The CEOs of the big three car makers have come to Washington telling lawmakers that they should give them multi-billion dollar loans so they can keep operating their businesses. They promise to return to profitability by reducing their dealerships, reducing the restrictiveness of work rules, etc., whatever is the latest explanation for their failures to be successful in the market. Why they never did these things before is not explained.
The fact is that the car companies are like the legacy airlines that couldn’t continue in the face of competition. Those airlines have gone out of business one after another because they long ago got into contracts with their suppliers and labor unions, at a time when they were insulated from competition by government regulations. When the regulations were lifted, competition arose and they fought a rear- guard action against new competitors until they finally recognized that they couldn’t sweep back the tide of competition and either went into bankruptcy or merged, or created new units that were not so shackled by past contracts. The car companies have not followed suit and now ask the public to support them while they try to get out of the most onerous of these contracts. So long as support is there, neither they nor those with whom they have contractual obligations will make the necessary changes.
The arguments for government support may persuade Congress but they signify a state of mind that has become too commonly accepted in America today. When they ask for support on grounds that the government bailed out financial institutions, it is like students in school who justify cheating on tests on grounds that “everybody does it so why shouldn’t I?” One can’t blame the car companies (and state and local governments, home buyers, divorce lawyers, and everyone else in the country) for asking for a hand-out but it is incumbent on the government to put its foot down and say “No.” Otherwise, the bad behavior will grow like a cancer until it rots the entire system.
Once government support starts, it increases the problem that called for it in the first place and it becomes harder and harder to withdraw the support. Think of rent controls in New York City or agricultural price supports. Politicians find it impossible to withdraw those regulations because it would be painful for renters, or farmers and their creditors, to make the necessary adjustment to market prices. If the big three go into bankruptcy without government help, however, they will not disappear, they will simply be reformed into leaner and more efficient producers and the politicians will not be blamed for the pain of adjustment. It isn’t true that American car companies don’t know how to produce good cars, or cars that the public wants. But they won’t be able to compete until they break free from the past and all the help, and all the intervention in the production process associated with government help will not prevent their ultimate failure.
This is a critical time in American history. Firms fail when, for whatever reason, they become inefficient and firms grow on the basis of efficient investment and management. If we cannot accept failure, we will end up with nothing but inefficient producers and an ultimate failure of our system of free enterprise.
Thursday, December 11, 2008
The CEOs of the big three car makers have come to Washington telling lawmakers that they should give them multi-billion dollar loans so they can keep operating their businesses. They promise to return to profitability by reducing their dealerships, reducing the restrictiveness of work rules, etc., whatever is the latest explanation for their failures to be successful in the market. Why they never did these things before is not explained.
The fact is that the car companies are like the legacy airlines that couldn’t continue in the face of competition. Those airlines have gone out of business one after another because they long ago got into contracts with their suppliers and labor unions, at a time when they were insulated from competition by government regulations. When the regulations were lifted, competition arose and they fought a rear-guard action against new competitors until they finally recognized that they couldn’t sweep back the tide of competition and either went into bankruptcy or merged, or created new units that were not so shackled by past contracts. The car companies have not followed suit and now ask the public to support them while they try to get out of the most onerous of these contracts. So long as support is there, neither they nor those with whom they have contractual obligations will make the necessary changes.
The arguments for government support may persuade Congress but they signify a state of mind that has become too commonly accepted in America today. When they ask for support on grounds that the government bailed out financial institutions, it is like students in school who justify cheating on tests on grounds that “everybody does it so why shouldn’t I?” One can’t blame the car companies (and state and local governments, home buyers, divorce lawyers, and everyone else in the country) for asking for a hand-out but it is incumbent on the government to put its foot down and say “No.” Otherwise, the bad behavior will grow like a cancer until it rots out the entire system.
Once government support starts, it increases the problem that called for it in the first place and it becomes harder and harder to withdraw the support. Think of rent controls in New York City or agricultural price supports. Politicians find it impossible to withdraw those regulations because it would be painful for renters, or farmers and their creditors, to make the necessary adjustment to market prices. If the big three go into bankruptcy without government help, however, they will not disappear, they will simply be reformed into leaner and more efficient producers and the politicians will not be blamed for the pain of adjustment. It isn’t true that American car companies don’t know how to produce good cars, or cars that the public wants. But they won’t be able to compete until they break free from the past and all the help, and all the intervention in the production process associated with government help will not prevent their ultimate failure.
This is a critical time in American history. Firms fail when, for whatever reason, they become inefficient and firms grow on the basis of efficient investment and management. If we cannot accept failure, we will end up with nothing but inefficient producers and an ultimate failure of our system of free enterprise.
The fact is that the car companies are like the legacy airlines that couldn’t continue in the face of competition. Those airlines have gone out of business one after another because they long ago got into contracts with their suppliers and labor unions, at a time when they were insulated from competition by government regulations. When the regulations were lifted, competition arose and they fought a rear-guard action against new competitors until they finally recognized that they couldn’t sweep back the tide of competition and either went into bankruptcy or merged, or created new units that were not so shackled by past contracts. The car companies have not followed suit and now ask the public to support them while they try to get out of the most onerous of these contracts. So long as support is there, neither they nor those with whom they have contractual obligations will make the necessary changes.
The arguments for government support may persuade Congress but they signify a state of mind that has become too commonly accepted in America today. When they ask for support on grounds that the government bailed out financial institutions, it is like students in school who justify cheating on tests on grounds that “everybody does it so why shouldn’t I?” One can’t blame the car companies (and state and local governments, home buyers, divorce lawyers, and everyone else in the country) for asking for a hand-out but it is incumbent on the government to put its foot down and say “No.” Otherwise, the bad behavior will grow like a cancer until it rots out the entire system.
