I got an email from a friend that I don't agree with, but I could use some help responding to it. How would you respond?

In the context of our ongoing discussion of markets and government, I can't help but feel that the meltdown of the last week lends considerable weight to my position that in the face of the value-neutral tendencies of free market capitalism the participation of a well informed, active public sector is imperative. There is a flip side to the way markets liberate economic energies; markets can become self-devouring. I accuse libert@rian ideas; they have brought us in large measure to this pass, because they foster a basic contempt for governance, ("government is the problem") the hallmark of the Bush administration.

When Robert Rubin bailed out the Mexican government by offering 20 billion dollars backing for their currency, there were howls of protest and forecasts of disaster from conservative minded politicians. Bush's laissez-faire attitude has resulted in a truly incredible 1 trillion dollar (!) giveaway. A replay, but only worse, of the S&L debacle that followed in the wake of the great free marketeer Ronald Reagan.

My friends B*b & I**a have three kids. B*b lost his teaching job.

Thank goodness that Connecticut has a "socialist" health program for people earning less than a certain amount. In Mississippi no one would come to rescue them. It would be against the grand american principles of self-reliance (or rather no bail outs for the powerless).

I'm not saying that I disagree with Paulsen and Bernake. At this point they have no choice but to intervene. But to my way of thinking the mistaken belief that the government should stay out of the way, the markets will take care of everything if left to their own devices, has led to this desperate state of affairs. Ironically, it is about is about to result in the greatest growth in government power since FDR.

My concern is that unlike the New Deal that sought to put people to work and create an ethos that we are all in this thing together, the current program will be directed at easing the pain of those who reaped the most benefits in the good times.

Henry Gifford responds:

FDRIf the mortgage market was really a "free" market, and not regulated, anyone putting money in would know there is risk, and not look to be bailed out. With regulation comes the excuse that the system let someone down, thus the system should come to the rescue.

And, if the mortgage market was really a "free" market in the sense of not being backed by Freddie Mac, etc., the penalty of default would be on the lender only, who would have watched out for their own money, and stopped making loans long before the appearance of billboards advertising 110% loans.

If the mortgage market was really a "free" market, Consumer Reports, Ralph Nader, etc. would be competing to sell information on which banks are safest, including selling stickers banks could put on the front window. The level of corruption in these private rating systems would be kept low for the same reason Coca-Cola doesn't cut corners by selling dirty or diluted soda, and the only cost to the citizen/taxpayer would be paying Consumer Reports, etc., if they chose to do so to get information to improve their decisions.

Craig Bowles writes:

Murray Rothbard’s History of Economic Thought is on six tapes but I don’t think he ever wrote the planned book. He didn’t think too much of Thomas Sowell. The tapes talk about Austrian economic theory which is the basis for libertarian views. He says that intervention alters the business cycle and causes inflation during the slowdown. The worst part though is it disrupts the allocation for production, so you get overinvestment in some areas (houses) and underinvestment in others (oil) with the liquidity-driven inflationary booms. Really great tapes and very applicable to today.





Speak your mind

11 Comments so far

  1. Henry Magram on September 22, 2008 3:12 pm

    Michael, your friend’s false statements betray his ignorance of economic theory. I would suggest you explain economic theory to him or direct him towards a source of knowledge such as the book Human Action by Ludwig von Mises. Maybe then he will stop resorting to false, metaphorical, and unscientific statements such as “markets can become self-devouring” to express his opinion.

  2. david beard on September 22, 2008 3:59 pm

    I get many of the same questions, especially from my family, who are stuck in the 1960’s form of liberalism, from which I extracted myself.
    The answers revolve around the questions of
    1. How competent and altruistic is government when writing law and
    2. What rights do citizens deserve (by law)?
    So to answer the email:
    1. The mortgage market was not a “free market”. Fannie could borrow cheaper (with its government backing) than private mortgage companies YET had mandate to lend to poor people (or rich owners of second homes), both of whom couldn’t afford the mortgage (and enriched its CEO in the process (
    2. The writer of the email assumes government laws and rules will be written by Plato’s philosopher king of a congress, which rarely happens. Although recent experience (the DMV is now on line for example) and Obama’s idealism give credence to the notion that government is better this time around.
    3. The writer of the email believes in a certain set of “rights” to which all people are entitled. These set of rights might not agree with yours set, the right to healthcare for free for example.

