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WHAT'S A FREE MARKETEER TO THINK? Volume 8

Commentaries

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Introduction

This being the eighth and final installment of “What’s a Free Marketeer to Think?,” I had hoped the series would end on a happier note than the week has proven.  Then, again, as Dow drops go, today’s was barely a blip – perversely good news for which I truly do give thanks.

As you may recall, a few weeks ago, in response to our nation’s financial emergency, I invited think tank and other colleagues from around Minnesota and the nation to take on the question above.  The first set of responses ran on September 23, and we’ve been publishing packages regularly since then.  Today’s five columns bring the total to 31; a larger number, frankly, than my colleagues and I first assumed.  Nerves clearly have been hit, in multiple ways.

I extend my thanks this time around to Lew Uhler of the National Tax Limitation Committee; Greg Blankenship of the Illinois Policy Institute; Dean Riesen of the Goldwater Institute; David Strom of the Minnesota Free Market Institute; and American Experiment’s Peter Nelson.

To read any of the previous seven volumes, see the links below or go to our website at AmericanExperiment.org.

Many thanks, and as always, I welcome your comments.

Mitch Pearlstein
Found & President
Center of the American Experiment

P.S.  As a perversely surreal coda to the series, you might like to take a look at a Dinner Forum presentation by James Glassman that we published in American Experiment Quarterly in the Summer of 2000:  “Dow 36,000: Are Stocks Actually Undervalued?”  Oh, well.
 

 

Government Must Not Prolong the Market-Cleansing Process

By Lewis K. Uhler

Abuse of the public treasury is not a new phenomenon.  Taxpayers have been the creditors of last resort for Chrysler, the savings and loans, defense contract overruns, the Boston “Big Dig” debacle, and countless other government excesses.  But the so-called mortgage (Wall Street) bailout we’ve just experienced carries us into new territory – and scary challenges.

It would be one thing for the president – or the Congress – to initiate and manage the response to the alleged crisis on Wall Street.  But to allow a hired hand – the Secretary of the Treasury (and his as-yet-unknown successor) – to initiate a bailout for his Wall Street cronies, and to control without any peer oversight or court review (as Henry Poulson initially proposed) the expenditure of $700 billion or so of taxpayer resources, is a new level of fiscal dereliction.  Why the president would endorse a plan that leaves him out of the loop in managing the response of his own administration is the final confession that he is not serious about fiscal discipline in his remaining days in office.

There is no mention in the Constitution of a Department of Treasury or a Secretary of the Treasury.  To give a person who holds such a non-constitutional office the power to bind our nation and its treasury to obligations for which there is no constitutional authority is patently absurd.

With respect to the details of the bailout, we should recognize that the problem was created by government policy and inaction.

 ● Government’s insistence, through the Community Reinvestment Act, that unqualified buyers be given mortgages set this problem in motion.

● Freddie and Fannie responded to their liberal political mentors – Rep. Barney Frank and Sen. Chris Dodd – and made tons of bad loans.

● Interest rates were kept low by the Fed, encouraging speculators to enter the market; as a result they joined in bidding up prices to unsustainable levels. (It’s estimated that speculators represented an unprecedented 25 percent of home buyers during this housing bubble, creating an oversupply of homes and assuring the foreclosure rate we have been experiencing.)

● The cartel of government-licensed rating bureaus obviously failed to do their jobs of properly rating the sub-prime mortgages which were securitized and sold around the world.

 The bailout need not risk a heavy loss for taxpayers if some simple principles guide government action.

 ● Change the “mark-to-market” rules so mortgage “packages,” which contain mostly performing loans (only about 7 percent of home loans have run into trouble) are not put on the block at fire sale prices and do not artificially undermine otherwise healthy companies.

● Let precarious financial institutions file for Chapter 13 bankruptcy and do a “workout” over time, as the bankruptcy law encourages, thus saving value for shareholders and for employees whose retirement may ride on the outcome.

Loan funds to financial institutions that are having problems rather than buy their assets, reducing taxpayer exposure and maintaining the viability of the private companies.

Above all, government involvement/interference must not prolong the market-cleansing process vital to rapid recovery.  Housing prices are testing the bottom now.  Turnaround can happen quickly if government doesn’t abort the process.  Markets work.  Our elected and appointed officials must once again accept that – and get out of the way.

Lewis K. Uhler is president of the National Tax Limitation Committee in Roseville, California. 


Free Marketers Must Remain Vigilant

By Greg Blankenship

Much ink has been spilled in the last year or so about the conservative movement running out of ideas.  Terms like “sclerotic” have been thrown around by David Brooks of the New York Times to describe conservative think tanks.  The same can be said of the conservative press, according to a New Yorker article by George Packer last May.

