The True Costs Of 'Protected' Trade... (UPDATED)

...Among other things--increased costs for consumers.

This WSJ op-ed by Don Nicolson is focused on the dairy market, but the larger point it makes about the ills of increased protectionism and the decline of free trade is particularly instructive, given the current climate. Subsidies negatively impact consumers everywhere.

In the U.S., DEIP [the dairy subsidy] means American families pay higher taxes to support subsidized dairy farmers, wiping out any savings they might enjoy from lower dairy prices. As in other countries, subsidies effectively shield farmers from true competition. Higher prices always result, and this price increase is passed straight onto consumers. There's nothing inherently "fair" about any form of subsidy.

Beware calls for trade protection. "Buy American," sounds good--who wouldn't want to "support" as it were, their fellow Americans over someone we don't know in some far off country? The reality is, it increases costs for consumers and hurts unrelated industries in the US whose goods are blocked in retaliatory trade protection moves in that far off country.

The Smoot-Hawley Tariff Act deepened the effects of the Great Depression--not only for Americans, but for people around the world. Reject the calls of the protectionists and remember that free trade benefits our exporting industries as well as keeping consumer costs low.

UPDATE 6:00pm BST: Dan K., Cambridge Econ PhD candidate writes:

Here's Robert Lawrence take on why American car manufacturers became embarrassingly uncompetitive: 40 years of Government protectionism

Although we call the big three automobile companies they have basically specialized in building trucks. This left them utterly unable to respond when high gas prices shifted the market towards hybrids and more fuel efficient cars.

One reason is that Americans like to drive SUVs, minivans and small trucks when gasoline costs $1.50 to $2.00 a gallon. But another is that the profit margins have been much higher on trucks and vans because the US protects its domestic market with a twenty-five percent tariff. By contrast, the import tariff on regular automobiles is just 2.5 percent and US duties from tariffs on all imported goods are just one percent of the overall value of merchandise imports. Since many of the inputs used to assemble trucks are not subject to tariffs anywhere near 25 percent -- US tariffs on all goods average only 3.5 percent -- the effective protection and subsidy equivalent of this policy has been huge.

It is no wonder much of the initial foray by Japanese transplants to the US involved setting up trucks assembly plants, no wonder that Automakers only put three doors on SUVs so they can qualify as vans and no wonder that Detroit is so opposed to the US-Korea Free Trade Agreement that would eventually allow trucks built in Korea Duty-Free access to the US market.

Here's the punch line:

If congress wants an explanation for why the big three have been so uncompetitive it should look first at the disguised largess it has been providing them with for years. It has taken a long time -- nearly 47 years -- but it seems that eventually the chickens have finally come home to roost.

47 years of government failure can't just be erased overnight. Sorry Detroit.

There is a certain irony in that US automakers lobbied for the protectionist policies that would ultimately have a large part in their total collapse.

If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Richard Posner On FDR & Reason

Via last Thursday's Political Diary, Judge Posner, writing in The New Republic:

[Arguably] what has now plunged the world into depression is a cascade of mistakes by rational businessmen, government officials, academic economists, consumers, and homebuyers, operating in an unexpectedly fragile economic environment, and that what is retarding recovery is not the 'unreasoning fear' of which Franklin Roosevelt famously spoke but the rational fears -- the reasoning fear, to use Roosevelt's idiom -- of businesspeople, consumers, and officials who confront economic uncertainties for which no one had prepared them.

[FDR is the guy on the left]


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Friedman Friday: The Power Of Choice

Given that I'll be traveling tomorrow, I figured I'd better resume the tradition of Friedman Fridays, today. This is an excerpt from his biography.

After watching this video, I'm left to wish, once again, that Milton Friedman were still alive. Does any other living economist have as much influence and gravitas?




If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

'Economists Have Abandoned Principle'

Oliver Hart, Harvard econ professor & Luigi Zingales, Chicago Booth finance professor:

This year will be remembered not just for one of the worst financial crises in American history, but also as the moment when economists abandoned their principles. There used to be a consensus that selective intervention in the economy was bad. In the last 12 months this belief has been shattered.

