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Monday, July 14, 2008
One Degree Higher
There aren't many sectors of the American economy entirely free of regulation. John Pugsley noted in The Alpha Strategy, written in 1980, that over forty thousand regulations apply to every hamburger served in a retail restaurant. If the number hasn't increased since then, your Curmudgeon will be very surprised.
Banking is not an unregulated industry. In fact, it's one of the most heavily regulated of all.
Today's big story concerns the financial straits of the Federal National Mortgage Association (FNMA or "Fannie Mae") and the Federal Home Loan Mortgage Corporation (FHLMC or "Freddie Mac"). In 2000 and 2001, Congress mandated a massive loosening of the criteria by which these government-created, government-managed, government-guaranteed entities were to grant loans and loan guarantees. The rationale? Helping the poor, of course. Minorities. Single parents. Residents of areas that lack "affordable housing."
The Clinton Administration, anxious to buttress its favor with the plebes, was in favor of this. The Bush Administration, more concerned with other matters, sat still for it. When the Federal Reserve Open Market Committee, anxious to reinflate the economy -- that's the word, folks; that's what a central bank does when it arbitrarily expands the currency supply -- drove the discount rate down to 1% and held it there by main force, the record low interest rate, in combination with the loosened mortgage restrictions and the invention of FNMA and FHLMC bonds for sale to private parties, blew an American housing bubble unlike anything in our history:
- We saw an incredible expansion of the banking industry, along with peripheral institutions such as mortgage brokers, packagers, and remarketers.
- We saw the birth of the sub-prime, interest-only, and negative-amortization mortgages.
- We saw no-income, no-asset mortgages proliferate.
- We saw an explosion in both realty development and realty speculation ("Flip That House," anyone?).
- We saw a nationwide increase in average real estate prices of 270% from low to high.
The short version: Many, many unwise purchases, made possible by many, many unsound loans, drove seven-years of speculative frenzy in the real estate market.
But as Baron Philippe de Rothschild said, "Trees do not grow to the sky." Bubble markets are "greater fool" markets: when there are no fools great enough to buy from the most recent crop, that crop discovers its folly in the most immediate imaginable way. They do their best to limit their losses, but losses are inevitable -- as is the collapse of the price level at which they bought into the bubble market.
Bubble markets are point-for-point analogous to pyramid schemes. No one wants to be the "greatest fool"...but ultimately, as in a game of Hearts, someone must get stuck with the Old Maid.
The real estate bubble was created by Congress. The great majority of the Representatives and Senators who engineered it are still in office. Senators Christopher Dodd (D, Conn) and Charles Schumer (D, NY) were both in the vanguard of the charge for loosened mortgage regulations. They're leading the attempt to blame the mess on the Bush Administration today.
What's wrong with this picture, Gentle Reader?
An artificially low price on money -- that is, an interest rate depressed below what the credit market would support naturally -- creates an incentive to overconsume credit. But the only thing that can hold interest rates down in a free financial market is a flood of newly created money; otherwise, the low interest rate would destroy the incentives for lenders to lend. The federal government did both these things, in the name of making mortgage credit affordable and available to the very persons now facing mortgage default from coast to coast.
With one or two self-demonstrating exceptions, our federal legislators are not stupid. Especially not the Democrats. Cheap credit was a way for them to pander to the voting blocs most susceptible to their pandering. Their current thunderings are merely the reverse face of that coin: an attempt to extract still more political capital from their machinations by shifting the blame for the financial crisis onto their ideological and political opponents. Americans didn't pay much attention at the beginning of the debacle; we were too busy finding things on which to spend our HELOC funds. In consequence, quite a lot of Americans are willing to swallow the Schumer / Dodd claims whole and uncritically.
Just as our political class has begun to openly discuss the nationalization of the health care and petrochemical industries, the bolder outriders among them are now noising about the nationalization of all banking and finance...to prevent any further collapses of major financial institutions, of course. But is there anyone in America who can't foresee the end of this line of development?
Rampant inflations have ruined many nations. Zimbabwe is undergoing one as you read this. Most of us have at least heard about the Weimar Inflation, even if we were never compelled to understand its genesis. But what about the Chinese inflation of 1947-1949, which destroyed the Chiang Kai-shek regime and paved the way for Mao Tse-tung? What about Juan Peron's inflation in 1950's Argentina? What about Uruguay's turn-of-the-Twentieth Century inflation? What about the post-Revolutionary assignat inflation of France, which gave rise to Napoleon?
Each of those inflations was a government-engineered event. Each one was founded on demands for cheap credit...some, so that the (ir)responsible government could borrow more heavily at a reduced cost; others, so the government could redistribute the wealth of the nation through the inflationary mechanism.
The United States has had several moderately serious bouts of inflation: the post-Revolutionary period, when Washington advanced too slowly in coping with the war debt; the "greenback" inflation the Lincoln Administration undertook to finance the Civil War; the Roaring Twenties inflation that culminated in the Great Depression; the Carter inflation, which drove the price of gold to $800 per Troy ounce. We recovered from each of them without losing our nation, our political system, or (much of) our confidence in ourselves and our government. Perhaps we'd have been better served if we'd suffered a genuine, Weimar-style collapse; it might have imprinted the gravity of the matter more clearly on our national psyche.
As long as our government controls the volume of our currency and awards itself the power to make or "guarantee" loans, this sort of evil will always hang over our heads. But no government has ever surrendered totalitarian authority over money and credit without the "incentive" of a violent revolution.
Torches and pitchforks, friends. Think torches and pitchforks.
Comments
Dear Mr. Poretto,
Absolutely correct except for one detail. The inflation during the Carter administration was caused by Nixon’s closing the gold window. Remember the “WIN” buttons? Nixon had no choice. Our European “allies” were conducting a raid on Fort Knox by buying as much gold at $35/oz as they could. This was a blatant abrogation of the Bretton Woods agreement of 1948.
Regards,
RoyPosted by on 07/15/2008 at 02:06 AMLord knows… but will torches and pitchforks be enough?
Posted by og on 07/15/2008 at 06:44 AM”...torches and pitchforks...”
Although I believe you are probably right, nonetheless, I hope you are wrong and it doesn’t come to that. Every revolution starts out idealistically. But the instigators never know how things are going to turn out at the other end.
We were very lucky and blessed that our own revolution of 1776 turned out okay. But that is not the norm. Indeed, most revolutions turn out more like the French or Russian revolutions.
Could anyone in Paris on Bastille day have predicted the 25 years of suffering that Europe endured, culminating at Waterloo? Could the cannoneers in Charleston who fired the shots at Ft Sumter have predicted Appomattox? Could anyone in 1933 Wiemar have predicted the ruin of Berlin in 1945?
I fear for my country.
Posted by on 07/15/2008 at 10:49 AMTerm limits first ol friend… Our politicians spend their whole career running for re election and stealing our money. We have to wait till they are dead for months so one of their hand picked buffoons can be anointed and begin a ‘whole new career’ of running and stealing.
Vote em all out! November would be a nice time.Posted by on 07/15/2008 at 03:02 PM
