Free Markets, Free People
If you listen to those who are semi-coherent in the Occupy Wall Street crowd, they blame Wall Street for the financial straits we’re in. They’ve been convinced (and I’m sure for most it didn’t take much convincing) that it is the greed and recklessness of bankers and Wall Street tycoons which caused the housing bubble and subsequent financial collapse.
However Peter Wallison has taken the time and made the effort to lay out the entire sequence of government actions (and their subsequent consequences) which drove both the housing bubble and its collapse which put us in the financial position we’re in today.
As usual, it was government intrusion – in the name of social justice – that distorted the housing market and created incentives that otherwise wouldn’t have been there. Social engineering, with the best of intentions, that led to catastrophic unintended consequences.
The irony, of course, and what Wallison points out, is the OWS crowd is clueless at best or mendacious at worst. But the fault for our condition should be laid squarely in government’s lap. Where these protests should be taking place is in front of Congress, the White House, Fannie Mae and Freddie Mac and the Federal Housing Administration – not Wall Street.
Beginning in 1992, the government required Fannie Mae and Freddie Mac to direct a substantial portion of their mortgage financing to borrowers who were at or below the median income in their communities. The original legislative quota was 30%. But the Department of Housing and Urban Development was given authority to adjust it, and through the Bill Clinton and George W. Bush administrations HUD raised the quota to 50% by 2000 and 55% by 2007.
It is certainly possible to find prime borrowers among people with incomes below the median. But when more than half of the mortgages Fannie and Freddie were required to buy were required to have that characteristic, these two government-sponsored enterprises had to significantly reduce their underwriting standards.
Fannie and Freddie were not the only government-backed or government-controlled organizations that were enlisted in this process. The Federal Housing Administration was competing with Fannie and Freddie for the same mortgages. And thanks to rules adopted in 1995 under the Community Reinvestment Act, regulated banks as well as savings and loan associations had to make a certain number of loans to borrowers who were at or below 80% of the median income in the areas they served.
So there are the required guidelines – by law – enforced by government. And note, it wasn’t just Democrats. It was Republicans too. But the impetus and driving force behind all of this wasn’t Wall Street. It was government.
Research by Edward Pinto, a former chief credit officer of Fannie Mae (now a colleague of mine at the American Enterprise Institute) has shown that 27 million loans—half of all mortgages in the U.S.—were subprime or otherwise weak by 2008. That is, the loans were made to borrowers with blemished credit, or were loans with no or low down payments, no documentation, or required only interest payments.
Of these, over 70% were held or guaranteed by Fannie and Freddie or some other government agency or government-regulated institution. Thus it is clear where the demand for these deficient mortgages came from.
The huge government investment in subprime mortgages achieved its purpose. Home ownership in the U.S. increased to 69% from 65% (where it had been for 30 years). But it also led to the biggest housing bubble in American history. This bubble, which lasted from 1997 to 2007, also created a huge private market for mortgage-backed securities (MBS) based on pools of subprime loans. [emphasis mine]
Subprime loans, required by law to go to a certain percentage of applicants who otherwise wouldn’t get loans, built to half of all loans closed. Bubble created. Why? Because you’re talking about government “guaranteed” loans – safe money. That created a private market for MBS because the subprime loans in question would have been a poor risk on their own, but were a good risk with the government guarantee.
Demand grew, the bubble grew. But this was a foundation built on financial sand:
As housing bubbles grow, rising prices suppress delinquencies and defaults. People who could not meet their mortgage obligations could refinance or sell, because their houses were now worth more.
Accordingly, by the mid-2000s, investors had begun to notice that securities based on subprime mortgages were producing the high yields, but not showing the large number of defaults, that are usually associated with subprime loans. This triggered strong investor demand for these securities, causing the growth of the first significant private market for MBS based on subprime and other risky mortgages.
Again, because of who was holding or guaranteeing the loans, the real risk was masked, thereby triggering demand for these high-yield securities. How risky could they really be if they’re backed by the full faith and credit of the US, right?
And so the MBS market continued to grow:
By 2008, Mr. Pinto has shown, this market consisted of about 7.8 million subprime loans, somewhat less than one-third of the 27 million that were then outstanding. The private financial sector must certainly share some blame for the financial crisis, but it cannot fairly be accused of causing that crisis when only a small minority of subprime and other risky mortgages outstanding in 2008 were the result of that private activity.
And there is the salient point. No government intrusion, no government guarantees, no laws which “encouraged” or put quotas on loans with a certain percentage in the subprime category and no housing bubble, no demand for risky MBS, no financial crisis.
