Notes on the Sub-Prime Credit Crisis

The recent news that Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Mortgage Corporation), the two giant quasi-private, government-created companies, are in need of a Federal bailout is the latest in a series of financial catastrophes that has led to widespread calls for new government regulatory powers over the banking industry. At the same time, a general consensus across the political spectrum (there are exceptions) has developed that holds that the crisis was caused by certain “deregulatory” actions in recent years. As a consequence, free-market capitalism is once again being blamed for a crisis clearly caused and exacerbated by government intervention into the economy.

Clearly, that is, if one takes a broad, historical perspective, which is sorely lacking today. Instead, the crisis is being looked at in snapshot fashion, seeing only the current banking and government set-up with all of its laws, institutions, programs, and regulations as a given. If one were to look at a mighty river, one would know that it did not just begin as what you are observing. Its beginnings trace back to thousands of trickles, which merge into hundreds of creeks, then streams and still larger streams, then tributary rivers, which finally merge into the mighty river you are observing.

But what is being observed in the banking and credit crisis today is only the mighty river at midstream. As a result, all that is seen is some relatively miniscule deregulation, while the whole labyrinth of ever-increasing government interventions dating back decades…the trickles, creeks, streams, and tributaries…are ignored. What is also being observed is that on the surface most of the players in this fiasco are private bankers, mortgage brokers, investment houses, and so on. This gives plausibility to the claim that the free market is to blame. The fallacy being employed, though, is to conflate capitalists with capitalism. Capitalists certainly do exist. But Capitalism, the system of laissez-faire (non-government intervention in private individual economic affairs) is nowhere to be seen.

Yet, it is Capitalism that is being tried, convicted, and sentenced without a hearing. For example, in an article repleat with evasion, Al Meyerhoff writes that "Without regulation, the invisible hand of the market is robbing us blind." (Read my response to Mr. Meyerhoff.) But the fact is that, in a classic scenario that has been repeated across many industries, the private financial industry has been progressively shackled and smothered under governmental controls and statist policies over the past 100 years, resulting in the almost total elimination of anything even remotely resembling a free market. The result has been predictable…one financial crisis after another. From the runaway inflation and soaring interest rates of the 1970s, to the savings & loan collapse of the 1980s, to the current sub-prime debacle that is still unfolding. Each time, the free market is blamed amid calls for more laws and controls.

But the “free market” that allegedly needs fixing is a mirage, having long ago disappeared. Consider:

*The Federal Reserve Board, America’s central bank, controls the value and quantity of money, the raw material of banking. It holds a coercive monopoly on the issuance of currency, which is fiat paper backed not by gold but only by the force of legal tender laws. Private banking institutions are forbidden from holding gold reserves and issuing notes (private money) backed by those reserves, as they were able to do prior to the creation of the Federal Reserve System in 1913, when the era of (almost) truly free banking ended. Private citizens are also forbidden from using privately minted gold and silver currency.

*The “Fed” controls short-term interest rates, expands and contracts credit through its discount window, establishes reserve requirements and capital to assets ratios, and regulates mergers and acquistions, bank ownership rules, and a whole host of other items. The Fed’s inflationary interest rate and credit (i.e., monetary) policies of the last eight to ten years are a big part of the equation in the current crisis.

* Banks are immune to the bankruptcy laws. Instead, when a bank begins to fail, the Fed steps in and “arranges” for a buyer to take over the failing bank’s assets. In other words, rather than face the objective oversight of a bankruptcy judge, as any business would in a free market, the failed bank is embraced by a paternalistic Fed. Depositors and customers are bailed out without even knowing it, helping to feed the illusion in the minds of people that the quality of the banking institution into which they place their savings is irrelevant, short-circuiting a key disciplinary feature of the market. The bankers know this too, which encourages excessive risk-taking and quick-buck artists.

