March 12, 2009

Under discussion: Meltdown: A Free Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse, Thomas E. Woods Jr., Regnery (2009), 194 pages.

Reality often bites, but news this fall of collapsing asset values and housing prices hit a baffled American public like a bombshell. After all, for years, so many Americans had been basking in the glow of their 401Ks and home-equity loans and generally enjoying the most prosperous years of their lives. Playing the stock market. Buying up Dream Houses with no money down. Going on fantasy vacations. Wasn”€™t that the American Dream? What the hell happened!?!

The term “€œAmerican dream”€ was coined by author James Truslow Adams in his 1931 book, The Epic of America. He wrote: “It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position.”

Reading that, it’s clear that the modern interpretation has strayed far from the original meaning. In fact, the “€œAmerican Dream”€ represents something more than the cars and big money that Adams warned about. Central planners and social engineers misappropriated the term a long time ago, and put it into use as a slogan to convey a sense of entitlement and equality as they began to shape and subsidize the home ownership nation that first got started with the creation of Fannie Mae in 1938.

In his new book, Meltdown, Thomas E. Woods Jr. suggests that the American dream became the American Nightmare through the reckless, self-serving actions of government institutions. And at once, Woods puts his finger on the unmistakable “€œelephant in the living room”€”€”the Federal Reserve System. Sad to say, other than a few assorted rumblings, there has been almost no discussion in the mainstream media of the Federal Reserve’s role in launching the crisis. But as Woods details, the Fed, which centrally plans monetary policy and interest rates, sowed the seeds of destruction by drastically reducing interest rates beyond levels that would otherwise have been set by a free market. “€œMaking cheap credit available for the asking does encourage excessive leverage, speculation, and indebtedness,”€ Mr. Woods writes. He adds, “€œManipulating interest rates and thereby misleading investors about real economic conditions does in fact misdirect capital into unsustainable lines of production and discombobulate the market.”€ This begins the authors”€™ explanation of the boom-bust phenomenon and how an artificial boom, and the financial holocaust it leaves behind, can be perfectly clarified and understood in terms of the Austrian theory of the business cycle.

Turn on the Bubble Machine

Thanks to the Fed’s easy-credit policies, the housing bubble became ground zero for the catastrophe. Mr. Woods highlights several factors that contributed to this mess, all of which were significant government interventions that emerged in order to fulfill a specific agenda. First there were Fannie Mae and Freddie Mac, two government-sponsored enterprises (GSEs) that had the benefit of an implied government backing, thus giving investors the appearance that their investments in these entities were essentially risk-free. Both entities were created for the sole purpose of intervening in the housing market and subsidizing home ownership, especially for the politically favored classes. Besides easing credit requirements so that banks could loan to dubious buyers, both Fannie and Freddie helped to spread the bubble’s aftermath by buying mortgages on the secondary market and pooling and selling the mortgages in the form of mortgage-backed securities. Soon everyone was getting their mitts on these securities and holding them as “€œinvestments.”€

Another factor in the housing bubble that Woods points to is the Community Reinvestment Act, a law born in 1977 that was given a new lease on life from Bill Clinton. The CRA was a crusade to jettison traditional lending standards in favor of an equality-based agenda aimed at putting minorities and the poor into homes they couldn”€™t afford. Woods points to a study by the Federal Reserve Bank of Boston that concluded, “€œeven allowing for differences in creditworthiness, minority applicants were still getting mortgage loans at lower rates than whites.”€ Consequently, it was determined that the mortgage banking industry was engaging in discriminatory lending policies and a massive government intervention was needed to stamp out the disparity. The result was the birth of the CRA, and the beginnings of a massive lending spree to unqualified, or “€œsubprime,”€ borrowers.

In spite of the obvious problem of granting long-term loans to high-risk individuals, perhaps one of the more illuminating points made by Mr. Woods is that the subprime loan mishap may have been overemphasized while the flurry of impractical lending innovations, such as 100 percent loans, ARMs, and interest-only loans, were given less attention.

The push for relaxed lending standards for low and middle-income borrowers was so pervasive and systemic, persisting for a full decade, that it is no surprise that it should have spilled over into the standards for higher-income borrowers as well.

…Not only were these easier mortgage terms available to speculators, but the surge in demand for housing caused by the much easier access to financing also led to increases in home prices that had the unintended effect of enticing speculators into the market in the first place.

As chairman of the Federal Reserve, Alan Greenspan rather publicaly put his stamp of approval on ARMs, thereby leading people to believe that they were reasonably safe options. Woods points out that the foreclosure crisis has not been confined to the subprime sphere, and in fact prime loan foreclosures increased in unison with subprime foreclosures.

Weekend at Ben and Hank’s

In the spring of 2008, Treasury Secretary Hank Paulsen claimed “€œwe are closer to the end of the market turmoil than the beginning.”€ Rather, it was just the beginning, as Bear Stearns had collapsed and the Fed set up a bailout arrangement with JP Morgan so it could acquire the investment bank. What followed was a meltdown of the entire financial system that had been incorrectly assessed time and time again, by both Paulsen and fed Chairman Ben Bernanke.