Practically every day the government launches a massively expensive new initiative to solve the problems that the last day's initiative did not. It is hard to discern any principles behind these actions. The lack of a coherent strategy has increased uncertainty and undermined the public's perception of the government's competence and trustworthiness.

Yup. You can say that again. "Willy-nilly" is the operative hyphenated word.


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

"Free-Market Capitalism Will Save Us"

Not in the religious sense.

Steve Forbes's latest column on the causes of the credit crises and its historical ramifications is enlightening. Though I don't agree with everything he says, his characterization of the Great Depression and the lessons to be learned from past mistakes feels right. I particularly like this pasasge:

The Depression was actually triggered by the Smoot-Hawley Tariff of 1929--30, which imposed massive taxes on countless imports. Other countries retaliated in kind. The global trading system collapsed. International capital flows dried up. The legislative history of Smoot-Hawley is instructive. When it first surfaced in Congress during the fall of 1929, the stock market cratered. When near the end of 1929 it appeared that Smoot-Hawley was being sidetracked, stocks rallied, ending the year almost where they had begun. But then in early 1930 Smoot-Hawley resurfaced, and stocks resumed their slide, which continued after Smoot-Hawley was signed into law that June. A devastating global contraction ensued.

Compounding that error was the U.S.' giant tax increase in 1932. President Herbert Hoover thought a balanced budget would restore confidence. The top income tax rate was raised from 25% to 63%. Hoover even legislated an excise tax on checks--you had to pay Uncle Sam a fee every time you wrote a check. Not surprisingly, strapped consumers withdrew massive amounts of cash from banks in order to conduct their business, which put even more stress on troubled banks. This check tax was one of the factors leading to the bank closures of 1933. The huge tax increase deepened the U.S. economic slump.

If not for the Depression, Hitler would never have come to power--the Nazis had carried only 2% of the vote in 1928.

It's impossible to separate the political from the economic. Protectionism and isolationism have already begun to rear their ugly heads--Obama's posturing on Nafta and other free trade agreements is just one example.

And, lest you think it's nothing more than airy campaign talk, bear in mind that trade unions are some of his biggest financial contributors and supporters. They would like nothing more than to kill Nafta and impose protectionist measures all in the name of, as Forbes puts it, "better" labor and environmental rules. This is entirely disingenuous.

Rather, expanding free-trade--revisiting Doha and continuing to pursue bi- and multi-lateral free trade agreements (Colombia, South Korea, Pacific Rim)--is the answer.

"Free-market capitalism will save us, if we let it."

(h/t Matt B.)


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

WWMS: What Would Milton Say?

If only Friedman were still alive and could pen a column for the Wall Street Journal on the Modern Great Depression (note: this is a parodic title). As it is, the only "influential" economist whose columns we can read are former Enron adviser, Paul Krugman's. And we already know what he's going to say: Blame Bush.

Fortunately and in an altogether different sort of way, we can also suss out what Milton Friedman might have said, were he alive. I'll leave it to his still-living colleague, Peter Robinson:

The day after Milton Friedman died in November 2006, The Wall Street Journal published an article about monetary policy that Friedman had written. Unable to recall when the article had first appeared, I asked the editor. "Today," he said. "Milton adapted it just a couple of weeks ago from a research paper he was working on."

This took a moment to sink in. Friedman, by universal consent one of the two or three most consequential economists of the 20th century, had still been performing original economic research then describing his findings for ordinary readers--at the age of 94.

What would Milton have said if he were still with us today? Friedman spent his final three decades at the Hoover Institution--my office was just two doors down the hall from his--and earlier this week I sat down with two of my Hoover colleagues, economists Thomas MaCurdy and Jay Bhattacharya, both close students of Milton, to decide what questions we would have asked him--and how he might have replied.

Would Milton have seen this crisis coming?

Of course. The moment the housing bubble burst Milton would have recognized that we were in for trouble. Why? Because as banks limited their lending, the money supply contracted. And whereas Milton believed that changes in the money supply affect only the price level over the long term, he recognized that over the short-term changes in the money supply can produce dramatic effects in the real economy.

"What would Milton have told you caused the recession in the early 1980s?" Tom asks. "[Federal ReserveChairman] Paul Volcker's reduction in the rate of growth of the money supply. And what has happened now? Another relativecontraction in the money supply. Milton would have told us we're headed right into a recession."

