A THOUGHT ON TODAY’S CRISES
By Publius II
Away back in 2005 William Bonner published a book called Empire of Debt: The Rise of an Epic Financial Crisis. Those who read the book then apparently thought that there will be no crisis, and just what induced Mr. Bonner to write this tome?
With the benefit of hindsight his motivation becomes obvious: he wanted to warn the people of a disaster in the making. With this in mind he referred to the citizens as an “imperial race.” Do the people accept this label, or have they been flimflammed?
They have been programmed to believe such ridiculous things as 1) house prices never drop; 2) a person can spend him/herself to riches; and 3) savings and deficits don’t matter. Did any thinking reader in 2005 and later compare this brainwashing process with Hitler’s propaganda machine? Probably not.
On August 15, 1971 President Nixon broke the bond between currency and gold. This meant the US government could print money at its pleasure and there was no practical ceiling on the public debt. Congressional meetings from time to time in order to set a new and higher limit became so routine that the news media did not bother to cover them. Until May 2011, when Standard and Poor’s threatened to downgrade the nation’s traditional AAA credit rating unless this trend was stopped.
Bonner: “All empires must pass away. All must find a way to destroy themselves. America found debt.” Paul Kennedy’s 1988 book The Rise and Fall of the Great Powers springs to mind, as does insights into human nature.
The Fed (Federal Reserve Bank board of governors) increased the supply of money, which drove the interest rate (price of money) below the level determined by a free market. Credit expanded with this increase, so the extra liquidity spread nearly everywhere. Unlimited credit enabled today’s government to carry on two or three foreign wars while still doling out entitlements to frequent-voting seniors back home.
Another factor fed the overliquification of the economy. In 1997-98 there was a financial crisis in East Asia. Afterward, governments accumulated huge trade surpluses as protection against a future crisis.
What to do with all this extra money? It went into the US bond market, where it further reduced interest rates and thus inflated the housing bubble.
Wall Street’s investment bankers inhaled the extra money while retail banks lent their surplus bucks to unqualified borrowers who bought McMansions. Distorted credit markets created “ultracapitalism,” as described by Ray Carey, author of Democratic Capitalism.
Government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were created years ago by Congress to increase home ownership among the population. These creations distorted the housing market, which is not good. For example, if a laid-off worker finds a job in another town he/she may need to pass it up because he cannot quickly sell his house. An apartment or condo dweller can move much more easily.
Retail banks lent much of the surplus money to high-risk house buyers until they had little capital left. In a presumed attempt to spread risk far and wide these GSEs bought and bundled mortgage papers of varying risk into shares. Having presumably dumped the risk of default on the GSEs, banks merrily kept lending. Eventually the point was reached where no one knew where the risk had gone and how much was involved.
The government, Wall Street and Main Street were happy while bubbles in housing and finance inflated. “Eat, drink and be merry because tomorrow the bubbles will burst and we may die (paraphrased).”
Big bankers have long been in the business of shifting big money to places where it can be utilized most efficiently. This is simply basic finance and a very useful service in capitalistic nations.
But as big money got bigger it attracted more government regulation. Wall St. superbrains made big bucks for their super-rich clients and themselves by eluding regulations. To do this they created such complex instruments as hedge funds, private equity, credit-default swaps, etc. Because they live and die in the money game they are always a jump or two ahead of the bureaucrats.
Today’s buzz has government dreaming up smarter regulation, presumably to make the superbrains shape up. But alas; it is swimming against a rip tide. The Economist (7/09): “—— unless the industry is reformed, the future will consist of banks that are too important to fail and central banks that are destined to do so.” No matter how smart, regulators cannot reform the industry. Pocket Gofer 8 elaborates.
The kicker here lies in the fuzzy dividing line between efficient allocation (capitalism) and siphoning money into smart pockets (ultracapitalism). With any surplus of money comes additional temptation.
