 WHAT’S A FREE MARKETEER TO THINK?
Volume One
September 23, 2008
In response to the federal government’s mammoth new involvement in financial markets, on Monday I invited a number of think tank and other colleagues from around the country and Minnesota to address a purposely free-swinging question: “What’s a free marketeer to think?” We will quickly email and post their columns as they come in over the next few weeks. I trust you will find their views consistently insightful, provocative, and helpful.
These first four pieces are by Jeff Sandefer, a director of both the Texas Public Policy Foundation and National Review magazine; the Rev. Robert A. Sirico, president of the Acton Institute in Michigan; Craig Westover, a senior policy fellow for the Minnesota Free Market Institute; and Devin Foley, director of development for American Experiment.
Many thanks, and as with everything the Center does, I welcome your comments. Mitch Pearlstein
Founder & President
Center of the American Experiment |
A Bailout that Sacrifices Freedom for Dependency
By Jeff Sandefer
Throughout our nation’s history, the size and scope of government has grown by leaps and bounds during times of crisis, financial or otherwise. The political class’ natural instinct is for government to rush to the rescue, particularly when an election is near. The current financial meltdown appears to be no exception, as our government responds with a $700 billion taxpayer-funded bailout that is at best a Band-Aid and at worst a more deadly strain of the same disease.
Rather than punishing taxpayers, an array of smarter options is at the government’s disposal: abandon cheap-money policy; remove financial incentives that make home purchasing so easy for those who don’t yet have the means to own a home; let solvent firms naturally emerge from the mess while firms without sound business models go under, just to name a few.
Many people have played into the hands of big-government apologists by arguing that free markets are "better" because "they work," rather than defending freedom as a fundamental, God-given right for everyone.
I was fortunate to be with Margaret Thatcher once in England when she reminded a group of Americans fretting about a temporary dip in the stock market: "The most important word in the phrase 'free markets' is not the word 'markets.' You cannot justify your freedom based on today's Dow Jones Industrial Average." Her words ring true, as Bush appointees scramble to stoke the engine of our economy by tossing in ever-larger quantities of our tax dollars and freedom.
Charging the Federal Reserve, investment bankers, and politicians to "solve" this crisis is like deputizing arsonists to fight a wildfire. The central enabler is the government, with Wall Street hucksters as eager accomplices. It’s time to let the market sweep away decades of excessive leverage and loose monetary policy.
Worrying about a repeat of the Great Depression is a valid concern. But check out hyperinflation in Germany in the 1930’s, or Zimbabwe in 2008, before you decide that flooding the world in dollars is a better idea. Free from intrusive governmental tinkering, markets will clear soon enough, even if it means many speculators are wiped out.
Pouring in more government dollars into bailouts may rescue a few Wall Street bondholders, but it will only harm the average American. In the end, vesting large amounts of economic power in a few government officials simply is a bad idea. It won’t work any better here than it did in the former Soviet Union. The world economy is too complex to be managed in a top down fashion, even by a Wall Street dealmaker and a Princeton economist.
Benjamin Franklin once warned: “Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety.” The seeds of this problem were sown long ago, and the financial bill will be paid one way or another. The only question is how much freedom Americans will lose in the process. Jeff Sandefer is a member of the board of directors of the Texas Public Policy Foundation and National Review magazine.
September 23, 2008 |
Losses are Part of the Market Process By Robert A. Sirico Consider that people complain about the market economy when there are profits and also when there are losses. But we can't have it both ways. So why aren't those who have complained about the amassing of wealth on Wall Street right now celebrating that toppling of previously invulnerable institutions? Instead, it seems like the critics of the market economy cannot be made happy. Whether people are making money or losing it, they are always ready to denounce the market for ideological reasons and advocate regulation and other forms of state intervention. We should understand a bit more about the source of the problem that emerged in the housing markets and the financial market generally before acting to remedy the current mess. The federal government's monetary system became rather promiscuous in the effort to promote homeownership, offering loose credit conditions through the two quasi-private mortgage holders Freddie Mac and Fannie Mae. It is essential that a free economy tolerate both the profit and the losses that come with this activity. But in the case of Fannie and Freddie, the profits were privatized while the losses were implicitly socialized, that is, born by taxpayers. This sets up a moral hazard. It means that people tolerate more risk than they should because the consequences will be shared. In other words, what we have here is not a free market at work but a subsidized and distorted market, one running on artificial credit and not subject to the same laws of accounting as every other institution in society. The financial events of the last weeks, and really the last months and years, are really market-based responses to earlier interventions in the market process. One has to wonder, then, what the purpose of new regulations would be. After all, were it not for the past regulations, past interventions, we wouldn't be in the fix we are in today. No one is granted any real favor when there is intervention to stop the losses associated with investments gone array. When spokesmen for the Fed and the Treasury Department talk of tens of billions, and even hundreds of billions of dollars for bailouts, we should remember those resources come from the general population in the form of taxes, debt, and inflation. It is impossible to speak of a market economy without remembering that it is also a responsibility economy. That means that people are free to profit, and there is nothing wrong with that. It is the reward for resources well invested and risk prudently taken. At the same time, losses must also be borne by those who take the risks. We need to tolerate both the rich and the situations when the rich are sent away by the winds of change. We also need clean lines of responsibility so that we know who is bearing liabilities for whom. This is the proper juridical framework for a market society. As is often in the case in a crisis, the long-run problem is not the initial crisis but the mistaken response to it. Rev. Robert A. Sirico is president of the Acton Institute in Grand Rapids, Michigan. September 23, 2008 |
The Elephant in the Room
By Craig Westover
When cornered by the media early last week, Senate majority leader Harry Reid warned that a solution to the turmoil in the financial markets wouldn't be forthcoming soon because, "No one knows what to do." A few hours later, Reid and a collection of bureaucratic and congressional cognoscenti emerged from a closed-door meeting knowing exactly what to do – put taxpayers on the hook for Wall Street's debt so bankers and brokers could take a balance sheet "Mulligan."