Whom would Milton have blamed?

For the bubble itself? Probably nobody. From the tulip mania in Holland more than three-and-a-half centuries ago to the dot-com bubble here in the U.S. less than a decade ago, wildly irrational behavior sometimes develops in markets. "Friedman never argued that markets are perfect," says Jay, "only that over the long run they're a lot more efficient than any other method of allocating resources." Sometimes, Milton recognized, bubbles just happen.

Whatever the origin of the bubble, however, Milton would have blamed Congress for making it much, much worse. Congress, after all, created Fannie Mae (nyse: FNM - news - people ) and Freddie Mac (nyse: FRE - news - people ), institutions that spent tens of billions of dollars on subprime instruments. "Congress told Fannie and Freddie to subsidize bad loans for the purposes of social engineering," says Jay. "It was terrible, just terrible."

What would Milton have made of government efforts to address the crisis?

He would have approved of such efforts in Britain--but expressed grave reservations about those here in the U.S.

"Milton would have wanted the authorities to find very, very aggressive ways of expanding the money supply," says Tom. The Bank of England did just that, placing large deposits in banks throughout the British financial system. "What they did in England was quick, clean and direct."

Here in the U.S., by contrast, Treasury Secretary Henry Paulson's original bailout plan, under which the Treasury would have spent hundreds of billions of dollars purchasing subprime and other instruments from major banks, went at the problem backwards. "The government should take responsibility for the money supply, but not for setting prices," says Jay. "The problem with subprime assets is that nobody knows what they're worth. Friedman would have told you that bringing the government in wouldn't have helped that."

With his new plan, under which the Treasury has now taken equity stakes worth $125 billion in nine big banks, Paulson has finally begun to make sense. "Direct injections of capital into banks--Milton would have approved of that," Tom says. "But why did it take so long? Why did we have to wait for the Bank of England to set the example?"

What would Milton have seen as the principal danger to the economy that the crisis now poses?

The very same equity stakes mentioned above. It is one matter for the government to make deposits in banks, as the Fed regularly does, Milton would have held, but another for the government to purchase equity, as Paulson has just done.

"Look, if the government wraps up its equity positions and gets out of the banks quickly, then okay," says Tom. "The danger is that the government will stick around and start managing the banks, setting loan policies, establishing salary limits for the top executives and stuff like that. Friedman would have been really clear on this. Banks should be run by bankers, not politicians."

Would Milton have seen the crisis as a setback for capitalism?

Only in the short term.

"If this election goes the way it looks as though it's going to go," says Tom, "then the political system is about to get a major overcorrection to the left. And that means the American people are about to get an extreme illustration of just how badly government intervention screws stuff up."

"If Milton were here," Tom says, "he'd tell us to remember what happened during the Clinton administration. After just two years, the Republicans ended up in control of both houses of Congress."

As much as anything else about Friedman, I appreciate his eternal optimism. This is a characteristic he shared with Ronald Reagan and William F. Buckley Jr.

And why were they optimistic? Because they shared a faith in the goodness and greatness of America.

(thanks to Branden B.)


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Brit Humor

Finally, after watching this, I understand the complex movement and machination of the markets.

(from Ace)


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

'Lazy Generation To The Rescue'

"[W]e're financially wrecked, and our forefathers don't have the slightest clue how to get us out of this mess-up. . . . I feel forced into action. As a 21-year-old, here is what I have decided I will do: Work. Hard. It pains me to type that. You must understand that this is no easy statement from someone born into the Lazy Generation. My hands have never bled before, at least not because of work, and I prefer to keep my brain nice and cozy, bathed in a pleasant solution of hard alcohol and Judge Judy. But no more. I'm beginning to feel desperate, and people in dire situations do crazy things."

- Jason Zabel in "The Lazy Generation to the Rescue"

(h/t WSJ Political Diary)


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Jack Welch On The Crisis

Listen to Jack Welch tell it like it is.

Murder on the Financial Express

Who is to blame for the great U.S. financial meltdown of 2008? BusinessWeek columnists Jack and Suzy Welch believe there are many culprits who deserve to reap bitter rewards. And they discuss why investment banks' going public contributed to the problem.