  3. acetrader on September 22, 2008 4:00 pm

    The guy who wrote that trash will be sad to see that his life is still the same once his bogeyman Bush leaves office! Maybe he should get some medication, get a a shrink, and take an Econ class…last time I checked, hard work and a college degree afforded me the American Dream…albiet w/o the 5,000sq ft mcMansion and 2 Suv’emouths…! Life is Beautiful! What a country! high five!

  4. Vangel Vesovski on September 22, 2008 7:01 pm

    I get tired of people who keep blaming the ‘free market’ for the failure of hampered markets. The fact is that they can claim that there is a free market but can’t support that claim with evidence.

    Let us begin with the Fed. It is a banking cartel that has been provided with a monopoly over the supply of money and credit. If we all laughed when the USSR used some bureaucrats to try to develop policies that would determine how much steel had to be produced why aren’t we laughing at the idiots at the Fed, who try to do the same with money and credit? You can’t argue that we have a free market when you have forced tender laws and monopoly power over money creation. A free market required free banking.

    Then we had the GSEs, which were created by government fiat, were regulated by government bureaucrats and were run by former government employees, mostly staffers in various administrations that used the GSEs to keep adding liquidity required to stimulate the economy whenever there was any threat of a slowdown. We need to remember that the GSEs were pressured to lend to minorities that did not qualify for mortgages under any prudent lending standard.

    And don’t the blame the ‘free market’ folks remember when bankers were browbeaten by posturing politicians for not lending enough to minorities? Haven’t they heard of the Community Reinvestment Act, which was passed during the Carter Administration? And what of the alphabet soup of government agencies and regulators who kept telling bankers to keep making loans to people who were bound to fail? Or about the tax rules that encourage mortgage debt and discourage savings?

    The statists need to find another set of arguments because this dog won’t hunt. While the US has been freer than other countries in the past it has never had a free market and never will. What we just saw was a major failure of statism across the globe. The Central Bankers are seeing their Ponzi schemes exposed for what they are and the smart money folks are starting to hedge their exposures by fleeing to real assets instead of fiat currencies and debt denominated in fiat currencies.

  5. Louis-Vincent Gave on September 22, 2008 9:41 pm

    The one consensus that emerges from the current credit crunch is that we need more regulation and more government intervention to ensure that such a crisis is never repeated. But why is no-one stopping to wonder why it is that all the problems seem to reside in banks—the most regulated entities in the financial industry—and in Western banks at that (when regulations in the OECD financial markets are typically far more strenuous than they are elsewhere)?

    Since 1998 and the LTCM hedge fund crisis, every year, doom-mongers have been predicting that the hedge fund industry, the least regulated entity in our financial markets, would see massive bankruptcies and engender large scale destruction of capital. Meanwhile, at the first hint of a liquidity squeeze, it is the banks (again, the most regulated entities), that are going bankrupt in alarming numbers. Is this a coincidence? We do not believe that it is. Meanwhile, and very alarmingly, policy-makers are getting ready to prescribe yet more regulation to solve a crisis which finds its source in… excessive regulations!

    Having had the privilege of working in the financial markets for a few years now, I have seen all kinds of bear markets. And I find that they typically fall in one of two categories:
    • The bear markets created by governments, usually triggered by protectionism, tax increases, monetary policy mistakes, regulatory overkill or war…
    •  The bear markets triggered by the market participants themselves, usually because of the belief in some kind of a “Ponzi scheme” (Ponzi was that ingenious investor who was guaranteeing a very high return and paid the returns to the old members by borrowing from the new members. As long as the entries are higher than the exits, the system grows; but then, of course, it collapses when it moves into negative cash flows…).

    A good Ponzi scheme always start with an “abnormally” high rate of return, “guaranteed” by a fairly respectable institution or individual. It also fulfills a need. With that framework in mind, let us review the current mortgage debacle.

