The Daily Warning

I remember when the economy really started to fall apart, everyone making the argument for some sort of governmental intervention that had an absurdly high cost and very little chance of actually working used the old go to “The cost is nowhere near as high as the cost of doing nothing”.  Republicans have spent the last 6 months trying to make sure everyone knows that their alternative to the stimulus was another stimulus.

I want to get into the thought process behind this.  First, we should go over the various forces which led to the economic collapse, and where those forces originated.

So at it’s most simple, the economy collapsed because most of our financial firms were massively leveraged in the housing market (this means they were borrowing money to invest in housing, so if they made gains they’d make more gains, and if they had losses, they’d lose more) (more specifically they were getting into mortgage markets, not the houses themselves).  Some of these firms were leveraged like 40-1 (for every dollar they had, they borrowed another 40 dollars, which they invested).  They invested in the housing market because mortgage lenders were lending huge sums of money to people who previously didn’t have access to that much credit, primarily because they more than likely couldn’t pay the loans back.  As anyone with less than stellar credit can tell you, you have to pay more in interest for each dollar you borrow, and so presuming the loans get paid back, it’s more profitable to lend to people with poorer credit.  So this led to a huge level of growth in our housing markets (due to the influx of demand coming from these people who couldn’t previously get the money to buy homes getting the money to buy homes).   Most of our politicians, if they even made it to the simplest level of analysis, did not make it past this point.  This is why they claim it was a problem with business, it was businesses behaving irresponsibly.  But as we all have IQ’s which exceed the average autumn temperatures in Alaska, let’s move beyond this point.

Why do businesses do what they do?  The pursuit of profit.  Profit in the short term, profit in the long term, any way they can get it, they’ll do it.  It’s inherent in the system.  The reality is that if you, at any point, decide that it’s not worth it to knife rape a grandmother for the 50 cents you could get out of her purse, someone else will, which means they have 50 cents more than you, which they can use to charge lower prices in consumer markets, and subsequently they will drive you out of the market by seizing your market share.

So if this is the case, why weren’t these firms as leveraged  in the housing market before?  Well, at its simplest level, it’s quite simple, the people with poor credit weren’t able to get that level of credit, so the credit markets weren’t nearly as profitable to invest in.  It wasn’t worth the risk associated with leveraging 40-1 to invest that much in the industry.  So that raises the question whether it was the fault of these firms, who have always been responding in the same way to the same stimuli.

 And the answer is no, it’s not their fault.  As we established, they can’t afford to neglect sources of net profit (they can’t neglect short term profit if the amount of short term profit is enough to outweigh the long term costs), and so the issue wasn’t that they were getting into this market, the issue was why this all of a sudden became so profitable, and why it could sustain its level of profitability.

So why was it so profitable all of a sudden, and why did it cease to be profitable?  It’s through this we find who the real crooks in this whole thing are.

 Back in the 1930’s the government created two semi-private firms called Fannie Mae and Freddie Mac.  These firms were unique because there was specific Treasury code that implicitly guaranteed that these firms would be bailed out if the need ever arose.  This was done to create what’s referred to as “moral hazard”.  Fannie Mae and Freddie Mac are mortgage clearing houses, which is to say they buy up mortgages from banks.  Because of the guarantee of a bailout, Fannie and Freddie were able to afford the absorption of more risk than the private banks who had no guarantee of a bailout.  So Freddie and Fannie were able to buy up higher risk mortgages (mortgages given to people with poorer credit), which in turn enabled banks to give mortgages to people with poorer credit (as they could sell the mortgages to Fannie and Freddie).  This was all for the purpose of making home ownership more accessible for less wealthy Americans.

But when moral hazard is left unconstrained, the results can be disastrous.  Fannie and Freddie are both private firms, and so they’re not free from the pressures all private businesses are subject to.  They need to maximize their profit.  This would mean using their unique status to buy up very high-risk mortgages, leading to people getting mortgages they couldn’t possibly pay back, causing a huge housing bubble that will lead to a huge number of foreclosures (sound like anything familiar?)

 And so Fannie and Freddie were regulated, as the market regulations (the cost of absorbing risk - losing money when people default) had been undermined by the government.

And so things worked out well for a while.  The nature of governmental interventions is that how well they work in accomplishing their goal is equal to the amount of damage they do to the economy.  So when increased minimum wages causes increased unemployment, governments frequently allow the currency to inflate to a point where the minimum wage is beneath the common wage for unskilled labor, so it doesn’t raise anyone’s wages, but it doesn’t cause increased unemployment.  Similarly, the freedom government provided Fannie and Freddie was undermined by governmental regulation, so the moral hazard isn’t allowed to help the people it was meant to help, but it doesn’t cause the unmitigated disaster that unconstrained moral hazard causes.

