Determined not to let their constituents’ overwhelming opposition stand in the way, Congress went ahead and passed the bailout bill. Evidently we are supposed to believe (once again) that those in Washington know how to spend our money better than we do. So shut up and open your wallet, citizen!
One of the many frustrating aspects of the current financial crisis is the media’s inability and the politicians’ unwillingness to identify root causes. Instead, what we get is an endless, panicked media diatribe that confuses the symptoms of the disease with the disease itself. For example, CNN/Money’s Chris Isidore wrote last week that the problem is,
“Banks and Wall Street firms, worried about both their own needs for cash and the condition of other institutions, essentially stopped loaning money to one another. That choked off the money being made available on Main Street in the form of mortgage loans, business loans, and other consumer borrowing.”
He continues on, saying “Others point out that bailout doesn’t address the root cause of the problems on Wall Street as well as the broader economy: falling house prices.”
One of the many frustrating aspects of the current financial crisis is the media’s inability and the politicians’ unwillingness to identify root causes. Instead, what we get is an endless, panicked media diatribe that confuses the symptoms of the disease with the disease itself. For example, CNN/Money’s Chris Isidore wrote last week that the problem is,
“Banks and Wall Street firms, worried about both their own needs for cash and the condition of other institutions, essentially stopped loaning money to one another. That choked off the money being made available on Main Street in the form of mortgage loans, business loans, and other consumer borrowing.”
He continues on, saying “Others point out that bailout doesn’t address the root cause of the problems on Wall Street as well as the broader economy: falling house prices.”
Falling housing prices may be a problem for certain individuals and financial institutions, but they are very clearly not the root cause of the problem. As one might expect a senior writer for CNN/Money to understand, the price of any good rises and falls with supply and demand. But this increasingly common misrepresentation of the issue echoes what Bernanke and Paulson were saying during the Senate hearings. Both kept yammering on about “fire sale prices” and “hold until maturity prices.” Their claim is that the markets need government intervention to value these toxic mortgage assets at the “hold to maturity price,” rather than allowing the market to liquidate at what they consider the “fire sale price.” But this is nothing more than an attempt to perpetuate the fiction that contributed to the problem in the first place – namely, the mistaken belief that housing prices never go down. The “hold to maturity” price is just a mythical number arbitrarily assigned by the Treasury. It doesn’t matter what Secretary Paulson thinks these assets might be worth if the housing market hadn’t been so screwed up. What matters is the actual valuation of these securities in the real world – and that can only be determined by the interplay of free market forces.
Bernanke and Paulson say that they are trying to manage the market correction, but this claim is ludicrous on its face. Government intervention is never needed to value assets. It is only needed if one wishes to prevent the proper valuation of assets by assigning a politically palatable price either above or below the one defined by the market. As any Econ 101 textbook will tell you, artificially setting the price of any good higher than its market price will result in a surplus of that good. Given the fact that in most areas of the country today the problem is precisely too many houses on the market, maintaining a surplus through price manipulations seems patently absurd.
Even if the boys and girls in the Treasury Department were able to find buyers to pick up the assets at the inflated prices needed to spare irresponsible financial institutions the consequences of their own actions, at the end of the day someone else is going to be left holding the bag. The assets will still be overvalued, and someone is going to take the hit for that eventually. In a free market, the one taking the hit for miscalculating the value of an asset would be the one who bought it in the first place. The White House, the Fed, and the Treasury Department don’t like that outcome, so they’d rather force you and me to take the hit instead.
The real question here – the one that Congress, the White House, the Fed, the Treasury Department, and the media are all taking great pains to avoid asking - is, “How could so many people to get so stupid in unison?”
The conventional wisdom is that the cause of this whole thing is greed. I’m not going to claim that there weren’t any greedy people involved in this, but greed in and of itself doesn’t really explain anything. Are we to believe that people on Wall Street just now discovered greed? Is greed a brand-new vice that was just invented by the housing sector? If that were the case, then surely these crises would happen every day. In fact, we’d never be able to have a functioning economy if greed were so overpowering that the market couldn’t find ways of dealing with it. So there has to be something else in play here.