(h/t Scott L.)

If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

How To Solve A Crisis? Ask Steve Forbes

The one-time candidate for POTUS, Steve Forbes, writes in the latest issues of Forbes magazine about what should be done to avoid a Modern Great Depression.

The first prescription for a cure is to formally strengthen the dollar and announce it publicly. A year ago August the price of gold was more than $650 per ounce. In late 2003 it had breached $400. The Fed should declare that its goal for gold is around $500 to $550. That would stabilize the buck--and stability is essential if animal spirits and risk taking are to revive.

Also of immediate urgency is for regulators to suspend any mark-to-market rules for long-term assets. Short-term assets should not be given arbitrary values unless there are actual losses. The mark-to-market mania of regulators and accountants is utterly destructive. It is like fighting a fire with gasoline.

Think of the mark-to-market madness this way: You buy a house for $350,000 and take out a $250,000 30-year fixed-rate mortgage. Your income is more than adequate to make the monthly payments. But under mark-to-market rules the bank could call up and say that if your house had to be sold immediately, it would fetch maybe $200,000 in such a distressed sale. The bank would then tell you that you owe $250,000 on a house worth only $200,000 and to please fork over the $50,000 immediately or else lose the house.

Absurd? Obviously. But that's what, in effect, is happening today. Thus institutions with long-term assets are having to drastically reprice them downward. And so the crisis feeds on itself.

The SEC should immediately reverse its foolish decision to get rid of the so-called uptick rule in short-selling. That would provide a small road bump to the short-selling that's helping to destroy financial institutions.

At the same time the SEC should promulgate an emergency rule (which we thought was already the rule): No naked short-selling. That is, you have to own or borrow shares in a company before you can short it. The rules should make clear that short-sellers must have ample documentation proving they truly possess the shares at the time of the short sale. Otherwise, each violation will result in heavy fines. That wouldn't be a road bump but a wall of Everest-like proportions. Regulators should also be told to instruct banks to keep their solvent customers solvent. The last thing the economy needs right now is for the banking system to seize up.

The federal government should also consider setting up a new Resolution Trust Corp., which was devised during the savings and loan crisis nearly 20 years ago as a dumping ground for bad S&L assets. Today's bad assets could then be liquidated in an orderly way. And, finally, the financial industry should be encouraged to create new exchanges for exotic instruments. This would result in the standardization of these things, which would mean more transparency.

(h/t Scott L.)


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Bryan Caplan On Doing 'Something' About The Modern Great Depression

My job at the MRC has me reading even more than I used to read in the past. I went from reading a lot of stuff to reading a heck of a lot of stuff. One of the new things I've come across and enjoyed reading is the Reason blog, Hit & Run. There's just something about their slogan--Free Minds and Free Markets--that I find incredibly appealing. I don't know what it is.

Let me think. For which of my biases does Reason serve as confirmation bias? Hmmm. They're certainly no great friend to conservatives--least of all social conservatives. Must be my knee-jerk fiscal libertarianism. Yup. That's got to be it.

At least I'm honest.

Recently, Reason convened an online meeting of the minds (via email) and asked a number of economics-types three questions:

1. How bad is the current market situation?
2. How bad are the current proposed bailout plans?
3. What's the one thing we should be doing that we're not?

Among the respondents was Bryan Caplan, associate professor of economics at George Mason University. Forthwith, his responses:

1. How bad is the current market situation?
To be honest, I'm not too sure. While we're blaming banks and investors for their "herd behavior," we should remember that politicians and the media often run with the herd, too. When the dust settles, I suspect we'll realize that conditions weren't as bad as people assumed—or at least they weren't until we tried to fix them.

2. How bad are the current proposed bailout plans?
Again, to be honest, I'm not too sure. The plans are creating a bad precedent—perhaps the worst precedent since the New Deal. But it's worth remembering that a "$700 billion bailout" doesn't literally mean that the government gives $700 billion to investors. Instead, it means that the government can buy $700 billion worth of assets; the transfer to investors is only the difference between $700 billion and the fair market value of the assets.