Consumers with a surplus of money slowly come to believe marketeers’ hype such as “spend here and save big!” Simple logic proves that no one can save money by spending it, but logic eludes the brainwashed.
During the 1970s US citizens saved 10% of their disposable income. By 2005 that had dropped to one percent. Many thought that big increases in the value of their homes were savings, and that these increases were never going to stop. Therefore millions of citizens are approaching retirement with far less stashed away than they will need, and Social Security has not prepared for them. This situation points to a declining society.
Capitalism includes a basic principle that requires those who make profits in good times take the pain in bad times. The lessons that should be learned are job losses, company bankruptcies, saving money against a recession and losses in investments. These lessons are critical, lest history be repeated.
US Government officials have for centuries been unable to stop meddling in the private marketplace, even tho it always distorts markets and therefore undermines the smooth functioning of capitalism. Naïve citizens and self-serving organizations demand intervention without realizing that in most instances it only makes a bad situation worse for the public. Worse yet, the government’s “solution” appears to solve the problem whereas the hidden reality is increased taking of taxpayer money.
Power-seeking public officials generate excuses to keep huge companies under their control. In this way they can exercise their power by micromanaging almost the entire economy. Today they are targeting the giant FAANG tech firms. These are Facebook, Apple, Amazon, Netflix and Google. Jefferson said it is natural for liberty to give ground to government.
But the kicker here is that this micromanaging is not motivated by capitalism. It is driven by politics. Besides, politicians as a group know practically nothing about how to run a private business.
Few citizens realize that this situation prevailed for decades in Russia and China before public officials wised up. Fannie Mae and Freddy Mac caused massive upheavals even tho they were arguably the world’s most heavily regulated enterprises.
Government sees the “too big to fail” argument as an opportunity to intervene and presumably save the companies. GM and AIG are cases in point. But quite possibly bad top managers of such firms drifting toward trouble may rush to recklessly expand more in order to qualify for TBTF. The decision to intervene, of course, is not determined by economics but rather by politics: when to stop? Unless restrained by thinking citizens politics knows no boundaries.
Maybe government guarantees of banks would be useful. But government guaranteed personal savings in 1988 and the result was the S&L (Savings-and-Loan) fiasco. Bank managers saw Joe/Jane Taxpayer covering their losses and so they went hog wild with depositors’ money and lost big, BIG. As usual, the taxpayer rode in on his/her white horse even tho both he and the horse did not want to do this.
The 2007-08 financial crises could have been predicted — Bonner.. Joe/Jane taxpayer was there for them in 1988, so why not also this time around? Sure as hells fire, the big bankers were right. So the situation was similar but writ much larger. As of 4/2010 the same direct dollar pipeline to the super-wealthy big bankers and from the unwealthy taxpayer still exists. Wall Street sees this as becoming conventional wisdom while main street is just beginning to think.
In the cases of Fannie Mae and Freddie Mac bad regulation was not the full story. Over time the housing market developed to where they were obsolete and should have been disbanded or turned into private firms. But no bureaucracy likes to be terminated so both companies hired lobbyists to call on congressmen while bringing bags of money. Congressmen love money so both GSEs (government-sponsored enterprises) were allowed to grow until they were TBTF.
Buying influence in government is corruption. Members of congress knew that the taxpayer would get stuck with the multi-billion-dollar bill. All too often the end result is what goes around comes around and bites. In October 2007 the Economist warned that greater growth of the FMs would be asking for trouble.
Congressmen must have figured no problem, and the lobbyists’ money surely was good. Most will go toward the next election to burnish their public images in front of their suckers, — er, voters.
Bush and treasury secretary Hank Paulson shoveled most of $700 billion toward bankers, wanting them to lend and kick-start the economy. But bankers were already lent out, much of it to subprime borrowers who were defaulting in droves. So the bankers had to “recapitalize;” that is, set money aside against a depositor “run” on their banks. New lending was all but nonexistent.