People, as they have for centuries, would have actually had to meet much stricter criteria for a loan and fewer would have owned homes. The market would have stayed stable, no bubble would have developed and we’d not be in the shape we’re in today. Oh, don’t get me wrong – government would still be out of control and on it’s eternal spending spree – but we wouldn’t have the added financial stress of a recession caused by government.
When the bubble popped, the inevitable happened:
When the bubble deflated in 2007, an unprecedented number of weak mortgages went into default, driving down housing prices throughout the U.S. and throwing Fannie and Freddie into insolvency. Seeing these sudden losses, investors fled from the market for privately issued MBS, and mark-to-market accounting required banks and others to write down the value of their mortgage-backed assets to the distress levels in a market that now had few buyers. This raised questions about the solvency and liquidity of the largest financial institutions and began a period of great investor anxiety.
The government’s rescue of Bear Stearns in March 2008 temporarily calmed the market. But it created significant moral hazard: Market participants were led to believe that the government would rescue all large financial institutions. When Lehman Brothers was allowed to fail in September, investors panicked. They withdrew their funds from the institutions that held large amounts of privately issued MBS, causing banks and others—such as investment banks, finance companies and insurers—to hoard cash against the risk of further withdrawals. Their refusal to lend to one another in these conditions froze credit markets, bringing on what we now call the financial crisis.
And there’s the real litany of how what happened happened. Market distortion by government is the real cause of this debacle. We’ve been pointing this out for quite some time. The problem, of course, is the unintended consequences of such intrusion seem never to be understood by the lawmakers and technocrats who come up with these sorts of grand social justice schemes. And again, understand that it wasn’t just the Democrats who helped this all along.
The bottom line however, as Wallison points out, is that while Wall Street isn’t blameless in all of this, their role, in comparison, is minor. The entire scenario was government inspired. However, that’s not what has been sold to the public. Instead we’ve gotten propaganda and class warfare in a blatant attempt to shift the blame to private concerns:
The narrative that came out of these events—largely propagated by government officials and accepted by a credulous media—was that the private sector’s greed and risk-taking caused the financial crisis and the government’s policies were not responsible. This narrative stimulated the punitive Dodd-Frank Act—fittingly named after Congress’s two key supporters of the government’s destructive housing policies. It also gave us the occupiers of Wall Street.
Indeed. If anyone needs to be in jail it is the perpetrators of the government policy that encouraged/required the market distortion that led to the bubble and ultimately collapse of the housing market.
That wasn’t Wall Street. What happened in the financial community is they reacted to an incentive created and supposedly guaranteed by government. But it was unsustainable. And it finally came to a head, dealing financial destruction all around.
Here’s the bottom line – no government intrusion, no incentive/requirement to push subprime loans. No subprime loans (especially in the amount required by government), no housing bubble. No housing bubble, no financial crisis. No financial crisis, no OWS, who simply have it all wrong.
But then, given the government propaganda effort to this group who want to believe what government is claiming, is anyone surprised?
With these debt ceiling negotiations underway, it is useful to remind ourselves, especially with an election year looming, how we got in this spot that has Moody’s threatening to downgrade our bonds based on the possibility of default on the debt.
On spending, it is important to recall how extraordinary the blowout of the last three years has been. We’ve seen nothing like it since World War II. Nothing close. The nearby chart tracks federal outlays as a share of GDP since 1960. The early peaks coincide with the rise of the Great Society, the recession of 1974-75, and then a high of 23.5% with the recession of 1982 and the Reagan defense buildup.
From there, spending declines, most rapidly during the 1990s as defense outlays fell to 3% of GDP in 2000 from its Reagan peak of 6.2% in 1986. The early George W. Bush years saw spending bounce up to a plateau of roughly 20% of GDP, but no more than 20.7% as recently as 2008.
Then came the Obama blowout, in league with Nancy Pelosi’s Congress. With the recession as a rationale, Democrats consciously blew up the national balance sheet, lifting federal outlays to 25% in 2009, the highest level since 1945. (Even in 1946, with millions still in the military, spending was only 24.8% of GDP. In 1947 it fell to 14.8%.) Though the recession ended in June 2009, spending in 2010 stayed high at nearly 24%, and this year it is heading back toward 25%.
This is the main reason that federal debt held by the public as a share of GDP has climbed from 40.3% in 2008, to 53.5% in 2009, 62.2% in 2010 and an estimated 72% this year, and is expected to keep rising in the future. These are heights not seen since the Korean War, and many analysts think U.S. debt will soon hit 90% or 100% of GDP.