    From 2000 to 2003, we had a huge bear market in equities, created by the previous Ponzi scheme called indexation (i.e.: the amazing belief that, the bigger a company became, the more you should own of it!). As a result of the indexation craze, pension funds, banks and insurance companies around the world found themselves undercapitalized. The regulators, always keen to close the barn door once the horses have fled, decided to prevent the undercapitalized institutions from buying anymore equities. This left pension funds, banks and insurance companies with a pressing question: how to replace equities, the high return part of their portfolios? Since, according to the new regulations, they could only buy bonds, they were forced, if they wanted to boost returns, to buy very low quality bonds, offering very high immediate returns (yields). The problem was of course that the regulators had told them that they could only buy high-quality bonds and that as a result of the massive demand for yield around the world, the returns on investment grade bonds were far below the returns on equities that they now had to replace…. So all of a sudden, here was a new need: the low-quality bond with a high rating.

    Now the beauty of capitalism is that a demand usually does not have to wait too long until a supply emerges. And if this is true of Main Street, it is true in spades for Wall Street. If I have learned just one thing in my career, it is that Wall Street will always find a way to satisfy a demand! The supply of financial products will always rise to meet the demand. In the late 1990s (the indexation bull-bear market), the work-load fell on consultants and indexers. This time around, it fell on the rating agencies and investment banks (who, as we saw before, were desperate to continue making money to compete with hedge funds).

    Through years in the financial markets, I have also learnt that there is no such thing as a simulation which does not look good. And sure enough, the mathematical geniuses in charge of building new products started to “design” portfolios of mortgages, mixing them in a way that, in the past, would have guaranteed the high returns needed, and the repayment of the principal at the end.
    The fact that the historical sample on which they built their computations had nothing to do with the current issues was of course never discussed. The ratings agencies, impressed by the soundness of the computation, and even more by the huge fees that they were getting for rating these (toxic) products, started to deliver “investment grade” ratings to products that had never met a (free) market, not paying enough attention perhaps to the slight conflict of interest that they could have. And before you knew it, the problem was solved: we had, at last, a junk bond with an AAA rating….

    It is thus fair to say that everything started with regulatory or political intervention, forcing a change in the asset or liability side of the balance sheets of financial institutions, without changing the other side. Preventing insurance companies, pension funds or banks from buying equities at the bottom of a bear market was a mistake of massive proportions. This decision reduced the future returns, without reducing the future costs (since they are a function of contracts, signed long before the intervention).

    Every crisis needs a scapegoat. Rather than take ownership of the monster that they have created, policymakers are busy pointing the finger at “evil hedge funds” and this crisis is being trumpeted everywhere as a crisis of free markets. But this is disinformation at its worst from policy-makers…

    This has to be the point of the ban on short-selling currently implemented in the US, UK, Holland, Australia, Taiwan… With their short-selling bans, policy-makers are saying “it wasn’t our bone-headed policies and our complete failures in regulatory oversight that created the problem; it was evil speculators! But now that the markets have failed we will come to the rescue and increase regulation to make sure this does not happen again”.

    Meanwhile, you can probably bet your bottom dollar that the next crisis will likely find its source in whatever increase in regulation our policy makers come up with…

    Unfortunately, the general media is buying the evil hedge-fund blame-shifting line hook line and sinker. This is probably because hedge funds make for good villains. Not only are they rich and secretive, but our whole cultural disposition is to loath financiers; whether in Balzac, Shakespeare or Tolstoy, the shylock has always been the evil one!

    Still, a cultural disposition to loath wealthy financiers should not absolve the general media from serving its purpose—namely questioning policymakers over how we got to the current predicament. Instead of trying to figure out which hedge fund made the most money out of this crisis, and then attacking that manager for doing his job well, the public would be better served if journalists started to ask policymakers why the books of the Lehman Brothers, Merrill Lynch, HBOS and Citigroup of this world were loaded with paper bought just a year or two ago and now worth cents on the dollar? And why was almost all of that toxic paper on the banks’ balance sheets and not the hedge funds’? Is it because people who work at hedge funds are so much smarter than people who work at investment banks? Or is it because hedge funds are free to look for returns in places that make sense while banks and insurance companies, because of regulations, were made to chase yields in places where they did not really exist?