(The Federal Reserve System was created allegedly in response to the “failures” of free, private banking and the gold standard, such as the supposed “confusion” caused by the issuance of multiple bank notes and occasional bank panics. But this phony argument ignores the fact that the US constitution defines American currency in specific weights of gold and silver [Article 1, Section 8], meaning a deviation by any private bank from those standards constitutes illegal fraud. Thus, the Federal Reserve System, having abandoned the gold standard, is itself an unconstitutional fraud. For more on this, consider what Ron Paul has to say. Also, for a detailed history of America’s free banking era, see Richard M. Salsman’s book Gold and Liberty

*Sound, prudent banking is penalized while risky, reckless lending is rewarded by Federal deposit insurance. Prior to deposit insurance (enacted in 1933 and expanded repeatedly since), an imprudent bank quickly saw its deposit base dry up, with the money gravitating toward sounder institutions. Deposit insurance subverts this natural market process, enabling banks with lax credit policies to proliferate at the expense of more cautious ones. Depositors run to banks offering the highest yields without regard to the soundness of the institution or its credit policies, knowing that the government (i.e., the taxpayers), will bail them out. Good banks lose, bad ones win, leading to more bad banks and fewer good ones. The increase in deposit insurance limits from $20,000 to $100,000 in 1980 is the prime reason for the 1980s savings and loan collapse. (For a detailed presentation on the history, practice, and failures of Federal deposit insurance, see Richard M. Salsman’s pamphlet, The Collapse of Deposit Insurance. Also note that money market mutual funds are not insured, yet are highly trusted and popular.)

*Unsound banking is encouraged in other ways as well. The Fed acts as “lender of last resort”, meaning banks know that big daddy will always be there to create money out of thin air…literally. A bank with an over-extended loan portfolio can turn to the Fed’s discount window for below-market, dirt-cheap credit. On top of that, the government’s "too big to fail” policy of bailing out financial institutions has rolled into an enormous snowball. Both of these activities lead to less disciplined and excessively risky credit practices. (Keep in mind that these government operations are financed by artificial money and/or credit creation [inflation], which robs the purchasing power of money held by the country’s productive citizens.)

*An enabling factor in the sub-prime crisis is the fact that the major bond-rating agencies completely missed the impending disaster. Being private companies, they are pointed at as another example of failed capitalism. But even here, the government’s intrusive hand can be found as the culprit. Steve Forbes explains in Cart This Cartel to the Dumpster (Forbes, 5/19/08)

For more than 30 years the SEC [Securities and Exchange Commission] has taken upon itself the task of deciding who should rate debt instruments and who shouldn't. Thus, the industry has been dominated primarily by three firms: Standard & Poor's, Moody’s and, at a distant third, Fitch. Competitors are hobbled in the credit-rating field without the SEC's regulatory blessing.

This cartel is further aided by government laws and regulations that require, in various instances, insurance companies, money funds, banks and other institutions to hold only those debt securities rated by these agencies. In this way the feds not only keep out the competition but also require customers to buy the services of these select few. Investors are ill-served by this federally mandated oligarchy. (emphasis added)

The banking industry is so heavily controlled and regulated that it would be more accurate to call it a quasi-arm of the government. Super-impose on this government appendage the massive state intervention into the housing markets, and you have the still-expanding sub-prime credit crisis. For example, the Federal Home Loan Bank system (FHLBank) was set up to artificially supply banks with funds for home loans. There is the wildly popular home mortgage and property tax deduction. There are the aforementioned Fannie Mae and Freddie Mac behemoths that create an artificially inflated mortgage resale market for mortgage originators to sell into. The government’s attempts to “encourage” homeownership has led to a massive over-“investment” in housing…a bubble that is now deflating.

Super-impose on that the actions of the Federal Housing Administration (or FHA, which insures mortgages for people with poor credit histories and/or minimal home equity) and the politically-imposed Community Reinvestment Act, which forces on lenders low mortgage underwriting standards to help the “poor” afford homes. Writes Jerry Bowyer, in the NY Sun:

The government compels banks to make loans in poor neighborhoods even if the applicants are not considered prime borrowers. You may not know about that because the Community Reinvestment Act is not exactly a household (excuse the pun) name.

But the commercial banks do know about it. They have a CRA department. They get a CRA rating. They know that the way to get a high CRA rating is to make loans to poor applicants or in poor urban neighborhoods regardless of the financial prudence of the loans.

They know that if they don't do this, they will be punished severely by the regulators when they try to make any major change which is dependent on regulatory approval. And they know that pretty much every major change a traditional bank makes is, in fact, subject to regulatory approval. So, they grit their teeth and stamp a big inky "yes" on an application which they know, according to traditional financial standards, deserves a "no."

Add it all up, and you have the witches brew now bubbling over and spreading everywhere, including overseas.

In classic form, rather than look upstream to the tributaries that contributed to this mighty river of financial turmoil, the government will now trample further the underpinnings of the remnants of the free market by abrogating contracts on a massive scale…the very contracts that it is the government’s proper role to enforce and honor. A massive bailout of homeowners and lenders is now underway, paid for with massive money creation (inflation) that is now beginning to manifest itself as it always does…in a general and accelerating spiral of prices.