This economic Yalta for free market advocates – much to the glee of the collectivists among us – is portrayed as the surrender of a free market Republican administration to irrefutable evidence that unfettered capitalism produces economic disaster.
The Wall Street turmoil, as stated in a New York Times article, is "a painful lesson" for evangelists of the free market.
True, there is indeed a painful lesson for free market advocates: Never ask a blind man what an elephant is like.
"This is not a market failure as so many are now claiming," wrote Ed Crane of the Cato Institute. "It is a government failure, pure and simple."
While I agree with Crane's conclusion that government intervention is the problem, the causes of our economic turmoil are not nearly so "pure" and certainly not as "simple" as Crane's disgust (and my own) with damage caused by collectivist philosophy would suggest. Like the six blind men who went to see the elephant, economists, pundits, politicians, war heroes, former community organizers and ex-small town mayors have been feeling up the situation, and not unexpectedly, their assessments of the crisis match the part they happen to be yanking on. What we have here is a problem of knowledge, the inability to see the whole problem. And therein lies the fundamental flaw with the economic mulligan coming out of Washington. Those-who-must-be-obeyed may have a plan that fulfills the collective desire to "do something," but Reid's original assessment is still the most astute – no one knows what to do.
Any plan coming out of Washington is based on dubious assumptions that are taken for granted. It assumes that the gathered officials possess all the relevant information, that their desired objectives are achievable, and that they possess the available means to implement the plan. Given those assumptions, the economic crisis becomes simply a complex puzzle that a bunch of really bright people can solve, given enough money and the coercive power to implement their plan.
But as F.A. Hayek notes as the general case in his essay "The Use of Knowledge in Society," which I am applying to this specific case, the economic problem of society does not have a strictly logical solution. As Hayek explains, "The reason for this is that the 'data' from the which economic calculus starts are never for the whole society 'given' to a single mind which could work out the implications and can never be so given."
Paraphrasing Hayek's general argument, the financial crisis facing our elected and unelected cognoscenti is not simply a problem of how to "adjust" existing market factors to preserve the financial system – if "adjustment" assumes that all relevant information is available to those crafting the adjustment. Rather, it is a problem of how to facilitate the most effective adjustments to the financial system to the benefit of any member of society, "for ends whose relative importance only these individuals know."
The misconception we are dealing with is that government can somehow come up with a solution that will simultaneously punish the wicked, reward the righteous, leave the ignorant blissfully blameless and the rest of us financially intact. The reality is that objective is unobtainable; there is no solution, only trade-offs. And right now armies of lobbyists are clashing on Capitol Hill over just what those trade-offs are going to be.
When battle ends, bodies will be buried and poppies will be planted and victory declared for a "solution" that serves visible collective ends but has only serendipitous connection to the ends important to any individual, of which no bureaucratic planner can ever have complete and timely knowledge, empathy or concern.
We don't need better policy for management and oversight of the financial markets. We do need policy that better facilitates dispersing economic knowledge to those making economic decisions. From the creation of Fannie Mae to passage of the Community Reinvestment Act, government interventions have jammed the economic signals that the market needs to function effectively. They have created moral hazard that breaks the bonds of market discipline and unchains greed and recklessness. We may be blind to the whole cause of the current economic crisis, but government intervention is without a doubt the elephant in the room.
Craig Westover is a contributing columnist to the Opinion page of the St. Paul Pioneer Press and the online news source MinnPost. He is a senior policy fellow at the Minnesota Free Market Institute.
September 23, 2008
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Emperor Paulson? By Devin Foley Examples abound in history when real and perceived crises were used to justify tremendous power grabs. Even in the land of the free and the home of the brave we’ve seen our fair share. Recall the Alien & Sedition Acts signed by President John Adams, FDR’s threat to pack the Supreme Court in the Great Depression, the Japanese internment during WWII, LBJ’s request and Congress’s adoption of the Gulf of Tonkin Resolution, and many others.
Amazingly, we have survived them all with most of our freedoms intact, which is a testament to the Founders’ wisdom and foresight laid out in the Constitution and the character of the American people. Indeed, either Congress or the Supreme Court eventually repudiated each grab for power in the examples just listed.
Today, we are told the Republic faces another crisis. Like Caesar poised to cross the Rubicon, Treasury Secretary Henry Paulson awaits the passage of the $700 billion bailout plan to save the Republic. He points to down markets, portends financial Armageddon, and urges Congress to act quickly to cede him power.
And what are some of the powers Secretary Paulson gives himself in the Bailout Plan? · Power to purchase, on his terms and conditions, mortgage-related assets from potentially any corporation or central bank in the world. (Section 2.a)
· Power to “enter into contracts … without regard to any other provision of law regarding public contracts.” Section 2(b)(2).
· Power to nationalize the entire financial system including banks, insurers, and other financial institutions. Section 2(b)(3). · Power to regulate and set guidance at will for unknown sectors of the economy. Section 2(b)(5). · Power to increase the national debt to $11.3 trillion (Section 10).