Here’s the WSJ chart talked about above:
In terms of percentage of the GDP, only WWII compares to the outlays we’ve seen in the past 3 years. And not only did the Democratic Congress and Obama “consciously blow up” the debt, they never offered a budget as required by law. This was just money thrown to the wind with the hope it would land somewhere where it might help. To call what they did a “plan” is to give real plans a bad name.
Now, suddenly, Obama is “serious” about this stuff, making demands that a fix be found, etc. Where the heck was he when this money was going out faster than little Timmy Geithner could print it? So let’s be clear, as Obama likes to say:
Congress is responsible for the way so much of this spending was wasted, resulting in little job creation and the slowest economic recovery since the 1930s. But in the U.S. political system, Presidents are supposed to be the fiscal adults. When they abdicate, the teenagers invite over their special interest friends and blow the inheritance.
The President is now claiming to have found fiscal virtue, but notice how hard he has fought House Republicans as they’ve sought to abate the spending boom. First he used the threat of a government shutdown to whittle the fiscal 2011 spending cuts down to very little. Then he invited Paul Ryan to sit in the front row for a speech while he called his House budget un-American.
How does one take this President seriously given this litany?
Easy answer – you don’t. I mean, look at this:
Now Mr. Obama is using the debt-ceiling debate as a battering ram not to control spending but to command a tax increase. We’re told the White House list of immediate budget savings, the ones that matter most because they are enforceable by the current Congress, are negligible. His offer for immediate domestic nondefense discretionary cuts: $2 billion.
As for Mr. Obama’s proposed entitlement cuts, they are all nibbling around the edges of programs that are growing far faster than inflation. He’s offering few reforms that would make a difference in the long run. Oh, and ObamaCare is untouchable, despite its $1 trillion in new spending over the next several years, growing even faster after that.
And this goes to the point of my previous post. When you look at how we got here and who is responsible (yeah, he didn’t inherit this – this is all his) it is hard to find any grounds for confidence that the same people have any idea or desire to change their ways. And yet they’re going to try to convince the American people that Obama should keep his job and Nancy Pelosi should be returned to the House speakership (with a sweeping victory putting a Democratic majority back in the House).
It’s enough to make a grown man cry.
It is a restriction of your freedom to choose. It is government assuming the role of deciding what is best for you instead of allowing market and consumers the freedom of making that decision and choice.
The greens and the Obama Administration assert that the new light bulbs are good for the lumpen bourgeoisie because they will cut electricity use and save the average household $50 a year. Mr. Obama’s Energy Department told Congress recently that to repeal the ban would "detrimentally affect the nation’s economy, energy security, and environmental imperatives." Yes, and cause the seas to rise to swamp Miami and New York too.
If you catch the sarcasm in the WSJ column cited, I believe it is well deserved. You see, if the average household found it worth $50 a year to make such a change, they’d do so based on their priorities, not government’s. That’s freedom. Instead we have the government forcing that decision on households whether they like it or not. And the reasoning? Well it has become almost cliché to cite Orwell when talking about many things modern government does, but in this case, and after the reading the following, tell me if you don’t agree it is entirely appropriate:
In classic doublespeak, the Department of Energy explains that outlawing incandescent bulbs will "empower consumers with lighting choices." Unless your choice is to buy the light bulb the government doesn’t like.
Indeed. There is no “choice” involved here at all, except to refuse to buy CFLs and sit in the dark.
When government can reach down to the level of deciding what you can and can’t buy for lighting your house, then you have seen your freedom diminished. And it can be for all sorts of good intentions – but it doesn’t change the simple fact that your freedom to choose is less today than yesterday. In fact, we need to update an old saying. The road to serfdom is paved with freedom killing laws based on good but collectivist intentions. Yeah, it’s not really very snappy but you get the idea.
Our freedom is slowly bleeding away, suffering a death by a thousand cuts. And we’re as much to blame as the government.
The question an (allegedly) free society should ask is if CFL bulbs are so clearly superior, why does the government have to force people to buy them?
Because it can. And we let it.
Insist Congress repeal the ban. Meanwhile – stock up on incandescent bulbs. I am.
Write it off to me being cynical about what any politician says, but while I like what I hear from Rubio in this WSJ op/ed, I wonder if, in fact, he’ll end up sticking to his guns:
Americans have built the single greatest nation in all of human history. But America’s exceptionalism was not preordained. Every generation has had to confront and solve serious challenges and, because they did, each has left the next better off. Until now.
Our generation’s greatest challenge is an economy that isn’t growing, alongside a national debt that is. If we fail to confront this, our children will be the first Americans ever to inherit a country worse off than the one their parents were given.