    The obvious answer to that question brings me to another: how many Ponzi schemes will we need to live through before regulators and politicians stop intervening in financial markets and institutions to improve the situation? The way things are going, policymakers will likely look at the uneven playing field that they have created between regulated financial institutions and hedge funds and decide that, rather than free up the tied hand of banks, insurance companies and pension funds to look for returns in places that make sense, they will instead tie the hand of hedge funds behind their backs so that they too will be forced to look for returns where they do not exist! 

    Unfortunately, all this will achieve is more inefficient markets, lower returns on capital, human and physical capital flight to truly unregulated markets such as Switzerland or Hong Kong, and overall lower economic growth for the other Western economies.

  6. steve leslie on September 22, 2008 10:01 pm

    Your friend obviously does not know what libertarians believe. They believe in very basic government. Limited in many ways. Bush is not libertarian he is republican. Democrats believe that government is the solution to the problems. And that large government is best. The President does not write laws, Congress does. People such as Barney Frank, Nancy Pelosi, Harry Reid, Schumers, chair very powerful committees since the Democrats are in power and have been there since 2006. They decide what becomes law who gets the money and everything in between . So to suggest that the "Bush administration somehow has their fingerprints all over this debacle is spurious at best." It is ironic that Democrats took credit for the economy during the 90's yet the Republicans were in power in congress. Now Democrats are in power and they blame the President for the economic woes. Naturally, politicians like to have it both ways,yet the corrupt the facts. Second, look at who sat on the boards of Fannie mae and Freddie Mac. Have him do some research on this pointon where these people come from and he should have an eye opening epiphany. You will see plenty of Democratic supporters and Clinton Administration holdovers. Next, have your friend listen to Mark Levin and his radio show for a week. Have your friend listen to Rush Limbaugh, Laura Ingraham, some really bright people who weigh in on these themes on a daily basis. If your friend listens with an objective attitude is will be an eye awakening experience. FDR's vaunted New Deal worked because nobody had jobs and nobody had money. You had to get people to work first to earn money so the Government created jobs by instilling such projects as TVA, Hoover Dam and a host of other infrastructure programs. This was crafted by Keynesian monetarist policy which ultimately proved to by highly inflationary and had it not been for the ascent of the German ic lust for ultimate power, and the ascent of the WW2 there may very well have been a second great depression six years hence from FDR's New Deal. In a twisted way, FDR was a beneficiary of the Third Reich and Adolph Hitler. In fact, FDR was in severe jeopardy of losing the 1940 election had it not been for the war clouds over Europe. Finally, show me one example where Government ran a business more efficiently than the private sector. For example what happened when Fedex decided to get into the business of delivery system. Prices came down and quality went up. Competition thrived. Look to Massachusetts and the Big Dig. look to the bridges and the pork barrel legislature that is tacked on to bills consistently. Have your friend explain one instance where European socialism works more efficiently than free market capitalism. For that matter compare and contrast Communism, fascism against free market capitalism. See what you come up with. Socialized medicine is a travesty. just look to our neighbors to the North. They love to come to the US for medical treatment if they can afford to. Otherwise in complicated procedures, they go on very extended waiting lists that last many months at a time. Ask a Canadian whether they "Thank God for socialized health care programs." Furthermore how can Connecticut be such a wonderful state to live in. Why not ask those who actually work and live in CT. and ask them how they feel about paying all those taxes they are assessed every year. Unfortunately there are many many holes to fill in this debacle of a train that has run off its tracks, that i will have to end here and leave the rest up to you. Good luck.

  7. Robert on September 22, 2008 11:29 pm

    Have him read “The Vision of the Anointed” by Thomas Sowell. Then remind him that the anointed thought Freddie and Fannie were a great idea.

    A relevant passage:

    In their haste to be wiser and nobler than others, the anointed have misconceived two basic issues. They seem to assume: (1) that they have more knowledge than the average member of the benighted, and (2) that this is the relevant comparison. The real comparison, however, is not between the knowledge possessed by the average member of the educated elite versus the average member of the general public, but rather the total direct knowledge brought to bear though social processes (the competition of the marketplace, social sorting, etc.), involving millions of people, versus the secondhand knowledge of generalities possessed by a smaller elite group.