Once government support starts, it increases the problem that called for it in the first place and it becomes harder and harder to withdraw the support. Think of rent controls in New York City or agricultural price supports. Politicians find it impossible to withdraw those regulations because it would be painful for renters, or farmers and their creditors, to make the necessary adjustment to market prices. If the big three go into bankruptcy without government help, however, they will not disappear, they will simply be reformed into leaner and more efficient producers and the politicians will not be blamed for the pain of adjustment. It isn’t true that American car companies don’t know how to produce good cars, or cars that the public wants. But they won’t be able to compete until they break free from the past and all the help, and all the intervention in the production process associated with government help will not prevent their ultimate failure.
This is a critical time in American history. Firms fail when, for whatever reason, they become inefficient and firms grow on the basis of efficient investment and management. If we cannot accept failure, we will end up with nothing but inefficient producers and an ultimate failure of our system of free enterprise.
Sunday, December 7, 2008
Odds and Ends
1. Commonly heard on the media: "To prepare for the 21st century ..." Imagine someone in January of 1901 talking about preparing for the 20th century. In his wildest dreams, he couldn't imagine what the world was going to be like in 1929 (depression), 1941 (WWII), 1945 (atomic bombs), etc.
2. Ever notice how major social issues are accompanied by little analysis? These days, the air is filled with discussion of three alternatives for government support of the Detroit auto makers: no aid, a bailout, or Chapter 11 bankruptcy. The threat of high increased unemployment seems to be foremost on the minds of those in Congress. But you hear practically no discussion of the fact that contraction of Detroit auto making would lead to increased demand for the Toyotas, Hondas and the other cars that are also made by car manufacturers in the U.S. -- along with their parts suppliers and other supporting industries. And the expansion of these industries would be accompanied by hiring of at least some of the former Detroit auto workers. How many people are involved, and how long would the shift take? All reasonable questions, but no one seems interested.
3. Americans express outrage when the Detroit Big Three fly in to testify before Congress on their corporate jets. How inconsistent for CEOs to plead poverty for their companies when their private fortunes are bulging! Well, it seems that some people can't decide whether they want a good leader or a Boy Scout. History offers many examples of people who were first-class leaders and third-class citizens. Not to mention the possibility that personal jets might be lots more efficient than travel on public airlines for people who lead billion-dollar businesses.
2. Ever notice how major social issues are accompanied by little analysis? These days, the air is filled with discussion of three alternatives for government support of the Detroit auto makers: no aid, a bailout, or Chapter 11 bankruptcy. The threat of high increased unemployment seems to be foremost on the minds of those in Congress. But you hear practically no discussion of the fact that contraction of Detroit auto making would lead to increased demand for the Toyotas, Hondas and the other cars that are also made by car manufacturers in the U.S. -- along with their parts suppliers and other supporting industries. And the expansion of these industries would be accompanied by hiring of at least some of the former Detroit auto workers. How many people are involved, and how long would the shift take? All reasonable questions, but no one seems interested.
3. Americans express outrage when the Detroit Big Three fly in to testify before Congress on their corporate jets. How inconsistent for CEOs to plead poverty for their companies when their private fortunes are bulging! Well, it seems that some people can't decide whether they want a good leader or a Boy Scout. History offers many examples of people who were first-class leaders and third-class citizens. Not to mention the possibility that personal jets might be lots more efficient than travel on public airlines for people who lead billion-dollar businesses.
Thursday, November 13, 2008
Capitalism on Trial
More than 50 years ago, in the midst of the cold war, Soviet Premier Nikita Khrushchev said, in speaking of capitalism, “We will bury you.” What he meant was that time was on the side of Communism and that the socialist system of government control of the economy would outlast the capitalist, free market approach. While Communism has faded as a military threat, it appears that Khrushchev’s vision of the inevitability of Socialism may have been accurate. Certainly, the world-wide political response of near hysteria about the credit “crisis” shows how insecure is freedom’s hold on men’s minds.
When faced with the fact that a number of privately owned banks and other financial institutions had made imprudent investments and were about to fail, our government decided that the ramifications of such failure would be intolerable. The Secretary of the Treasury and the Chairman of the Federal Reserve proclaimed a crisis and called for immediate legislative action to allow them to stave off that failure.
Even those most ardent supporters of government control of economic decisions recognize that action taken to deal with a “crisis” is likely to be misguided and surely that has been the result. First came an attempt to inject liquidity into the system so that banks would lend to each other. That failed to build confidence among those with deposits in shaky banks, so deposit “insurance” was increased and expanded to cover previously uncovered deposits. That favored banks at the expense of other institutions so money market funds had to be guaranteed. Then, insurers who had invested unwisely in risky securities came in for a handout. Now, mortgage borrowers at risk of default are hoping for a bailout along with automobile manufacturers and any other group that can squeeze in line for a government handout.
Now, essentially all financial institutions in the U.S. are being supported and are under the control of the Treasury and the Federal Reserve; public officials have to decide on a case-by-case basis who is worthy of government support and who is not. Khrushchev’s prediction is on its way to being fully borne out.
The freedoms we tout so avidly as the hallmark of our country are often thought of as relating to those guaranteed by the Bill of Rights enumerated in the Constitution. Although not enumerated, perhaps because it was never considered necessary, another important freedom is the freedom to fail – to bear the consequences of one’s own mistakes. In a system in which government controls the economy – Khrushchev’s model – economic failure is traceable to the controlling politicians and it is not allowed.
People can argue forever about what might have happened had the government not stepped in, but what has been done has been done. The issue now is what can be done to undo the damage. It is not enough to let the politicians fail by throwing them out of office because the damage they have done will live on after them, like rent control in New York City. What should be occupying the minds of economists and political scientists everywhere is how to bring to an end the disastrous policies we are adopting in the name of preventing failure.
