“[Treasury Secretary Paulson] can inject all the money he wants into the consumer credit market and it isn’t going to make us want to buy cars or use our credit cards.
We did enough of that for a while. More than enough. Too much. And right now, before we spend, spend, spend, we’re going to wait and see if we keep our jobs. [...]
When no one knows how the rules of the game are going to change — and they seem to change from week to week — who wants to take a risk? Who wants to borrow money? Who wants to invest? Business and consumers are hunkering down, waiting for the storm of change to pass.
The problem isn’t liquidity.
It’s uncertainty.
Paulson doesn’t realize that his erratic attempts at creating liquidity are creating the uncertainty that makes liquidity meaningless.”
This clip demonstrates that perhaps a crowd of “uneducated” people will be better at predicting futures than the experts. Intrade, a website which hosts a slue of future markets, has had impressive results. Intrade hosts future markets which are valued between $0.00 and $1.00. $0.00 = 0% while $1.00 = 100%. Users of this website use real money and invest in futures ranging from politics to the predictions of the stock market. An example of a market follows: A market for Barrack Obama to win the presidency was recently on the website. If he were valued at $0.80, that means that the aggregation of people believe Obama has an 80% chance to win the election. This would leave McCain at 20%. Lets say I invest 100 shares in McCain. If he ends up winning (which we now know is false), I would profit $0.80 per share. It’s a neet utility that seems to have some useful applications. Check it out!
The financial bailout was not neccessary. Even if all the big Wall Street banks failed, there would still be people who wanted to lend money and there would still be people who wanted to borrow money. Do you think they would be unable to find each other?
The bailout of the big three is not neccessary either. Even if all three Detroit companies failed the auto sector would still motor on ahead. There are still people who want to buy cars and there are still people who want to make them.
The bailouts are a giant wealth transfer from normal, productive citizens and businesses to businesses who are losing money - because of their own poor decision-making and management. The economy will not be healthy again until we stop rewarding bad companies at the expense of wise and efficient consumers and producers.
I don’t care what the rent-seeking fatcat taxeating grovelling lobbyists from the bailout-hungry big corporations tell you, the world would be better off if we were left to use our own money the way we see best; on the things which bring us the most value.
We need to cut the pigs off at the trough. If we do not, we stand to lose much reasonable, peaceful, voluntary social cooperation and commerce and devolve into a mess of panicked special interests clamoring to please politicians, instead of clamoring to please customers as a free-market would require.
It’s not that complicated; the bailouts are immoral and ineffective.
(Not to mention, bailouts are a distraction from the causes of many of our current economic problems. The same political class who overspent, over regulated, and overinflated the currency is now deflecting attention from these causes and attempting to swoop in as savior and give more of your money to well connected interests, the big three being the most recent.)
Here’s the secret about what’s going on in the economy: nobody knows exactly what’s going on. Not the Fed. Not Congress. Not some high-level hedge fund manager. No one. So while we all know that something is bad, we don’t know why it is bad. But without knowing, is it even a “crisis”?
That’s why I enjoyed Russell Roberts’ editorial in the Wall Stree Journal today, “Don’t Just Do Something. Stand There!” Check it out here.
As Russell shows, there’s the impetus to do something and there are no rules for what should be done. There’s no model that definitively explains everything here, so any plan seems justified.
It could end up as a battle over the narrative. Was it Herbert Hoover that caused the Depression or monetary policy? It seems the most common explanation today is that deregulation caused it. James Gattuso if the Heritage Foundation clearly shows that this is a big lie. The deregulation of anything stopped in the 80s. You can read his piece here.
Sometimes I feel bad for reporters who are charged with producing up to the minute news on the financial world. There are times when there just isn’t anything to say. Take this headline from the AP:
“Stocks fluctuate as investors weigh economy”
Isn’t that kind of like saying, “the market is acting like the market, based on the things that make the market do what it does”? At least the make-news people are simply looking for something to say, whereas the much more dangerous creatures in Washington are always trying to manufacture problems so they have something to do. And it’s never good for us.
The real tragedy of the ongoing financial crisis is not the $700 billion bailout, the moral hazard that will accompany it, or the fact that our children and grandchildren will have to pick up the tab for the irrational spending habits of politicians. Instead, it is the false notion that “deregulation” and capitalism are to blame for where we find ourselves today. The answer isn’t so simple. John Stossel has more:
“It’s deregulation’s fault!”