All of this is possible with the loosely written language found in the bailout plan. After all, the plan gives the Secretary of the Treasury the power to define the loose terms of the legislation and the actions of the Secretary are not open to review by any courts or any agency. Section 8 of the plan reads, “Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.” What hubris occupies Secretary Paulson that he would write a law removing himself from the judicial review that our Constitution guarantees? Are you comfortable with Secretary Paulson acting on his proposed powers with no oversight by any court or administrative agency? It may seem far-fetched to imagine the following scenarios, but taking many of the proposed sections of the plan to their logical conclusions results in such possibilities and more potentially becoming true. · If you own mortgage-related assets in good standing worth $1 billion, are you comfortable with Secretary Paulson forcibly buying those assets from you for $500 million. Are you comfortable with that act when you have no access to the courts on the matter? · If you have a checking account at a local bank, are you comfortable with Secretary Paulson nationalizing that account and regulating how you can use your money in the account? Are you comfortable with that act when you have no access to the courts on the matter? · Are you comfortable as a taxpayer and an American in bailing out foreign companies and central banks when they funnel their bad debt into foreign-owned, U.S. based corporations? Are you comfortable with that act when the courts have no say on the matter?
Americans, this Bailout Plan, as currently written, is a grave threat to our freedoms, our personal property, and our Republic. Republicans and Democrats, conservatives and liberals, and any and all who believe in the importance of upholding the Constitution and our way of life ought to stop and consider just how much power our elected representatives are considering giving the unelected Secretary of the Treasury and former Goldman Sachs CEO, Henry Paulson. As it stands, the markets are only down 16 percent for the year. That drop has justified an 80 percent ownership of AIG by the United States government and the nationalization of $5 trillion in mortgages, roughly half of the mortgages in America. Additionally, $300 billion was spent on the housing bailout bill, $160 billion on stimulus checks, and $100 billion in loans to institutions such as Bear Stearns and temporary clearing loans to institutions such as Lehman Brothers. Set aside the idea of another bailout that further socializes losses and privatizes profits, remove the partisan blinders, and recognize that we are marching down the road to serfdom at a frightening pace. Come what may, we must not destroy our children’s future by burying the nation in debt and destroying the Constitution in exchange for false promises of financial security provided by one man. We must protect and continue our American Experiment in self-government. If you have not yet read the $700 billion bailout plan, click here. Devin Foley is Director of Development for Center of the American Experiment.
September 23, 2008 |
WHAT’S A FREE MARKETEER TO THINK?
Volume Two
September 24, 2008
In response to the federal government’s massive new involvement in financial markets, on Monday I invited a number of think tank and other colleagues from around the country and Minnesota to address a purposely free-swinging question: “What’s a free marketeer to think?”
We published four pronto columns yesterday and here, in what might be described as Volume Two, are four more by former Minnesota congressman and current Brookings Institution scholar Bill Frenzel; Shannon Goessling, president of the Southeastern Legal Foundation in Atlanta; Larry Reed, president of the Foundation for Economic Education in New York; and Devin Foley, American Experiment’s director of development. We will continue disseminating incisive pieces likes these as we receive them over the next two weeks. Many thanks, and needless to say, I welcome your comments. Mitch Pearlstein
Founder & President
Center of the American Experiment |
No Democracy will Allow its Economy to Implode
By Bill Frenzel Our credit markets are in shambles. Few Americans comprehend the reasons for the system’s failure, but nearly everybody understands that it is “broke.” Ironically, a country renowned for devotion to free markets now seems to require the government to “save” those markets.
The Bush Administration, led by the Secretary of the Treasury and the Chairman of the Federal Reserve Board, is asking Congress to enact a $700 billion rescue plan. There is heavy resistance. But, after much complaint and criticism, and the addition of its own “improvements,” Congress will probably agree to some version of the proposal.
Purists and populists alike bewail the plan. A government solution is usually a wrong solution. The greedy risk-takers should not be protected. Every other loser in the country will insist on salvation, too. Even those who have lost nothing will demand much.
Whenever the government meddles in the marketplace, whether in crisis or to respond to criminal behavior, it tends to go too far. There is always an urge to overdo the relief, or to reward an unworthy class, or to lay on too much burdensome regulation.
The critics, many of them conservatives, are dead right. A free market system should require that mistakes be corrected, and paid for, in the marketplace. The problem is, however, that no democracy will allow its government to stand idly by while its economy implodes. Most people would devoutly hope that the government would not have to intervene. But when the panic strikes, the people can usually be counted upon to demand government interference.
A basic question policy-makers need to ask and answer is this: How bad is it? If the crisis can be weathered without major damage to the economy, the urge to meddle should be restrained.
Cases for restraint would include the Chrysler and New York City loans of the 1970s, specific industry requests like the current auto industry loans, and the never-ending demands for protectionism. The economy can withstand the loss of a couple of big companies which made mistakes.
But when the whole financial system begins to crumble, the government is driven to respond. Failure to act means punishing everybody, probably for a very long time, until the system is rebuilt.
Another basic question: Whose rescue plan is to be used? When the government is poised to meddle, the time-tested rule is don’t let Congress lead. If the Executive Branch does not lead, Congress will. With Congress in charge, the rescue becomes a bidding match to shower benefits on favored constituencies. Everybody gets paid off with someone else’s money.
The good news here is that there are some successful modern precedents. Two of them are Long-Term Capital Management and Continental Illinois Bank. Those rescues were swift and successful. The system was protected and the economy hardly burped.
More to the point is the case of the Resolution Trust Corporation, a five-year rescue operation of the early 1990s. Savings and loan firms were beginning to fail in significant numbers. The financial system appeared to be at risk.
RTC was successful. Its operations shored up the system. Many S & Ls failed, but most survived. Best of all, RTC left the taxpayers about as well off as they were before its creation. Its success, and reductions from Cold War Defense spending levels, helped put the U.S. budget in the black in the mid-‘90s.
No two crises are the same. The S & L meltdown, we are told, was only half as difficult as today’s problem. Different situations require different solutions. No one can be sure that the Paulson-Bernanke rescue plan will work like the RTC did, but experts assure us the problem is serious.
So how does this free marketeer react to the Paulson-Bernanke rescue operation? He wishes that they had not been obliged to propose it. He is grateful that they waited long enough to be sure the crisis was real. Believing that it is, he is equally grateful that they have finally moved toward a solution they believe is adequate.