I should add, though, that I don't think the people spearheading the bailout have a clear idea about what they're doing either. They remind me of the old saying: "Something must be done. This is something. Therefore this must be done." I'm a former student of Chairman Ben Bernanke and his behavior during this mess has been a big disappointment.

3. What's the one thing we should be doing that we're not?
Waiting a couple of years. Unemployment is only 6.1 percent; by standard measures, we're still not in a recession. Even if you have no libertarian sympathies, shouldn't you at least give familiar, low-impact responses (especially standard monetary policy) before you throw caution to the wind?

(emphasis added)

Let me repeat his last question for the government-intervention inclined: shouldn't you at least give familiar, low-impact responses (especially standard monetary policy) before you throw caution to the wind?

Read the rest of the responses from the rest of the respondents.

It's informative and for all of you who disagree with me vehemently, one man's confirmation bias is another man's whatever the opposite of confirmation bias is.


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Jeffrey Miron, Harvard, Blames Fannie/Freddie Too

That's why I'm posting his article here. Because he agrees with me. Because I make no secret of my biases. Because I don't try to pretend I'm not biased. Because I haven't duped myself into thinking don't have any biases. It's called confirmation bias and WE ALL DO IT.

Jeffrey Miron in his own words:

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle.

Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.

The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.

The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.

Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

The bailout has more problems. The final legislation will probably include numerous side conditions and special dealings that reward Washington lobbyists and their clients.

Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.

So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.

The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.

(emphasis added)


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Charles Calomiris & Peter Wallison On Fannie/Freddie & The Democrat Party

Add Calomiris and Wallison to the growing consensus on who is actually to blame for the current financial crisis--known in some parts as Modern Great Depression. Want the 'who's responsible' Spark Notes? Democrats (specifically Barney Frank) for enabling Fannie Mae and Freddie Mac--not Republicans and deregulation.

Here's the article:

Many monumental errors and misjudgments contributed to the acute financial turmoil in which we now find ourselves. Nevertheless, the vast accumulation of toxic mortgage debt that poisoned the global financial system was driven by the aggressive buying of subprime and Alt-A mortgages, and mortgage-backed securities, by Fannie Mae and Freddie Mac. The poor choices of these two government-sponsored enterprises (GSEs) -- and their sponsors in Washington -- are largely to blame for our current mess.

How did we get here? Let's review: In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of "affordable housing." They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.

It is important to understand that, as GSEs, Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities. Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them. By late 2004, Fannie and Freddie very much wanted subprime and Alt-A loans. Their accounting had just been revealed as fraudulent, and they were under pressure from Congress to demonstrate that they deserved their considerable privileges. Among other problems, economists at the Federal Reserve and Congressional Budget Office had begun to study them in detail, and found that -- despite their subsidized borrowing rates -- they did not significantly reduce mortgage interest rates. In the wake of Freddie's 2003 accounting scandal, Fed Chairman Alan Greenspan became a powerful opponent, and began to call for stricter regulation of the GSEs and limitations on the growth of their highly profitable, but risky, retained portfolios.

If they were not making mortgages cheaper and were creating risks for the taxpayers and the economy, what value were they providing? The answer was their affordable-housing mission. So it was that, beginning in 2004, their portfolios of subprime and Alt-A loans and securities began to grow. Subprime and Alt-A originations in the U.S. rose from less than 8% of all mortgages in 2003 to over 20% in 2006. During this period the quality of subprime loans also declined, going from fixed rate, long-term amortizing loans to loans with low down payments and low (but adjustable) initial rates, indicating that originators were scraping the bottom of the barrel to find product for buyers like the GSEs.

The strategy of presenting themselves to Congress as the champions of affordable housing appears to have worked. Fannie and Freddie retained the support of many in Congress, particularly Democrats, and they were allowed to continue unrestrained. Rep. Barney Frank (D., Mass), for example, now the chair of the House Financial Services Committee, openly described the "arrangement" with the GSEs at a committee hearing on GSE reform in 2003: "Fannie Mae and Freddie Mac have played a very useful role in helping to make housing more affordable . . . a mission that this Congress has given them in return for some of the arrangements which are of some benefit to them to focus on affordable housing." The hint to Fannie and Freddie was obvious: Concentrate on affordable housing and, despite your problems, your congressional support is secure.