And so what happened?  Well, Democrats progressively fought to remove some regulations, because there was always someone who needed to seem like they were giving houses to poor people.  Over time, the regulations were undermined, allowing unconstrained moral hazard into the market.

But it wasn’t just that.  That, in and of itself, would’ve caused the foreclosures, it would’ve caused some of the financial problems, it would’ve caused some of the overleveraging, but not it all.

In his first term, President Bush dealt with two significant economic events.  The first was the pop of the tech bubble, the second was 9/11.  In response, Bush cut taxes for the rich and ran up significant budget deficits.  It was an effective short term stimulus, and we were growing like we’ve never grown before by 2003, but it was short sighted.  When you combine a quickly inflating currency (a currency that is losing its value because of increases in the money supply - which happens when you increase deficit spending), which makes people think in the short term that they have more money coming in than they actually do, with the moral hazard coming from Fannie and Freddie, you have a huge increase in the mortgage markets.  This is because people who used to pass on accepting credit they couldn’t afford now don’t pass because the government tricked them into thinking they did have enough to cover the loan.  It shouldn’t be surprising to anyone that a lot of the bad mortgages were ARMs (Adjustable Rate Mortgages - which are good for people who expect their wages to keep rising, but disastrous for anyone who’s income stagnates after they get it) because wages were increasing (real wages were not, because of inflation).

So when you get past the simplest level of analysis, it becomes clear that this entire thing was caused by the government.  Most was caused by the Democrats, but it was turned into the perfect storm it became by big government interventionist Republicans.

Anyone who is any kind of a (good) student of the long term impacts of governmental intervention should be able to tell you that expecting net benefit from governmental intervention is like telling you that it’s beneficial to not pay your credit card bills and just dodge the collection agencies.  It can always be justified in the short term (I don’t have the cash, I can’t afford to save to pay for it, etc.) but in the long term you’re always worse off than if you had just made the harder more responsible decision from the get go.

I’ve been taught that half-truths are much more dangerous than lies, and that’s the case with governmental intervention in the economy.  John Meynard Keynes, the guy who constructed the theory behind most governmental intervention in the economy since the 1930s, wasn’t wrong in his theories, but they were half truths.  His theories, if enacted to the t, could smooth over the edges of a market economy.  The problem is that economic theories, no matter how good, are never followed to the t.  Governmental decisions are made politically, and the only way to get past that is to have a dictator with such total control that he doesn’t have to give a damn what anyone thinks of what he does.  Mass brainwashing, public executions, reeducation camps, etc. all are necessary premises of a government being able to enact Keynesian theory in the technocratic fashion it requires.  Since this isn’t understood, and politicians love to lie and claim they make their decisions based on what the experts tell them is best, the practical impact of Keynesian theory is that it’s used as an excuse for government to push further governmental intervention, which they will just use as a means of controlling more resources in order to buy more votes.

And so we get back to the question, should the government do anything when it comes to the economy?  The short answer is no.  The longer answer is that some things are necessary, if not maximally efficient.  If we have food codes that are enforced, then a tourist can come into town and know they can eat in any restaurant they want.  People can’t reasonably be expected to know enough about individual taxi drivers to make an informed decision, and so taxis have to be regulated in an area for people to feel comfortable using the taxis.  Environmental regulations are necessary because of externalities.  Government has to regulate the use of public goods.  Governmental funding of scientific research and protection of infrastructure are necessary premises of a lot of economic growth.

But the government cannot be trusted to manipulate the economy.  Now I’m not as comfortable as many of my right-wing counterparts declaring the Obama stimulus a failure yet.  I think we’re going to experience some short-term growth from the stimulus that we haven’t experienced yet.  We might even technically get out of the recession.  The stimulus wasn’t structured to be immediate, it obviously isn’t working as well as the architects initially anticipated, but you can’t flush a trillion dollars into the economy and not experience some short term growth.

But it will be a disaster.  There will be inflation, and it’s going to wipe out savings, pushing us back into having a negative rate of savings, causing consumer bubbles which will cause more stuff like what we’re going through now in the future.  And we’re going to go through what we went through in the early 80’s, only worse.  We’re going to have fed rates pushed up into at least the 20’s (22% fed rates in 1979 caused a 2 year recession in the early 80s), we’re going to have many many more bailouts of financial firms who have been given more moral hazard in the last year than we have ever had in the history of our country.  It’s fitting that politicians get caught up on the immediate political problem - the current recession - and see taking an extra 6 months to recover as being a bigger problem than an even bigger, much worse recession and credit collapse in the not-too-distant future.

Don’t trust your government to handle your money.  They will always screw you.  The cost of doing nothing is that you have to count on yourself to handle your business, the cost of doing something is giving that power to people who don’t care about you, don’t know what they’re doing, and really don’t care that they don’t know what they’re doing.   

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