When faced with the fact that a number of privately owned banks and other financial institutions had made imprudent investments and were about to fail, our government decided that the ramifications of such failure would be intolerable. The Secretary of the Treasury and the Chairman of the Federal Reserve proclaimed a crisis and called for immediate legislative action to allow them to stave off that failure.
Even those most ardent supporters of government control of economic decisions recognize that action taken to deal with a “crisis” is likely to be misguided and surely that has been the result. First came an attempt to inject liquidity into the system so that banks would lend to each other. That failed to build confidence among those with deposits in shaky banks, so deposit “insurance” was increased and expanded to cover previously uncovered deposits. That favored banks at the expense of other institutions so money market funds had to be guaranteed. Then, insurers who had invested unwisely in risky securities came in for a handout. Now, mortgage borrowers at risk of default are hoping for a bailout along with automobile manufacturers and any other group that can squeeze in line for a government handout.
Now, essentially all financial institutions in the U.S. are being supported and are under the control of the Treasury and the Federal Reserve; public officials have to decide on a case-by-case basis who is worthy of government support and who is not. Khrushchev’s prediction is on its way to being fully borne out.
The freedoms we tout so avidly as the hallmark of our country are often thought of as relating to those guaranteed by the Bill of Rights enumerated in the Constitution. Although not enumerated, perhaps because it was never considered necessary, another important freedom is the freedom to fail – to bear the consequences of one’s own mistakes. In a system in which government controls the economy – Khrushchev’s model – economic failure is traceable to the controlling politicians and it is not allowed.
People can argue forever about what might have happened had the government not stepped in, but what has been done has been done. The issue now is what can be done to undo the damage. It is not enough to let the politicians fail by throwing them out of office because the damage they have done will live on after them, like rent control in New York City. What should be occupying the minds of economists and political scientists everywhere is how to bring to an end the disastrous policies we are adopting in the name of preventing failure.
Thursday, November 6, 2008
The Bush Administration Should Attack Iran's Nuclear Capability Now
The Bush administration should act to destroy Iran’s nuclear capability before it leaves office.
Now is the perfect time. The prospect of Iranian nukes being funneled to the terrorist delivery system influenced by Iran is the greatest geo-political risk the United States now faces. The Obama administration is not likely to view this risk as seriously as the Bush administration does, so time is running out.
President-elect Obama would have credible deniability: "I was not aware of this before-hand, and if I had been I would have advised against it."
Some say that our hand has been stayed by fear that Iran would retaliate by attacking our forces in Iraq. But the coming change in administration makes that a less attractive response, since Iran would know that it would make the Obama administration less inclined to deal favorably with Tehran.
Iran probably views Obama as its best shot in decades at resuming relations with the US on something close to its terms. The loss of its imminent nuclear arsenal would do nothing to change that. A response that involved them in a war with American troops in Iraq might. Even if they did respond in Iraq, or in Israel, Obama could rise to the occasion and negotiate a settlement that still left Iran without its nuclear capability. It would be well worth a month or two of problems.
Now is the perfect time. The prospect of Iranian nukes being funneled to the terrorist delivery system influenced by Iran is the greatest geo-political risk the United States now faces. The Obama administration is not likely to view this risk as seriously as the Bush administration does, so time is running out.
President-elect Obama would have credible deniability: "I was not aware of this before-hand, and if I had been I would have advised against it."
Some say that our hand has been stayed by fear that Iran would retaliate by attacking our forces in Iraq. But the coming change in administration makes that a less attractive response, since Iran would know that it would make the Obama administration less inclined to deal favorably with Tehran.
Iran probably views Obama as its best shot in decades at resuming relations with the US on something close to its terms. The loss of its imminent nuclear arsenal would do nothing to change that. A response that involved them in a war with American troops in Iraq might. Even if they did respond in Iraq, or in Israel, Obama could rise to the occasion and negotiate a settlement that still left Iran without its nuclear capability. It would be well worth a month or two of problems.
The Bush Administration Should Attack Iran's Nuclear Capability Now
The Bush administration should act to destroy Iran’s nuclear capability before it leaves office.
Now is the perfect time. The prospect of Iranian nukes being funneled to the terrorist delivery system influenced by Iran is the most serious geo-political risk the United States now faces. The Obama administration seems unlikely to view this risk as seriously as the Bush administration does, so time is running out.
President-elect Obama would have credible deniability: He can say, "I was not aware of this before-hand, and if I had been I would have advised against it.
Some say that our hand has been stayed by fear that Iran would retaliate against our forces in Iraq. But the coming change in administration makes that a less attractive Iranian response, since it would likely make the Obama administration less inclined to deal favorably with Tehran.
Iran probably views Obama as its best shot in decades at resuming relations with the US on something close to its terms. The loss of its imminent nuclear arsenal would do nothing to change that. A response that involved them in a war with American troops in Iraq might. Even if they did respond in Iraq, or in Israel, Obama could rise to the occasion and negotiate a settlement that still left Iran without its nuclear capability. It would be well worth a month or two of problems.
Pre-empt now!
Now is the perfect time. The prospect of Iranian nukes being funneled to the terrorist delivery system influenced by Iran is the most serious geo-political risk the United States now faces. The Obama administration seems unlikely to view this risk as seriously as the Bush administration does, so time is running out.
President-elect Obama would have credible deniability: He can say, "I was not aware of this before-hand, and if I had been I would have advised against it.
Some say that our hand has been stayed by fear that Iran would retaliate against our forces in Iraq. But the coming change in administration makes that a less attractive Iranian response, since it would likely make the Obama administration less inclined to deal favorably with Tehran.
