g m g D e s i g n . c o m

CS Monitor has an editorial on why the government is to blame for the current economic woes and why we don’t need more regulation–as many politicals are screaming–but less.

The WSJ has a similarly themed editorial on the government’s journey into the domestic car business.

First, a choice excerpt from the WSJ’s car editorial:

Our other concurrent bailout — of the banking industry — has been accompanied by a debate of laissez faire versus intervention. How amusing. Banking in fact illustrates what might be called the GM Effect, for both industries have been around long enough to have accrued an almost incalculable baggage of government intervention, which explains why more intervention is demanded today.

Why don’t the auto makers limit themselves to paying competitive wages and benefits in line with what workers could earn elsewhere? Because, in the 1930s, Congress passed the Wagner Act with the nearly explicit purpose of imposing a labor monopoly on Detroit to keep wages at higher-than-competitive levels.

CS Monitor discusses the housing/mortgage crisis. Choice quote:

Throughout the 1990s, Washington encouraged these GSEs [government sponsored enterprises, referring to "Fannie Mae" and "Freddie Mac"] to expand home-ownership among lower-income, and thus more risky, borrowers. In 2004 and 2005, following the accounting scandals at Freddie, both GSEs paid penance to Congress by agreeing to expand their direct lending to low-income, higher-risk customers. Both acquired more subprime and Alt-A loans, making it profitable for banks to originate them, confident that the US taxpayers ultimately stood behind Freddie and Fannie. From 2003 to 2006, the percentage of loans the GSEs made in those riskier categories grew from8 percent to about 20 percent in 2006. This meddling helped drive up housing prices, leading other players to pile fancy new instruments on top of those mortgages, leading to a speculative bubble that was, at root, caused by the actions of two government-sponsored entities unleashed from the normal profit-and-loss checks of the free market.

Fueling this speculative fire was the Federal Reserve, also a government-sponsored organization. The Fed moved interest rates to extraordinarily low levels beginning in 2001. The additional credit it provided artificially lowered the cost of mortgages and dramatically accelerated the housing boom begun in the 1990s.

Did people suddenly get greedy in their pursuit of McMansions, second homes, and flipping homes for easy profit? Yes, but only because abnormally low interest rates made it foolish not to be. This was hardly a failure of free markets or greed. It was the predictable consequence of government distorting the interest rate.

I’m not dogmatically against all regulation or government intervention across the board. Some level of “involvement” serves a rational purpose. But most involvement is purely political. Some just accumulates over time, multiplying and reducing market efficiency. The answer to any economic problem that was caused, in part or in full, by market intervention by the government is not more regulation, but less.

Here’s some evidence that the editorial board of the NY Times is clueless about econ. The board proposes that, in addition to the bailout, the US gov’t do the following:

• extend unemployment benefits
• allow bankruptcy courts to reduce homeowner’s mortgages
• provide subsidies to cities/states for food stamps and financial aid for health care, construction jobs, etc.

In economics, there’s no free lunch, so money that subsidizes the unemployed comes from somewhere in some form, such as from taxes–from companies. I.e., the companies that provide employment. Additional taxes on those companies reduce their capacity to provide employment. Sorry, but I measure progress not by how many are “successfully” on unemployment benefits, but how many people are off such benefits. Providing economic incentives for people to remain unemployed is a bad idea.

I have no idea why bankruptcy courts should arbitrarily be allowed to alter mortgages. Maybe there’s a compelling reason (seriously). But it seems like a perversion of normal market incentives. In fact, I can see the number of bankruptcies going up for people who are on the “edge” financially, banking on a reduction in their monthly mortgage rate. Oh, and how would this affect lenders’ willingness to lend? Probably not positively, knowing that the state could dissolve loan agreements en masse. Sounds like a bad idea to me.

Bottom line is that the editorial is economically simplistic, revealing an underlying lack of understanding of basic economics (or a failure at explaining their points rationally). I’m all for an improvement in living standards and an easing of the stress from the current market turmoil. But fiat manipulation of markets by the government often winds up doing much more harm than good for Wall Street and Main Street alike.

After reading plenty of the bailout plan, I’ve become convinced that, while there is a role for the central government in all this, the bailout plan is sub-optimal, and possibly very dangerous to our long-term economic health.

Here’s a post by John Cochrane on why the bailout plan is a dreadful idea. Concluding para:

Yes, we need to do something. But “doing something” that will not work — with potentially dire consequences — is not the right course, especially when sensible and well-understood options remain.

Another editorial on RealClearPolitics on why the bailout plan is a bad idea (one of the better one’s I’ve read that explains itself without going into so much detail as to be too abstruse for laymen). Beginning para:

The proposed bailout of the financial system is a misguided scheme that will hurt the U.S. economy in the short run and long run. The economy currently is stumbling as a consequence of a government-created housing bubble, but a bailout of companies, executives, and shareholders that made unwise decisions would, at best, extend the economy’s adjustment process. More likely, the bailout would impose considerable additional economic damage because political factors would at least partially supplant market forces in determining the allocation of resources.