But as we see from the reaction of the press and our politicians to the financial crisis that currently challenges us, conservative ideas of free markets and limited government are very much in need of defending.

The broadsides from the Obama presidential campaign blaming de-regulation for the fiasco need to be addressed.  After all, much of this crisis can be laid at the feet of politicians of both parties because of their meddling in the housing market.  Finance professionals and investors share the blame by acting irresponsibly in their efforts to make a quick dollar and consumers for purchasing more than they can afford.  

This alone should rouse the free marketeer to defend the free enterprise system by pointing out that meddling in markets set the stage, not unfettered capitalism.  It also suggests that ideas such as prudence, thrift and moderation should be reinforced.  Risk taking is an important part of capitalism, and bubbles are going to occur in an imperfect world.  But it is moderation and rationalism at the heart of free market ideas that mitigate crises and relegates moral hazard to academic discussions rather than actual practice.  Now is the time to reinforce these ideas.

Our critics in the movement seem to have put forth the idea that we’ve somehow reached the end of conservative history – an idea only too readily adopted by our friends on the left.  We’ve run our course and we are bereft of ideas is how the story goes. 

Yet somehow everyone seems to be missing that the other side isn’t offering anything new.  The politics of the left, as Amity Shlaes informed us in The Forgotten Man, haven’t changed since FDR.   Their fixes for the financial system are more of the same: Scapegoating, demonzing, increased regulation and redistribution of wealth.  Once hidden behind environmentalism and other fads, the champions of statism, as a result of this crisis, have been flushed into the open.

Why should we stop defending ours ideas?  Should Sen. Obama assume the presidency, he assuredly will not be a Bill Clinton or Tony Blair.  Both accepted much of the Reagan and Thatcher revolutions.  While some items were rolled back, none of it was wholly rejected.  Obama does wholly reject the underpinnings of these revolutions.  He intends to raise capital gains taxes, introduce more regulation and do nothing about some of the highest corporate income taxes in the world – all as America tries to climb out of this financial crisis and what many believe to be an inevitable recession.  

High tax rates, a credit crunch, and the energy crisis were combated with our ideas in 1980.  They worked.  Now, we seem bent on a different approach that won’t work.  At the same time we are told to try something new because the current election doesn’t look so good.  I’m sorry, but that isn’t a good enough reason.

No, now is not the time to abandon our missions and our ideals for some abstract new coalition or new conservatism.  This is not the end of conservative history; it’s just the beginning of a new round in the fight between liberty and statism and free marketeers should embrace this challenge.

There is an old cliché that says the Chinese symbol for both crisis and opportunity are the same.  For the vigilant free marketeer we have before us a new opportunity.  We should take it.

Greg Blankenship is president and founder of the Illinois Policy Institute in Springfield.


Confidence, Credit and Growth

By Dean Riesen

As a free-market bank director and commercial real estate investor, I find these challenging times.  We face a massively complex problem that is the result of human nature, the acceleration in the past ten years of extremely complex financial engineering, and significant government interference in markets.

The core problem was a residential real estate ‘bubble’ like no other we have ever experienced.  This was facilitated by the easy money strategy of the Federal Reserve under Alan Greenspan, who largely ignored asset inflation as an economic problem.  The government magnified the easy money problem with its mistaken social engineering policy of making housing more “affordable” by weakening traditional lending standards through its government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, egged on by Democrats Barney Frank, Charles Schumer, and Christopher Dodd. 

The GSEs created massive demand for a product (sub-prime debt) that didn’t really exist. This led the “free market” of mortgage originators, home builders, and home buyers to an orgy of construction and expansion.  These mortgages were then ‘engineered’ into all sorts of very new and complex vehicles that were then sold and traded around the world in a way that has caused the inevitable bubble busting to infect the entire global financial system with a very serious disease which has all but shut off global growth.  Adding insult to injury, this is happening in the middle of a very contentious Presidential election making it very difficult to sort out reality from fiction.

The reality is that Democrats led the charge to expand the mortgage purchases of GSEs, criticizing Republican attempts to regulate these public-private monsters.  

● On September 10, 2003, Rep. Barney Frank told a hearing of the House Financial Services Committee:  “The more people, in my judgment, exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see.  I think we see entities that are fundamentally sound financially . . . .”