In light of the collapse of Fannie and Freddie, both John McCain and Barack Obama now criticize the risk-tolerant regulatory regime that produced the current crisis. But Sen. McCain's criticisms are at least credible, since he has been pointing to systemic risks in the mortgage market and trying to do something about them for years. In contrast, Sen. Obama's conversion as a financial reformer marks a reversal from his actions in previous years, when he did nothing to disturb the status quo. The first head of Mr. Obama's vice-presidential search committee, Jim Johnson, a former chairman of Fannie Mae, was the one who announced Fannie's original affordable-housing program in 1991 -- just as Congress was taking up the first GSE regulatory legislation.

In 2005, the Senate Banking Committee, then under Republican control, adopted a strong reform bill, introduced by Republican Sens. Elizabeth Dole, John Sununu and Chuck Hagel, and supported by then chairman Richard Shelby. The bill prohibited the GSEs from holding portfolios, and gave their regulator prudential authority (such as setting capital requirements) roughly equivalent to a bank regulator. In light of the current financial crisis, this bill was probably the most important piece of financial regulation before Congress in 2005 and 2006. All the Republicans on the Committee supported the bill, and all the Democrats voted against it. Mr. McCain endorsed the legislation in a speech on the Senate floor. Mr. Obama, like all other Democrats, remained silent.

Now the Democrats are blaming the financial crisis on "deregulation." This is a canard. There has indeed been deregulation in our economy -- in long-distance telephone rates, airline fares, securities brokerage and trucking, to name just a few -- and this has produced much innovation and lower consumer prices. But the primary "deregulation" in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

If the Democrats had let the 2005 legislation come to a vote, the huge growth in the subprime and Alt-A loan portfolios of Fannie and Freddie could not have occurred, and the scale of the financial meltdown would have been substantially less. The same politicians who today decry the lack of intervention to stop excess risk taking in 2005-2006 were the ones who blocked the only legislative effort that could have stopped it.

(emphasis added)


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Economic Crisis: How We Got Here From There

Call this The Best Simple Explanation Of the Current Crisis I've Read Yet (And I've read a lot).

Chairman of the Blackstone Group, Stephen Schwarzman:

It's a perfect storm. It started with Congress encouraging lending to lower-income people. You went from subprime loans being 2% of total loans in 2002 to 30% of total loans in 2006. That kind of enormous increase swept into the net people who shouldn't have been borrowing.

Those loans were packaged into CDOs rated AAA, which led the investment-banking firms [buying them] to do little to no due diligence, and the securities were distributed throughout the world, where they started defaulting.

When they started defaulting, out of bad luck or bad judgment, we implemented fair-value accounting....You had wildly different marks for this kind of security, which led to massive write-offs by the commercial-banking and investment-banking system.

In the face of those losses...you needed to raise new equity...which came from sovereign-wealth funds, in part, which then caused political resistance to sovereign-wealth funds, who predictably have withdrawn from putting money into the system....It seemed pretty obvious that would happen. We now find ourselves with a liquidity crisis where fundamentally the cost of money for financial intermediaries [such as investment banks] is significantly in excess of their cost of lending it. So several institutions found themselves in a structurally impossible position. ...Goldman reverted to a banking charter for a lower cost of funds, which today is still not low enough for the business.

So that's the story of how we got there.

This pretty much underscores what I've been saying all along--take Fannie Mae & Freddie Mac out of the equation and the economic crisis pretty much goes away. In fact, it doesn't just "pretty much" go away, it literally goes away.

And, Fannie/Freddie are government created institutions, spurred on in their reckless mortgaging by government enablers, backed by the government (now confirmed by fact), subsidized by the government, ergo, the current crisis was government created.

After everything I've read, I can't find a compelling reason for their existence in the first place. They didn't actually provide cheaper mortgages to anybody. In the second place, if they were to have all of these implicit and explicit government guarantees, the government should have made darn sure that they weren't making bad loans and putting the rest of the financial system and therefore the economy at tremendous risk.

But they didn't. Because Barney Frank, the same Barney Frank supposedly leading House Democrats in their efforts to resolve the crisis, stonewalled every attempt to actually, you know, provide some sort of oversight and regulation of Fannie & Freddie so that the crisis didn't occur in the first place.


