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Dollars Are No Panacea or Million Dollar(s) Baby

December 30, 2008 1 comment

The pervasive belief amongst mainstream economists today is that pumping in dollars is the only way to save the economy from heading off the proverbial cliff. This logic is illogical. First, dollars are not wealth. If pumping more dollars into the economy generated wealth, then why not give every single individual a million dollar check? Then we would all be millionaires right? In nominal terms yes. In real terms however, no. The amount of dollars in one’s pocket would increase, but the purchasing power (the real measure of one’s wealth) would remain the same. Price levels would increase in proportion to the amount of money given out to each individual. Being worth a million dollars would not mean anything more than before the government handed out its stimulus checks.

If economists are referring to the effect of pumping money into the economy in spurring growth in lending activity, the logic again proves to be quite flawed. Easy money policies look as if they generate positive economic activity. However, as is the result of every government policy, there is what is seen and what is unseen. We see stock prices rise, particularly in given sectors. It looks like every investor is striking it rich. The frenzy in the market reaches euphoric levels and soon everyone rushes in to speculate. Does this scene look familiar?

Yet while this would look comparatively bright relative to the doldrums it appears we are in today, this would all be a mirage. As with all inflationary booms, they are just that, inflationary — nominal but not real. Real growth and real wealth as argued by the Austrian school are generated by savings and capital accumulation. These factors are put to productive use by those with an appetite for risk-taking, an entrepreneurial drive and a spirit of individualism. If the government wants to pave the way for renewed prosperity, it should look for ways to stimulate these three factors, the ones most sorely lacking in our society today.

Categories: Uncategorized

Foreclosure Relief

December 20, 2008 Leave a comment

Barney Frank and friends are finishing the touches on “foreclosure relief” in the form of $350 billion in TARP funds. The favored logic of the Washington crowd is that since housing is at the heart of the crisis, it is most important to “stabilize” the housing market, and that foreclosure relief is the best means to do so. The funds will be released to the Treasury with conditions that President Obama and Secretary Paulson will agree to programs that cut interest rates and “forgive” a portion of principal on mortgages. There are two elements to this that are inherently flawed. One is the economic aspect and the other is the moral aspect.

From an economic perspective, in terms of creating stability in the housing market this plan does anything but that. I would define stability as a situation in which supply and demand meet, so that there is a fair market value established for real estate. Given that this price is set by a constant stream of transactions between buyers and sellers, as with all markets the housing market is unstable until it clears.  Just as in trying to flatten out market cycles however, the truth that stabilization is generated by chaos is lost on Washington.  

By artificially reducing interest rates and thus prolonging the time before foreclosure for those who cannot afford their houses, the market value of these houses will remain artificially high. This is because the government will reduce the supply of houses that otherwise would have been foreclosed and liquidated, thus keeping imprudent people (at least temporarily) in their homes and people with the cash to purchase the homes out.  Since house prices will remain artificially high, it will take even longer for mortgage-backed assets to reach their true market value as well.  In addition, the banks providing the mortgages will receive less money than they otherwise would have were the market for houses free, both in terms of lower interest rate payments and the government-imposed “forgiveness” on a certain percentage of mortgage principal.  To recap, the government steps in and alters a private contract so as to relieve the debtor at the expense of the creditor.  This seems like a great incentive for banks to continue to lend in the future.  

The other aspect of this is the moral one. First, what kind of precedent does the government set if when a homeowner can’t afford a home, the government can arbitrarily abrogate a contract made by two private consenting individuals in favor of one side — and the side of the debtor no less? This creates a major moral hazard, because now people will see that if they go into serious debt to buy a home, the government will bail them out by offering more favorable terms if they fail to fulfill their obligations.  Of course I suppose this precedent has already been set in people’s minds given the government’s increasing socialization of risk in the private sector.  