 ● Two weeks later, Congressman Frank, who now chairs the Financial Services committee, said:  “I do not want the same kind of focus on safety and soundness that we have in the OCC [Office of the Comptroller of the Currency] and OTC [Office of Thrift Supervision].  I want to roll the dice a little bit more in this situation towards subsidized housing . . . .”

In 2005, Republicans (now in control of the Senate), passed a strong reform bill out of the Senate Banking Committee that could have prevented much of the financial disaster, only to have Democrats prevent it from coming to a floor vote.  Sen. Barack Obama did not support the bill or oppose his party’s efforts to keep it from coming to a vote.  Sen. John McCain said at the time: “If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system and the economy as a whole.”

So in somewhat of a role reversal, we had Republicans trying increase regulation and Democrats opposed.  Of course Republicans were trying to regulate government in the form of GSEs and prevent it from distorting the market.  Democrats were trying to protect a piggy bank that made massive contributions to their favorite groups like ACRON and Jessie Jackson’s organizations as well as their political campaigns. (Senators Obama, Schumer, and Christopher Dodd and Representative Frank are among the top four recipients of political contributions from GSEs.)  Senator Obama still lists Franklin Raines, former CEO of Fannie Mae and someone who should probably be sitting in a federal prison for massive accounting fraud, as an adviser to his presidential campaign.

So from my perspective the government had a major role in creating the mess we find ourselves in and, therefore, must be part of the solution.  The crisis has reached the stage where banks are afraid of each other.  Credit is becoming difficult to find, which means there won’t be economic growth and in reality economic contraction is more and more likely. 

There is no market for many securities because there are no buyers.  It doesn’t mean they aren’t worth anything.  The government will now be involved in helping to create a “market” for the distressed securities allowing banks to rebuild their balance sheets which, in turn, will lead to confidence to lend money which can then lead to economic growth.  There is clearly a risk that government will create additional problems in the functioning of the free market but it’s a risk we must take since the market has gone on strike.  We must watch closely to ensure it does the least amount of damage to the functioning of future free markets.

 Dean Riesen is a member of the board of directors of the Goldwater Institute in Phoenix.


 “Regime Uncertainty”

By David Strom

There is lots of blame to go around for how our credit markets got into the current mess.

Counterproductive government regulations, poor judgment by investment bankers and mortgage brokers, and an irrational belief that housing prices never fall all played a major part in getting us to where we are today.  Do I even have to mention the easy money policies of the Federal Reserve earlier in the decade?

But it has become increasingly clear that the transformation of the credit problems of last year into the crisis of today has one main author – the federal government.

For months, the markets had been nervous about the fallout from the popping of the housing bubble, and rightly so.  Major financial institutions had taken a beating to their balance sheets and by early this year it was clear that some would not survive the shakeout in the industry.

It is unsurprising that the Fed and Treasury would try to head off a full-blown crisis by trying to ensure that the fallout from the expanding financial woes would occur in an orderly fashion.  That’s why they intervened in the Bear Stearns liquidation, and took over Fannie Mae, Freddie Mac, and AIG.  These moves were intended to ensure that “systemic risk” to the financial system was avoided by propping up indispensible players.

The problem is that it didn’t work – nor did the passage of the $700 billion bailout package.

Looking back there’s a pretty simple reason why these extraordinary measures failed to prevent the ongoing meltdown of the financial system: In the eyes of investors the federal government has replaced one systemic risk – the possible default of major financial institutions – with another – the sudden evaporation of their investment values through a government takeover of whatever financial institution they might choose to invest in.

Recent government actions have made private investment in financial institutions – precisely what is needed to recapitalize shaky banks and investment firms – extremely risky.  A government “bailout” can put your capital at risk just as much as any prospective failure of that same institution (just ask the stockholders of Bear Stearns or AIG).

By intervening so directly in the financial markets the federal government has caused what economist Robert Higgs of the Independent Institute called “regime uncertainty” in describing the perverse effects of government interventions in the economy during the Great Depression.

Under conditions of regime uncertainty investors stay on the sidelines because they are don’t know what the prevailing rules in the markets will be in the future.  Changes in government policy – especially changes that seem to occur in a rapid fashion – erode the confidence that investors need in order to decide whether or where to deploy capital in the market.

The great irony is that the actions of the Fed and Treasury that were intended to shore up confidence in the financial markets seem to have had the opposite effect.  What had been a serious but relatively slow moving problem morphed into a full-blown, fast-moving crisis.  It seems clear that whatever dangers the government saw in doing nothing, nobody anticipated that the results of the recent interventions would be such a catastrophic collapse of confidence in the market.