Iran probably views Obama as its best shot in decades at resuming relations with the US on something close to its terms. The loss of its imminent nuclear arsenal would do nothing to change that. A response that involved them in a war with American troops in Iraq might. Even if they did respond in Iraq, or in Israel, Obama could rise to the occasion and negotiate a settlement that still left Iran without its nuclear capability. It would be well worth a month or two of problems.
Pre-empt now!
The U.S. Should Attack Iran Now
The Bush administration should act to destroy Iran’s nuclear capability before it leaves office.
Now is the perfect time. The prospect of Iranian nukes being funneled to the terrorist delivery system influenced by Iran is one of the great geo-political risks faced by the United States. The Obama administration seems unlikely to view this risk as seriously as the Bush administration does. So time is running out.
President-elect Obama would have credible deniability. He could say, "I was not aware of this, and if I had been I would have advised against it."
Some say that our hand has been stayed by fear that Iran would retaliate on our forces in Iraq. But the coming change in administration makes that a less attractive Iranian response, since retaliation would likely make the Obama administration less inclined to deal favorably with Tehran.
Iran probably views Obama as its best shot in decades at resuming relations with the US on something close to its terms. The loss of its imminent nuclear arsenal would do nothing to change that. A response that involved them in a war with American troops in Iraq might. Even if they did respond in Iraq, or in Israel, Obama could rise to the occasion and negotiate a settlement that still left Iran without its nuclear capability. It would be well worth a month or two of problems.
Now is the perfect time. The prospect of Iranian nukes being funneled to the terrorist delivery system influenced by Iran is one of the great geo-political risks faced by the United States. The Obama administration seems unlikely to view this risk as seriously as the Bush administration does. So time is running out.
President-elect Obama would have credible deniability. He could say, "I was not aware of this, and if I had been I would have advised against it."
Some say that our hand has been stayed by fear that Iran would retaliate on our forces in Iraq. But the coming change in administration makes that a less attractive Iranian response, since retaliation would likely make the Obama administration less inclined to deal favorably with Tehran.
Iran probably views Obama as its best shot in decades at resuming relations with the US on something close to its terms. The loss of its imminent nuclear arsenal would do nothing to change that. A response that involved them in a war with American troops in Iraq might. Even if they did respond in Iraq, or in Israel, Obama could rise to the occasion and negotiate a settlement that still left Iran without its nuclear capability. It would be well worth a month or two of problems.
Sunday, October 26, 2008
Financial Crisis: What is the Real Threat?
Media headlines broadcast the end of free-market capitalism in the financial industry—the current situation is a failure of the free market, and we need to adopt strict government regulations to rein it in.
Only one problem. The current situation is a failure of government, not free markets.
The media has it right, that the current financial situation stems from the fact that lending institutions granted subprime mortgages—loans with low interest rates and low down payments—to people who couldn’t afford them. Home prices were rising, and homeowners thought they could always sell their homes if they got into trouble. Fannie and Freddie bundled these mortgages into securities they sold to financial institutions—which used them as reserves to make even more loans.
When home prices stopped rising and started to fall, many sub-prime mortgage holders couldn’t make their monthly payments, and the financial firms who had bought the securities were left without adequate reserves to sustain the losses. Since the new equilibrium prices have not yet been determined, some lending institutions are increasing their credit requirements, which is therefore denying loans to some applicants.
Why did Fannie and Freddie take these risks? First, they are not agents of unfettered capitalism. Fannie and Freddie are not called GSEs (Government Sponsored Enterprises) for nothing. Because the federal government stood behind them, they lacked the normal incentives of private firms to avoid risk. Second, some highly-placed Congressman “strongly encouraged” Fannie and Freddie to make home ownership possible for more of their constituents. Fannie and Freddie went along, and lowered credit requirements in response. And finally, although there were attempts to rein in the riskier lending practices in the mid- and late 1990s, these measures were defeated on strict party-line votes.
It is certainly true that there has been a movement toward lower regulation in the last couple of deades. But these regulations were not in the financial industry, and thus did not contribute to our current problems. The deregulations were in the airline, telephone and trucking industries—where we now enjoy lower prices.
Which brings us to the question of the real threat the current situation poses for our economy. The current financial tightness will pass in time. The real threat, however, is that legislators who believe that a free financial market was the cause will adopt restrictive and long-lasting regulations that will finally choke out whatever life remains of the free market, the institution that has created the amazing wealth that we Americans now enjoy.
And there is additional collateral damage. First, as George Will recently pointed out, nationalizing the financial sector will lower the productivity of capital as it passes into government control. Lower GDP and lower incomes will be the result.
Second, in addition to the negative effects of the regulation itself, even the current effort to draft it is counter-productive because everyone is waiting for regulations to be issued. Left to themselves, private institutions that have not engaged in risky lending would have produced a faster, natural solution by buying up assets at fire sale prices. (Count on the “greed” that is so despised at present.)
Finally, government control will be hard to change even if the drawbacks of nationalization become widely known. The new executive branch will form regulatory bureaucracies and commissions, the new Congress will form committees and hire staffers, and the financial industry will develop vested interests in the new style. Witness how long it took before Maggie Thatcher rescued Great Britain from the socialism that was choking the economy.
The new legislation and regulations will prove to be a cure that is worse than the disease.
Only one problem. The current situation is a failure of government, not free markets.
The media has it right, that the current financial situation stems from the fact that lending institutions granted subprime mortgages—loans with low interest rates and low down payments—to people who couldn’t afford them. Home prices were rising, and homeowners thought they could always sell their homes if they got into trouble. Fannie and Freddie bundled these mortgages into securities they sold to financial institutions—which used them as reserves to make even more loans.
When home prices stopped rising and started to fall, many sub-prime mortgage holders couldn’t make their monthly payments, and the financial firms who had bought the securities were left without adequate reserves to sustain the losses. Since the new equilibrium prices have not yet been determined, some lending institutions are increasing their credit requirements, which is therefore denying loans to some applicants.
