WHAT WENT WRONG?
What caused the economic crisis? Although securitization, failures at rating agencies, and greed on Wall Street all played a role, at the root of the crisis, ultimately, were misguided federal government polices. The first of these was the attempt to expand homeownership. Let me begin by saying that government has no business taking a stand on how many people should or should not own homes, just as it has no business trying to influence how many toaster ovens we buy. There is no plausible market failure in the production of housing or in people’s decisions about whether to buy homes. Yet government has been interfering for decades. A partial list of policies designed to increase homeownership includes the Federal Housing Administration, the Federal Home Loan Banks, Fannie Mae, Freddie Mac, the Community Reinvestment Act, the deductibility of mortgage interest, the homestead exclusion in the personal bankruptcy code, the tax-favored treatment of capital gains on housing, the HOPE for Homeowners Act, and the Emergency Economic Stabilization Act -- also known as the bailout bill. The U.S. government’s pro-housing policies did not have major deleterious effects for decades. The reason is that the interventions in part substituted for activities the private sector would have undertaken anyway, such as providing a secondary market in mortgages.
Over time, however, these mild interventions began to focus on increased homeownership for lowincome households. In the 1990s, the Department of Housing and Urban Development ramped up pressure on lenders to support affordable housing. In 2003, accounting scandals at Fannie and Freddie allowed key members of Congress to pressure these institutions into substantial risky mortgage lending. By 2003-2004, therefore, federal policies were generating strong incentives to extend mortgages to borrowers with poor credit characteristics. Financial institutions responded and created huge quantities of assets based on risky mortgage debt. This expansion of risky credit was especially problematic because of the second misguided federal policy, the long-standing practice of bailing out failures from private risk-taking. Bailouts have occurred often and widely, especially in the banking sector. In the context of the recent financial crisis, a crucial example is the now infamous “Greenspan put,” the Fed’s practice under Greenspan of lowering interest rates in response to financial disruptions in the hope that expanded liquidity would prevent or moderate a crash in asset prices. In the early 2000s, in particular, the Fed appeared to have made a conscious decision not to burst the housing bubble and instead to “fix things”.
The banking sector’s history of receiving bailouts meant that financial markets could reasonably have expected the government to cushion any losses from a crash in risky mortgage debt. Since government was also exerting pressure to expand this debt, and since it was profitable to do so, the financial sector had every reason to play along. It was inevitable, however, that at some point a crash would ensue. The expansion of mortgage credit made sense only so long as housing prices kept increasing, but this could not last forever. Once housing prices began to decline, the market had no option but to suffer, the unwinding of the positions built on untenable assumptions about housing prices. This interpretation of the financial crisis therefore puts primary blame on federal policy rather than on Wall Street greed, inadequate regulation, failures of rating agencies, or securitization. These other forces played important roles, but it is implausible that any or all would have produced anything like the recent financial crisis had it not been for the two misguided federal policies. Wall Street greed, for example, certainly contributed to the situation, if by “greed,” one means profit-seeking behavior. Many on Wall Street knew or suspected that their risk exposure was not sustainable, but their positions were profitable at the time. Further, markets work well when private actors respond to profit opportunities, unless these reflect perverse incentives created by government. The way to avoid future crises, therefore, is for government to abandon generating such incentives.
BAILING OUT THE BANKS
The Treasury’s bailout plan was an attempt to improve bank balance sheets and thereby spur bank lending. The justification offered was that, as of early September 2008, major banks were facing imminent failure because their mortgage backed assets had declined rapidly in value. No one disputes that several banks were in danger of failing, but this does not justify a bailout. Failure is an essential aspect of capitalism. It provides information about good and bad investments, and it releases resources from bad projects to more productive ones. As noted earlier, housing prices and housing construction were too high at the end of 2005. This condition implied a deterioration in bank balance sheets and a retrenchment in the banking sector, so some amount of failure was both inevitable and appropriate. Thus, an economic case for the bailout needed to show that failure by some banks would harm the economy beyond what was unavoidable due to the fall in housing prices. The usual argument is that failure by one bank forces other banks to fail, generating a credit freeze. That outcome is possible, but it does not mean the bailout was right.