That’s the conventional explanation for the economic mess.
Barack Obama said, “This is a final verdict on the failed economic policies of the last eight years … that essentially said that we should strip away regulations, consumer protections, let the market run wild, and prosperity would rain down on all of us”.
Is deregulation is the culprit? It can’t be. There was no relevant deregulation in the last 25 years. Meanwhile, highly regulated institutions eagerly bought risky government-guaranteed mortgages, stimulating excessive housing construction and an unsustainable price bubble.
Deregulation wasn’t the problem, and reregulation isn’t the solution.
It’s intuitive to assume that regulation prevents problems, but it’s rarely true. First, how would regulators know what to do? Leaving aside the bias they might have and the brutal fact that regulation is physical force, how can a small group of people understand the workings of a market sufficiently to regulate sensibly? Markets, especially financial markets, are far more complicated than any mind can grasp. They consist of many millions of participants making countless decisions on the basis of unarticulated know-how and intuition. To attempt to regulate such activity requires knowledge no one can possess.
If anyone is interested this looks to be a great event! Details below were sent to me by professor Veryser at the University of Detroit Mercy (a fine place to get a Masters in Econ. I might add!) along with this note on the event:
“The Symposium will emphasize the Austrian School of Economics’s position on the present crisis. It should be mentioned that this school gives the best explanation of the today’s situation. Austrians have been consistently warning about the probability of this crisis because of the tremendous expansion of bank credit in the recent past. This symposium will describe the causes and possible solutions to this meltdown.”
“The American Economy in Crisis”
Saturday, November 1, 2008, 9 a.m. - noon
Macomb University Center
44575 Garfield Road, UC-1
Clinton Township, Michigan
Featured speakers include: Joseph A. Weglarz, senior lecturer at UDM on
“The Winners and the Losers”
Ryan Mackinder, financial associate at Thrivent Financial on
“Capital Based Macro-Economics”
David R. Breuhan, vice president and portfolio manager at Gregory J. Schwartz and Company, Inc. on
“Capital Markets: An Overview”
Harry C. Veryser, senior lecturer at UDM on
“A Program for Monetary Reform”
Paul M. Veryser, vice president of PMA on
“Manufacturing: Requirements for Recovery”
Seating is limited!! RSVP at 313-993-1589.
This event is sponsored by the University of Detroit Mercy, Department of Economics, Macomb University Center, Clinton Township, Michigan and the
UDM Center, Michigan Council on Economic Education
The Failure of Regulation or the Failure to Regulate?
Among the multiple questions that can be asked about the current financial turmoil, this is perhaps the most crucial one. The same issue was raised many times in the past. For instance after the fall of the Berlin wall in 1989, some said that while it showed that the economy in Eastern Europe couldn’t survive at the time, it didn’t prove that communism as a system could not work because its principles had perhaps been misapplied for all these years. This opinion didn’t survive long, however, in view of the successes of the reforms that were taking place in the world at the time (UK, USA, New Zealand, Australia, etc) and the rise of the so-called Washington consensus.
But here we are almost 20 years after the fall of communism in midst of what is perhaps the most serious financial downturn the world has known since the Great Depression. The question comes back again with a vengeance and the voices supporting the failure to regulate view are now pretty loud. See President Sarkozy of France for instance. In the tradition of the populist French right, he is now calling for a “renewal of capitalism” in order to end the abuses of financial speculation. As he put it: “Le marché qui a toujours raison, c’est fini” (the idea that market is always is right is over).
The failure to regulate has also a moral component in this crisis. It is not only the failure to regulate markets because they are prone to failures; it is the idea that society has let highly paid immoral beings prey on the common person (in Main Street). As Dick Meyer on NPR puts it:
"I am now even more firmly convinced that there really is a predator class. The people responsible for creating and bingeing on the mortgage junk bonds, derivatives and financial insurance scams that are now being bailed out are our society’s most educated, highly trained and wealthiest professionals. The Meltdown of ‘08 was not caused by con men, crazed moguls and panicked masses. It was caused by financial bureaucrats of the baby boom generation who were paid megabucks for office jobs, who wear Patagonia fleece, $12,000 Brioni suits and read books about "reinventing the Self.""