Why did Fannie and Freddie take these risks? First, they are not agents of unfettered capitalism. Fannie and Freddie are not called GSEs (Government Sponsored Enterprises) for nothing. Because the federal government stood behind them, they lacked the normal incentives of private firms to avoid risk. Second, some highly-placed Congressman “strongly encouraged” Fannie and Freddie to make home ownership possible for more of their constituents. Fannie and Freddie went along, and lowered credit requirements in response. And finally, although there were attempts to rein in the riskier lending practices in the mid- and late 1990s, these measures were defeated on strict party-line votes.
It is certainly true that there has been a movement toward lower regulation in the last couple of deades. But these regulations were not in the financial industry, and thus did not contribute to our current problems. The deregulations were in the airline, telephone and trucking industries—where we now enjoy lower prices.
Which brings us to the question of the real threat the current situation poses for our economy. The current financial tightness will pass in time. The real threat, however, is that legislators who believe that a free financial market was the cause will adopt restrictive and long-lasting regulations that will finally choke out whatever life remains of the free market, the institution that has created the amazing wealth that we Americans now enjoy.
And there is additional collateral damage. First, as George Will recently pointed out, nationalizing the financial sector will lower the productivity of capital as it passes into government control. Lower GDP and lower incomes will be the result.
Second, in addition to the negative effects of the regulation itself, even the current effort to draft it is counter-productive because everyone is waiting for regulations to be issued. Left to themselves, private institutions that have not engaged in risky lending would have produced a faster, natural solution by buying up assets at fire sale prices. (Count on the “greed” that is so despised at present.)
Finally, government control will be hard to change even if the drawbacks of nationalization become widely known. The new executive branch will form regulatory bureaucracies and commissions, the new Congress will form committees and hire staffers, and the financial industry will develop vested interests in the new style. Witness how long it took before Maggie Thatcher rescued Great Britain from the socialism that was choking the economy.
The new legislation and regulations will prove to be a cure that is worse than the disease.
Financial Crisis: What is the Real Threat?
Media headlines broadcast the end of free-market capitalism in the financial industry—the current situation is a failure of the free market, and we need to adopt strict government regulations to rein it in.
Only one problem. The current situation is a failure of government, not free markets.
The media has it right, that the current financial situation stems from the fact that lending institutions granted subprime mortgages—loans with low interest rates and low down payments—to people who couldn’t afford them. Home prices were rising, and homeowners thought they could always sell their homes if they got into trouble. Fannie and Freddie bundled these mortgages into securities they sold to financial institutions—which used them as reserves to make even more loans.
When home prices stopped rising and started to fall, many sub-prime mortgage holders couldn’t make their monthly payments, and the financial firms who had bought the securities were left without adequate reserves to sustain the losses. Since the new equilibrium prices have not yet been determined, some lending institutions are increasing their credit requirements, which is therefore denying loans to some applicants.
Why did Fannie and Freddie take these risks? First, they are not agents of unfettered capitalism. Fannie and Freddie are not called GSEs (Government Sponsored Enterprises) for nothing. Because the federal government stood behind them, they lacked the normal incentives of private firms to avoid risk. Second, some highly-placed Congressman “strongly encouraged” Fannie and Freddie to make home ownership possible for more of their constituents. Fannie and Freddie went along, and lowered credit requirements in response. And finally, although there were attempts to rein in the riskier lending practices in the mid- and late 1990s, these measures were defeated on strict party-line votes. (The push for lower regulation that some quote as a contributing cause for the current situation was in the airline, telephone and trucking industries—where we now enjoy lower prices.)
Which brings us to the question of the threat the current situation poses for our economy. The current financial tightness will pass in time. The real threat, however, is that legislators who believe that a supposedly free financial market was the cause will adopt restrictive and long-lasting regulations that will finally choke whatever lifeblood remains out of the free market, the institution that has created the amazing wealth that we Americans now enjoy.
And there is additional collateral damage. First, as George Will recently pointed out, nationalizing the financial sector will lower the productivity of capital as it passes into government control. Lower GDP and lower incomes will be the result.
Second, in addition to the negative effects of the regulation itself, even the current effort to draft it is counter-productive. Left to themselves, private institutions that have not engaged in risky lending would have produced a faster, natural solution by buying up assets at fire sale prices. (Count on the “greed” that is so despised at present.) This solution is now foreclosed because everyone is waiting for government action.
Finally, government control will be hard to change even if the drawbacks of nationalization become widely known. The new executive branch will form regulatory bureaucracies and commissions, the new Congress will form committees and hire staffers, and the financial industry will develop vested interests in the new style. Witness how long it took before Maggie Thatcher rescued Great Britain from the socialism that was choking the economy.
The new legislation and regulations will prove to be a cure that is worse than the disease.
Only one problem. The current situation is a failure of government, not free markets.
The media has it right, that the current financial situation stems from the fact that lending institutions granted subprime mortgages—loans with low interest rates and low down payments—to people who couldn’t afford them. Home prices were rising, and homeowners thought they could always sell their homes if they got into trouble. Fannie and Freddie bundled these mortgages into securities they sold to financial institutions—which used them as reserves to make even more loans.
When home prices stopped rising and started to fall, many sub-prime mortgage holders couldn’t make their monthly payments, and the financial firms who had bought the securities were left without adequate reserves to sustain the losses. Since the new equilibrium prices have not yet been determined, some lending institutions are increasing their credit requirements, which is therefore denying loans to some applicants.