The $700 billion TARP (Toxic Assets Recovery Program) prevented the collapse of large banks and averted the possible collapse of the US and world financial systems. Today these banks have recovered and most of that $700 billon has been paid back. And there is more to come.
If this sounds like the government finally got it right, Neil Barofsky (News & Observer 4/3/11) begs to differ. He was the special inspector general of the bail-out program. He stated that what really happened was a massive swindle of the taxpayer.
“Billions of dollars in taxpayer money allowed institutions that were on the brink of collapse not only to survive but even to flourish. These banks now enjoy record profits and the seemingly permanent (our emphasis) competitive advantage that accompanies being deemed ‘too big to fail.’
“Treasury’s plan for TARP shifted from the purchase of mortgages to the infusion of hundreds of billions of dollars into the nation’s largest financial institutions, ——- promise that it would restore lending.
“Treasury, however, provided the money to banks with no effective policy or effort to compel the extension of credit. There were no strings attached: ———- not even a request that banks report how they used TARP funds.
“The biggest banks are 20% larger than they were before the crisis and control a larger part of our economy than ever. They reasonably assume that the government will rescue them again (emphasis added), if necessary. Indeed, credit rating agencies incorporate future government bailouts into their assessments of the largest banks, ————-.” This describes the situation as of May 2011. Taxpayers should think again, and then act.
Huge bucks were given to big bankers whose misbehavior contributed to the present mess. And now prudent taxpayers who qualified for prime home loans are being asked, — nay, forced, to help out those who overextended on their loans. They are rightfully bent, and argue that a valuable lesson should be learned, lest the whole fiasco recur in the future.
When government takes over banks lending will not be guided by capitalistic considerations. It will be guided by political considerations. A favored crony gets a juicy loan and kicks part of it back to the congressmen who engineered the vote in favor. This is how today’s Washington works. And, yes, it is corrupt. See PG7.
Bail-outs are not only anti-capitalistic; they become a chronic disease. The Detroit auto companies have several times in the past gone to government for help. Rather than insisting that the companies roll up their sleeves and dig, Uncle said yes. Ergo, GM and Chrysler were recently at the well again and Detroit became a ghost town. Every bail-out avoids a vital lesson learned while it rips taxpayers.
Top dogs at these companies knew months and probably years in advance that they were headed for big trouble. They continued on course anyway, secure in the knowledge that the taxpayer would come to their rescues. With jobs in GM and Chrysler saved by taxpayers, they saturated the market for cars, small trucks and SUVs, making survival difficult for everyone in the industry.
Believing the taxpayer’s wallet has no bottom, others are lining up. And they will continue to do so as long as the chronic disease remains uncured. Whenever mountains of taxpayer money pile up and stick around for a while clever hands will find ways to tap into them. This is the curse of BIG GOVERNMENT; Pocket Gofer 15 elaborates.
With trillions being tossed about in a frenzied effort to get things moving again what little accountability that previously existed goes bye-bye. This is not corruption; it is good old fashioned grand theft.
It takes tough leaders to face adversity eyeball-to-eyeball. As long as Uncle Sam cooperates it is much easier to go to Washington, hat in hand. But this practice does not breed tough leaders. It renders companies less competitive and it ships jobs overseas.
Writing in 1942, famous economist Joseph Schumpeter said that an economic downturn can act as a “good cold shower for the economic system.” It removes capital, labor and equipment from weak companies as they fold their tents and directs them to stronger ones. But Schumpeter’s prescription can work only when government keeps its hands clear.
Capitalism means millions of voluntary agreements between sellers and buyers being struck every day while free of interference by the dead hand of government. It means risk-taking entrepreneurs starting businesses thru borrowing surplus money saved in banks and the stock and bond markets by workers and managers. It means funds going to their most efficient use thru decisions by astute money managers, bankers and investors.