To see why, note that allowing banks to fail does not mean the government plays no role. Federal deposit insurance would prevent losses by insured depositors, thus limiting the incentive for bank runs. Federal courts and regulatory agencies (such as the FDIC) would supervise bankruptcy proceedings for failed institutions. Under bankruptcy, moreover, the activities of failing banks do not necessarily disappear. Some continue during bankruptcy, and some resume after sale of a failed institutions or its assets to a healthier bank. In other cases, merger in advance of failure avoids bankruptcy entirely. Private shareholders and bondholders take the losses required to make these mergers and sales attractive to the acquiring parties. Taxpayer funds go only to insured depositors. The bailout distracted attention from the fact that government was the single most important cause of the crisis. More broadly, the bailout will continue to encourage perverse actions by institutions that are eligible for the money, such as acquiring toxic assets that the Treasury might buy or taking huge risks with Treasury capital injections. The Treasury bailout of 2008 also initiated a government ownership stake in the financial sector.
This means that, going forward, political forces are likely to influence decision making in the extension of credit and the allocation of capital. Government might (again) push banks to aid borrowers with poor credit histories, to subsidize well-connected industries, or to lend in the districts of some legislators. Government pressure is difficult for banks to resist, since government can threaten to withdraw its ownership stake or promise further injections whenever it wants to modify bank behavior. Further, bailing out banks sets a precedent for bailing out other industries. Thus, the long-run implications of the bailout are unambiguously bad. Ironically, the bailout itself may have exacerbated the credit crunch. The announcement that the Treasury was considering a bailout likely scared markets by suggesting the economy was worse than markets recognized. Likewise, the announcement may have encouraged a credit freeze because bankers did not want to realize their losses or sell their institutions to acquiring firms if government was going to get them off the hook. The bailout introduced uncertainty because no one knew what the bailout meant: how much, what form, for whom, with what restrictions, and for how long.
THE STIMULUS
The American Recovery and Reinvestment Act of 2009 -- better known as the “stimulus” -- represents a massive transfer of resources away from the private sector to well-connected interest groups. The funds will come from our taxes and flow to the education sector, the health care sector, the creation of “green jobs,” and federal contractors and unions. Some proponents argue that the stimulus money was needed to embark on projects that are not being supported by the market but should be. This is the “market failure” argument for government spending. In fact, federal spending is already too high in most areas. From the $15 billion we spent on the failed Big Dig in my town of Boston to tens of billions we spend per month fighting in Iraq, there’s plenty of ill-conceived government spending to be cut. The spending that was included in the stimulus bill went in many cases to sectors that are neither facing especially high unemployment nor experiencing the worst declines in activity (e.g. education).
The stimulus was not about improving economic efficiency but about distributing funds to favored interest groups. If the administration was really concerned about education, for example, it should have promoted policy changes that improve outcomes while saving money, such as reduced restrictions on who can become a teacher. The administration instead chose to shovel money to the teacher’s unions. Part of the stimulus bill came in the form of tax cuts, but these were mainly one-shot cuts aimed at redistribution rather than improved economic efficiency. Although shifting money to private citizens and away from government is a good thing, repeal of the corporate income tax would have improved long-run incentives and created the foundation for economic growth in the future. Alternatively, the stimulus could have taken the form of lower employment taxes, which would have encouraged more hiring.
PEERING INTO THE LOOKING GLASS
Obama’s new budget is at least honest; it is an unapologetic attempt to restructure the U.S. economy and expand the role of government. The budget forecasts that have come from the administration appear extremely optimistic. In particular, the extra revenue being projected from repealing the Bush tax cuts understates the dynamic response of the economy to this higher rate. Faced with higher taxes, people will cut back on their work or withdraw from the labor force. On the spending side, the new initiatives will surely cost many times as much as projected; that is the iron law of government spending. Combined, if Obama enacts half of what he has slated, we will see trillion-dollar deficits for years to come. The stunning thing about the proposed budget is that nothing announced looks like it will improve the efficiency of the economy. Nothing looks like it’s in the direction of freedom or liberty. Nothing looks like it has any faith whatsoever in markets. It’s all about rewarding interest groups: unions, the green lobby, the education lobby, and the health care sector. To sum up, the crisis was at its most fundamental level the result of government policies, not market failures. The government policies adopted have been misdirected, at best. The lesson is clear; it is better to do nothing than to make things worse. In economics, as in medicine, the dictum is “first, do no harm.”