He prefers an executive branch plan over a legislative branch plan, and hopes Congress does not “water up” the administration’s proposal by adding pay-offs for favored constituencies. Or, more realistically, he hopes congressional add-on costs and regulations can be limited in scope.
Finally, he hopes that our fabulously successful market system will infrequently require future interventions and that the marketplace will be able to exact its own punishment for incompetence and greed.
He has regrets but no illusions about government intervention into the private marketplace. It will happen again, and often. We simply have to do our best to manage it carefully.
Bill Frenzel is a guest scholar at the Brookings Institution and a former Member of Congress from Minnesota who voted against federal loans to Chrysler and New York City in the 1970s.
September 24, 2008 |
Gold. Solid as a Rock
By Shannon L. Goessling The underlying strengths of our economy, and the creative power of our people, are testament to the adage, “The business of America is business.” American commerce and industry – along with the world-sustaining entrepreneurial class – is now held hostage to a Government-Finance cartel dictating the future of our Republic This week, the world responded with a resounding NO when the $700 billion-plus bailout plan was announced – the dollar sank, commodities flew off the charts, and foreign banks threatened to stop funding the U.S. deficit. Doing “something” is not necessarily better than doing nothing, at least when the public fisc is at stake. The evidence is in: the leveraged fiat money system has run its course, and it cannot be sustained.
A startling and seriously underreported statement came from the world’s largest purchaser of U.S. dollars. "The U.S. dollar is no longer a stable anchor in the global financial system, nor is it likely to become one," said Fan Gang, a member of the Monetary Policy Committee of the Chinese central bank and director of the National Economic Research Institute. "Thus it is time to look for alternatives." Who do we think services our national debt? It’s not American free enterprise.
If the assets of Main Street are on the table, then let’s make “the people’s dollar” – the world’s reserve currency (at least for now!) and the “oil” that runs the global economy – an asset that matters. The “full faith and credit” of the American people means that this nation’s real assets, not just our ability to be taxed indefinitely and exponentially, should back our currency – precious metals, a commodities basket, or other alternative that demonstrates that the true wealth of this nation is not in its ability to print and loan and borrow leveraged money, but rather in our shared value as an industrious, innovative, and productive nation. Think it’s just not done anymore? It’s too old-fashioned? Ask the more than 40 nations who have moved back to the gold standard, including and especially Switzerland, which never left the gold standard. Solid as a rock.
The results would be nearly immediate – a refloated, revalued U.S. dollar backed by tangible assets will stave off inflationary pressures and avoid the boom and bust cycles we’ve experienced, and will once again make our markets attractive to essential foreign investment. The United States simply cannot be the world’s marketplace if the currency representing our productivity is degraded and debased, as we are currently witnessing.
American freedom, independence, and strength are at risk – this is truly a “once in a lifetime” crisis that begs for the right actions, not reactive maneuvers that fail to address the real danger. And certainly not actions that result in outright government ownership of a significant percentage of our economy.
Shannon L. Goessling is executive director and chief legal counsel of the Southeastern Legal Foundation headquartered in Atlanta.
September 24, 2008 |
Not So Fast!
By Lawrence W. Reed
“Thank God we had the federal government last week to bail out the private sector!”
That’s what a rather statist friend of mine declared, almost gleeful that the financial crisis seemed to be proving how much we all need a massive federal establishment to both regulate and rescue us.
Never mind the federal government’s own indispensable role as an enabler in the crisis, from its reckless monetary policy to its jawboning banks to make dubious mortgage loans. Never mind the long-term danger of its assumption of colossal new obligations and the moral hazard in the message its intervention sends. My response to my friend was of a more narrow focus. “Thank God we have the private sector to bail out the federal government not just last week, but EVERY week!”
Think about it. Taxes on the private sector pay a majority of the federal government’s bills. For most of the rest, the government borrows by selling its debt obligations mostly to private sector entities—including banks, insurance companies, and individuals.
The federal government is the world’s biggest taxer and the world’s biggest debtor. If those of us in the private sector didn’t pay our taxes or didn’t buy Washington’s paper, the feds would have gone belly-up decades ago. We’ve rescued Washington to the tune of about $10 trillion and rising. A big difference between Washington bailing out the private sector and the private sector bailing out Washington is that the private sector has to work, invest, employ people and produce goods to come up with the cash. It can’t print it like Ben Bernanke can.
Our friends in Washington have blessed us with future burdens almost too astronomical to comprehend. In the name of taking care of us in our old age, we are saddled with no less than $6 trillion in Social Security payouts over the next 75 years for which there are no presently earmarked funding streams. The unfunded obligations for the new federal prescription drug program, enacted under President Bush, according to Brian Riedl of the Heritage Foundation, total another $8 trillion. On and on it goes. The private sector has an awful lot of bailing out to do in coming decades.
If you have any doubts about the role played in the present crisis by the very federal government now posturing as our rescuer, take a look at this article from the September 30, 1999 edition of The New York Times: http://tinyurl.com/3jdn9e. And then contemplate how deeply we taxpayers will have to dig in the not-too-distant future to pay the bills of our benevolent, compassionate and forward-thinking government.
Lawrence W. Reed is president of the Foundation for Economic Education in Irvington-on-Hudson, New York (www.fee.org) and president emeritus of the Mackinac Center for Public Policy in Midland, Michigan.
September 24, 2008 |
Distorting the Very Idea of Free Markets By Devin Foley
We may or we may not be at the brink of Great Depression 2.0. Whether we are or not, the crisis will likely worsen in coming weeks and through it all, the death knell for markets, particularly of the free variety, will be sounded.
