Confidence in the economy is very low. Oil prices are very high. Stock prices are falling. Financial companies are losing money…some are failing. The government is busy bailing out Fannie Mae and Freddie Mac, creating “stimulus,” establishing new lending facilities, and cutting interest rates. With all of this happening at the same time, it’s not surprising that some people are questioning the basic underpinnings of capitalism. Trust in free markets seems to be falling and the idea of “market failure’ is gaining ground.
For example, United Airlines just sent an open letter to all its customers asking them to join in a protest against “market speculation,” which it says is driving up oil prices. At the same time, politicians are demanding more regulation of financial institutions.
A running theme is that if only the government had been more active in the first place, these problems could have been avoided. But in our view, instead of focusing on the mistakes businesses make, much more attention needs to be focused on the government failures that were the primary cause of our current problems.
As everyone who reads this page already knows, we believe the Federal Reserve cut interest rates too low, held rates there too long, and raised rates too slowly, all of which precipitated a sharp increase in inflationary pressures (including oil) and a housing feeding frenzy. Add to this the effects of the Community Reinvestment Act (“CRA”), which forced many lenders to finance homeowners who had a tenuous ability to repay, and we have a recipe for excess risk-taking in housing and painful increases in commodity prices.
The problems at Fannie Mae and Freddie Mac are also clear signs of what happens when government gets too involved in markets. Because investors have treated, correctly as is now clear, Fannie/Freddie as having an implicit government guarantee, they were able to grow much more rapidly than a free market would have allowed.
One of the reasons Fannie/Freddie are too big to fail (at least right now) is that their access to government credit has “crowded out” what could otherwise have been a flourishing competitive market in mortgage securitization, with no one firm dominant enough to necessitate federal help. In addition, because Fannie/Freddie were able to dominate the market using subsidized credit, they pushed private firms toward the fringes of the securitization process and into territory which included subprime and Alt-A loans. Clearly, Fannie/Freddie led to a world with greater securitization of mortgage debt than would otherwise be the case.
Unfortunately, in the headlong rush to fix problems that many assume were caused by the market, there is too little discussion of, or belief in, “government failure.” And this can lead to even more mistakes in the future. For example, by cutting interest rates aggressively in the past ten months, the Fed has caused another leg up in oil prices. And blaming speculation undermines trust in markets. The good news is that the US has lived through similar problems in the past and thrived.
Bera says:
Americans are blaming the Bush government for a lot of things but they don't seem to notice they've(USA) been an empire since the creation of this evil country.
All US presidents are criminals ,big time criminals.
Bush is not an exception, he's just another US president who likes to play with his toys.
And the American people stand by and do nothing at least most of them.
Sarah Howard says:
We've been fed the mantra that America is a free market and that free markets right themselves - so why is the govt not just allowing the free market forces to sort out the current mess. Because I trusted in the free market I didn't buy home when prices were what I judged wildly excessive. I've been renting and waiting quietly on the sidelines frugally saving my money at an effective 0% interest rate. I'm seriously pissed off now that I realize the govt is just going to bail out everyone in the housing market an not let a price correction take place.
Christopher says:
5% of total US mortgages said to be toxic thus the magnitude of the problem is cataclismic? Who's lying?
Global economy and outsourcing is good for US, creating middle classes elsewhere (shriking it here) so I can get cheap Wall Mart toys...but folks up there get richer, buy cars no bicycles, drive oil demand, and I pay 4 times more for gas...supply and demand hei...who's lying?
Avg bonus for Wall Street analysts 100K, an army of brilliant analysts with PhD in quatitative analysis and risk planning... with all this nobody forecasted the credit, housing and all these disasters? who's lying?
Marxwuzrite says:
The crisis was caused by declining real wages and the piling up of the savings, which would normally have accrued to wage earners, in the coffers of the wealthy.