There is a second major moral problem with this as well. The law of the land here is favoring debtors over creditors. The conception that one should “forgive” a portion of principal on a mortgage is absolutely ludicrous. The person who saves their money does the debtor a favor by lending them money, and so the fact that just because market conditions change, the creditor than has to sacrifice his or her rights to the person who borrowed in the first place is egregious. To be sure, a saver takes a risk by lending, but they also have a contractual right to certain claims if the debtor cannot fulfill his or her obligations, so for the government to be able to intervene and “relieve” the debtor to me seems unjust.  If contracts can be violated by government fiat then the glue of society must come undone.

Legalized Plunder

December 19, 2008 3 comments


No life, no liberty and no property. This is the message coming from Albany based upon Governor Paterson’s proposed budget. In order to weather the economic downturn, Mr. Patterson has prescribed the age-old cure of tax and spend, and while New York’s budget represents perhaps the most perverse and grossly irresponsible of any in the nation, it is nevertheless a sign of things to come across more prudent states over the next year. Patterson’s scheme more or less amounts to a “soak-the-middle-class,” effort, although in reality the ripple unintended consequences will without a doubt hurt everyone. As the venerable Post reports, the plan calls for:

* An “iTunes tax” of 4 percent on videos, music or pictures downloaded from the Internet.

* A 4 percent tax on taxi, limo and bus rides. That means a $10 cab ride would cost 40 cents more.

* A 4 percent entertainment tax on tickets to movies, concerts and sporting events. That would add nearly 50 cents to a $12 movie ticket or $1.80 to the cheapest $44.50 seat at a Knicks game.

* The tax on beer increases 24 cents per gallon, or more than double the current rate, which means about 30 cents a case.

* An 18 percent tax on nondiet soft drinks, which aims to reduce child obesity. A $1.50 can of Pepsi would then cost at least 25 cents more.

* A 4 percent tax on cable TV and satellite services, raising a $100 bill by $4.

* Hiking the cost of “personal” services – including haircuts, manicures, pedicures, massages and gym memberships – by 4 percent.

* A 4 percent sales tax on clothing and shoes under $500, except for two weeks out of the year.

* Elimination of the law that caps the state sales tax on gasoline at 8 cents per gallon.

* Boosting the average vehicle registration fee for drivers by $11, from $44 to $55. Fees for new or renewed licenses also would increase 25 percent, or increase from $50 to about $62 to renew a license over eight years.

In addition, all drivers would have to get new, “reflectorized” license plates at a fee of $25 each.

While officials believe this will help them generate the greatest “revenue” increase in the history of the state at $4.6 billion annually, the state’s budget will still increase by 1.1%. If there were ever a way to cripple a state, this is the way to do it. When a reasonable person gets into trouble economically, they cut back their expenditures. They must become fiscally responsible or ultimately declare bankruptcy. What is true for a man should be true for a state. But sometimes, in fact as we’ve seen most of the time it isn’t. That’s government for you.

What could they do if they wanted to get their fiscal act in order? Slash taxes across the board while privatizing each and every public service that is inefficient (presumably almost all of them) in order to bring the budget level to its bare minimum. Instead, it is clear that they are going to resort to legalized plunder, by taxing the citizens of the state on basic entertainment and sustenance. There is something morally wrong when a state is actively seeking things to tax, as it appears New York is. If the government has to look for ways to take your money from you, then clearly they are not serving as faithful stewards of the public good. They are legalizing theft. Bastiat says:

See if the law takes from some persons what belongs to them, and gives it to other persons to whom it does not belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime. Then abolish this law without delay … If such a law is not abolished immediately it will spread, multiply and develop into a system.

This perfectly characterizes our system of law — the spreading and multiplying of injustice. Were we to hold government to Bastiat’s standard, the one the Constitution seemingly ensured, we would see the inherent flaws in our laws; namely, that the vast majority of our laws benefit some at the expense of most and legalize plunder.

In the final analysis, my question is, what happens when New York has no income earners to tax anymore? This is the real risk that they and every other fiscally irresponsible state run. Moreover, what happens when a nation loses its income earners? Atlas Shrugged is just around the corner.

