Democrats And The Housing Crisis

The housing crisis that may severely depress the economy is caused by gov't, as have been most of the evils in human history. Jefferson understood this and so was a Republican against gov't. Accordingly, Jefferson also stood against a gov't central bank that would control much of the nation's economy. Instead he favored a private, free enterprise banking system..

In such a system there is no banking Czar in Washington DC who makes dictatorial wild guesses about how the economy ought to function or what the money supply should be. Instead, the decisions are left to millions of individuals making their own moment to moment analyses about the economy. The capitalist wisdom of the masses is considered superior to the whimsy of a gov't ego maniac central banker; even a well intentioned one.

The current crisis is caused because the gov't, in effect, printed too much money that was then injected into the housing industry. The idea was to pull up the entire economy, in the wake of 9/11, by encouraging the construction of more and bigger homes. But sadly, if the housing sector can pull up the entire economy it can also pull down the entire economy, which it is threatening to do now. There can be no free lunch cooked up by printing money or shuffling papers in Washington, as much as Democrats would love it to be so. The economy is shaky now, specifically because of about 700,000 projected foreclosures in 2007. The number is projected to rise to 1,200,000 in 2008 at which point the economy may suffer dramatically more. No one knows what will happen but with at least a year or two of a growing foreclosures to come it may well get dramatically worse from where it is now.

The Federal Reserve's (our central bank) response to the crisis created by printing too much money was to, in effect, print more money - more drugs to ease the pain of withdrawal. In the long run it might work, but only if it is part of the process of withdrawal by which the Fed stabilizes the current economy and then slowly reduces the money supply back to "normal" levels. But, we don't know if the Feds will panic about the money supply or what their guessing will prompt them to do. We do know that the entire nation's economy is in their hands since we have given them complete control over how much money to print. After looking at the monetary history of the United States, we know that our central bank usually will guess wrong. They will print too much for too long into a expansions and then deflate for too long into a recessions; thus whipsawing the economy back and forth doing serious damage to economic efficient and growth as whole industries expand and then collapse in very wasteful and inefficient ways.

In a real banking system the paper money is backed by gold which exists in a fixed supply. Gov't Czars can't create more of it and in generally will not destroy it; so the money supply is always comparatively constant. There is no delusion that gov't geniuses can print money and thereby create real wealth or manipulate the economy to get a desired outcome. You deposit money in your bank which in turn the bank loans out to pay you interest. Banks compete by offering to pay higher interest rates to depositors and by keeping a higher percentage of your money in reserve in case you want to make a withdrawal. If one bank pays more than the others you know it may be because they are loaning too much of your money for too risky investments. Thus, interest rates are set in a free market in which each bank has an incentive to hold the most money in reserve and yet still needs to loan out the most money to earn interest for its' depositors. It's perfectly rational, and more over, it's localized so if one banker is a criminal, just has very poor judgement, or even very bad luck. the crisis is localized whereas if the federal gov't makes one decision for the entire economy it can guess wrong for the entire economy and create a nationwide panic, recession, or depression.

To make matters worse, once you have accepted the idea that individual bankers and depositors are stupid, and that their affairs must be handled in Washington you open the door to even greater abuses of the free market. The Democrats of course love to substitute their gov't wisdom for that of their stupid constituents. So in this case their primary initiative seems to be to expand the operational scope and Fannie Mae and Ginnie Mae. In the end this means the Democrats want the Federal Reserve to print excess money and the Congress wants taxpayers to bailout those (through Ginny and Freddie) who waste the excess money. All the easy Democratic money circulating around makes the economy soar for the moment but when too many people can't pay the easy money back, the system freezes, and then may collapse.

At this point it is startling how far the disease has spread. First, only those directly in the building and mortgage business were affected, but then the crisis spread as it became clear the mortgage debt had been securitized and sold everywhere. Now you have money market funds, asset backed commercial paper, hedge funds, corporate bonds, Treasuries, private equity, and international exchanges all affected. As the Fed has printed new money to bail out the housing industry, short term Treasuries rates have collapsed well below the Fed Funds rate as investors put the money where they want; not into housing or housing related industries where the Federal Reserve wanted it to go. The system has no rationale and so may well endanger us all in the end.

If ever there was a case to decentralize a market this may be it. Oddly, if the gov't took over the auto industry there would be a huge reaction from the Republicans about socialism, as there will be when Hillary tries to take over the health care industry, but everyone is mysteriously silent when the gov't, besotted by pure ignorance, takes over every industry by taking over the highly centralized financial industry.

The further irony here is that Wall Street took the mortgage business away from local Savings and Loan banks with Republican approval on the theory that a larger mortgage market would mean lower more competitive rates with less risk for all involved, and that is probably true. But the tremendous consolidation that takes place as everything is sold to Wall Street, divided up, securitized, bundled, and leveraged, and sometimes sold derivatively, in a frenzied attempt by a comparatively few people in a few markets to make instant returns is far different from the real banking system which often featured a local banker driving by each individual house in his portfolio to see that the mortgagor was keeping up his property.