Bad loans and lending practices can always occur in the free market. But in a free market, where there is no central bank or coercive governmental money monopoly, bank failures are localized and contained. Only government, which today controls the banking industry, can cause such a system-wide failure. The sub-prime crisis has a made-by-government label written all over it. Government, to which the entire banking industry is tied, is the common denominator. Rather than blame the non-existent free market or the pseudo-deregulation of recent years, what’s needed is a thorough examination of the government’s policies, regulations, and programs…including all “sacred cows.” Today’s crisis is only the latest in a series of financial calamities that may only be symptoms of an approaching apocalypse. There will be more. Ultimately, only a return to some form of gold-convertible money will restore financial sanity. As Edmund Contoski writes in Liberty magazine, “…there has never been a paper money unredeemable in a material asset that did not eventually become worthless.” ( Housing Bubble and Bust, Liberty Magazine, July, 2008, page 24)

These brief notes are just that…brief notes…and should not be construed as an exhaustive analysis. They are intended to focus attention on the banking system as it actually is. Everywhere one looks, one finds the distorting hand of government intrusion. As in the case of healthcare, the root of the problem is in the fact that free market capitalism in the financial industry is conspicuous by its absence. The road to recovery begins not in blaming capitalism, but in discovering it.

Post Reference 33





Cart This Cartel to the Dumpster

Ron Paul

Gold and Liberty

The Collapse of Deposit Insurance-and the Case for Abolition

money market mutual funds are not insured

Research & Commentary: Privatization of Fannie and Freddie

Central Planning-Housing Bubble and Bust

Legal Tender Laws and fractional-Reserve Banking

Too Big to Bail

The Government Did It

THE REAL SCANDAL
HOW FEDS INVITED THE MORTGAGE MESS

Don't Blame the Markets

Commentary 39- The "Diversity" Fraud

Diane Schwartz has recently published two articles over at NJVoices. In the first, she extols the virtues of so-called "diversity." In the second, Ms. Schwartz laments "hate and discrimination." These essays cry out for rebuttal, especially considering how many Americans have swallowed the collectivist line implicit in the acceptance of diversity as a value.

The diversity movement and its correlary, multiculturalism, represent direct assaults on America's unique, though battered and bruised, culture of reason, individualism and capitalism. As such, they deserve a much more thorough examination than provided here (which I hope to tackle in the future). In my commentary, I touch upon the actual meaning of diversity, and show why the basic premise underlying the diversity ideology leads to the opposite of the advocates' alleged goal of “tolerance.” Here are some excerpts:

…the basic premise underlying diversity theory is the same premise as that which fosters discrimination, prejudice and stereotyping. That premise is racism…

The diversity movement…wants to fight "discrimination, prejudice and stereotypical behaviors" based on race, ethnicity, and cultural heritage...by categorizing everyone according to race, ethnicity, and cultural heritage.

There is only one true diversity...intellectual diversity. And the intellect is the property of the individual, and only the individual. By equating beliefs and ability...i.e., an individual's character...with uncontrollable traits like race undermines and destroys people as individuals…

To read the articles and my full commentary, click here.

Commentary 38- Guilty Without a Trial

I have previously stated that Capitalism is repeatedly blamed for the failures of government policy. E.J. Dionne, a widely read left wing columnist, has declared in a recent piece that “capitalism is ailing.” In a brazen act of context-dropping, Mr. Dionne looks around, sees economic problems, and declares that free markets are at fault without any reference to the role that our massively intrusive government might have played. I have responded strongly to this classic statist ploy. Here are a few excerpts:

Mr. Dionne is attacking a straw man. Capitalism and free markets don’t exist today, except in bits and pieces here and there. Massive government intervention and control in our lives now approaches or exceeds the elements of freedom that still exist.

Today, it is not the distorted and shackled free market remnants, but ever-growing government interventions in private economic decision-making that has failed. Yet, Mr. Dionne and other statists blame free market capitalism, then call for even wider government powers to close whatever “loopholes” of freedom still exist.

To read the article and my full commentary, click here

Oil Execs and Polar Bears

Real-life events can sometimes coincide in such a way as to dramatize the fundamentals of an issue better than any theoretical discussion can. In this case, one cause and effect relating to the current energy crisis is demonstrated by two concrete government actions occurring within about a week of each other.