Dit essay van Jeffrey Miron verscheen oorspronkelijk in het kwartaalblad "Cato's Letter" en werd nadien in verkorte versie ook in "Reason Magazine" en op "Real Clear Politics" overgenomen.
Meer teksten van deze liberale econoom op www.catosletter.org.
5 Reacties:
- At 19:43 Vincent De Roeck said...
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Environmentalism and Other Challenges of the Current Era
Speech/Article by Dr. Vaclav Klaus
(This is an extract from the speech Dr Klaus delivered at the Cato Institute, in Washington DC, on 9 March 2007. The extract is published in the Economic Development Bulletin No. 10 by the Center for Global Liberty and Prosperity, at Cato Institute in Washington DC. The author, Dr. Klaus, is President of the Czech Republic.)
Everyone has a list-mostly an implicit one-of issues, problems, and challenges that he feels are most relevant. I will reveal at least some of the items on my own list. All are inevitably related to something that was absent during most of my life in the communist era. The experience of living under communism provides me with a special sensitivity, if not an oversensitivity, to lack of freedom. I consider it more important, therefore, to speak about our internal challenges, three of which are main challenges of the current era – Neostatism, Europeism and Environmentalism.
I came here today as president of the free and democratic Czech Republic-a country that succeeded more than 17 years ago in getting rid of communism; a country that quite rapidly, smoothly, and without unnecessary additional costs overcame its communist heritage and transformed itself into a normally functioning European-style parliamentary democracy and market economy; a country that is an integral part of the free world, a member of NATO and of the European Union, and a good friend of the United States of America.
Everyone has a list-mostly an implicit one-of issues, problems, and challenges that he feels and considers-on the basis of his experiences, prejudices, sensitivities, preferences, and priorities-to be crucial, topical, menacing, and relevant. I will reveal at least some of the items on my own list. All are inevitably related to something that was absent during most of my life in the communist era.
What I have in mind is, of course, freedom-something that Americans value very highly, in spite of the fact that they have not experienced its nonexistence or absence personally. The experience of living under communism provides me with a special sensitivity, if not an oversensitivity, to lack of freedom.
Where do I see the main dangers to freedom at the beginning of the 21st century? I will not speak about the current headlines, and I will decline to speak about our external enemies, such as the Taliban, al-Qaeda, and Islamic fundamentalism, because I have nothing special to say or add to the issue of terrorism and I don't want to just repeat well-known arguments and facts. Suffice it to say that our ability to go ahead and eventually face external dangers depends to a large extent on our beliefs, visions, convictions, internal strength, coherence, ability to function, and so on.
I consider it more important, therefore, to speak about our internal challenges, three of which are main challenges of the current era. - At 19:44 Vincent De Roeck said...
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Dr. Klaus: Neostatism (continued)
My first topic is connected to communism. The Czech Republic-as did all the other former communist countries-had to undergo a difficult transition. We came to understand very early on that the transition had to be homemade as it was impossible to import a system devised abroad. We also came to understand that such a fundamental change was not an exercise in applied economics but a man-made evolutionary process and that we had to find our own path, our "Czech way," toward an efficiently functioning society and economy.
Over the last 15 years, I spoke many times in the United States about the process of transition; about its nonzero costs; about its benefits, tenets, and pitfalls. Now, when it is over, we face a different problem.
We succeeded in getting rid of communism, but along with many others, we erroneously assumed that attempts to suppress freedom, and to centrally organize, mastermind, regulate, and control society and the economy, were matters of the past, an almost-forgotten relic. Unfortunately, those centralizing urges are still with us. I see more examples of such urges in Europe and in most international organizations than in the United States, but they can be found here as well.
The reason for my concern is the emergence of new, very popular and fashionable, "isms" that again put various issues, visions, plans, and projects ahead of individual freedom and liberty. There is
social-democratism, which is nothing more than a milder and softer version of communism, and there is human-rightism, which is based on the idea of mostly positive rights applicable all over the world. There are also internationalism, multiculturalism, europeism, feminism, environmentalism, and other similar ideologies.