We’re already hearing how markets have failed, how greed overtook the country, and how deregulation and free market ideology are to blame. The solution? Almost always more government control.
Unfortunately, over the past few decades many policy wonks, public leaders, and politicians have claimed the ideas of free markets as their own, all the while increasing the size, scope, and budget of government. They paid lip service to the ideas, but in few ways did they actually work toward implementing the ideas. In doing so, the very definition of free markets has been distorted making public debate about whether or not markets are failing, especially free markets, terribly difficult in this present crisis.
Let’s clear things up a bit.
Are “free markets” to blame for this mess? Simply put, no. A market is basically an individual or corporation trading something of value for something else of value with another individual or corporation. A free market would be one in which the exchange is free of government regulation or manipulation. Try and think of something that isn’t somehow regulated by the government. It’s hard to do because free markets do not exist in America and have not for a very long time, if ever.
So what about markets in general? Did they fail? Are they to blame for all of this mess? Again, the answers are no. What you are seeing is the failure of government and the power of the market. Try as the government might, it simply cannot suppress the invisible hand of the market. One way or another, the invisible hand will sort things out to determine the real value of stocks, goods, houses, labor, and anything else of value.
If you walk into a grocery store to buy some apples and find that apples are $10 a pound, are you going to buy? Probably not. Is that a failure of the market? No. It simply means that the grocery store overpriced apples. So if the grocery store crashes the price of apples to something more reasonable like $3 a pound, are you going to buy? Probably. Did the market fail because the price came down? Absolutely not.
It’s the same thing for stocks and houses.
Last week Treasury Secretary Henry Paulson said, “Let me step back a bit and provide a little perspective. As I've long said, the housing correction is at the root of the challenges facing our markets and our financial institutions.”
I disagree. The root of the challenges facing our markets and our financial institutions is the government-sponsored credit binge.
Under Alan Greenspan’s leadership, the Federal Reserve opened the spigot to easy money and the country drank deeply. Money was printed and credit was made available to the banks. The banks naturally took their cut and then passed the credit on to their customers in the form of easy-to-get loans of all sorts. The customers then went out and bought houses, cars, TVs, vacations, and all manner of consumption goods. We were drunk on credit.
All of this easy credit inflated asset prices, kept the economy growing, and thoroughly indebted the country. Home prices climbed to unsustainable levels in every housing market around the country. And how do we know house prices climbed too high? We know, because the markets worked and the housing bubble popped. Just like the overpriced bag of apples at $10 a pound, the overpriced houses are coming down in price.
Sadly, now that our country and many of its people are up to their eyeballs in debt there isn’t a lot of cushion for an economic slowdown and so there isn’t a lot of tolerance for pain. Instead of taking the pain and working through the debt hangover, in a panic the government is now proposing we drink a new, credit-induced bailout to forget about our problems.
The cure for too much debt is not more debt. The cure for this problem is to free the markets, set a responsible monetary policy, and let the chips fall where they may. If we do not confront the problem now and deal with it like adults, the government’s actions will push us into a great depression, just like in 1929.
Devin Foley is director of development for Center of the American Experiment.
September 24, 2008 |
WHAT’S A FREE MARKETEER TO THINK?
Volume Three
September 26, 2008
In light of the ongoing financial crisis, on Monday of this week (September 22), I invited think tank and other colleagues from around Minnesota and the nation to address a purposely free-wheeling question: “What’s a free marketeer to think?”
We published four quick-turnaround columns in Volume One on Tuesday, another four in Volume Two on Wednesday, and we’re pleased to broadly disseminate six more in Volume Three today by David Himebrook of Arbor Capital Management in Minneapolis; Randall Holcombe of the James Madison Institute in Tallahassee, Florida; John Hay, formerly of the Prudential Life Insurance Company of America; Jake Haulk of the Allegheny Institute in Pittsburgh; Tom Schock of Capital Growth Real Estate in St. Paul; and Gordon Anderson of the Professors World Peace Academy, also in St. Paul.
Please note most of these columns were written just before the White House and congressional leaders reached their tentative – and then dashed – agreement on Wednesday night (September 24). We will continue publishing creative and important pieces like these as we receive them over the next ten days or so.
Many thanks, and as always, I welcome your comments.
Mitch Pearlstein
Founder & President
Center of the American Experiment
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“Much Like the War Bonds of the 1940s”
By David Himebrook I begin with the assumptions that a bailout of some sort is necessary and that $700 billion is the correct amount needed to stabilize the system. The current alternatives being discussed are considered government bailouts. They would be more accurately described as taxpayer bailouts under which the taxpayers have nothing to show for their participation other than a functioning financial system. My proposal calls for a government "facilitated" indirect program to be funded primarily by the American tax-paying public.
In general it would work as follows. The Federal Reserve would purchase the securities in a manner consistent with existing plans. All securities would be placed in a pooled structure. All taxpayers would then be able to purchase units of the pool at the price consistent with that paid by the Federal Reserve. These units would be marketed much like the "war" bonds of the 1940's to finance the war of survival for our financial system. A patriotic duty to participate.
In order to enhance the attractiveness of this investment the government would allow a one-time contribution of up to $100,000 per taxpayer to a tax-free, IRA-like account to fund the purchases. These contributions would be fully deductible for federal tax purposes over five years without restriction.
These securities would be hold-to-maturity in nature with the only cash flows coming from collections of the underlying pooled securities.
If only the top 5 percent of taxpayers participated to the full extent the program would be nearly 100 percent privately funded. It would be hoped that taxpayers at all levels would participate giving them a feeling of direct participation in the solution and an improved national savings rate.