Why did Fannie and Freddie take these risks? First, they are not agents of unfettered capitalism. Fannie and Freddie are not called GSEs (Government Sponsored Enterprises) for nothing. Because the federal government stood behind them, they lacked the normal incentives of private firms to avoid risk. Second, some highly-placed Congressman “strongly encouraged” Fannie and Freddie to make home ownership possible for more of their constituents. Fannie and Freddie went along, and lowered credit requirements in response. And finally, although there were attempts to rein in the riskier lending practices in the mid- and late 1990s, these measures were defeated on strict party-line votes. (The push for lower regulation that some quote as a contributing cause for the current situation was in the airline, telephone and trucking industries—where we now enjoy lower prices.)
Which brings us to the question of the threat the current situation poses for our economy. The current financial tightness will pass in time. The real threat, however, is that legislators who believe that a supposedly free financial market was the cause will adopt restrictive and long-lasting regulations that will finally choke whatever lifeblood remains out of the free market, the institution that has created the amazing wealth that we Americans now enjoy.
And there is additional collateral damage. First, as George Will recently pointed out, nationalizing the financial sector will lower the productivity of capital as it passes into government control. Lower GDP and lower incomes will be the result.
Second, in addition to the negative effects of the regulation itself, even the current effort to draft it is counter-productive. Left to themselves, private institutions that have not engaged in risky lending would have produced a faster, natural solution by buying up assets at fire sale prices. (Count on the “greed” that is so despised at present.) This solution is now foreclosed because everyone is waiting for government action.
Finally, government control will be hard to change even if the drawbacks of nationalization become widely known. The new executive branch will form regulatory bureaucracies and commissions, the new Congress will form committees and hire staffers, and the financial industry will develop vested interests in the new style. Witness how long it took before Maggie Thatcher rescued Great Britain from the socialism that was choking the economy.
The new legislation and regulations will prove to be a cure that is worse than the disease.
Tuesday, October 14, 2008
No Representation Without Taxation!
“No Taxation without Representation” is one of the oldest slogans in U.S. history. It was a principal justification for the American Revolution, and predated it by more than 25 years. The slogan is still powerful because taxation without representation contradicts the underlying idea of a democratic society, which derives its power from the will of the people, not from a monopoly on force as is the case in dictatorships. And the slogan still retains its appeal today: it is written on the license plates of cars in the District of Columbia as a call to action for D.C. residents who lack voting representation in Congress.
But the slogan also has a more subtle implication, that taxation should reflect the desires of those being taxed. This principle is currently being ignored, however, by a major thrust of the Democratic candidate's platform. The proposal to raise the taxes of the top 5 percent of earners implies that it is the desires of the majority that are to be considered, rather than the desires of those being taxed. Surely it is akin to tyranny for the majority to pick out a small, and in this case, unpopular minority and take its property. Yet that is what our democratic society has come to.
There is a considerable imbalance between these two groups. In 2004, approximately 58 million individuals, or 44% of the total working population of 133 million paid no taxes at all: Approximately 15 million people had earnings but filed no returns, and 43 million filed returns but incurred no tax liability. (These figures exclude those individuals without any earnings at all.) Assuming that these figures reflect the voting population as well, 44%, or less than half of all voters are paying no taxes but are nevertheless contributing to decisions about how much the remaining 56% of the population should pay. But even this greatly understates the degree to which the tax burden is shifted toward the top: the top 1% of taxpayers contributes almost 40% of total taxes.
I propose we remove this imbalance between who decides and who pays by adopting a reverse of the old revolutionary slogan: “No Representation without Taxation.” Much federal spending is income redistribution, and there is much to be said for living in a generous society where those who are less well-off are helped by the more affluent. And the degree of after-tax voluntary philanthropy indicates that the wealthier members of our society are, indeed, quite generous. But it is contrary to the spirit of democratic principles to use the power of the federal government to create the current separation between the two groups—those who decide tax policy, and those who pay the taxes. Making voting dependent on whether or not one pays taxes would go a long way toward making politics more responsible.
But the slogan also has a more subtle implication, that taxation should reflect the desires of those being taxed. This principle is currently being ignored, however, by a major thrust of the Democratic candidate's platform. The proposal to raise the taxes of the top 5 percent of earners implies that it is the desires of the majority that are to be considered, rather than the desires of those being taxed. Surely it is akin to tyranny for the majority to pick out a small, and in this case, unpopular minority and take its property. Yet that is what our democratic society has come to.
There is a considerable imbalance between these two groups. In 2004, approximately 58 million individuals, or 44% of the total working population of 133 million paid no taxes at all: Approximately 15 million people had earnings but filed no returns, and 43 million filed returns but incurred no tax liability. (These figures exclude those individuals without any earnings at all.) Assuming that these figures reflect the voting population as well, 44%, or less than half of all voters are paying no taxes but are nevertheless contributing to decisions about how much the remaining 56% of the population should pay. But even this greatly understates the degree to which the tax burden is shifted toward the top: the top 1% of taxpayers contributes almost 40% of total taxes.
I propose we remove this imbalance between who decides and who pays by adopting a reverse of the old revolutionary slogan: “No Representation without Taxation.” Much federal spending is income redistribution, and there is much to be said for living in a generous society where those who are less well-off are helped by the more affluent. And the degree of after-tax voluntary philanthropy indicates that the wealthier members of our society are, indeed, quite generous. But it is contrary to the spirit of democratic principles to use the power of the federal government to create the current separation between the two groups—those who decide tax policy, and those who pay the taxes. Making voting dependent on whether or not one pays taxes would go a long way toward making politics more responsible.
Tuesday, September 30, 2008
A Simple Q&A On The Financial "Crisis"
Is there a crisis?
For many in the banking industry, yes. For the economy as a whole, no.
Why is the administration shouting crisis?