Communism is over, but attempts to rule from above are still here, or perhaps they have merely returned. - At 19:45 Vincent De Roeck said...
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Dr. Klaus: Europeism (continued)
The second main challenge that I see is connected to our experience with the European Union, but goes beyond the EU, because it is part of a broader tendency toward denationalization of nation-states and toward worldwide supranationalism and global governance.
The special sensitivity that I and many of my countrymen have makes me view many current trends in Europe rather critically. My opponents do not seem to hear my arguments. They keep rejecting the views that they don't like a priori. To understand my criticism requires knowledge of developments in the EU-its gradual metamorphosis from a community of cooperating nations to the union of nonsovereign nations-and of prevailing supranationalistic tendencies. Those developments are not well-known in the United States.
I have always been in favor of a friendly, peaceful, and mutually enriching cooperation and collaboration among European countries. However, I have many times pointed out that the move toward an ever-closer Europe, the so-called deepening of the EU, as well as rapid political integration and Europe's supranational tendencies that are not buttressed by an authentic European identity or European demos, are damaging to democracy
and freedom.
Freedom and democracy-those two precious values-cannot be secured without parliamentary democracy within a clearly defined state territory. Yet that is exactly what the current European political elites and their fellow travelers are attempting to eliminate. - At 19:46 Vincent De Roeck said...
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Dr. Klaus: Environmentalism (continued)
I see the third main threat to individual freedom in environmentalism. To be specific, I do understand the concerns about eventual environmental degradation, but I also see a problem in environmentalism as an ideology.
Environmentalism only pretends to deal with environmental protection. Behind their people- and nature-friendly terminology, the adherents of environmentalism make ambitious attempts to radically reorganize and change the world, human society, our behavior, and our values.
There is no doubt that it is our duty to rationally protect nature for future generations. The followers of the environmentalist ideology, however, keep presenting us with various catastrophic scenarios with the
intention of persuading us to implement their ideas. That is not only unfair but also extremely dangerous. Even more dangerous, in my view, is the quasi-scientific guise that their oft-refuted forecasts have taken on.
What are the beliefs and assumptions that form the basis of the environmentalist ideology? Disbelief in the power of the invisible hand of the free market and a belief in the omnipotence of state dirigisme., Disregard for the role of important and powerful economic mechanisms and institutions, primarily those of property rights and prices, in an effective protection of nature. . Misunderstanding of the meaning of resources and of the difference between potential natural resources and real ones that can be used in the economy.. Malthusian pessimism over technical progress.. Belief in the dominance of externalities in human activities.. Promotion of the so-called precautionary principle, which maximizes risk aversion without paying attention to the costs. . Underestimation of long-term income growth and welfare improvements, which results in a fundamental shift of demand toward environmental protection and is demonstrated by the so-called environmental Kuznets Curve. . Erroneous discounting of the future, demonstrated so clearly by the highly publicized Stern Report a few months ago.
All of those beliefs and assumptions are associated with social sciences, not with natural sciences. That is why environmentalism-unlike scientific ecology-does not belong to the natural sciences and can be classified as an ideology. That fact is, however, not understood by the average person and by numerous politicians.
The hypothesis of global warming and the role of humanity in that process is the last and, to this day, the most powerful embodiment of the environmental ideology. It has brought many important "advantages" to the environmentalists: . An empirical analysis of the global warming phenomenon is very complicated because of the complexity of the global climate and the mix of various long-, medium-, and short-term trends and causes. . Environmentalists' argumentation is based not on simple empirical measurements or laboratory experiments but on sophisticated model experiments working with a range of ill-founded assumptions that are usually hidden and not sufficiently understood. . The opponents of the global warming hypothesis have to accept the fact that in this case we are in a world pervaded by externalities. . People tend to notice and remember only extraordinary climate phenomena, not normal developments and slow long-term trends and processes.
It is not my intention here to present arguments for the refutation of that hypothesis. What I find much more important is to protest against the efforts of the environmentalists to manipulate people. Their
recommendations would take us back into the era of statism and restricted freedom. It is therefore our task to draw a clear line and differentiate between ideological environmentalism and scientific ecology. - At 16:36 Anoniem said...
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Vaclav Klaus moet de eerste Europese President worden!