Quoting large chunks of the editorial, the author claims that the bailout is a bad idea for the following reasons:

• The bailout is bad for the economy. The unfortunate truth is that bad government policy has resulted in excess investment in the housing sector, and the inevitable reallocation of labor and capital is going to cause some economic dislocation. The good news, though, is that this process – if not hindered – will create a stronger and more vibrant economy. A bailout, however, will discourage this process and reduce economic efficiency. This may not seem important in the short run, since modest changes in the rate of economic growth are difficult to perceive. But in the long run, because of compounding, even small changes in the rate of growth can have a significant impact on living standards. Small differences in annual growth rates are why disposable income in the United States is substantially higher than disposable income in nations that practice economic interventionism, such as France, Germany, and Japan.

• The bailout repeats the mistakes Japan made in the 1990s. There are several historical episodes that indicate the dangers of government intervention to prop up a bubble. Japan faced a similar situation at the end of the 1980s, with real estate prices rising to absurd levels. The bubble then burst, but rather than let market forces operate, Japanese politicians sought to prop up both insolvent institution and asset prices. This interfered with the orderly reallocation of labor and capital, created considerable uncertainty, and contributed to a “lost decade” of economic stagnation. Another worrisome parallel is what happened during the 1930s. Policy mistakes such as protectionism (Hoover), higher tax rates (Hoover and Roosevelt), increased government spending (Hoover and Roosevelt) and increased intervention (Hoover and Roosevelt), helped turn a stock-market correction into the Great Depression.

• The bailout will increase corruption in Washington. When politicians have more power over the allocation of economic resources, people have an incentive to play the “rent-seeking” game of exchanging campaign contributions and hiring lobbyist in hopes of obtaining unearned wealth (or, more honorably, taking the same steps in hopes of protecting themselves from those seeking unearned wealth). The squalid mess at Fannie Mae and Freddie Mac was made possible in part because politicians received enormous amounts of money from advocates of the two government-sponsored enterprises. If the government obtains power over financial markets, including the ability to steer money to particular firms, it will create a feeding frenzy of lobbying and influence peddling.

• The bailout rewards executives and companies that made poor choices. Unfettered markets are the best generator of prosperity because people have incentives to make wise decisions. If an entrepreneur figures out a way to provide a valued good or service to others, he can become wealthy. But if that entrepreneur makes a mistake, he will suffer losses and maybe even bankruptcy. If investors put money into a well-run company, they can increase their wealth. But if they put their money into a poorly-run firm, the opposite can happen. In other words, market forces encourage people to make smart decisions so they can prosper. But it is equally important that people bear the consequences when they make wrong choices.

• The bailout will encourage imprudent risk in the future. The debacles at Fannie Mae and Freddie Mac, as well as the savings & loan failures from the late 1980s/early 1990s, are compelling examples of the negative economic consequences that occur when profits are privatized but losses are socialized. Faced with this perverse incentive structure, people engage in riskier behavior (analogously, if you are in Vegas, and somebody else is going to cover your losses, you obviously have an incentive to make bigger bets). A bailout would extend this risky behavior to the whole financial system, if not the entire economy.

Ironically enough, the writer espouses the idea (supported by many others, but disputed by some) that the government had a role in creating the problem in the first place (I support this view as well, though not dogmatically). In other words, through legislation like the Community Reinvestment Act (which encourages lending to the non-credit worthy–you know, subprime lending), lenders took unreasonable risks that they would not have taken in non-manipulated markets. I.e., the conservative concept that the government is often the problem is corroborated by this view point.

That editorial referenced above is a good one and one that largely concurs with my thinking on the issue. I.e., we need to “do something,” but let’s not pervert normal market incentives as a result of this crisis. Let’s not permanently wreck our financial system due to the lending fiasco.

My biggest worry is not whether or not we’ll get out of this mess. I think we will. My concern is that, for the foreseeable future, the idea that free markets are a good thing and that wasteful regulation is a bad thing will take a back seat to the illiberal economic view points espoused by the more socialist-inclined members of Congress. I.e., we’re already seeing calls for a “New, New Deal.” A tighter regulatory regime might be helpful, so long as the scope is rationally defined, but a “New New Deal” sounds disastrous to our economic freedom and our prosperity. I foresee calls for government intervention all over the economy (including where government is already involved, and often doing harm, such as health care), despite the lack of relevance that that has in the current fiscal crisis.

Free-market, laissez-faire types will have to take a back seat to illiberal socialists. But then again, with socialism, we wouldn’t have this problem: our economy would never have generated the wealth for this to ever have become an issue.