All Commentary
Friday, September 26, 2008

State Capitalism in Crisis

Let’s take a bird’s-eye view of what the Bush administration, with congressional complicity, proposes to do about the financial problems. The administration wants the authority to spend a minimum of $700 billion buying, among other things, bad mortgage loans — loans no one else will buy — from solvent banks and other institutions. The draft of this extraordinary measure contains this extraordinary provision:

Decisions by the [Treasury] Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Treasury Secretary Henry Paulson would become the Mortgage Czar, free to hire outside managers to help manage his portfolio. His new authority would empower him to “designat[e] financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them.”

All this of course comes on top of the federal government’s full takeover of government-sponsored mortgage underwriters Fannie Mae and Freddie Mac, the bailout of AIG, and the other acts of Big-Business Socialism we’ve witnessed in recent days.

Congress will insist on oversight. But will anyone sleep better knowing Rep. Barney Frank and Sen. Chris Dodd, enablers of the whole rotten system, are keeping watch? They’re going to spot the next crisis in the making? Tell me another one.

Congress will also likely add provisions to give the government an ownership stake in the rescued companies, to control executive pay, and to empower bankruptcy judges to change the terms of mortgages contracts. What do you call a political system with that kind of power?

Sen. Jim Bunning of Kentucky got close to the truth when he said, “The free market for all intents and purposes is dead in America.”

I say “close to the truth” because Bunning seems not to realize that the free market has been dead — by murder — for some time. Were that not the case, there’d be no financial crisis for Washington to expand its power over. How can one say there was a free market in mortgage financing, if government-backed corporations are able to disconnect the mechanisms of market discipline that naturally keep lenders from systematically making bad loans? This finance industry has the government’s fingerprints all over it.

If you need further evidence, look at this from a 1999 New York Times report:

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits….

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

In the rush of daily events — with each day bringing news of a government imposition more astounding that the last — we are apt to lose sight of the big picture. Washington Post columnist Sebastian Mallaby reminds us:

With truly extraordinary speed, opinion has swung behind the radical idea that the government should commit hundreds of billions in taxpayer money to purchasing dud loans from banks that aren't actually insolvent. As recently as a week ago, no public official had even mentioned this option. Now the Treasury, the Fed and congressional leaders are promising its enactment within days. The scheme has gone from invisibility to inevitability in the blink of an eye. This is extremely dangerous.

Fortunately congressional opposition is mounting. We can only hope it succeeds in stopping this outrageous bailout of lenders.


Magical Government


Words from politicians are like incantations. You’re not supposed to ask exactly how an alleged government solution will work. You’re just supposed to feel reassured. The well-meaning politicians and their experts have things under control. No need to worry. Nothing to see here. Move along.

But let’s be mischievous and wonder how government plans to fix the financial markets it so royally screwed up over many decades. The government will take bad loans off the hands of the lenders. For how much? No one else wants the loans, so Czar Henry is the only buyer. Some kind of reverse auction will perhaps be held. Will that yield the “right” price? Is there a way to tell? And do you think there’ll be lobbying and rent-seeking going on in the selection of what to buy and how much to pay? If you think not, you still believe in the tooth fairy too.

The jockeying for advantage has begun! “Financial companies were already lobbying to broaden the plan. And the Bush administration did indeed widen the scope by allowing the government to buy out assets other than mortgage-related securities as well as making foreign companies eligible for government assistance,” the New York Times reported. Bad credit-card debt and car loans could also be on the government’s shopping list.

It goes without saying that Paulson will not be spending his own money. Last I heard, the government was running a $400 billion budget deficit. There isn’t $700 billion tucked away in a petty-cash drawer somewhere. That’s 700,000,000,000 dollars. Seven hundred thousand million dollars, or 2,333 bucks and change per man, woman, and child in the United States. More than the Pentagon spends in a year. More than the Iraq war has cost. It’s a lot of money.

By the way, it is not $700 billion total; that’s amount that can be “outstanding at any one time.”