I’m sure I’ve used this analogy before, but I think it bears repeating. If you’re walking by a lake and you see a single fish floating belly-up in the water, you shrug your shoulders and move on. After all, individual fish do die from time to time. But if you’re walking by the lake and you see the entire school of fish floating belly-up, you instantly recognize that there must be something in the water – something external to the fish that caused them all to die at the same time. Because although individual fish die from time to time, fish as a species are pretty good at surviving.
The same thing applies to any business sector. Sure, from time to time individual banks make bad loans and may even go out of business as a result, but banks as a whole are pretty good at understanding their environment, forecasting, and making sound decisions. So when dozens of banks all go belly-up at the same time, there has to be something in the water.
That something is government interference in the marketplace. In the case of the mortgage and financial industry, government has had its thumb on the scale for almost a century. Interest rates have been subject to manipulation ever since the advent of the Fed in 1913, and they have been kept especially low (even by government standards) ever since the 9/11 attacks in 2001. The demon twins Fannie Mae and Freddie Mac were hatched by FDR way back in 1938, and have always enjoyed below-market interest rates that were backed by the government’s implicit guarantee – a guarantee which has now been made explicit, of course. All of this manipulation warped the incentive structure that the market had devised, and helped break down the system of checks and balances that had existed previously.
I heard another good analogy recently. Imagine that I took you to Las Vegas, and I told you that you could keep whatever you won, and that I would cover any money you lost. Don’t you think that would change your behavior in the casino a bit? You would have no incentive to be cautious, and would have every incentive to bet the house. And in the case of Freddie and Fannie, that’s just what they did – literally.
So sure, individual greed may have been a factor in all this, but the fact that Freddie and Fannie stood in the background, with their below-market rate money, willing to buy up just about any property that was offered to them with virtually no questions asked helped to enable that greed. If they hadn’t been there, then those “greedy” financial institutions and mortgage brokers would have had to review their loan portfolios in a very different light, because if they judged an applicant incorrectly, they would be stuck with more of those loans on their books, and they would have suffered the consequences directly. Freddie and Fannie, in essence, put a safety net under those firms where none would have existed in the free market.
The catch phrase in the media these days is “Capitalism on the way up, socialism on the way down.” Of course, we know that it wasn’t capitalism on the way up - it was socialism. And it’s going to be even more socialism on the way down. I think that’s one reason why libertarians need to be very careful when speaking to non-libertarians. We need to make clear that when we speak of things like “capitalism” or “the free market,” we are not referring to the economic system as it exists in the US today. We’re talking about an economic system that has never existed fully, but one to which we have been closer in the past than we are today. We need to make sure others understand that government support of business through sweetheart deals, protectionism, or subsidies is no more capitalist than government restrictions on business. Government-sponsored entities like Fannie Mae and Freddie Mac are in no way, shape, or form free-market creations.
This bailout program is a remarkably bad idea. It results from a fundamental misdiagnosis of events, and will cause further agony down the road. But the impact to the financial system is probably not going to be the worst effect of this whole thing. What is really going to be detrimental over the long term is the lesson that most people take away from this episode. The current financial crisis and the bailout plan will be held up as another example of so-called “market failure” and used as a justification for more regulation, more restrictions on the market, and bigger and bigger government. The Great Depression occurred almost eighty years ago, but even today statists refer to it as an example of how capitalism failed and FDR’s socialism saved us. It’s all nonsense, of course, but it’s great propaganda for those who wish to push a big-government ideology. This latest episode will just perpetuate the same economic myths that have plagued us for almost a century.
Bernanke and Paulson say that they are trying to manage the market correction, but this claim is ludicrous on its face. Government intervention is never needed to value assets. It is only needed if one wishes to prevent the proper valuation of assets by assigning a politically palatable price either above or below the one defined by the market. As any Econ 101 textbook will tell you, artificially setting the price of any good higher than its market price will result in a surplus of that good. Given the fact that in most areas of the country today the problem is precisely too many houses on the market, maintaining a surplus through price manipulations seems patently absurd.
Even if the boys and girls in the Treasury Department were able to find buyers to pick up the assets at the inflated prices needed to spare irresponsible financial institutions the consequences of their own actions, at the end of the day someone else is going to be left holding the bag. The assets will still be overvalued, and someone is going to take the hit for that eventually. In a free market, the one taking the hit for miscalculating the value of an asset would be the one who bought it in the first place. The White House, the Fed, and the Treasury Department don’t like that outcome, so they’d rather force you and me to take the hit instead.