The first event was another in a long line of congressional kangaroo court lambastings of American oil company executives for the purpose of determining “how their companies can in good conscience make so much money, while American drivers pay so much at the pump.” (CNNMoney.com, May 21, 2008)

The executives responded timidly, but factually.

“ ‘We cannot change the world market,’ said Robert Malone, chairman and president of BP America Inc. ‘Today's high prices are linked to the failure both here and abroad to increase supplies’…In addition, [John] Hofmeister [president of Shell] said access to resources in the United States has been limited for the past 30 years. ‘I agree, it's not a free market,’ he said.

“The executives pushed the idea that large parts of the U.S. that are currently closed to drilling - like sections of Alaska, the Rocky Mountains and the continental shelf - should be opened.
‘The place to start the free market is in our own country,’ said one executive.”

The second event came in the form of a ruling by the Bush administration declaring the polar bear an endangered species. While there are many “endangered species” listed under the Endangered Species Act, what makes this ruling unique is that the polar bear is not actually endangered. If you want to find a major cause of “American drivers pay[ing] so much at the pump” and for which the oil execs are being subjected “to yet another barrage of rhetorical questions, interruptions, accusations, and sermons” (Capitalism Magazine, May 28, 2008) , look no farther than this news item.

This polar bear designation has likely gone over the heads of most Americans, who are busily trying to, among other things, keep up with soaring energy costs. But we should all really be paying close attention to this, because the disastrous long-term consequences for our standard of living…indeed, our way of life…that this ruling can have cannot be overstated. That is because this decision is unique.

What the Interior Department has declared is that, for the first time, a species has been given protection under the Endangered Species Act (ESA), not because it is actually endangered, but because it can become endangered…by man-made global warming. Now, environmentalism is one of the main culprits in the energy price spiral. The polar bear ruling represents an exponential increase in the scope of the ESA, placing a powerful new weapon in the hands of what can more accurately be called the anti-industrial revolutionaries. .

The threat to American energy production that this precedent-setting ruling represents is significant. Already, the prospects for a proposed major natural gas pipeline across Alaska have diminished in it’s wake.

But the threat goes well beyond any particular energy project. For the environmentalist movement, armed with nothing more than hypothetical computer models and a dogmatic zealotry, this dangerous precedent means there is no limit to the number of species that can be deemed to be “threatened” in some distant future. Therefore, there is no limit to the restrictions that may be imposed on our freedom and our very lives, or on the growth of the power of government. Writes George Will:

“Now that polar bears are wards of the government, and now that it is a legal doctrine that humans are responsible for global warming, the Endangered Species Act has acquired unlimited application. Anything that can be said to increase global warming can -- must -- be said to threaten bears already designated as threatened.

"Want to build a power plant in Arizona? A building in Florida? Do you want to drive an SUV? Or leave your cell phone charger plugged in overnight? Some judge might construe federal policy as proscribing these activities. Kempthorne says such uses of the act, unintended by those who wrote it in 1973, would be ‘wholly inappropriate.’ But in 1973, climate Cassandras were saying that ‘the world's climatologists are agreed’ that we must "prepare for the next ice age" (Science Digest, February 1973)…

“No one can anticipate or control the implications that judges might discover in the polar bear designation. Give litigious environmentalists a compliant judge and the Endangered Species Act might become what New Dealers wanted the National Industrial Recovery Act of 1933 to be -- authority to regulate almost everything.” (Emphasis added.FDR’s National Industrial Recovery Act of 1933 was declared unconstitutional by the Supreme Court. We may not be so lucky, this time.)

While not the only cause, if you want to see a real-life demonstration of one of the primary causes of the energy price explosion, don’t bother to blame the oil producers and their executives who are unjustly being made scapegoats. Look no further than the Bush Interior Department’s polar bear ruling, the Endangered Species Act itself, and the anti-science, anti-industrial religion of environmentalism.

Post Reference 32

Commentary 37-On State/Church Separation

...the Founders were deeply suspicious of organized religion, including Christianity and its multiple sects. They understood fully the inherent dangers to liberty of placing into the hands of people whose beliefs rest on faith rather than reason the coercive power of government...

In America, the practice of religion by one is no threat to any other. We owe the unfettered right to our own beliefs free from fear of persecution to that "wall of separation." As an athiest, I cannot understand how any religionist would want to begin chipping away at that safeguard with such nonsense as "faith-based initiatives."

