Wednesday, October 1, 2008

The Naked Emperors — President Bush

or, How a Pragmatist Deals With Economic Difficulties

Herbert Hoover II, more commonly known as President Bush, appeared before the American people two weeks ago to urge passage of the Paulson plan for solving the country's economic crisis. I wanted to scream at the TV to urge Americans not to listen to him. My emotional surge came from the knowledge that he was recommending the same kind of actions that prolonged the Great Depression in the 1930s.

Now, as then, the President thinks his colleagues know better than private businessmen how to cure the crisis. He believes, as his spiritual predecessor did, that the 'failures of the market' need to be cured by government corrections.

Bush declares:
Our system of free enterprise rests on the conviction that the federal government should interfere in the marketplace only when necessary.
Properly, "necessary" is only when fraud has occurred. To the extent that Franklin Raines, former CEO of Fannie Mae, and others may have committed it, I'm all for investigations and, if the evidence warrants, prosecutions.

But the largest part of the problem is not generally thought to be deals done behind closed doors in violation of the law. It is the result of actions taken in the open by a large number of people operating according to the rules laid down by the Federal Government itself. And, clearing the irony hurdle with ease, the Olympic athletes in that sport are the Feds themselves. It was the Federal Reserve, after all, who monkeyed with interest rates the past 5 years and more in order to try to 'stabilize' prices.

The President doesn't seem to be aware of how that might be relevant, saying, "There will be ample opportunity to debate the origins of this problem."

Nor does he show any evidence of realizing what a chimera such a goal must always remain. Prices in a free market are never stable. Far from being a flaw, that is part of its strength. Prices adjust to conditions — when they are allowed to do so.

In order to know how to solve a problem, it is often highly helpful to know how it occurred. Yet, it is evident that Pres. Bush, in standard range-of-the-moment fashion, is not particularly interested in that question. The result is that neither he nor his colleagues will generate a viable solution.

Worse is his lack of understanding the convictions on which free enterprise actually rests: that freedom is good; that it creates prosperity. In short, to use the pragmatist's language "it works."

Those convictions are backed by generations of free market theory and, even better, over 200 hundred years of experience. But it is only true that freedom works, i.e. leads to prosperity, when it is allowed to exist. The Feds' second guessing the market on random days of the week does not constitute a free market.

Tragically, the President does not trust free enterprise to operate well in exceptional circumstances. If he did, he could not say this:
Given the precarious state of today's financial markets — and their vital importance to the daily lives of the American people — government intervention is not only warranted; it is essential.
It is precisely when things are precarious that Federal intrusion into the marketplace is the most dangerous. It invariably mis-weights important facts. It distorts incentives. It guarantees injustices. Rather than allowing thousands of the best minds in business to exercise their own judgments about how to price assets, liquidate bad debt, etc, it substitutes the judgment of politicians and bureaucrats. Rather than allow private citizens to evaluate their own self-interest, Bush and crew insist on substituting their evaluations — backed by government force — whenever they deem it "necessary."

As William Pitt famously recognized, "Necessity is the plea for every infringement of human freedom. It is the argument of tyrants; it is the creed of slaves."

But such pragmatic 'necessity' isn't even practical.
In recent weeks, the federal government has taken a series of measures to help promote stability in the overall economy. To avoid severe disruptions in the financial markets and to support home financing, we took action to address the situation at Fannie Mae and Freddie Mac.

The Federal Reserve also acted to prevent the disorderly liquidation of the insurance company AIG. And in coordination with central banks around the world, the Fed has injected much-needed liquidity into our financial system.

These were targeted measures designed primarily to stop the problems of individual firms from spreading even more broadly. But more action is needed. We must address the root cause behind much of the instability in our markets — the mortgage assets that have lost value during the housing decline and are now restricting the flow of credit. America's economy is facing unprecedented challenges, and we are responding with unprecedented action.[emphases added]
None of that has worked. For those, unlike Bush, who have some understanding of capitalist economic principles, that is no surprise.

Excess liquidity, in the form of easy credit generated by the actions of Federal Reserve, is a large component of the cause of the past years' problems. For every boom, there must be a bust. To imagine that "targeted measures" can solve those problems is to live in a fool's paradise. In what Bush himself admits is a "financial system [that] is intricate and complex" it is fantasy to suppose the Federal government can tweak just the right levers by just the right amount.

Nor is turning over dictatorial power to the Treasury Secretary and a small army of helpers, as in the Paulson plan, going to endow them with the magic ability to do so. Those dictators will do no better than the millions employed by commercial and investment banks, insurance companies, and the whole panoply of firms that constitute the financial system. But in their attempt to do better they will necessarily be wielding government power to override the judgments of those millions. That is how pragmatism leads to fascism.

The President insists this is necessary because "the risk of not acting would be far higher." He adds:
Further stress on our financial markets would cause massive job losses, devastate retirement accounts and further erode housing values, as well as dry up loans for new homes and cars and college tuitions. These are risks that America cannot afford to take.
He offers no reasons to believe these dire predictions, nor has anyone in the Administration before or since. Indeed, as the smooth turnover of WaMu and Wachovia show, no additional 'plan' is needed.

But one thing is sure. Lessening risk by government action is exactly what should not be done. Risk is one of the natural brakes used in a free market to limit damage. The Fed's policy of greasing those brakes by mollifying the effects when the investor's guess turned out to be wrong is part of what has got us where we are. More of the same will not improve the situation.

And, how bizarre is it, given what concretely started this whole mess, that the President is worried about "eroding home values" and suggesting we help people take out "loans for new homes."

Unsustainable high prices, driven by demand that resulted from too easy credit, led to a bubble that has now burst. (The securities on which they were based followed.) There are plenty of homes available now at much lower prices, with plenty of loan money for those well-qualified to buy them. The present 6 1/8 rate on a fixed 30-year mortgage is hardly ruinous for financially healthy individuals. Making it easier for every man Jack and artificially propping up prices is just more of the poison making the system ill.

Nor are the financial markets as a whole 'frozen' as the Administration contends. As reported by Robert Higgs of the Independent Institute,
Commercial and industrial loans of all commercial banks, which are reported monthly, have grown rapidly. The most recent report, for August 2008, shows outstanding loans of $1,514 billion, an all-time high. This loan volume is 15.5 percent greater than it was a year earlier, and 30.8 percent greater than it was two years earlier. Frozen credit?

Consumer loans at all commercial banks, which are reported monthly, have also grown rapidly. The most recent report, for August 2008, shows outstanding loans of $845 billion, an all-time high. This loan volume is 9.2 percent greater than it was a year earlier, and 16.5 percent greater than it was two years earlier. Frozen credit?

Even real estate loans at all commercial banks, which are reported monthly, grew rapidly until very recently. The most recent report, for August 2008, shows outstanding loans of $3,642 billion, only slightly below the all-time high (in May 2008). This loan volume is 4.1 percent greater than it was a year earlier, and 15.5 percent greater than it was two years earlier. Frozen credit?
[For the complete datasets, see here and here.]

The bubble hasn't yet fully deflated and President Bush wants to add yet more air. But, then, the hallmark of the pragmatist is the dismissal of cause and effect. Let us not do likewise and repeat the mistakes of the 1930s.

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