Under this proposal the opponents who claim the government is bailing out "Wall Street" would lose standing as most funding would be private and voluntary. For those who think the government actually stands to profit from the ultimate collection of these securities, this plan would allow those profits to flow through directly to those individuals who contributed to the solution in direct proportion to their contribution. For those who think individuals wouldn't buy these worthless securities, let them know that we the taxpayers are buying them under any solution, the only difference being whether or not we have something to show for our purchase. If the securities prove worthless then that loss will be born by those who made a voluntary decision to participate.
From the government perspective, the forgone tax revenue on the IRA-like contributions seems to be a small concession for a direct funding by U.S. citizens.
Let’s recognize some bailout is necessary and try to structure it in an optimal fashion that is not just lose/lose for the taxpayer. The appropriate pricing for the “junk” securities from the financial industry remains an issue but no more so under this proposal than under others.
David Himebrook is a partner with Arbor Capital Management in Minneapolis.
September 26, 2008 |
Government Actions Encouraged
Wall Street's Risky Business
By Randall G. Holcombe Many observers blame the current financial crisis on a breakdown of private markets. A more careful look shows that government policy, step by step, led to the current crisis.
First, Fannie Mae and Freddie Mac were created to help provide mortgages for people who didn’t qualify for conventional mortgages. As government-sponsored enterprises (GSE), they rapidly grew to where their debt was nearly half the size of the federal government’s debt.
As long as housing prices rose, they could handle their debt. When prices fell, they rapidly became insolvent. This wasn’t a surprise. Experts had warned that they might collapse, but low-interest loans to poorly qualified buyers were too popular for Congress to rein in those lenders.
In part their popularity was due to the mortgages, but it was also because the GSEs used profits generated from their favored status in the “market” to make campaign contributions and offer high-paying jobs to congressional staffers. They purchased political support.
A related problem began with the Community Reinvestment Act (CRA) of 1977. If lenders wanted to expand their lending, they had to balance their loans to financially secure buyers with loans to buyers who did not meet the conventional mortgage criteria.
The push to extend mortgages to less qualified buyers was amplified by the Home Mortgage Disclosure Act (HMDA), passed in 1975 and expanded in 1991 to require lenders to report rejection rates by race. Lenders were put on notice that their lending practices would be examined for evidence of bias, with violators facing the possibility of fines as high as $500,000.
The CRA was broadened in 1995, allowing the securitization of sub-prime mortgage loans. Securitization combines a large number of loans into a security that can then be sold. The idea was that while some loans might default, most would not, so the securities would spread the risk and make it safe to hold portfolios of sub-prime loans.
An obvious drawback is that the originating lenders had little incentive to consider mortgages’ long-term prospects because the loans are held only a short time before they’re sold off and securitized.
A third factor in this crisis was easy-money policy adopted by the Federal Reserve Bank early in the decade to mitigate the effects of an incipient recession exacerbated by the after-effects of the September 11, 2001 terrorist attacks.
Low rates meant lower-cost mortgages, further enabling people to buy houses. But the increased demand pushed prices up, and many buyers wouldn’t have qualified for mortgages except for the relaxed standards.
Worse, many borrowers used variable-rate mortgages. The idea was that in a rising housing market, owners who couldn’t afford to refinance if the rates rose could always sell and turn a profit.
As long as interest rates remained low and housing prices rose, the problems were hidden. From 2004 to 2006, however, the Fed boosted the Federal Funds rate to 5.25 percent, pushing up mortgage rates and bringing the artificial housing boom to an end.
Those mortgage-backed securities, so attractive when interest rates were low and housing prices were rising, lost their luster quite abruptly when conditions changed. Firms that held lots of them found themselves in trouble. AIG, which insured such mortgages, foundered and was effectively nationalized.
The current crisis has two root causes. First, the federal government tried to extend home ownership to people who formerly wouldn’t have qualified for mortgages. This vastly increased the risk, which was hidden because mortgages were quickly resold, bundled, and “securitized.” Second, the Fed’s artificially low interest rates enabled the mortgage-backed security market to grow rapidly.
So government policy, not the free market, created much of the current financial crisis. Market participants aren’t blameless, however. Nobody forced Wall Street’s large investment banks to take big risks. They willingly accepted such risks in pursuit of bigger profits.
Why should the government now support the firms that made risky bets and lost? To do so would forever change our financial markets, which can work only if firms that accept risk in the pursuit of profit also suffer the loss if the market turns against them.
To bail out firms that made risky bets and lost would mean, at best, supporting managed capitalism and, at worst, the nationalization of financial markets. The long-term harm would far exceed any short-term financial stability a bailout might bring.
Randall G. Holcombe is DeVoe Moore Professor of Economics at Florida State University and Senior Fellow of the James Madison Institute in Tallahassee.
September 26, 2008 |
No Returning to Capitalism as We Have Known It
By John Hay I’m truly a "Free Marketeer." A graduate of the Wharton School at Penn and a retired vice president of the what used to be known as the world's 'largest and greatest" insurance company, a "mighty pump" (as Fortune magazine then characterized it), whose money pump helped to drive the economy back in the 1950s and ‘60s – the Prudential Insurance Company of America, as it was known then. That grand prominence, of course, has been diminished, though Prudential Financial is still very much a great company and has been holding up pretty well under the current onslaught.
What's happened within our capitalistic economy over the past couple of weeks was inevitable, almost prophetic, had we but been able to read the tea leaves. How could it have progressed in any other way?
We now have almost three generations of citizens who have experienced few, if any, remarkable economic hardships in their lives. Nothing has been so serious as to keep them from the shopping malls. No one in government has asked them for any sacrifices through the Vietnam and Iraq wars. And everyone in government has told them they can have it all, regardless of the consequences. Indeed, there would be no consequences. Just keep consuming, and we will be OK.