Current federal policies make it harder for job creators to start and grow businesses. Taxes on individuals are complicated and set to rise in less than two years. Corporate taxes will soon be the highest in the industrialized world. Federal agencies torment job creators with an endless string of rules and regulations.
So to summarize, Rubio sees a need to find ways to help the economy grow and to keep the national debt from not growing. Okay, sold. Next he sees existing federal policies – those, one assumes, include taxes and regulations – as one of the main obstacles to economic growth and one of the main contributors to national debt. Again, check. I think, in the main, he’s right.
Here’s the QotD:
We’re therefore at a defining moment in American history. In a few weeks, we will once again reach our legal limit for borrowing, the so-called debt ceiling. The president and others want to raise this limit. They say it is the mature, responsible thing to do.
In fact, it’s nothing more than putting off the tough decisions until after the next election. We cannot afford to continue waiting. This may be our last chance to force Washington to tackle the central economic issue of our time.
Well yes and no. The defining moment in American history seems to arrive every couple of years when Congress routinely raises the limit again and again. We’re now at a level that almost matches the yearly GDP with no end in sight if you look at the projected budgets for the next 10 years. So is this particular vote on the debt ceiling really a “defining moment in American history”? Only if Congress refuses to raise it. Otherwise, it is business as usual.
Wit ill it be business as usual or a “defining moment in American history”? I agree with Rubio that as it stands Congress and the president have obviously decided covertly that they’re not going to “tackle the central economic issue of our time” at the moment. So where does that leave Rubio?
Well, here’s his position:
I will vote to defeat an increase in the debt limit unless it is the last one we ever authorize and is accompanied by a plan for fundamental tax reform, an overhaul of our regulatory structure, a cut to discretionary spending, a balanced-budget amendment, and reforms to save Social Security, Medicare and Medicaid.
No tax reform, regulatory overhaul, cuts to discretionary spending, balanced budget amendment as well as reforms to save Social Security, Medicare and Medicaid, no Rubio “yes” vote?
That’s what his statement says to me and anyone familiar with the “goings on” in Congress know -given Rubio’s list of “must haves” before he’d vote “yes” – it is a virtual impossibility. Not going to happen – at least not anytime soon.
I would then deduce that Rubio is a permanent “no” on any legislation coming along in oh, the next 20 years, that raises the debt ceiling. Because, watching politics in Washington for all these years has convinced me that until it all crashes and burns, those folks aren’t going to really do a thing.
And I think Rubio knows it too:
Whether they admit it or not, everyone in Washington knows how to solve these problems. What is missing is the political will to do it.
I’ve seen no indicator that there is now a real will to do it, even after the wave election washed over 60 Republican freshmen into the House and upped the minority numbers for the GOP in the Senate. Oh there’s talk, of course, but I see the usual turf protection and re-election concerns already beginning to cloud the once clear mandate that said “fix this mess”. I see knees becoming weak and spines beginning to buckle.
Rubio stakes out a pretty unambiguous position here – not that I think he’s going to be able to stop the debt ceiling from being raised. On the contrary, I think we’ll see it raised many more times in the coming years. But I’m wondering how true Rubio will remain to his pledge here. It will be an interesting exercise to watch a supposedly principle driven and incorruptible Tea Party candidate work in the atmosphere of Washington DC that almost demands “team play” and compromise to “get along” or advance. He and Rand Paul, along with Allen West (R-FL) in the House are my “white mice” in this Tea Party experiment. I want to see how true they stay to their pledges, how well they resist the Washington gravitational pull and resultant sell-out that usually occurs.
I, for once, hope my cynicism isn’t rewarded as it usually is.
I’m sympathetic with the argument – even in this era of austerity – that DoD made a mistake by stopping the production of the F-22 Raptor. It is the premier air superiority fighter in the world (5th generation stealth). It was designed to keep our edge in air superiority/air dominance that we’ve enjoyed for 56 years or since the Korean war (no soldier or Marine on the ground has been killed in that time frame by enemy air).
But in a recent WSJ article (subscription), Michael Auslin attempts to make the case that F-22 production ought to be revived (I agree) and paid for by cutting F-35s (I disagree). Yes, I think we need more F-22s. We’ve manufactured about 180 to replace a fleet of 4th generation air superiority fighters than number 800. Not exactly a number that is able to give us the flexibility we need to do all the missions those 800 allowed us.
So Auslin’s arguments that we need more F-22s make sense.