While contenders of the free market thought they had lost the battle of implementation but won the battle of ideas, it is now becoming clearer that they lost both. Indeed, if the battle of ideas had been won, fewer voices would now speak against the free market. Instead, central banks are pumping more cash in markets around the world, downward adjustments of prices (and deflation) are seen as the devil, banks are not allowed to fail, and the US government is about to engage in the biggest market intervention it has done since WWII. In 2008 the ideas of the Reagan revolution are dead.
So how do we explain that the problem is the failure of regulation, not the failure to regulate? It is difficult because it goes at the heart of what is proof and truth in economics (i.e. the battle between empiricism and rationalism), but also it seems clear that arguments about market theory are not enough to convince policymakers and the public. One needs more.
Talking to people around me gives me an idea of the type of questions they have. For instance, some think that economists need to be more precise about what ‘regulation’ means, what regulation we are talking about, and why it could have unintended consequences. Some think that regular banks are more regulated than investment banks and are better off. Some don’t understand why standard rules such as prudential capital adequacy requirements are failing. Some believe that the SEC and other organisms lack power to intervene. But most can’t see the role of uncertainty in the system and the limit of knowledge on the part of regulators and actors in the market.
The trouble is that many economic problems are too complex to be understood by non-specialists and thus the public will always be ignorant (this relates to Bryan Caplan’s thesis). Economists have answers that the public won’t listen to or won’t understand. It is a tough job because (free market) economists are permanently caught in some kind of Sisyphean nightmare: called to explain the workings of the market to see their advice ignored over and over again. It’s no wonder why so many decide to become the counselors of the prince.
"In a sense, calling on the government to solve the resulting problem is a bit like putting Charlie Manson in charge of Children Protective Services, or making Lorena Bobbitt the Surgeon General."
From the Shotgun Blog, where they are spending this week celebrating free speech…
People who wholeheartedly support free speech and other social or “civil” liberties often have no problem opposing free markets. Unfortunately for them, social freedom and economic freedom are inexorably intertwined.
If government has the power to regulate economic activity – grant licenses to businesses or tradesmen, regulate accounting practices, implement workplace safety regulations, etc. – then they inevitably have the power to restrict social freedoms, not least of which is free speech.
I have personally met many business owners who have strong opinions on issues, but who would never voice them or fund organizations that advocate their position because they fear having their license revoked, or being denied a permit. These are not stories of people in the former Soviet Union, these are actual everyday citizens the U.S.
In Michigan, the Department of Environmental Quality is particularly troublesome and has extremely broad discretion in granting licenses and stopping businesses from engaging in peaceful activity. They can classify literally any piece of land as a “wetland”, and prohibit development. They can arbitrarily require hundreds of thousands of dollars in changes to septic systems, parking lots, seawalls, and more. Many of these decisions are made entirely by field agents and can be decided by nothing more than his or her mood. Others come from the top of the department down.
Tax laws are also notoriously complex and nearly impossible to comply with. I’ve spoken to accountants who tell me that if ten different accountants ran the typical business tax return they would come up with ten different results. I’ve even been told if the same accountant ran the same return ten times he would likely come up with ten different results. When the laws are this complex, it means that at any given time nearly every citizen is likely to be in violation of some tax law or another. State treasury departments or the IRS, if they really wanted to, could find some way in which everybody was out of compliance.
What does this mean for free speech? It means that at any time government agents or their bosses in the executive or legislative branches can, if they so choose, deny licenses, impose costly requirement and find out of compliance anyone that voices opinions they dislike. This is a reality, not a worst case or slippery slope argument. Thousands of business owners find themselves in trouble with regulatory bodies when they stick their neck out to oppose government. As I said before, I have met dozens of business owners who refuse to get involved in political issues, at least not while they are in the middle of some ridiculously long licensing or inspection process.
Remember that every new regulation on the market is another tool in the chest of those who wish to restrict free speech.
By the Mackinac Center’s own David Littman in today’s Detroit News:
Reject bailout rush to socialism
Fix government ventures, rules that got nation into trouble, not market
David Littmann
Prudent workers, taxpayers and firms are getting the bum’s rush on a massive proposed bailout from panicked politicians who are weeks away from a national election of extraordinary significance.
In this case, a bipartisan group is forcibly trying to eject this country from a market-based, decentralized economic and financial system. Washington, its politicians and armies of regulatory employees are touting another elixir of taxpayer dollars to fix yet another of their colossal fiascos. The proposed federal intervention (up to a $1 trillion bailout of distressed assets and bonus-paying firms) is the antithesis of what the competitive markets of capitalism would permit.
