Wednesday, April 9, 2008

I'm Mad At You Because I Didn't Pay You Back

More and more I am reading the idiotic and contradictory claim that the current economic crisis is the fault of "laissez-faire" policies or a lax regulatory environment which led to mortgage bankers making bad loans. Quoting this WSJ link :

The prevailing view among critics faults Mr. Greenspan on two main counts.

First, they say, his Fed lowered rates too much from 2001 to 2003 to cushion the economy from the bursting dotcom bubble. Then it took too long to raise them again. Low rates fueled mortgage borrowing, driving home prices to unsustainable heights.

Second, they say, the Fed was lax in its regulatory role. The central bank failed to press for stiffer rules for underwriting mortgages to people who ultimately couldn't afford them, they say. Also, they say, the Fed failed to anticipate banks' exposure to risky home buyers, leaving them with too little capital to absorb the eventual losses on those mortgages.

At the time, Mr. Greenspan expected his policy to boost housing because the rest of the economy was relatively unresponsive to lower interest rates. Based on decades of his own research, he believed a buoyant housing market would spur consumers to borrow against home values and spend more. This would not produce a housing bubble, he predicted, because it was difficult to speculate in homes and the memory of the 2000 tech-stock bust remained fresh.

First, the fundamental problem lies in the nature of central banking per se. If the government has the power to create money out of thin air to fund its deficits and avoid the political pain of raising the taxes necessary to pay for its bloated expenditures then it will do so. The process of rapidly inflating the money supply relative to increases in precious metal supplies tends to cause an increase in the price of everything. In this case, as the prices of houses went up, it fueled the belief that the trend would continue indefinitely and led to a proverbial bubble in house prices. The government eager to avoid a Latin American style hyper inflation must turn off the inflation at some point which leads to a credit crunch and typically to dramatic recessions or even depression as we are now witnessing. This is the well known boom-bust cycle that has been explained and understood for over one hundred years most recently and most eloquently by Dr. Reisman.

The idea that the government should have "anticipated banks' exposure" to housing and imposed stiffer regulations on mortgage underwriters is absurd. If the entire housing and financial industry which is comprised of millions of individuals who stood to lose hundreds of billions of dollars did not anticipate these risks then how should the Supreme Dictator of Financial Regulation have anticipated these risks? Who didn't believe housing would continue to go up in price at the time? If housing prices had continued to go up and mortgage originators had continued to reap huge (dollar) profits and credit was being made easily available through low interest rates and the government continued to pose as the ultimate underwriter then a financial company would have been assailed by its shareholders for not having participated. This is precisely what inflation does. It creates bizarre distortions in the perceived profitability of various economic sectors and leads to malinvestment. It is only in hindsight (when the inflation is stopped) that many investments are recognized to be disasters. Recall that this phenomenon occurred during the stock market bubble. At the time, the market "seemed" high but many went bankrupt trying to short it. Then many who were long went bankrupt as the market plummeted. The malinvestments which take years to unwind represent an enormous destruction of capital which has real effects on our economy and standard of living.

Furthermore, ironically, to the extent that the mortgage industry would have denied loans to risky customers they would have been charged as "greedy", "miserly", and "heartless" bankers who don't care about the little guy and are only out to make a buck. In fact, historically the government has used its powers to either force banks to make loans to these types of customers and/or to underwrite them through its intermediary agencies like Fannie Mae and Freddie Mac. Far from "laissez-faire", the government's own regulatory policies contribute to the problem by creating "moral hazard" or creating a situation where businessmen have incentives to take greater risks since they reap the gains but are shielded from the consequences of those risks.

So, when these mortgage bankers awash in paper dollars pumped into the banking system by the Federal Reserve finally go on an orgy of lending to everyone and their brother without much regard to the underlying credit quality of the borrower (since the belief was that homes used as collateral would continue to go up in price) were they lauded for their benevolence at bringing home ownership within the grasp of the heretofore have-nots? No, of course not. The banks are assailed as being "greedy" and somehow responsible for screwing all of these people who got money from the banks which they do not have to pay back!? In other words, they were greedy for not lending and now are greedy for lending too much. Which is it? In fact, many of these banks are now failing and writing off hundreds of billions of dollars in losses. In what sense can someone who makes loans to people who don't pay them back be considered greedy?

Say a drug addict comes to you begging for money. So you give him the loan which he predictably doesn't pay back, so you take something of his to recover some of the losses. Should the drug addict be mad at you for having lent him the money?!!! Shouldn't it be the other way around? Shouldn't the banks be howling at all of these people who took out loans and aren't paying them back?

More ironically, the solution is certainly not more government regulation nor is it appointing a Financial Dictator who will somehow discern a future that millions of brilliant people with money at stake somehow cannot. The solution is to eliminate regulations discouraging bankers from taking risks and eliminating policies encouraging bankers to take added risk, with the proviso that the government will not be the lender of last resort and that those who enter voluntarily into financial contracts will bear the consequences of those contracts. Those with financial interest in the banks such as their depositors, shareholders, and insurers are responsible for their own actions and must act accordingly. Furthermore, it is high time we completely dismantle the Federal Reserve System and return to a 100% reserve gold standard and private banking along the lines detailed by Dr. Reisman and stop the boom-bust cycle once and for all.


Anonymous said...

do you or does anyone have a good book recommendation for the creation and history of the Federal Reserve?

Doug Reich said...

You could probably start here

with Murray Rothbard's history and critique of the Federal Reserve System

The Mises store undoubtedly has other works on this topic is George Reisman's site where you can find his book which does not really go into the details of the creation or detailed history of the Federal Reserve although he does discuss in depth the way the Fed works, consequences of the Federal Reserve system, the relationship of the Federal Reserve to the Great Depression, and the general consequences of central banking

in his "library of liberty" at

he has linked Ludwig Von Mises Theory of Money and Credit which is a more theoretical treatment of the nature of money

Let me know if you find another book that you like

Anonymous said...

A quote from Henry Ford: "It is well enough that people of the nation do not understand our banking and monetary system for, if they did, I believe there would be a revolution before tomorrow morning."

The most powerful international bankers (Rothchilds, Morgans, Rockefellers, etc.) essentially created a pseudo-government central bank (it's essentially private) to shift all of their banking liabilities to American taxpayers. I think the Fed is the single most evil institution ever created and we need to look into this. Ron Paul, the only anti-Fed candidate was smeared and laughed at by major media outlets.

The book I'd love to have, commissioned by Ezra Pound, is The Secrets of the Federal Reserve written by Eustice Mullins - copies are tough to find

Doug Reich said...

I agree the Fed is an evil institution and needs to be immediately shut down. It's amazing that so many people take fiat money as if it is the norm and consider the idea of commodity money to be looney. It is quite the opposite. Commodity money has been used forever as it is well, real. The idea of fake money created by the government is an idea only modern intellectuals could love.

Before the Fed, there were two other attempts at a National Bank. Rough timeline here at

The history of this is fascinating. Jefferson rightly opposed the creation of a national bank saying:

"If the America people ever allow private banks to control the issuance of their currencies, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their prosperity until their children will wake up homeless on the continent their fathers conquered."

The current crisis should be used as a cardinal example of why we should abolish central banking.

Anonymous said...

also the "Creature from Jekyll Island" by Griffin. Widely available