It means creating productive jobs and paying workers what they are worth in a free labor market. It means inventing new products, services and processes according to what the market demands. It means trusting unknown people, along with a firm legal system for discouraging the negative side of human nature and punishing those who ignore this restraint. It means protection of people’s ownership rights in private property and the sanctity of contracts. Finally, it means doubling and tripling living standards over decades.
Built into the risk is both success and failure. The latter is an excellent learning tool for the entrepreneur who thru deep thinking may analyze his/her mistakes and then have another go.
As successful companies grow they need more money than they can generate thru profits, so they tap into the capital markets. These consist of stock and bond markets created for middle and upper class savers who see better prospective returns on their money than banks can provide. Capitalism enables these institutions to exist and thrive.
As suggested above, capitalism creates losers as well as winners. Those who don’t make out so well may (instead of another go) get together and petition government for help. GM is but one of many examples.
This is where capitalism is undermined because politicians seeking re-election are tempted to take petitioners’ money to help their re-election campaigns. They enact rules to favor these groups in return for it. This behavior is unconstitutional and corrupt, but they do it anyway because they know no one will call them on it.
Career politicians cause increasing abuse over decades. Eventually elections get rigged. It is a great life so long as the peasants are kept dumbed down and brainwashed. Neighborhoods in northwest Washington, DC have become the nation’s richest. (When the nation was young members of congress met twice a year and, while in Washington, stayed in hotels and boarding houses.)
Cooperative news media help top officials like Barack Obama to state that the economy is turning around when the reality is iffy. He can be forgiven for attempting to initiate a self-fulfilling prophesy. But if people get fooled into spending now they will be even worse off during a lingering recession. (Government has probably told the news media not to use this word.)
So, about when will the dawn come? A study was done recently on 14 “severe” banking busts, including the Great Depression and several major countries besides the US (Economist 1/10/09, pg. 68). The results suggest that a recession/depression following a financial crisis will be long and deep.
Per capita GDP fell on average by about 9% from its peak and slid downward for about two years before rallying. Applied to the current situation, GDP peaked in 2008 with very little advance from 2007. Later there seemed to be some indication of growth, if news reports can be believed.
The study showed an average increase in unemployment of 7%, suggesting that in the US it could reach 11-12% and peak about five years after it started increasing. (Businesses always hesitate to hire at the end of a recession because they don’t know if it is actually over.)
House prices dropped for about five years to the bottom, for an average loss of 36%. Government debt rose by an average of 86% (end of study).
Median house prices peaked in November 2007 at $249,000, about when economists figure the recession began. In November 2008 the number was $221,600 and in March 2009 $201,400 with perhaps 3.5 years to drop further before it turns around.
Unless the study is flawed the outlook was not good. The national debt could top $20 trillion or $267,000 for a typical family of four. And that is just what shows on the books. Today that horrible prophecy has come true.
Numbers of this magnitude can cause eyes to roll and minds to boggle. Putting them in perspective is a challenge, but people, especially those with children, should understand the implications for the future. Here is a simple exercise aimed at enlightening citizens.
To begin, taxing, borrowing and spending big money is what governments do. But only a century ago big money budgets meant $millions. Fifty years ago they had become $billions. Today it is $trillions. Graphically:
MILLIONS: $X,000,000
BILLIONS: $X,000,000,000
TRILLIONS: $X,000,000,000,000
The last has 12 zeros. Each added zero multiplies the full number by ten, so today government is borrowing and spending BIG BIG money. Combine this with the fact that over the past 100 years the population has multiplied by about four times and maybe some rolling eyes will stop and their owners will begin to think.
Over the past 100 years the cost of living has increased about 21 times. But trillions divided by hundreds of millions leaves ten thousand times. (This is only approximate, but nonetheless scary.)
Many countries’ governments and investors are financing the debt today, mostly by buying US treasury bonds. Interest on these must be paid regularly and someday the debt must be paid. Today’s and tomorrow’s taxpayers will be stuck with the bill as government continues as it has for decades: spending tomorrow’s money today.