History Repeats Itself

December 13, 2008 Leave a comment

I’ve been doing a lot of re-reading of Murray Rothbard’s, America’s Great Depression recently, and I think that this passage is particularly pertinent:

But the important fact is that the banking system had arrived at a critical impasse. Usually, in the placid course of events, radical (in the sense of far-reaching) economic reforms, whether needed or not, meet the resistance and inertia of those who drift with the daily tide. But here, in the crisis of 1933, the banks could no longer continue as they were. Something had to be done. Essentially, there were two possible routes. One was the course taken by Roosevelt; the destruction of the property rights of bank depositors, the confiscation of gold, the taking away of the people’s monetary rights, and the placing of the Federal Government in control of a vast, managed, engine of inflation. The other route would have been to seize the opportunity to awaken the American people to the true nature of their banking system, and thereby return, at one swoop, to a truly hard and sound money.

The laissez-faire method would have permitted the banks of the nation to close—as they probably would have done without governmental intervention. The bankrupt banks could then have been transferred to the ownership of their depositors, who would have taken charge of the invested, frozen assets of the banks. There would have been a vast, but rapid, deflation, with the money supply falling to virtually 100 percent of the nation’s gold stock. The depositors would have been “forced savers” in the existing bank assets (loans and investments). This cleansing surgical operation would have ended, once and for all, the inherently bankrupt fractional-reserve system, would have henceforth grounded loans and investments on people’s voluntary savings rather than artificially extended credit, and would have brought the country to a truly sound and hard monetary base. The threat of inflation and depression would have been permanently ended, and the stage fully set for recovery from the existing crisis. But such a policy would have been dismissed as “impractical” and radical, at the very juncture when the nation set itself firmly down the “practical” and radical road to inflation, socialism, and perpetuation of the depression for almost a decade.

Do we jump off of the precipice to full on socialism, or do things get so bad that we choose the path to sound currency and liberty? The choice is ours.

Bush and Hoover

December 12, 2008 2 comments


In reference to the potential failure of the auto bailout bill to fail (which it did on Thursday), Dick Cheney it is reported told Senators that it could be “Herbert Hoover time” again. In fact, Cheney was wrong. It is Herbert Hoover time again. Under the Bush administration’s tenure, the government has undertaken an extensive series of measures that Hoover once called his own in the hopes of preventing calamity. Let’s go to the replay booth, courtesy of Murray Rothbard:

  • Hoover repeatedly inflated credit in an attempt to provide liquidity to the system after the market fell precipitously in 1929 (as he had done during the 20s to fuel the boom in the first place).
  • Under the Futures’ Trading Act, in order to counter the activity of speculators a tax of 20 cents per bushel was placed on speculative transactions including puts and calls, and bids and offers, except when made in certain specific markets when authorized by the Secretary of Agriculture. Perhaps more significantly, he also forced Richard Whitney, the head of the NYSE to agree to withhold loans for the purpose of short-selling, and later stock exchange authorities at Hoover’s urging imposed a full ban on short-selling of securities.
  • Hoover held a Conference on Home Building and Home Ownership to promote the widening of home ownership and to lower interest rates on second mortgages.
    The conference resulted in a heavy increase in long-term credit at lower interest rates and aid to low-income housing. Hoover also tried to force insurance companies not to foreclose on insolvent homeowners.
  • Hoover set up the National Credit Corporation, forcing strong banks to pool their money together to extend credit to weaker banks, which they would finance through Federal Reserve assistance of up to $1 billion. The banks would rediscount bank assets that the Federal Reserve couldn’t legally rediscount on their own. When this proved insufficient, Hoover set up the Reconstruction Finance Corporation to disburse Treasury funds to struggling banks, industries, agricultural and credit agencies and local governments. “For the first five months of its life, the lending activities of the RFC lay shrouded in secrecy, and only determined action by the Democratic Congress finally forced the agency to make periodic public reports,” as Murray Rothbard notes. 80% of the loans went to banks and railroads, of which 40% went to railroads because it was felt that if the railroads defaulted, the insurance companies and savings banks particularly would be stung. As well, as John T. Flynn noted, “When the R.F.C. lent money to one railroad to pay rentals to another railroad, it was in effect using public funds to pay dividends to railroad stockholders.” The RFC went into action fairly quickly, but Hoover himself complained because it took six weeks during which time securities continued to plummet in value.
  • Under the Glass-Steagall Act, Hoover significantly broadened the assets eligible for rediscount and permitted the Fed to use government bonds as collateral for notes as well as commercial paper; through the FRB, the government purchased major amounts of securities.
  • The government worked to weaken the rights of creditors by giving debtors more time to come up with payment before having to disburse of their assets.
  • When the government imposed bank holidays, they forced national banks who could have stayed open and functioned sufficiently to close as well.