Whatever the government does to get the money will hurt the public. The harm from raising taxes is obvious. If the Federal Reserve creates the money out of thin air, our purchasing power will dive. That’s an implicit tax, an act of plunder no less than any explicit tax. And if the government borrows the money, it will simply divert the cash from productive investment to securities no one else will touch.

President Bush said the taxpayers may get some of the money back. I guess he means that the Treasury later might be able to sell some of the paper for more than it paid. But hold on a second: the taxpayers won’t really get the money back. The government will spend it. And even if the money were returned to the taxpayers, that wouldn’t make up for the damage done by taking it in the first place.

The administration’s proposal lists as its second objective, after shoring up the economy, “protecting the taxpayer.” Why does that make me think of foxes and henhouses.


Unclogging the Capital Markets?


But the government must remove the bad loans from the financial markets so they can be free to lend again. Or that’s the song being sung by all the officials trying to rush the bailout through Congress. That assumes no one is lending now — a gross distortion, as Robert Higgs shows here. At any rate, if the infusion of money comes from the three tainted sources just enumerated, where’s the gain? The precondition for sound lending is savings. Therefore, if the government wants to encourage lending, it needs to encourage savings. The best way to do that is to slash taxes and government spending. People will save if they are free to keep what they earn and aren’t lulled by the false promise that the government will take care of them.

Another way the government can help is to remove of the day-to-day uncertainty over what hare-brained scheme will next issue from Washington. Such uncertainty prolonged the Great Depression, and it will keep today’s financial markets in turmoil. No one will undertake risky investments if they fear what the government may do to them.

Any other government “solution” is an illusion that sews the seeds for the next crisis. But hey, it’ll get the politicians past the next election. What, they worry?

Another way to see the danger of the government’s approach is to recall that much of the current problem is the result of falling house values in various parts of the country. That decline was made possible by the government-inflated housing bubble. Governments at all levels drove up the price housing through policies to make mortgages available to people without assets or good credit, through land-use policies that created housing shortages, and through other interventions. So what good are new policies designed to drive housing values back up? (Freddie and Fannie are being urged to underwrite even more loans.) Wasn't that the problem in the first place? Such policies will only put us on the road to turmoil once again. If the government causes houses to be overvalued, the only solid fix is to let the market valuate those houses honestly. In other words, government: get out of the way.

We also have to rid ourselves of the notion that the government is doing the public (as opposed to special interests) a favor when it rescues troubled companies. Capital is always scarce. If it’s tied up in one company, it’s unavailable to anyone else. So when government keeps a firm from failing, it’s locking up scarce capital in a proven loser. That doesn’t serve the general welfare. Frederic Bastiat would ask, who’s not getting access to capital and producing useful goods because the government intervened?

There’s been a great deal of smoke about regulation and deregulation. But overlooked is the fact that there hasn’t been any relevant banking deregulation since Bill Clinton signed the repeal of the Glass-Steagall Act in 1999. (And that has nothing to do with what’s now going on.) But even had there been deregulation under George W. Bush, the complaint would be misleading. The government can seriously intervene in the market — and dangerously distort decision making — without regulating. It can do so by subsidizing businesses, for example, or promising to rescue companies — and government-sponsored enterprises — when they pursue foolish missions at the behest of politicians. As it happens, that is what the government has done for generations.

The focus on regulation, narrowly defined, distracts attention from all the ways that the government has made the financial and housing industries unstable through guarantees and other privileges. Those guarantees systematically transferred the risk of dubious mortgage lending from bankers to taxpayers. It’s a classic case of Baptists and bootleggers, Bruce Yandle’s term for when moralizers (promoting, for example, the “American dream through home-ownership for all”) and rent-seekers (the building, banking, and real-estate industries) implicitly team up to push government intervention.

The transfer of risk through government privilege — the removal or weakening of market discipline — more than accounts for what’s going on these days. What we’re witnessing is a crisis of state capitalism, and those with a stake in that system are desperately trying to save it. That explains the rush to a bailout. Let's hope they fail. If we want freedom, justice, and prosperity, we need a genuine free market. Accept no substitutes.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.