What doesn’t make sense are his arguments that F-35s should be cut to do so. He gives three reasons why the F-22 should be funded via cuts in F-35s:
• The emergence of foreign challengers. Russia and China are steadily developing heavy, twin- engine aircraft with stealth capabilities. Based on their size and potential capabilities, the smaller, single-engine F-35 probably will not have the speed or power to compete.
The Chinese ostentatiously first test-flew their J-20 prototype last month during Mr. Gates’s visit to Beijing. Western analysts are still debating the plane’s capabilities. Some believe it will serve as a supersonic fighter-bomber, given its large size (more than 20% bigger than the F-22 itself). Whatever the ultimate capabilities of the J-20 or the Russian PAK-FA turn out to be, we can expect more surprises in their development. The U.S. government apparently did not know about two new Chinese nuclear submarine models until they were revealed on the Internet several years ago.
Here’s a dirty little secret – speed and power aren’t what will determine who wins future battles between 5th generation fighters. As missile and radar technology have advanced over the years, those type fights have taken place at longer and longer range – to include over the horizon attacks. What will determine who will win those type fights is the range, reliability and speed of the missiles and the ability of the radar systems on board to detect the enemy before he detects you.
It really doesn’t matter how many engines an aircraft has or how fast it can go, a manned aircraft cannot outrun a missile. If the F-35 has the better missiles and the better and longer range detection capability, it should do just fine.
• Sophisticated air defenses are a growing threat to American fighters. Russia, China, Iran and North Korea, among others, are developing and fielding integrated air-defense systems, including interlinked radar sites and advanced surface-to-air missiles such as the S-400. The lower operational ceiling of the F-35 (around 40,000 feet) and its subsonic cruising speed means it will be at much higher risk in attempting to penetrate such heavily defended airspace.
The F-22 was designed precisely to fight and survive in such environments—as attested by its 60,000-foot operational ceiling and supercruise (cruising at plus-mach speeds without afterburners) ability.
This is simply not accurate. Air superiority fighters do not take out enemy air defenses and the operational ceiling or speed has little if anything to do with any ability to accomplish that mission. The military has a doctrine which is called Suppression of Enemy Air Defenses (SEAD) which requires strikes on enemy air defense sites before we introduce air superiority platforms such as the F-22 into the conflicted air space.
Aircraft of choice? Multi-role fighters. Presently the Airforce uses the F-16, a multi-role single engine fighter with HARM missiles. The Navy and Marine Corps use the F/A 18, a multi-role fighter. The F-35 is perfect for the role … not the F-22.
• F-35 delays and cost overruns. The JSF program has run into numerous delays and cost increases, with the unit price of each plane nearing $100 million. In early January, Mr. Gates put the F-35B program on hold for two years, as its vertical take-off-and-landing capabilities ran into significant development problems. Many industry observers question whether the F-35 will reach initial operating capability before the end of this decade. And given the rising costs of the plane, the likelihood of further procurement cuts is very real, putting the F-35 potentially on the same death-spiral as the F-22.
Again, not really accurate. The F-35 is well on its way to reaching "initial operating capability" before the end of the decade. The A and C variants (The Airforce and Navy) are on target and ahead in their flight testing programs. The B variant (the STVOL Marine Corps version) is the one that has given the most problems, but it appears the problems are known, understood and not show stoppers.
Look, the F-35 is a developmental aircraft. That means they’re taking something from concept to reality based on capabilities the customer (in this case DoD) has asked for. That means you design, test, refine, retest, fix and finally deploy the product. It’s a long and laborious process that, as you might imagine, costs money. However, the F-35 cost model is based on consistent and predictable increases in production rates to maintain program affordability. If the current production projections are maintained, the average unit cost of the Conventional Take Off and Landing variant (the Airforce model) will be about $65M (in 2010 dollars). That’s about the same cost as a fully mission equipped 4th generation F-16 costs today.
What Auslin wants to do is cut the production rate of F-35s (in favor of more F-22s) which would make the cost problem he quotes a self-fulfilling prophesy.
I think Auslin is right about needing more F-22s. I don’t disagree in the least. Even in these days of austerity, I think closing down the production line for these aircraft is a strategic mistake. We many not need 800 of them, but we need more than the number we’ve now produced.
However, I think doing so at the expense of the F-35 would be a bigger mistake. Both aircraft are vital to our ability to dominate the battlefield of the future, both in the air and on the ground. Like it or not, our potential enemies are going to build and field 5th generation fighters that we may meet someday in combat. Both of these aircraft will be vital to our effort then. What we don’t need is cannibalizing capability on one side to pay for it on the other. We can be sure those building rival 5th generation fighter aircraft certainly won’t.