Interest rates were so low (and relatively speaking, still are) that money was almost free. It was loaned, and then traded creatively on secondary markets, with abandon. Almost any Joe or Jane could qualify for any kind of a loan. Extraordinarily obscene amounts of money were being made on Wall Street, by people of just ordinary talents. But we now all know that sordid story. Now the markers are being called in, and we're about to pay the piper.
Enter the politicians! Inevitable. Like vultures circling far above a wounded animal, waiting for it to die before they pounce and pick at the carcass. The two presidential candidates know absolutely nothing about economics and can't even begin to understand the current problems, but, of course, that doesn't keep them from mouthing off. Fire Cox! Yeah, right. No doubt, that will take care of everything. And Nancy Pelosi, Harry Reid, Chris Dodd, and Barney Frank will inevitably agree before this week is out to Hank Paulson's and Ben Bernanke's $700 billion bailout "solution." But not before making Paulson and Bernanke sweat before the TV cameras. And not before taking the stage themselves and pontificating their righteous and populous views before the American people. Quite a show, if the consequences were not so terribly serious.
It's now far too late to let the financial markets sort this out. The American people are now used to, and indeed demand, instant fixes. Entitlements have now become, well . . . entitlements. Rescue me from my ill-considered decisions. Put these CEOs in jail (where, of course, some of them probably deserve to be!). But, above all, make me whole. Make this all go away, and do it quickly. And, as a small business owner, what are you now going to do for me? You're taking care of the big guys, and I want my share. And then there's Ford and Chrysler and GM, ad infinitum.
After Congress acts this week, there will be no returning to capitalism as we have known it. I'm afraid the march to ever-increasing government meddling has taken one giant step forward, never to look back. Hey, you can't spend $700 billion of taxpayers' money without the Democrats (and some Republicans) extracting a quid pro quo. FDR is looking more conservative every day!
John Hay is a retired executive with the Prudential Insurance Company of America.
September 26, 2008 |
Hayek was Right
By Jake Haulk
In yet another verification of the Hayekian warning that government involvement in the marketplace begets more government involvement, we now face the mother of all financial market bailouts, putatively to prevent a credit market collapse of economy-endangering proportion. The bailout is needed to counter the consequences of the granddaddy of government interventions in the economy. Beginning with the Community Reinvestment Act, it moved on to the congressionally forced conversion of Fannie Mae and Freddie Mac into buyers and sellers of junk mortgage paper. And now the toxicity of the colossal volume of subprime loans and the securities they back has spread like flesh eating bacteria through the financial world.
So far this year the Federal government and the Federal Reserve arranged for and assisted in a buyer takeover and bail-out of Bear Stearns; arranged a $300 billion program to help banks and homeowners in foreclosure or danger of foreclosure; created an open-ended credit line for Freddie Mac and Fannie Mae; made a loan of $85 billion to AIG; and now has recently placed Fannie Mae and Freddie Mac in conservatorship.
Despite these heroic efforts to shore up the nation’s confidence in financial markets, it has now become necessary to launch a staggering $700 billion program to buy up the ever-growing stack of bad mortgage paper and the securities they back. As of this writing, the final details are not in place and we do not know if $700 billion will be enough. And little wonder. Together Freddie and Fannie have $5.4 trillion in guaranteed mortgage backed securities and debt – about the same figure as the publicly held national debt. What’s worse they are still in business, still acquiring more loans and mortgage-backed securities.
Free marketeers have long since warned against the intrusion of government into the economy, especially the intrusions that create market distortions and moral hazards. These intrusions cause people and businesses to make misguided decisions and engage in hyper-risky behavior they would not contemplate absent the government’s promise to prevent their suffering any serious consequences for bad decisions.
Unfortunately, these warnings have not only gone unheeded, they have been totally ignored. So, all things considered, there is not much free marketeers can learn from another episode that merely confirms what they have confidently predicted would happen.
There is one new and frightening twist in this latest calamity. It has become obvious that most of the major media are completely in the tank for Obama and will report nothing that might harm his chances to be elected, including his ties to Jim Johnson and Franklin Raines, both of whom played major roles at Fannie Mae. Nor is there any mention of his being the biggest recipient of Fannie Mae contributions over the last three years. Neither will the liberal media begin to point out, as Fox News has done, the perfidy and complicity of Democratic senators and congressmen in creating the mess that Freddie Mac and Fannie Mae have become, refusing even to allow corrective legislation on a number of occasions when it was clear that the two behemoths were about to go careening off the tracks. The media have to protect those miscreants as part of the protect Obama effort. And besides, they’re in bed politically with the liberal Democrat agenda anyway.
So what we have learned to our great horror and dismay is that liberal media and some legislators have no real concern about the underlying institutional infrastructure of the United States and are willing to undermine it, even at enormous risk to the nation, if it is necessary in order to promote their selfish political goals. They will get away with it because the Bush administration failed to draw a line in the sand five years ago and say this will not be allowed to happen on our watch. And they will get away with it because as long as the American people cannot get the truth from the major media, a large number of them will continue blindly believing that it was all Wall Street greed that created the mess and Wall Street, as they all know, is a bunch of Bush-loving Republicans. Yet another media created untruth.
That’s what one free marketeer thinks.
Jake Haulk is president of the Allegheny Institute in Pittsburgh.
September 26, 2008
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Same Fix as with Failed Savings & Loans
By Tom C. Schock Our best course of action likely would be to handle this debacle as was done with the failed Savings & Loans: Sell the loans for market value and then, due to the implicit guaranty attendant to “Fannie” and “Freddie” securitized loans, have the federal government (in reality, taxpayers) make the mortgage holders whole by covering the shortfall between the amounts owed and the amounts the loans sell for. In this manner, taxpayers end up “stuck” only for the spread between fair market value of the loans and the balance owed on them. This, as opposed to picking up the tab for the entire amounts owed.