There was a problem in the banking industry and they wanted legislative authority to address it. If they had asked for it in the normal way, the Congress would have viewed it as a normal, i.e. special interest bill favoring the constituents of the (right wing) Republicans. Then every centrist and (left wing) Democrat would have demanded his share of the pie as a price for going along. The administration hoped that by shouting crisis, they could get immediate action and forestall all that log-rolling.
What would have happened if they had succeeded?
They would have written a vague (3 page) bill that allowed great administrative latitude. The result would have been better than the (110 page) bill they had to come up with on a second try but neither version would have been better than not proposing any bill at all.
Having proposed action, any market adjustment that would have occurred in response to the "crisis" has been delayed while the players in the game wait for government money to play with.
What will happen if Congress can't agree on a bill?
If they give up and say "No Bill," the strong banks will gobble up the weak and the "crisis" will be over. If they hang on and keep debating for weeks, eventually the industry will give up and take care of the issue without help but it will take a long time to give up on the prospect of $700 billion.
What will happen if Congress does pass a bill?
The proponents hope that by promising to "do something" the panic will subside; they may be right. But it will take a long time for a bureaucracy to get set up and even longer to get started handing out money. It won't be long before Congressional oversight results in complaints of foot dragging, hasty decisions, bad personnel decisions (that has already started, even before the bill has passed), favoritism, and ultimately, graft and corruption. By then, all the administration actors will have left the scene so they can complain, along with everyone else, that the next administration has botched what was a well-designed plan. Meanwhile, these adverse results will be with us for years to come.
For many in the banking industry, yes. For the economy as a whole, no.
Why is the administration shouting crisis?
There was a problem in the banking industry and they wanted legislative authority to address it. If they had asked for it in the normal way, the Congress would have viewed it as a normal, i.e. special interest bill favoring the constituents of the (right wing) Republicans. Then every centrist and (left wing) Democrat would have demanded his share of the pie as a price for going along. The administration hoped that by shouting crisis, they could get immediate action and forestall all that log-rolling.
What would have happened if they had succeeded?
They would have written a vague (3 page) bill that allowed great administrative latitude. The result would have been better than the (110 page) bill they had to come up with on a second try but neither version would have been better than not proposing any bill at all.
Having proposed action, any market adjustment that would have occurred in response to the "crisis" has been delayed while the players in the game wait for government money to play with.
What will happen if Congress can't agree on a bill?
If they give up and say "No Bill," the strong banks will gobble up the weak and the "crisis" will be over. If they hang on and keep debating for weeks, eventually the industry will give up and take care of the issue without help but it will take a long time to give up on the prospect of $700 billion.
What will happen if Congress does pass a bill?
The proponents hope that by promising to "do something" the panic will subside; they may be right. But it will take a long time for a bureaucracy to get set up and even longer to get started handing out money. It won't be long before Congressional oversight results in complaints of foot dragging, hasty decisions, bad personnel decisions (that has already started, even before the bill has passed), favoritism, and ultimately, graft and corruption. By then, all the administration actors will have left the scene so they can complain, along with everyone else, that the next administration has botched what was a well-designed plan. Meanwhile, these adverse results will be with us for years to come.
Sunday, September 28, 2008
Main Street vs. Wall Street—the Wrong Debate
Much of the current debate about the financial "crisis" describes the issue as Wall Street vs. Main Street. This reflects a fundamental misunderstanding of our economy. It is true that a government buy-out of the failed mortgages will probably require a substantial increase in taxes, at least for a while. And a buy-out might certainly be a bad idea, as another blog on this site argues. But underlying the debate is a fundamental misunderstanding, by many of our legislators and the media, of the role of Wall Street in our economy.
The capital markets channel funds from Main Street to create and support the businesses that hire all the workers, from unskilled to highly skilled, who produce our GDP—the vast array of goods and services that we all consume, food, clothing, homes, cars, repair sites, churches, schools, and so on.
The media often follows the mention of Wall Street with reference to the high salaries and golden parachutes that some large firms pay to attract CEOs—as if that's a defining characteristic of Wall Street. But that's an entirely separate issue. Those payments are an infinitesimal part of the total value of the failed mortgages that we're worrying about, and have no place in a discussion of major government policy regarding what to do about them.
The debate is not about Wall Street vs. Main Street. It's about the best way to serve the interests of our citizens.
The capital markets channel funds from Main Street to create and support the businesses that hire all the workers, from unskilled to highly skilled, who produce our GDP—the vast array of goods and services that we all consume, food, clothing, homes, cars, repair sites, churches, schools, and so on.
The media often follows the mention of Wall Street with reference to the high salaries and golden parachutes that some large firms pay to attract CEOs—as if that's a defining characteristic of Wall Street. But that's an entirely separate issue. Those payments are an infinitesimal part of the total value of the failed mortgages that we're worrying about, and have no place in a discussion of major government policy regarding what to do about them.
The debate is not about Wall Street vs. Main Street. It's about the best way to serve the interests of our citizens.
Saturday, September 27, 2008
The Government Buy-out Congress is Contemplating
There is probably not a single trained economist who ever encountered the term “market freeze-up” in his graduate studies. Yet, when asked for details of what to expect from the proposed buy-out of “toxic securities” (another neologism) held by banks, freeze-up is the threat mentioned repeatedly by Dr. Bernanke and Secretary Paulson.
What is it really about? The outlines of the current “crisis” are reasonably well-known. Banks and mortgage brokers made a lot of mortgage loans without the traditional buyer equity contribution. They made such “sub-prime” loans on the expectation that with home prices rising, the necessary equity would magically appear in a short time. The mortgages and securities (bundles of mortgages) were easily sellable and were counted as liquid assets by the banks that owned them. So when the home prices stopped rising and actually began to fall, lots of borrowers went into default and lenders found that their loans were, after all, not adequately secured. Many banks, lending institutions and individuals ended up with securities based on those mortgages that have not only lost value but are, at present, virtually unmarketable; what had been liquid assets have become illiquid. That is what the “freeze” seems to be all about.