Regime uncertainty is surely at least partly to blame.  Until investors clearly understand the exact consequences of government interventions in the marketplace they would be irrational to jump right in and start investing their own money.  Even bargain hunting becomes irrational because a company that appears to be a bargain today might be nationalized by the government tomorrow.

By intervening in an ad hoc manner the federal government has destabilized the current financial regime without providing any clarity at all about what the new rules of the game will be.  It is vital that private investors get clarity about what those rules will be, because until they do private capital will remain mostly on the sidelines.

David Strom is president of the Minnesota Free Market Institute.

  


Five Questions

by Peter J. Nelson 

 As much as I continue to pore over news stories, blogs, and academic papers, at least five fundamental questions regarding the so-called bailout remain unanswered.

 

● First, why was everyone so sure that credit markets would seize without immediate action from Congress?  In other words, what was the rush?

● Second, and related to the first, if credit dried up from banks, why wouldn’t substitutes quickly emerge to meet that demand and, thereby, profit from higher interest rates?

● Third, when the oil-for-food program in Iraq couldn’t keep track of $65 billion used to buy oil—a commodity with a set price—how can anyone reasonably expect to oversee a $700 billion program used to buy bundles of junk mortgages that the smartest investment bankers can’t properly value?

● Fourth, the bailout intends to pay fair market value for mortgage-backed securities, which means a bank’s balance sheet remains the same as before.  If a bank’s asset levels remain the same, is this really the most effective way to expand credit?

● Fifth, won’t the bailout encourage riskier behavior in the future by establishing a precedent that the government will bail out bad investment decisions?

Normally when I can’t find answers for myself, I start looking or asking around for advice from people with more expertise on the matter.  Unfortunately, those whom I normally tap for sound economic advice do not see eye to eye.  The Heritage Foundation (a conservative think tank in DC), the Wall Street Journal editorial board, Steve Forbes, and even Jack Kemp all supported the bailout while the Cato Institute (a libertarian think tank in DC), a slew of academic economists, and Newt Gingrich opposed it.

Though conservative supporters all expressed grave reservations, many accepted the immediacy of the crisis and believed the bill would be far better than no bill.  In contrast, the academics agreed a crisis exists that needed “bold action,” but they were highly critical of the bailout and charged that it was an unfair subsidy to investors, ambiguous in its mission and oversight, and damaging to the long-term health of capital markets. 

So, what is a free marketeer to think?

The answer seems to be that a free marketeer can think quite broadly on the topic.

Unable to find satisfying answers and with no consensus among my advisory council, I’m left to decide with my gut, with instinct, with feelings.

At the outset of the crisis, my gut resounded with a clear no.  Let’s just say my gut had a trust deficit when it came to Paulson, Congress, the president, and Wall Street.

Without knowing many facts, it was clear Treasury Secretary Paulson could not be trusted after he proposed removing the bailout from judicial review, as if constitutionally guaranteed oversight would be too meddlesome for his unprecedented socialization of private debt.  Moreover, the biggest cheerleaders for this bailout came from Wall Street types like William Gross, the chief investment officer at PIMCO, and Kenneth Lewis, the CEO and president of Bank of America.  Forgive me if I don’t trust Wall Street at this juncture.

Initially, the number of free market believers—people I’ve long trusted—who were out lobbying for the bailout mitigated my trust deficit. 

But today, my gut is again shifting to a trust deficit.  You see, the New York Times just reported that the bailout, on top of giving Paulson the power to buy toxic securities, gave Paulson the power to buy a stake in troubled banks. 

What?  Since when did the government’s direct purchase of stock in banks become part of the deal? 

The option was certainly discussed, and it was actually the preferred option among many academic economists.  Injecting banks with capital by buying newly issued stock gets to my point in the fourth question above: the bailout as sold does nothing to change a bank’s balance sheet.  Buying an ownership stake does.

But as Justin Fox, Time Magazine’s business and economics columnist, states in his blog:  “That wasn’t how Treasury initially advertised its Troubled Asset Relief Program.  It was sold as a way to get the market for mortgage securities moving (or, to use the jargon, ‘liquid’).”

To say the least, it’s unsettling that the most significant and most debated counter proposal to the bailout ended up in the final bill without anyone taking notice.  The Secretary of the Treasury now holds even more discretion over $700 billion than even the closest observers thought possible.

My gut now rumbles with the worrisome notion that America might be giving way to a new era: one that more broadly accepts government’s heavy hand as a backstop to people and corporations that make foolish bets and precludes the kind of prosperity that can only exist under the discipline of free markets.

Peter J. Nelson is a policy fellow with Center of the American Experiment. 

 

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