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

1 Of 200: Paola Sapienza On Her Opposition To The Paulson Plan

At this point, I don't think there's any doubt that Congress is going to pass some sort of legislation to forestall what many are calling a Modern Great Depression. To avoid letting the perfect be the enemy of the good, I'm persuaded that something must be done now in order to stave off, to the extent possible, serious socialization that would inevitably occur with a possibly Democrat controlled Congress & White House.

If the Paulson Plan or another one like it can keep us off of The Road to Serfdom, then I'm all for it.

Recently, Paola Sapienza, associate professor of finance at Northwestern, gave an interview to The Chronicle about her efforts to draft a letter, signed by 200 economists, opposing the Paulson Plan.

Q. Your petition was apparently explicitly discussed at yesterday’s White House session. And hundreds of thousands of people must have seen the footage of Richard Shelby waving it in the air. Is that more impact than you’d expected?

A. It’s quite amazing. To be honest, I didn’t know about any of this until I got calls from the press. You never know when these things are going to work. There were a lot of skeptics saying, Ah, they’re not going to listen to us. But we gave it a try because we thought there was some hope.

Q. How did the project begin?

A. A colleague, Luigi Zingales, and I were working on our own research. We just had read the Paulson plan [proposed by Treasury Secretary Henry M. Paulson Jr.], and we started to exchange comments, saying this is really bad, we’ve got to do something. And so it was just an impulsive urge to draft a letter … We went down the corridor to see if other people would contribute. Professor Anil Kashyap gave us some input. And then Bob Shimer and John Cochrane. So the five of us organized the effort.

Q. I assume the 200 signers of the petition have diverse, and probably conflicting, ideas about how to solve the crisis.

A. Very much so. We had that in mind from the beginning, that we wanted it to be very concise. Everyone agreed on the flaws of the administration plan. As for the right way to act, there is a large number of solutions out there.

Q. How fast do you believe Congress needs to act?

A. I think getting it right is very important. And I don’t feel the urgency of making a decision in the next couple of days. All of the signs that we see seem to confirm what I’m saying. Today Washington Mutual went under — but immediately, J.P. Morgan bought all of the assets, and the market received this as very good news. … At the end of the day, these firms still have some very good investments. There is some capital moving out there. Warren Buffett invested in Goldman Sachs this week. …

I’m not denying that it’s possible that the administration knows something that we don’t know about, and they want to intervene based on that. But all the other numbers — I don’t see the need for this urgency. I think it would be a huge mistake to rush.

Because there are so many potential alternatives, I think opening up the debate, holding hearings, taking some time, is the right thing and the democratic thing to do.

If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Jeff Frankel Grudgingly Supports The Modified Paulson Plan

Frankels is at Harvard (for those of you who care about such things).

Here's his analysis of the plan:

When the Treasury came out with its $750 bailout plan on September 22, I thought it lacked so many necessary ingredients that it deserved a thumbs down.

But in the negotiations between the Treasury and Congressional leaders over the course of last week, most of the missing ingredients were inserted. Starting with the additions that were most necessary on the merits, and moving toward the ones where the necessity was more political, they were:

· Institutionalized oversight of the Treasury, which had previously been startlingly absent.

· Provisions so that the taxpayer would share in the upside potential of banks and other financial institutions, rather than just socializing the losses. These provisions should allow the possibility that the government could recoup most or all of its short-term losses as has often ultimately been true in past unpopular bailouts.

o First, by giving the government equity stakes in the banks that sell their bad loans to the Treasury.

o Second, by having the president in five years submit legislation to recoup the cost from the financial sector if the taxpayer is still in the red at that point.

· Limits on executive compensation, especially golden parachutes, at banks taking advantage of the opportunity to dump their bad loans on the Treasury.

· Dividing the $750 billion into three slices over time, which at least offers the congressional negotiators a little bit of cover.

· A provision for possible government insurance of mortgages instead of acquisition of them. This was a bone thrown to the Congressional Republicans who had blocked the plan several days ago; I don’t know why they would want this provision, but at least it can’t do much harm.

Some other proposed provisions, from both the right and left, were left out, and for good reason in most cases.

(h/t Ryan D.)


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.