Applying this methodology would result in the mortgagees getting “bailed out,” not the Wall Street gurus with latent liability after monumentally profiting from securitizing and selling substandard loan packages.
I understand the Fed and Treasury’s concern regarding getting liquidity into the system as quickly as possible. However, it’s well known that vast sums are sitting on the sidelines; money that will come back into the financial markets once a plan is in place and which would be available to purchase packages of mortgage-backed securities at their current fair market value.
The other inevitable result of the current plan on the table, as noted by another author in this American Experiment series, will be inflation due to “monetizing the debt.” This is an economist’s term for printing money. In addition to the methodology I just described for liquidating troubled assets, I would suggest the Fed now look to increase interest rates and decrease the money supply in order to keep inflation in check and to ward off further declines in the value of the dollar.
Tom C. Schock is a developer with Capital Growth Real Estate in St. Paul.
September 26, 2008 |
Don’t Give into a Protection Racket
By Gordon L. Anderson The first American Revolution was fought, in part, because the British wanted to control our money. Ben Franklin is reported to have once said that the economy of the colonies was so prosperous because the colonies issued their own money, “colonial scrip,” issued in proportion to the level of goods and services in the economy. No interest was paid to anyone for it. The result was that the British declared the use of colonial scrip illegal.
Consolidation of money accompanied the consolidation of Federal power over the states with the Civil War, with the National Banking Act of 1863 and the two revisions which followed in 1864 and 1865. This legislation promoted currency notes issued by nationally chartered banks rather than state banks. The Act imposed a 10 percent tax on state banknotes, effectively eliminating non-federal currency from circulation.
The control of federal money was largely taken away from the government, with the Federal Reserve Act and secrecy following later.
It isn’t that we weren’t warned by the founders about the consolidation of power and credit. The request by Fed Chairman Bernanke and Secretary of the Treasury Paulson was delivered in the form of a Mafia protection racket: “Give us your money now or something bad will happen.” No serious explanation, no attempt at accountability, no willingness for transparency.
It may be that some type of bailout by the government is called for under the premise that the role of government is to protect innocent people from harm by others. And that mandate refers to financial harm as well as physical harm. But the bailout as requested does not sufficiently meet this basic test. Who is innocent and who is culpable must be established, and any bailout should be accompanied by protection of the innocent from financial harm and punishment for the guilty. If Congress does not proceed in a way that protects the innocent and simply pays extortion, they will only be compounding the problem.
Gordon L. Anderson is general secretary of the Professors World Peace Academy in St. Paul.
September 26, 2008 |
WHAT’S A FREE MARKETEER TO THINK?
Volume Four
September 30, 2008
In light of the continuing financial crisis, a week ago I invited think tank and other colleagues from around Minnesota and the nation to take on the question: “What’s a free marketeer to think?” Here are four new columns, bringing the running total to 18.
My thanks to former United States Senator Rudy Boschwitz; King Banaiain of St. Cloud State University and the Minnesota Free Market Institute; Jim Van Houten, formerly CEO of MSI Insurance Companies; and Gary Palmer, president of the Alabama Policy Institute.
Please note these columns were written before the House of Representatives on Monday defeated a proposal aimed at remedying the problem. American Experiment will continue publishing important pieces like these as we receive them over the next week or so.
Many thanks, and as always, I welcome your comments.
Mitch Pearlstein
Founder & President
Center of the American Experiment
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Failure to Act will Cost Much More in Dollars and Pain
By Rudy Boschwitz I regard this bailout as a positive, as it’s something only the federal government can do. The result of not doing it would be far more costly to the people of our country in many ways, and the Federal government would lose far more tax revenue from a serious economic downturn than the cost of the bailout. I believe the bailout will cause the economy to bottom out and start upwards again – far sooner than would occur without this government action.
It is not going to cost $700 billion as the press irresponsibly trumpets. The government may indeed buy $700 billion of mortgages or mortgage packages that are in trouble. If the underlying real estate covered by the mortgages is worth zero, it will indeed cost the government $700 billion. But the underlying property is far from worthless. You may remember the Savings & Loan crisis of the late ‘80s. The government took over many S&Ls which had gone broke for somewhat different reasons than the root cause of the present mess – though the S&Ls were also a mess.
Those S&Ls held several hundred billion dollars of real estate through defaulted mortgages. The government created the Resolution Trust Corporation (RTC) to sell the real estate and recovered 65-70 percent of the value of those mortgages through an orderly sale of the property. In hindsight I think they rushed the sale of the real estate a bit and could have recovered more if they held on to it longer and given the market more time to recover.
It's the same with the "bailout" of AIG. The press gives the impression that present action by the U.S. government has already cost the taxpayer $85 billion. Not so unless you count the value of AIG at zero and it is far from that. It is (purportedly) the largest insurance company in the world. That’s big! The government got rights to about 80 percent of AIG stock. Remember the "bailouts" of Chrysler and Lockheed? As I recall the government saved both companies and made some money in the process by obtaining rights to some of its stock in exchange for guarantees and capital infusion – very much like what Warren Buffet has now done in providing additional capital for Goldman Sachs.
I was involved in another similar situation which occurred in agriculture in the late-1980s. The farm economy was very stressed due to falling land prices plus low commodity prices. Because farmers were stressed, their principal lender (for farm land), the Farm Credit System, was headed for bankruptcy. The FCS was an independent government agency. If it had failed, it would have cost the government many billions. In the Senate the FCS came under the jurisdiction of the Agriculture Committee, of which I was a member. More directly, it came under the credit sub-committee of the ag committee. Sen. David Boren, a Democrat from Oklahoma, was its chairman and he recruited me to be a member specifically to deal with the farm credit crisis. So I became the ranking Republican on the sub-committee.
The FCS was organized in nine (as I recall) districts around the nation, with one of |
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