“Why then should capitalism take the blame today–when capitalism doesn’t even exist? Consider the current crisis. The causes are complex, but the driving force is clearly government intervention: the Fed keeping interest rates below the rate of inflation, thus encouraging people to borrow and providing the impetus for a housing bubble; the Community Reinvestment Act, which forces banks to lend money to low-income and poor-credit households; the creation of Fannie Mae and Freddie Mac with government-guaranteed debt leading to artificially low mortgage rates and the illusion that the financial instruments created by bundling them are low risk; government-licensed rating agencies, which gave AAA ratings to mortgage-backed securities, creating a false sense of confidence; deposit insurance and the “too big to fail” doctrine, whose bailout promises have created huge distortions in incentives and risk-taking throughout the financial system; and so on. In the face of this long list, who can say with a straight face that the housing and financial markets were frontiers of “cowboy capitalism”?”
Great article from Mises.org on how absolutely stupid it is to claim that laissez faire caused the credit crisis.
A fundemental rule of sound argument is to define your premises. In this statement, “laissez faire caused the crisis”, one of the premises is that we currently live under a system of laissez faire. This requires a definition of laissez faire, which is seldom given by those making the claim, yet the phrase gets defined de facto in the context of the article in which the statement appears. And it ussually comes to mean completely unleashed free-market capitalism - a definition which would destroy the original statement, since we do not live under such a system.
Russ Harding, former director of Michigan’s Department of Environmental Quality and current director of the Mackinac Center’s Property Rights Network, was invited to Hillsdale College by a group of students who wanted to learn about what’s going in in Michigan with property rights.
After the Kelo decision, Michigan citizens amended the state constitution to strengthen protections for property owners from government use of eminent domain. But, as Russ shared, government isn’t through taking our property. They don’t have to use eminent domain to take the value and use of the property, they can simply and often arbitrarily tell property owners that they cannot use their land. All kinds of crazy (and costly) requirements have been put on citizens for pieces of property deemed “wetlands” that are sometimes no more than a manmade mud puddle. Check out this site for some stories.
Anyway, as Russ spoke I Twittered some highlights, including, “It cost $160,000 more to develop the same restaurant in Michigan than Indiana based solely on regulations”, and this great line by Russ, “I support green belts; I’m just opposed to stealing them.”
When it comes to the financial “crisis” (I still don’t like using that word…it’s an invitation to deprivation) I’ve heard various explanations for what got us here, but most of them go something like this:
“Greed got us into this mess”, or, “Banks were way too leveraged so they could make a buck in the short term”, or, “lenders took advantage of borrowers who didn’t know any better and gave them more loan than they could afford”.
I have several questions in response: When did people all of the sudden become more greedy? Can you give me a date? Did greed suddenly increase in the mid 1990’s? Were people in prior decades not greedy? Is greed a new phenomenon? When did banks all of the sudden decide to become overleveraged? If they could have made all kinds of money being overleveraged before, why did they wait until the mid 1990’s? Why weren’t banks pushing these risky loans long ago?
The obvious answer to all of these questions is the old adage, “there’s nothing new under the sun”. Greed is not new, and people are no more greedy today than they’ve ever been. Banks did not all of the sudden decide to overleverage and start pushing bad loans - to do so would be against their own (greedy) interest, as we now see with many collapsing. If you want to make greed the culprit, you have to also make it the culprit for everything else that happens in the economy, since people are always greedy (or, if you prefer a less pejorative term, self-interested). That means when wages rise, stocks grow, unemployment drops, gas prices go down and poverty shrinks you have to also blame greed. Greed is ever-present, so it’s unfair to only blame it when things go bad but not when things go well. Blaming greed is like blaming gravity.
These childish analysis cannot account for our current financial situation. But what can? Why would banks all of the sudden make overly risky loans? If it wasn’t in their interest to do so before, why now? Because the rules of the game changed.
I’ve blogged on it here before, and there is lots of great analysis elsewhere (look here and here), but the bottom line is Uncle Sam changed the rules of the game by mandating banks to take bigger risks, creating a “moral hazard” by implicitly or explicitly promising to bailout those who failed, and by sending false signals through the market via artificially low interest rates (which induce more lending than real economic productivity would warrant). To summarize, banks and financial institutions behaved in a way counter to their own long-term interest because government made it beneficial and in some instances necessary to do so.
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.
A study by Dr. Michael J. Hicks for the Ball State University Bureau of Business Research finds what economic theory predicts - minimum wage hikes increase unemployment.
The study, released just today, begins with a summary of the findings on the impact of the Federal minimum wage increase enacted in July:
"Our analysis concludes that a 10 percent increase in the minimum wage would result in a roughly 0.19 percent increase in unemployment. Applied to the U.S. labor market in July, this results in a one-time decrease in employment of approximately 160,000 workers."
Who are those workers? Likely those on the very bottom of the economic ladder. Forcing employers to pay them more than thier productivity warrants eliminates an opportunity for them to enter the labor market and improve their value and skills. It essentially cuts of the bottom rung of the economic ladder, letting those who are holding onto it fall.
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.