The problem is not the fundamental well-being of our economic system. At midyear, the U.S. economy was still running at growth between 2-3 percent above 2007 levels, even discounting inflation. The national unemployment rate was 6.1 percent, not the 35 percent of the Depression era. The stock market remained higher than the levels of four years earlier.
No, the problem lies with the bursting of the residential housing bubble that developed an irrational price exuberance (except in Michigan) in the wake of the Federal Reserve’s exceptionally easy monetary policies from 2003 to 2006. Economics students understand this axiom: “Loose money policies create tight credit conditions.”
In this case, the tight credit situation — where banks fear lending, and markets no longer supply bonds or equity capital — emerged because of the collapse of the housing bubble and the suicidal regulatory mandates that politicians and their special-interest campaign fund-raisers legislated. And Wall Street’s pursuit of opaque financial derivatives and the credit rating agencies’ complicity in subprime mortgages played a role.
Yet, to cover their corrupting decisions and past complaisance, Washington’s major mouthpieces — from former Federal Reserve Chairman Alan Greenspan and Treasury Secretary Hank Paulson to Senate Banking Committee Chairman Chris Dodd — now say that unless we trust them with a new round of our scarce resources, the U.S. economic system will collapse. This rhetoric is meant to panic us into accepting a new federal steward of our hard-earned dollars.
But when you dissect the palaver, what you see is a bare-knuckled proposal to further centralize federal control over the marketplace of investments and savings. Such a revolutionary move is socialism. It will not simply be a matter of taxing the rich or those with some ability to pay for the purpose of redistributing shelter to the poor. It will represent an institutionalization of financing immoral behavior. Why?
If I take an interest-only loan with the hope and bet that my new mortgage will pay for itself as home prices escalate, it leaves me free to spend, not save, on other things. I have little reason to defer purchases. When housing prices go south, however, I can walk away as if my payments were just rentals and the lender gets back a depreciated asset. Why reward this kind of behavior by either the lender or the borrower?
Considering the incentives that were in place, we now know why so many fellow citizens chose these reckless options. And clearly, Washington does not want you to remember the four ways it has brought us to this unfortunate moment. Let’s review:
• The Community Reinvestment Act (approved in 1977 during the Carter administration) compelled banks and other lenders to loan money and grant mortgages in areas where they would have never dreamed of making such loans because of the exceptional risks of default. Banks were denied charters for growth and geographical expansion if regulators found them to be out of compliance with these politically correct regulations, enforced by the Federal Reserve and others.
• Government-sponsored enterprises (such as Fannie Mae and Freddie Mac) received taxpayer subsidies to provide mortgages and are favored by politicians and regulators with the privilege of maintaining very thin capital reserves as buffers against losses that result from defaulting on delinquent mortgages.
• Insane accounting rules, the Sarbanes-Oxley regulatory regime and Securities and Exchange Commission rules have contributed to the mess, especially the devastating “mark-to-market” requirement. The financial reports of firms and financial organizations must carry assets on their ledgers as though they were forced to sell them immediately into distressed markets, rather than at book value.
This is like requiring people to send wedding or graduation photos of themselves to newspapers while sick with the 24-hour flu rather than pictures of themselves when they are healthy the rest of the year. No wonder the market seized up.
Regulators require that firms go to the market and raise capital when their assets fall below book value, even if it is a paper value, rather than a real loss, that is registered. When hundreds of large and small firms all seek scarce capital at once, the market can’t meet their needs.
• And the Federal Reserve spurred subprime lending by pursuing inflationary money policies that dropped bank-borrowing rates to 1 percent.
To avoid greater government involvement and messes in the future (think Medicare, Medicaid and Social Security), Washington must extricate itself from the market. As real estate prices become more affordable, credit-worthy firms and individuals throughout the nation and world are ready to pounce on bargains that will appreciate.
The government got America into this situation. The solution is simple: Government, get out.
Many Americans today are asking themselves how the economy got to be in such a bad spot.
For years they thought the economy was booming, growth was up, job numbers and productivity were increasing. Yet now we find ourselves in what is shaping up to be one of the most severe economic downturns since the Great Depression.