The kicker here is that there is a point where foreign lenders will begin wondering if they will be repaid. They will think about this, and possibly decide to buy no more treasury bonds and call for repayment on those outstanding.
The government would of course lack the money to answer this call (or bleed the taxpayer dry) and the world’s biggest economy would be bankrupt. And there would not be any Chapter 11 to save it. It could print the money, but then the purchasing power of the dollar would go into free fall.
Lenders know this, so this knowledge would cause them to charge a higher price (interest rate) to “roll over” existing debt. The higher rate will divert still more money from economic growth, thus further weakening the economy. This in turn will cause lenders to hike the price again. Economists call this vicious cycle a debt trap.
Decades of reckless spending by the congress and loose monetary policy by the Fed have caused the economy to tank. Therefore there is no “rainy day” fund that should have been reserved for the next inevitable recession. So taxpayers get stung once again, big time.
A realistic conclusion is that the situation is indeed grim. Publius II has thought about this. His recommendation invites BIG GOVERNMENT to butt out.
After the Great Depression and World War II retail banks were regulated. They could only accept deposits and make loans, and there was a restriction on the number of branches. Banks were small and they operated in thousands of small towns. Nearly everyone in town knew the local bankers.
People trusted their bankers, but only up to a point. It was at that point that the independent bank examiner entered the picture. It was fear of that examiner that kept bankers accountable and free of temptation. In summary, the system worked. For some 40 years it contributed to a doubling of living standards for nearly everyone.
The key was trust. That vital attribute provided far more regulation than could any government agency or group of agencies. Today trust is all but nonexistent. It is intriguing to speculate just what has happened since WWII that caused trust to evaporate and why. A full explanation appears on page three of the essay “Society Vs. Government.”
Trust must be rebuilt. This will be a long process in any event. It has become obvious from the above discussion that government will not rebuild trust unless citizens demand it. Betrayal simply pays too well.
Publius II recommends that trust be rebuilt by citizen entrepreneurs who create banks at the local level. In the short term these would restrict their activities to accepting deposits and making loans, thus allowing capitalism to allocate resources to their most efficient uses.
The late Friedrich von Hayek was a prominent economist. He recommended that each bank create and maintain its own currency, which it would defend against competitors with its all-important reputation. The idea got scant press when announced. But today, with instant electronic communications and exchange rates a buyer could spend or invest money issued by his/her bank anywhere. Under this condition would any bank be tempted to play fast and loose with depositor funds?
This movement has already begun. Lending.com is a peer-to-peer bank where a group of lenders coalesces to make a loan to a qualified borrower. The deal is done online. Lending-tree operates in a similar manner.
As it was just after World War II bankers would acquire a reputation for honesty, which would be verified by active citizens and bank examiners. Constant scrutiny would replace government regulation by clamping a firm lid on temptation.
In this way “trust but verify” could and would be built from the bottom up. Thru citizen discussions and debate the mechanism would with time become more sophisticated and transparent. Trust could then reach out toward investment banking and capital markets, possibly by forming consortiums. Pocket Gofer 4 elaborates.
While others thrive some banks will fail, both retail and investment. But that’s show bizz under capitalism, provided the dead hand of government cannot meddle. Citizens would give notice to big banks and other large companies that “too big to fail” is history.
Critics would wonder what would happen to the multi-trillion-dollar national debt. Bond holders would surely be unhappy with this sweeping change in the financial system, and justifiably so.
Today holders of unsecured bonds issued by American corporations in trouble may expect to get somewhere around 10 cents on the dollar. They are not happy campers. Wealthy foreign lenders would feel the same way.
But neither group would have much choice in the matter. Where there is money there is risk. This would be the first time in American history that the “full faith and credit of the US government” has failed. Restoring it would take time, just as it will with surviving companies.
Note that this recommendation ties in closely with Publius II’s proposed constitution of the United States of America, a summary of which can be found in the essay titled “A Thought on Government over the Long Term.” The full proposal appears in PG21.