The government seized control of Fannie Mae and Freddie Mac just a couple of months after it placed IndyMac Bank into receivership. Lehman Brothers filed for bankruptcy, Merrill Lynch was rescued by the Bank of America, Washington Mutual was seized by the FDIC, the government poured billions into the failing giant AIG, and Wachovia was scooped up by Wells Fargo. The White House responded by announcing its Emergency Economic Stabilization Act of 2008 that would give unprecedented powers to the US Treasury. This bailout bill was sold to the American people via repetitive, tactical scaremongering. Woods notes that the public was told:

…all kinds of horror stories of what would happen to them if they failed to do as their betters told them: the decimation of their retirement plans, the collapse of housing prices, the inability of small businesses to make payroll (as if a healthy small business borrows to make payroll), and on and on. The bailout had to be passed right away.

This epic bill that was too big to read and passed too quickly for debate to take place, was put forth as necessary to breathe life back into an expiring economy that only the Fed gods could save with their collective financial genius and business acumen. Of course, once the Feds decide something is a “crisis,” that opens the door to inescapable solutions, and only government can ever provide those solutions. Crisis, then, becomes the doorman for a massive series of government interventions. The “€œdo something”€ mentality of the bureaucrats acted on impulse, making things up as they went along, changing their minds whenever it was convenient. This produced, in Mr. Woods’s words, “€œa Weekend at Bernie’s economy, with sunglasses and Hawaiian shirts on zombie companies supposed to give the impression of life and health.”€

The housing mania wasn”€™t the only hiccup, however. The Federal Reserve had successfully ushered in a “No Adult Left behind” policy for the credit-intoxicated, consumption-crazed masses with its years of low interest rates. Government had created a credit dependent society in which people did not want to give up their newfound “€œprosperity”€ quite so easily. With the average American saving little or no earnings, and thus living dangerously on the edge of insolvency, it became apparent that bubble-driven lifestyles did not reflect real prosperity, but rather, it gave birth to the new nation of Two-Thousandaires”€”those with a Hummer and a Mercedes, a huge house, all the latest toys, vacations that Bernie Madoff would envy, and $2,000 in the bank.

Soon thereafter came the nationalization of the banking system so that the credit markets could be propped up and the extravagant lifestyles everyone had come to expect sustained indefinitely. Loan! Spend! Don”€™t Save! Or so said the Keynesians who saw spending as being the key ingredient of a prosperous economy. Paulsen even lamented the illiquidity that was said to be “€œraising the cost and reducing the availability of car loans, student loans and credit cards.”€ The lesson is this: give rise to more of what caused the financial mess in the first place.

Who Done It?

Deregulation. Market failure. Greed. Not enough government oversight. All kinds of fallacious explanations are being trotted out as primary causes of the economic meltdown. And yet, as Woods explains, the housing market, and the American economy more generally, isn”€™t exactly wanting for government intervention. Evoking F.A. Hayek’s theory of the business cycle, Woods explains what happens when the visible hand of the Federal Reserve manipulates interest rates, distorts the supply of credit, and misrepresents investment opportunities for entrepreneurs, thereby leading them to commit clusters of errors that lead to the misallocation of resources. The Austrian theory of the business cycle, Woods says,

Exonerates the free market of blame for the boom-bust cycle, since the factors that bring the cycle about”€”the artificially low interest rates that provoke the boom, and the foolish government interventions that prolong the bust”€”are all examples of interference with the free market.

The Fed’s fingerprints are all over this calamity, and Woods calls into question a monetary system that devalues the dollar, expropriates through the hidden tax of inflation, and manipulates the money supply in order to achieve specific political agendas. He refers to the Federal Reserve Act of 1913 as “€œspecial-interest legislation masquerading as a public-spirited measure.”€ As a follow-up, Woods puts forth the notion that a monetary system based on precious metals, or a commodity standard, is the only system available that will return America to a sound monetary policy free from entrenched political privileges and central planning machinations.

Throw the Bums Out

Tom Woods doesn”€™t disappoint those who want to hear how the current system can be rescued from the grip of despots and placed onto a free-market foundation for building genuine prosperity. He speaks clearly to the free-market reforms that are necessary to convert America from a bankrupt nation to a free and flourishing republic. The solutions, however, are radical, and in fact, so radical that Ron Paul, who sought the same reforms, was disavowed by his Republican Party members for the crime of endorsing the intellectual roots of this country’s Founding Fathers.

Toss the too-big-to-fail baloney, says Woods, and let insolvent, inefficient, bloated giants fail, because the free market will take the best of what’s left and make good use of it without having to poach the taxpayers”€™ pockets for Friday night beer money. As to Fannie and Freddie, say goodbye, and as to all government bailouts of private institutions, good riddance. “€œProblems caused by excessive spending and indebtedness,”€ says Woods, “€œcannot be cured by more spending and more indebtedness, any more than the cure for excessive lending is more excessive lending.”€

Finally, since “€œmoney is the most socialized sector in the American economy,”€ it must be liberated. We don”€™t need yet another layer of government dedicated to monetary oversight, as Ben Bernanke has argued for in the past few days; we need a separation of money and state. And such a thing is only possible if the central bank again becomes a subject of public debate (as it once was.)

Metldown does a lot to get this process started. Connoisseurs of Austrian economists, along with newbies to the freedom movement and everyone else in between, will find it to be a compelling piece of contemporary history, and one that sheds light on the darkest economic times our generation has ever encountered.


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