Unfortunately, the government’s preferred solution to the crisis is the very thing that got us into this mess in the first place: government intervention.
Ever since the 1930s, the federal government has involved itself deeply in housing policy and developed numerous programs to encourage homebuilding and homeownership.
Government-sponsored enterprises Fannie Mae and Freddie Mac were able to obtain a monopoly position in the mortgage market, especially the mortgage-backed securities market, because of the advantages bestowed upon them by the federal government.
Laws passed by Congress such as the Community Reinvestment Act required banks to make loans to previously underserved segments of their communities, thus forcing banks to lend to people who normally would be rejected as bad credit risks.
These governmental measures, combined with the Federal Reserve’s loose monetary policy, led to an unsustainable housing boom. The key measure by which the Fed caused this boom was through the manipulation of interest rates, and the open market operations that accompany this lowering.
When interest rates are lowered to below what the market rate would normally be, as the Federal Reserve has done numerous times throughout this decade, it becomes much cheaper to borrow money. Longer-term and more capital-intensive projects, projects that would be unprofitable at a high interest rate, suddenly become profitable.
Because the boom comes about from an increase in the supply of money and not from demand from consumers, the result is malinvestment, a misallocation of resources into sectors in which there is insufficient demand.
In this case, this manifested itself in overbuilding in real estate. When builders realize they have overbuilt and have too many houses to sell, too many apartments to rent, or too much commercial real estate to lease, they seek to recoup as much of their money as possible, even if it means lowering prices drastically.
This lowering of prices brings the economy back into balance, equalizing supply and demand. This economic adjustment means, however that there are some winners — in this case, those who can again find affordable housing without the need for creative mortgage products, and some losers — builders and other sectors connected to real estate that suffer setbacks.
The government doesn’t like this, however, and undertakes measures to keep prices artificially inflated. This was why the Great Depression was as long and drawn out in this country as it was.
I am afraid that policymakers today have not learned the lesson that prices must adjust to economic reality. The bailout of Fannie and Freddie, the purchase of AIG, and the latest multi-hundred billion dollar Treasury scheme all have one thing in common: They seek to prevent the liquidation of bad debt and worthless assets at market prices, and instead try to prop up those markets and keep those assets trading at prices far in excess of what any buyer would be willing to pay.
Additionally, the government’s actions encourage moral hazard of the worst sort. Now that the precedent has been set, the likelihood of financial institutions to engage in riskier investment schemes is increased, because they now know that an investment position so overextended as to threaten the stability of the financial system will result in a government bailout and purchase of worthless, illiquid assets.
Using trillions of dollars of taxpayer money to purchase illusory short-term security, the government is actually ensuring even greater instability in the financial system in the long term.
The solution to the problem is to end government meddling in the market. Government intervention leads to distortions in the market, and government reacts to each distortion by enacting new laws and regulations, which create their own distortions, and so on ad infinitum.
It is time this process is put to an end. But the government cannot just sit back idly and let the bust occur. It must actively roll back stifling laws and regulations that allowed the boom to form in the first place.
The government must divorce itself of the albatross of Fannie and Freddie, balance and drastically decrease the size of the federal budget, and reduce onerous regulations on banks and credit unions that lead to structural rigidity in the financial sector.
Until the big-government apologists realize the error of their ways, and until vocal free-market advocates act in a manner which buttresses their rhetoric, I am afraid we are headed for a rough ride.
The turmoil in the housing market and the resulting financial crisis is just the latest example of political failure. Politicians wanted more home ownership than the market produces on its own, especially among low-income families. To encourage this politically popular goal, Fannie Mae (nyse: FNM - news - people ) and Freddie Mac (nyse: FRE - news - people ) were allowed to privatize their profits and socialize their losses. At the same time, Housing and Urban Development (HUD) required them to expand their commitment to affordable housing. Freddie and Fannie achieved this goal by buying bundles of subprime mortgages.
Now taxpayers are on the hook for at least $200 billion, and the dominoes are still falling. The real cost of this failure is that the return to housing was artificially inflated, funneling billions of dollars of capital into housing instead of more productive assets.
Politicians and policy makers ignored the essentially organic nature of market forces and assumed that one piece of the market could be altered while everything else remained unchanged. But politicians always think they can design a market from the top down as long as just the right regulations are put in place.
And they will tell us that the right regulations can be put into place to patch things up. Color me skeptical.