Bush’s administration has followed Hoover’s playbook to a tee. The government has pumped tons of money into the system (charts courtesy of this St. Louis Fed Report) as Hoover did, and we are now approaching critical mass at the so-called “zero bound,” where only unconventional monetary policy can be used to inflate according to the eminent Mr. Bernanke. The exchange authorities have resorted to imposing restrictions on short-selling in certain securities. The government has encouraged mortgage companies to keep people in their homes, and is devising plans to work to reduce foreclosures through a number of options. The pooling of money from the good banks to buy poor banks with the insurance of the federal government has been done in the wake of Bear Stearns and the Fed and Treasury’s brokering of the deals to merge other financial institutions. The ever-changing TARP program is essentially the modern-day RFC, even down to its secrecy. Just as in Hoover’s time, money is being allocated to certain companies deemed too interconnected to the financial system to let fail. And of course, just as back then the money has been used by banks for reasons counter to what the government had hoped. According to Mr. Bernanke, like under Hoover the Fed has continually expanded its powers to accept securities at the discount window, purchased massive amounts of securities and even resorted to purchasing stock in banks, a step beyond Hoover (which Roosevelt eventually took). The weakening of the rights of the creditors under Hoover amounted to allowing insolvent debtors to keep functioning, something underlying literally all of the bailout plans for both homeowners and corporations being proposed or already enacted. Finally, the episode of the government forcing banks to take bank holidays even if they were financially sound is reminiscent of the banks being forced to receive TARP funds today.

What is even scarier about all of this is that most of what President-elect Obama is proposing in his “New” New Deal is even more far-reaching and radical. The era of Bush and Obama I believe will look exactly like the era of Hoover and FDR. It appears we are doomed to make the very mistakes that led us to the Depression we faced nearly 80years ago, in large part due to our “laissez-faire” Mr. Bush and his administration.

Categories: Bernanke, Bush, Depression, Hoover, TARP

Why Governments Should Never "Sponsor" Enterprises

December 11, 2008 Leave a comment


Today in the WSJ, the editorial board has a nice little piece on our favorite siblings, Fannie and Freddie. Apparently, Henry Waxman and the other esteemed gentlemen and women are having a horse and pony show in Washington to absolve themselves from the meltdown of these two government behemoths.

There are a few things that strike me as ridiculous about the whole Fannie and Freddie concept to begin with. First, what exactly is the motive of a government-sponsored enterprise? A government initiative is supposed to promote the “public good,” something that has obviously been totally distorted. But anyway, say the government makes the excuse that providing “affordable” housing for lower-income people is a public good (though of course, apples to oranges the bad from these companies has clearly outdone the good). What about the enterprise part of the equation? Generally an enterprise is in the business of maximizing profits by providing a service that the market demands. Now, I would certainly argue that private enterprises serve the public good because they give the public what they want at a competitive price and create jobs. However, to ask a government sponsored enterprise (of that efficient government we have in Washington) to serve the dual mandate of both providing a public good and seeking to maximize profit seems like somewhat of an impossible balancing act.