Therefore, fewer people were able to save for a downpayment anymore. No problem, because the wealthy had all this money which HAD to be lent out , even if the interest rate was low. They can't stick it in a mattress or bury it in the backyard.Therefore, you get 100% financing from an essentially unlimited supply of money. Owners of money competed against each other to lend it out. Hence, the low interest rates and skyrocketing housing prices limited ONLY by what a borrower could pay monthly, even though it was interest only, negative amortization or whatever and only temporary. People who wanted houses, as people always have, had no choice but to go along with the program.
Hadley V. Baxendale says:
Why are we blaming a president when it is Congress that has passed all the laws that have created our present economic situation; Congress even told the president as Commander in Chief to invade Iraq. Basically, for the past 7 years Congress has acted irresponsibly and have deflected the blame by allowing the media to point a finger at Bush -- admittedly, Bush could have vetoed all the laws passed by Congress, etc.
tiga says:
Why congress do nothing for letting free market works? As far as housing market, most congress members have aquired multiple real estate equities around the country. That is why! who wish to see dropping their investiment if they have a power to sustaint it. That's what is happening in the US now.
timjowers says:
"underpinnings of capitalism" except we live in a Corporate Aristocracy. Anyone who thinks we live in a competitive capitalistic economy is very naive or living in a bubble. America has been overthrown by corrupt Congress and Whitehouse. Plain and simple.
Dan says:
> All US presidents are criminals ,big time criminals.
Bush is not an exception, he's just another US president who likes to play with his toys.
Most U.S. presidents don't torture people to death. Yeah, a lot of them suck, but few are Hitler-bad like Bush.
Repeatedly drowning civilians, mauling people alive with dogs, piling men up in naked pyramids, covering people in sh1t (literally!), electrocuting people's genitals.
Yeah, Bush is in a league of his own.
Dan says:
> Bush could have vetoed all the laws passed by Congress, etc.
Exactly. Plus, Bush's illegal war bankrupted our nation.
As for Congress, they have been terrible as well. I used to think that Republicans were fiscally responsible even if they were selfish. Turns out, they are as bad with our nation's money as Democrats. Given that they are also anti-human-rights, what's the point of voting Republican.
Democrats will screw up the budget, but at least they won't shock your balls and drown you.
Dan says:
> The crisis was caused by declining real wages and the piling up of the savings
Savings have never caused any problem in the history of the world.
Declining real wages, of course, do. But this is caused by inflation, the increase in the M3 money supply.
If we didn't have inflation, none of this fiscal crisis would be happening. Inflation is the greatest evil of our society because it causes or increases all other evils including war, poverty, violent crime, lack of health care, low education, etc.
Get rid of fractional banking, and you'll get rid of inflation and all the problems in our banking system. Colonial script worked. It's demise was the real cause of the American Revolution according to both Ben Franklin and Thomas Jefferson.
We need another revolution.
Dan says:
Another reason Bush is partially to blame is this: "President George W. Bush nominated Henry M. Paulson, Jr. to be the 74th Secretary of the Treasury on June 19, 2006." (http://www.whitehouse.gov/government/...)
Bush made Paulson the Secretary of the Treasury and now Paulson is screwing things up even more by trying to steal our (taxpayer's) hard earned money to bail out the banker pigs.
Just like Bush appointed Michael D. Brown, Stewards Commissioner for the International Arabian Horse Association, to direct FEMA and then that guy screwed over the residents of New Orleans and killed over a thousand of them.
John Powers says:
Dan,
I think there are at least 2 people at Bear Stearns who would disagree with you, as the bankers there lost 90%+ of their retirement accounts, life savings etc, with Jimmy Cayne and Joe Lewis each losing upwards of a billion dollars.
JBP
Ben says:
Wise and succinct. The 7 years of Bush and Cheney have been the most irresponsible, politically motivated and shortsighted in my lifetime. To say no one foresaw anything is a falsehood as well. I read enough columns of various authors that dangers were understood, and we still have multiple shoes to drop, boomers retiring, medicare, social security, etc., and the budget process is still more of a popularity contest than a grand plan.