The battle today is not between Islam and Christianity. It is between theocratic tyranny and political freedom. Our soldiers are fighting not for an atheistic government or a Christian government, but for the freedom to hold his, and our, own personal beliefs and for a government that protects that freedom.

A nations legal framework, to be just and fair, must be based upon some set of ideas...of universal principles...that all people can relate to and that can be the basis for resolving disputes peacefully. The Declaration of Independence is America's set of universal principles.

That New York Court's decision to force Catholic hospitals to pay for abortion coverage for their employees is, indeed, an abomination. It is a violation of the rights of the owners of the Catholic hospitals (or their representatives) to be true to their religious principles (a blatant violation of the establishment clause, as I interpret it). It is also a violation of a whole host of other rights, such as their right to set the terms and conditions of employment at their institutions, including what to include in the health care coverage they offer.

Excerpts from my latest activism. Read the rest.

Independence Day- Bittersweet, But Hope for the Future

The Fourth of July is a national holiday that, to me, stands far above all of the others. It represents the greatest political achievement in world history. More than that, the birth of the United States of America represents a towering and unprecedented philosophical achievement. America, born of the Enlightenment, is the first nation founded on the principle that man the individual has a fundamental, natural right to his own life, and that government’s responsibility is to protect that right…that the people act by right, while the government acts by permission.

I quote from Michael S. Berliner’s June 26, 2008 post at Principles in Practice

“ ‘Independence Day’ is a critically important title. It signifies the fundamental meaning of this nation, not just of the holiday. The American Revolution remains unique in human history: a revolution--and a nation--founded on a moral principle, the principle of individual rights…

“The Declaration of Independence was a declaration against servitude, not just servitude to the Crown but servitude to anyone…

“Political independence is not a primary. It rests on a more fundamental type of independence: the independence of the human mind. It is the ability of a human being to think for himself and guide his own life that makes political independence possible and necessary…

“To the Founding Fathers, there was no authority higher than the individual mind, not King George, not God, not society. Reason, wrote Ethan Allen, is ‘the only oracle of man,’ and Thomas Jefferson advised us to ‘fix reason firmly in her seat and call to her tribunal every fact, every opinion. Question with boldness even the existence of a God.’ That is the meaning of independence: trust in your own judgment, in reason; do not sacrifice your mind to the state, the church, the race, the nation, or your neighbors.

“Independence is the foundation of America. Independence is what should be celebrated on Independence Day. That is the legacy our Founding Fathers left us.”

Americans are more and more ignoring and moving away from the glorious principle of which Mr. Berliner speaks, “the independence of the human mind.” This is what gives Independence Day a bittersweet quality for me. Our freedom erodes steadily as its only real guardian, intellectual independence, gradually gives way to a growing entitlement mindset. Just surrender one more bit of our individual self-determination and personal responsibility in exchange for the free lunch of the illusion of government-guaranteed security, and our “national” problems can be solved…in healthcare, in education, in finance, in housing, in energy.

As a result, America is moving towards a time when the government acts by right, but the people act by permission. Or, as America’s Philosopher, Ayn Rand, puts it:

“We are fast approaching the stage of the ultimate inversion: the stage where the government is free to do anything it pleases, while the citizens may act only by permission; which is the stage of the darkest periods of human history, the stage of rule by brute force.”

But our drift toward statism is not inevitable. There is no such thing as historical determinism. Ideas move human history. The ideas that created America still exist, waiting to be rediscovered. That rediscovery is beginning to emerge. This time, however, those ideas come armed with a full philosophical and moral defense and justification. That armament is Objectivism, the philosophy of Ayn Rand.

So the bittersweet feeling that, for me, accompanies Independence Day should not be mistaken for pessimism or cynicism. If I thought that the fight to save America long term was futile, I would not have started this blog, or speak up at every opportunity for my beliefs in conversation, online forums, or any other medium open to me. And I am not alone, as the two linked articles in this piece show.

So I will continue to do my part as a patriotic American citizen by exercising “the independence of the human mind”…my own. This has and will continue to include the radical, but quintessentially American, Jeffersonian urging to “Question with boldness… every fact, every opinion.” I will continue at the task of "Changing the Wind.”

Have a great and happy Independence Day.

Commentary 36 and 36a

The only way freedom can be preserved is for every citizen to be willing to stand up and defend not only his own rights, but all peoples' rights. This issue is about more than gun owners, and the anti-2nd Amendment crowd should think again here. Those who would vote away the rights of others, should know that they are voting away their own, as well.

Excerpt from my latest activism. Read the rest.