As the journal notes,

Memos and emails at the highest levels of Fannie and Freddie management in 2004 and 2005 paint a picture of two companies that saw their market share eroded by such products as option-ARMs and interest-only mortgages. The two companies were prepared to walk ever further out on the risk curve to maintain their market position. The companies understood the risks they were running. But squeezed between the need to meet affordable-housing goals set by HUD and the desire to sustain their growth and profits, they took the leap anyway.

That is a pretty good reflection of the problem with these companies. They were trying to balance out achieving market share (in reality crowding out true free market competition if there were other people willing to take the risk to provide “affordable” housing to people that probably couldn’t really afford the housing in the first place) with helping people live in houses that again, most probably could not afford. Wasn’t there a time where if you struggled to pay for a house, you simply rented? Not in America I guess.

Anyway, besides these fundamental problems, these companies received the management quality that the taxpayers deserve from their quasi-owned enterprise:

In early 2004, Freddie’s executive team was engaged in a heated debate over whether to start acquiring “stated income, stated assets” mortgages. And in April of that year, David Andrukonis, the head of risk management, wrote to his colleagues, “This is not an affordable product, as I understand it, but a product necessary to recapture [market] share. . . . In 1990 we called this product ‘dangerous’ and eliminated it from the marketplace.” Freddie went ahead anyway.

One Fannie Mae document from March 2005 notes dryly, “Although we invest almost exclusively in AAA-rated securities, there is a concern that the rating agencies may not be properly assessing the risk in these securities.” But they bought them anyway, both to maintain their market share and to show people like Democrat Barney Frank that they were promoting affordable housing.

By April 2008, according to a document prepared for then-Fannie Mae CEO Daniel Mudd and marked “Confidential — Highly Restricted,” Fannie’s $312 billion in Alt-A mortgages represented “12% of single-family credit exposure.” This book of business, the document notes, “was originated to maintain relevance in market with customers — main originators were Countrywide, Lehman, Indymac, Washington Mutual, Amtrust.”

Oh yea, and the CEO of Freddie Mac also had the audacity to state that, “It is remarkable that during the period that Fannie Mae substantially increased its exposure to credit risk its regulator made no visible effort to enforce any limits.” So even though it was his people that mismanaged the company, it was the government regulators fault for not ensuring that the company was taking prudent risk? Imagine if any of the CEOs of the Investment Banks blamed the regulators for the financial crisis? No real enterprise could ever make this argument.

Of course Franky Raines also had a point. “What Mr. Raines failed to mention was that, all along, Fannie and Freddie were spending millions on lobbying to ensure that regulators did not get in their way. As the AP reported Sunday night, Freddie spent $11.7 million in lobbying in 2006 alone…” This is another fundamental problem with these businesses. The politicians supported affordable housing for low income people because it would help their constituents. To me, it seems like a big slush fund to get votes. Personally, if I knew the government was going to redistribute our tax money to subsidize a housing market for low income people, I’d rather them just buy the houses outright. That way we would at least see where the money was going.

The fact of the matter however is that the government does not see or care for the unintended consequences of maintaining a quasi-governmental enterprise to do this. Shouldn’t it tell them something if the market never dictated that their be real competitors for Fannie and Freddie? Ah well, Barney Frank and Co. can always blame it on greedy corporate America and the wild excesses of the free market.

Categories: bailout, Fannie, Freddie, GSE

Hat Tip

December 11, 2008 Leave a comment

The Virtues of Big 3 Bankruptcy:

“A government bailout of the Big Three keeps huge amounts of productive inputs in firms that can’t use them efficiently. Forcing taxpayers to subsidize the continued employment of gargantuan quantities of raw materials, labor and capital goods in unproductive pursuits is a recipe for economic stagnation. The popular and politically convenient myth has matters backwards: The bigger the unprofitable firm, the more vital it is that it be allowed to fail.”

Great stuff.

Categories: Uncategorized