    The presumed irrationality of the public is a pattern running through many, if not most or all, of the great crusades of the anointed in the twentieth century–regardless of the subject matter of the crusade or the field in which it arises. Whether the issue has been ‘overpopulation,’ Keynesian economics, criminal justice, or natural resource exhaustion, a key assumption has been that the public is so irrational that the superior wisdom of the anointed must be imposed, in order to avert disaster. The anointed do not simply happen to have a disdain for the public. Such disdain is an integral part of their vision, for the central feature of that vision is preemption of the decisions of others.

    The vision of the anointed is one in which ills as poverty, irresponsible sex, and crime derive primarily from ’society,’ rather than from individual choices and behavior. To believe in personal responsibility would be to destroy the whole special role of the anointed, whose vision casts them in the role of rescuers of people treated unfairly by ’society’.

    The charge is often made against the intelligentsia and other members of the anointed that their theories and the policies based on them lack common sense. But the very commonness of common sense makes it unlikely to have any appeal to the anointed. How can they be wiser and nobler than everyone else while agreeing with everyone else?

  8. Anonymous on September 23, 2008 10:00 am

    speaking of the subject at hand: The Senate banking committee is holding hearings on CNBC concerning the proposed bail out plan that has been put together by the Federal Reserve and the Treasury. The composition is 11 Democrats 10 Republicans 1 woman Elizabeth Dole. I have been watching opening grandstanding comments by Schumers, Dodd, Reid, Hagel,Akaka et al. and this gives you great insight into how they conduct their business. Once again we experience the bloviating of elected officials reading from prepared scripts,flanked by their clerks and minions and I think on the fact that all of them are quite wealthy and most of them claim lawyer as their prior profession.

    I think the The Great and powerful Oz had it right when he chastized the scarecrow “Enough, you billowing bag of bovine fodder!” such applies to the Senate Banking committee.

  9. Jeff Watson on September 23, 2008 12:51 pm

    I might suggest an alternate title for this article, “Did the Intellectual Looters get us into this mess?”


  10. Adam on September 23, 2008 7:36 pm

    “Socialized medicine is a travesty.”

    In a word no. I live in Canada and there are quite a few people who, “Thank God for socialized health care programs”. Without going into excessive detail (Tyler Cowan’s blog Marginal Revolution has covered this a few times) the US has better outcomes for aggressive cancers and Cardiac issues but mortality and life expectancy are roughly equal. Canadians sacrifice some quality of care and quality of life for protection from financial ruin and access for all. Utopia? No but certainly not a travesty either.

  11. Sean O'Reilly on September 30, 2008 12:19 am

    What is the problem today in the housing and credit markets? Too little regulation? Too many derivatives? A faulty premise that housing prices would go up forever? All answers sound good, but they don’t really capture the situation fully. To get the real answer, let’s take a trip back in time. Just as it was in the Garden of Eden, there was a time when the housing market was free from government involvement, when we hadn’t eaten from the tree of government manipulation.

    Fannie Mae and Freddie Mac can find their origins during the Great Depression, like many other government distortions of the economy. From 1938 to 1968, the secondary mortgage market in the United States was monopolized by the Federal National Mortgage Association (Fannie Mae). This means that for 30 years, the government was the sole buyer and seller of mortgages after the loan has been made, thus allowing banks to get mortgages off their books quickly, and able to re-loan the money to yet another new home owner. The purpose of this is to further the American Dream that is home ownership. In order to provide some competition for Fannie, Congress charted Freddie Mac to do the same thing, and eventually Fannie was also privatized. Of course, solving a government monopoly with a government duopoly is a little like cutting back on cheating on one’s spouse by dropping your number of lovers from 2 to 1.

    And so on this little charade went, these two “corporations”, grew and grew, becoming the darlings of Wall Street. After all, what corporation wouldn’t grow it’s earnings at 15% a year if given special treatment by good old Uncle Sam? It’s partnership with the government allowed it to take on debt at unnaturally low interest rates, a huge advantage in Fannie and Freddie’s line of work. After all, if either messed up, Uncle Sam would be there to pick him up. This continued until one day, these firms had been so successful given their special privileges, that they had their fingers in half the mortgages in the United States.

    Not one politician today asks what would have been had these two Frankenstein-monsters of the financial industry never been created by the government all those years ago. Would we have all these homes in inventory with no buyer? Would money of even been available for those questionable loans everyone talks about? And people wonder why I was a Ron Paul supporter…


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