If you want to understand why Moody's and Standard and Poor's didn't rate sub prime collateralized securities poorly to wave off Wall street, you have to consider that it was all happening too fast for them to find the time to really look into the product with 1 /10 the concern of the old fashioned Saving and Loan officer. It's unforgivable yes but it's typical when you have such speed, concentration, billions of dollars, and the blind faith that you too must be part of the eternal Wall Street bull market. As Sarbanes Oxley now holds corporate CEO's responsible for the accuracy of their financial statements in the wake of Enron, a new law might hold Moodys and Standard & Poors responsible for their bond ratings in the wake of this housing crisis, or at least make it possible for them to be sued for fraud when their ratings turn out to be dead wrong. At least it should not be impossible for them to derive 60% of their fees from those who they rate.

On the hopeful side is that the total dollars involved in sub prime foreclosures is actually tiny (about $6-700 million in the next year in a $12 trillion economy) so in theory it should not be enough to sink the entire nation's economy, but, as they say, a 25% loss on Main Street can easily become a 100% loss on Wall Street. This is why the Fed was moved to take such extraordinary action last week. Here's how it works: when a mortgage is created in Peoria it ends up, often, on Wall Street. The local banker thus has less risk (and less need to be so careful about to whom he is in making the loan), but then the first handler on Wall Street wants less risk too so he bundles it with other loans of various quality and sells it all or in part to others who in turn want the profit on the loan or mortgage but may again seek to limit their risk. When weak loans get packaged with the strong loans and the weak loans turn out to be very weak everyone has to sell everything as fast as possible to minimize their risk from the very weak mortgages. The whole system can freeze with too many sellers and no buyers.

To further complicate the process, derivatives (virtual securities derived from real ones) are created by Wall Street in which money is invested to hedge against losses in the real mortgage backed securities. This serves to multiply the total investment dependant upon the original mortgage loans. But, because of the manic desire for profits and bonuses on Wall Street the money invested in derivatives, and in many other things, is often leveraged. That means a third party will loan you a multiple of what you want to invest in the derivatives so any returns you get from guessing correctly about the future price of the the derivatives is in turn multiplied. If some of the original mortgages go bad the problem is bad enough, but if they go bad and the derivatives hedging strategy goes bad at the same time you can have a huge effect well beyond the size of the original sub prime mortgages. To further complicate the problem many use the derivative markets not only to hedge or manage risk but merely to speculate. This can further multiply the effects of a few bad sub prime mortgages.

Understanding modern capital markets while all that is going on becomes nearly impossible. Short term treasuries, for example, have dropped like a stone recently prompting some investors to see it a sign of how stable the US gov't is, and others to see it as a sign of how rotten everything else is besides the gov't. Or, because hedging and speculative hedging have become so common you can't be sure whether people are buying because they expect prices to go up or down so it can be very difficult to know what signals the markets are sending about the health of the economy.

To manage the problems inherent in the system we need, firstly, to pray that a Democrat is never appointed to be Chairman of the Federal Reserve. The system was only figured out in the 1960's by Milton Friedman who was an ardent Libertarian Republican. Chairman since then , both here and abroad, have accepted his theory. Most well known among them was Alan Greenspan who was also a noted Libertarian. It is not an overstatement to say that the post WW2 prosperity the world has enjoyed would not have been possible without the Republican genius of Freidman and his followers who finally figured out the effects of central banking on the economy. Not surprisingly, they were resisted every step of the way by Democrats, most notably Karl Marx and John Maynard Kaynes. Before that was Williams Jennings Byran's famous pro- inflation line: "You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold."

Nevertheless, the battle for freedom from gov't; in particular, its strangle hold on the economy and capital markets, goes on and on. Ideally, this would mean getting rid of the Federal Reserve altogether and using gold backed, real money that the gov't cannot inflate or deflate. Failing that (admittedly a very long shot, in an environment where Republicans are reduced to fighting gay marriage instead of fighting divorce) Ginny May And Freddie Mac should be eliminated as dangerous Federal institutions that merely encourage printing money and bad home loans. The Federal Reserve, if it is to exist, should be required to think in terms of expanding the money supply just enough to maintain constant prices in a growing economy with a growing population, and not in terms of whipping up inflationary or false economic activity by printing money in order to look good as an election approaches. General interest rates (the Fed Funds rate ) should not be used to expand the entire economy when a particularly sector ( in this case the housing industry) can be targeted, in extreme circumstances, more specifically through the Discount Window, and even then the targeting should be aimed at specific healthy borrowers rather than all housing borrowers.

As always it's the Republicans who since Jefferson have generally been doing the right thing regarding freedom from gov't, and the Democrats who would subvert the process with gov't printed easy money in an attempt to buy votes or simply because they lack the ability to understand that printing money and shuffling papers in Washington cannot create sustainable economic growth.

Ted Baiamonte
bje1000@aol.com
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