The real question here – the one that Congress, the White House, the Fed, the Treasury Department, and the media are all taking great pains to avoid asking - is, “How could so many people to get so stupid in unison?”
The conventional wisdom is that the cause of this whole thing is greed. I’m not going to claim that there weren’t any greedy people involved in this, but greed in and of itself doesn’t really explain anything. Are we to believe that people on Wall Street just now discovered greed? Is greed a brand-new vice that was just invented by the housing sector? If that were the case, then surely these crises would happen every day. In fact, we’d never be able to have a functioning economy if greed were so overpowering that the market couldn’t find ways of dealing with it. So there has to be something else in play here.
I’m sure I’ve used this analogy before, but I think it bears repeating. If you’re walking by a lake and you see a single fish floating belly-up in the water, you shrug your shoulders and move on. After all, individual fish do die from time to time. But if you’re walking by the lake and you see the entire school of fish floating belly-up, you instantly recognize that there must be something in the water – something external to the fish that caused them all to die at the same time. Because although individual fish die from time to time, fish as a species are pretty good at surviving.
The same thing applies to any business sector. Sure, from time to time individual banks make bad loans and may even go out of business as a result, but banks as a whole are pretty good at understanding their environment, forecasting, and making sound decisions. So when dozens of banks all go belly-up at the same time, there has to be something in the water.
That something is government interference in the marketplace. In the case of the mortgage and financial industry, government has had its thumb on the scale for almost a century. Interest rates have been subject to manipulation ever since the advent of the Fed in 1913, and they have been kept especially low (even by government standards) ever since the 9/11 attacks in 2001. The demon twins Fannie Mae and Freddie Mac were hatched by FDR way back in 1938, and have always enjoyed below-market interest rates that were backed by the government’s implicit guarantee – a guarantee which has now been made explicit, of course. All of this manipulation warped the incentive structure that the market had devised, and helped break down the system of checks and balances that had existed previously.
I heard another good analogy recently. Imagine that I took you to Las Vegas, and I told you that you could keep whatever you won, and that I would cover any money you lost. Don’t you think that would change your behavior in the casino a bit? You would have no incentive to be cautious, and would have every incentive to bet the house. And in the case of Freddie and Fannie, that’s just what they did – literally.
So sure, individual greed may have been a factor in all this, but the fact that Freddie and Fannie stood in the background, with their below-market rate money, willing to buy up just about any property that was offered to them with virtually no questions asked helped to enable that greed. If they hadn’t been there, then those “greedy” financial institutions and mortgage brokers would have had to review their loan portfolios in a very different light, because if they judged an applicant incorrectly, they would be stuck with more of those loans on their books, and they would have suffered the consequences directly. Freddie and Fannie, in essence, put a safety net under those firms where none would have existed in the free market.
The catch phrase in the media these days is “Capitalism on the way up, socialism on the way down.” Of course, we know that it wasn’t capitalism on the way up - it was socialism. And it’s going to be even more socialism on the way down. I think that’s one reason why libertarians need to be very careful when speaking to non-libertarians. We need to make clear that when we speak of things like “capitalism” or “the free market,” we are not referring to the economic system as it exists in the US today. We’re talking about an economic system that has never existed fully, but one to which we have been closer in the past than we are today. We need to make sure others understand that government support of business through sweetheart deals, protectionism, or subsidies is no more capitalist than government restrictions on business. Government-sponsored entities like Fannie Mae and Freddie Mac are in no way, shape, or form free-market creations.
This bailout program is a remarkably bad idea. It results from a fundamental misdiagnosis of events, and will cause further agony down the road. But the impact to the financial system is probably not going to be the worst effect of this whole thing. What is really going to be detrimental over the long term is the lesson that most people take away from this episode. The current financial crisis and the bailout plan will be held up as another example of so-called “market failure” and used as a justification for more regulation, more restrictions on the market, and bigger and bigger government. The Great Depression occurred almost eighty years ago, but even today statists refer to it as an example of how capitalism failed and FDR’s socialism saved us. It’s all nonsense, of course, but it’s great propaganda for those who wish to push a big-government ideology. This latest episode will just perpetuate the same economic myths that have plagued us for almost a century.
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