Politicians and the media are currently in a frenzy to attach blame, but the question now is what, if anything, should be done to throw a lifeline to banks drowning in the bad debt they created? The administration has seized the initiative by proposing a buy-out, leaving unspecified what or how it is to be bought. Moreover, they have demanded immediate action as if the apocalypse is upon us and a delay of days would produce catastrophe. Many in the Congress and Executive branch have bought the Administration's point that the government should indeed take action, and are now arguing over the details. Like sheep following a bellwether, they seem to be saying, “I don’t know anything about how markets work, but these are smart guys and they must know what they are talking about, so I’ll accept their judgment.”
Only a few, however, are questioning whether any government action is called for at all. First of all, the buy-out is not without problems. A close reading of the statements by Bernanke and Paulson indicates that they don’t feel as confident as their followers. They use terms like “if this works,” and “we hope.” Not “here is what we will do and this is what will happen.” In fact, what they will do is defined in only the barest outline: they propose to buy what they think are unsellable securities from banks, and maybe other institutions, at prices that have not yet been determined and sell them at some uncertain future date when their value can be determined. An op-ed by Andy Kessler in Thursday’s Wall Street Journal even claimed that if the Paulson plan goes through, the government will end up making money.
The most important question, however, is why the government has to attempt the rescue at all, rather than private investors. One thing is clear: these securities are not unmarketable in principle. Some mortgages are in default, some properties are already foreclosed on, and some will likely go under in the future. But all of these mortgages, thrown on the market, would bring a price greater than zero. If buyers and sellers want to get more information about the value of these securities, estimates can be made in a relatively short time. That should go a long way toward reducing the uncertainty and unfreezing the market. J. P. Morgan Chase has just bought Washington Mutual at a fire-sale price based on just such estimates of future profitability.
The administration's proposal has already inhibited market solutions to the problem. Experience has shown that when the government promises to spend money on an activity that the private market would otherwise finance, private investors pull back and wait and see what will happen. If the Congress manages to reach agreement and pass legislation, that will be only the beginning of the process. Endless haggling will ensue about what to buy, what to pay, who should make the decisions, which Congressional districts should receive what benefits, and ultimately, who has been doing what illegal things to rip off the public. With $700 billion at stake, and possibly more before it is all over, the sharks will be circling for years to come.
If they really want to “solve the problem,” the Congress should prominently announce that it will not, under any circumstances, participate in this operation. In short order, securities would be sold, the losers would go under, and we could all go back to watching reruns on television.
What is it really about? The outlines of the current “crisis” are reasonably well-known. Banks and mortgage brokers made a lot of mortgage loans without the traditional buyer equity contribution. They made such “sub-prime” loans on the expectation that with home prices rising, the necessary equity would magically appear in a short time. The mortgages and securities (bundles of mortgages) were easily sellable and were counted as liquid assets by the banks that owned them. So when the home prices stopped rising and actually began to fall, lots of borrowers went into default and lenders found that their loans were, after all, not adequately secured. Many banks, lending institutions and individuals ended up with securities based on those mortgages that have not only lost value but are, at present, virtually unmarketable; what had been liquid assets have become illiquid. That is what the “freeze” seems to be all about.
Politicians and the media are currently in a frenzy to attach blame, but the question now is what, if anything, should be done to throw a lifeline to banks drowning in the bad debt they created? The administration has seized the initiative by proposing a buy-out, leaving unspecified what or how it is to be bought. Moreover, they have demanded immediate action as if the apocalypse is upon us and a delay of days would produce catastrophe. Many in the Congress and Executive branch have bought the Administration's point that the government should indeed take action, and are now arguing over the details. Like sheep following a bellwether, they seem to be saying, “I don’t know anything about how markets work, but these are smart guys and they must know what they are talking about, so I’ll accept their judgment.”
Only a few, however, are questioning whether any government action is called for at all. First of all, the buy-out is not without problems. A close reading of the statements by Bernanke and Paulson indicates that they don’t feel as confident as their followers. They use terms like “if this works,” and “we hope.” Not “here is what we will do and this is what will happen.” In fact, what they will do is defined in only the barest outline: they propose to buy what they think are unsellable securities from banks, and maybe other institutions, at prices that have not yet been determined and sell them at some uncertain future date when their value can be determined. An op-ed by Andy Kessler in Thursday’s Wall Street Journal even claimed that if the Paulson plan goes through, the government will end up making money.
The most important question, however, is why the government has to attempt the rescue at all, rather than private investors. One thing is clear: these securities are not unmarketable in principle. Some mortgages are in default, some properties are already foreclosed on, and some will likely go under in the future. But all of these mortgages, thrown on the market, would bring a price greater than zero. If buyers and sellers want to get more information about the value of these securities, estimates can be made in a relatively short time. That should go a long way toward reducing the uncertainty and unfreezing the market. J. P. Morgan Chase has just bought Washington Mutual at a fire-sale price based on just such estimates of future profitability.
The administration's proposal has already inhibited market solutions to the problem. Experience has shown that when the government promises to spend money on an activity that the private market would otherwise finance, private investors pull back and wait and see what will happen. If the Congress manages to reach agreement and pass legislation, that will be only the beginning of the process. Endless haggling will ensue about what to buy, what to pay, who should make the decisions, which Congressional districts should receive what benefits, and ultimately, who has been doing what illegal things to rip off the public. With $700 billion at stake, and possibly more before it is all over, the sharks will be circling for years to come.
If they really want to “solve the problem,” the Congress should prominently announce that it will not, under any circumstances, participate in this operation. In short order, securities would be sold, the losers would go under, and we could all go back to watching reruns on television.
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