Essential Economics for Politicians

One of the reasons deregulation is viewed with so much skepticism and even hostility is that disasters of various kinds have been falsely, even laughably, blamed on deregulation. For Americans over a certain age, deregulation recalls the presidency of Ronald Reagan, and in particular the sad story of the Savings and Loan institutions (S&Ls), in which 747 of those institutions failed at a cost of over $160 billion, most of which was paid by means of a federal government bailout. In the days before Reagan and his crazy deregulation spree, the story runs, everything worked fine. Then Reagan was elected, and he repealed all the laws. Society reverted to barbarism. Wolves ran free in the streets.

What actually happened was rather less cartoonish. First, so-called deregulation of theS&Ls began under Jimmy Carter, not Reagan. I say “so-called” because, as with most measures trumpeted as “deregulation,” it was not really deregulation: all throughout the process of alleged deregulation, the S&Ls’ deposits continued to be covered under government deposit insurance. Deregulation means the removal of government involvement and control. Does this sound like the removal of government involvement and control? To the contrary, it gave us the worst of both worlds – now the government- guaranteed institution was permitted to take greater risks while taxpayers remained on the hook for any losses. Not exactly the free market at work.

Under the government-established rules, the S&Ls could charge 6 percent on 30-year mortgage loans, and could offer depositors 3 percent. Since most depositors had nowhere else to go, they had to content themselves with a mere 3 percent return. But with the advent of the money-market mutual fund, ordinary people suddenly had the chance to earn higher returns than S&Ls could pay, and began pulling their money out of S&Ls in droves. Consequently, the S&Ls wanted permission to offer higher interest returns for depositors, so “deregulation” allowed them to do so. Had the original government requirements remained in place, the S&Ls would have gone under then and there.

A consensus began to form that in order to save the S&Ls, their government- established loan and deposit interest-rate requirements, as well as the kind of loans they could make, had to be modified in light of the impossible conditions under which these institutions were then being forced to operate. The S&Ls needed to be permitted to engage in riskier investments than 30-year mortgages at 6 percent. (Notice: it’s the free market’s fault when the government modifies the government-established rules of a government-established institution, while deposits continue to be guaranteed by the government. Got it?)
 
Maybe the S&Ls should have gone under in 1980. Perhaps they really did have an impossible business model. There is no non-arbitrary basis for deciding one way or the other, since the S&Ls were never genuinely subject to a market test. The government husbanded and cartelized the S&Ls, and stood ready to bail them out after that. Yet the string of failures continues to be blamed on “deregulation” and the market.
 
(1) When Alan Greenspan flooded the economy with newly created money and brought interest rates down to destructively low levels, thereby distortingentrepreneurial calculation as well as consumers’ home purchasing decisions, was that the fault of the free market? Do you think the Fed’s creation of cheapcredit out of thin air makes market participants more careful or less careful in how they allocate borrowed funds?
 
(2) When Long Term Capital Management was bailed out in 1998, and AlanGreenspan made clear that the Fed’s assistance would be forthcoming were heunable to lean on his friends in the financial industry, was that a “free market”phenomenon? Do you think the Fed thereby encouraged more or less risk- taking among other major market actors?
 
(3) The Financial Times spoke in 2000, in the wake of the dot-com boom, of an increasing concern that the so-called “Greenspan put” was injecting into the economy “a destructive tendency toward excessively risky investment supported by hopes that the Fed will help if things go bad.” “All the insane dot-cominvestment we’ve seen, all this destruction of capital, all the crazy excesses of thepast few years wouldn’t have happened without the easy credit accommodated by the Fed,” added financial consultant Michael Belkin. Did the free marketcause that? Do lending standards decline for no particular reason, or could this phenomenon have a teensy bit to do with (a) government regulation aimed atincreasing “homeownership” and (b) loose monetary policy by the Fed?

All three questions--Tom Wood
 
WOODS: Let’s start off with a couple of explanations that we’ve heard for the financial crisis and housing bust that are just not true, but which have seeped into the consciousnessof the public to the point where it’s hard to dislodge them.

The key one is that people were being sold mortgage packages that they just didn’tunderstand. They were being scammed by bankers who were tricking them into mortgages that they couldn’t afford. The poor public was put upon by these predatory lenders, and of course it all came to this bad result. What’s wrong with that explanation?

WALLISON: Well, of course that happened in some cases, probably a limited number of cases. I was on the Financial Crisis Inquiry Commission, and one of the things I asked isthat, well you know, there’s been a lot of talk about predatory lending causing thisproblem; let’s have some numbers on this. Why don’t you find out how much of these loans were predatory? And of course, they couldn’t find out.

The answer really is that there was much more predatory borrowing going on than predatory lending. More people were taking out loans that they knew they couldn’t afford,because they were so cheap. These mortgages were being offered so inexpensively to people that they took them out even though when the mortgages reset so they were going to become more expensive, they couldn’t pay them. They hoped that by the time themortgages reset, they would be able to pay them, but by that time there was a financialcrisis, mortgages had fallen in value, homes had fallen in value, they couldn’t refinance themortgages, and they defaulted. So I think the real answer is that there was much more predatory borrowing going on than predatory lending in the financial crisis.
 
Laced said:
Money is a government-issued instrument, without which the modern market cannot function. Money, without government setting interest rate, is like a bird without wings.
Click to expand...
And without property rights both would not exist. In fact, the existence of both have violated property rights through monetary policies like Tariffs, QE, and the affordable care act.
 
Dan Mitchell: I periodically explain that labor and capital are the two factors of production and that our prosperity depends on how efficiently they are allocated.

But I probably don’t spend enough time highlighting how they are complementary, meaning that workers and capitalists both benefit when the two factors are combined. Simply stated, workers become more productive and earn more when investors buy machines and improve technology.

In other words, the Marxists and socialists are wrong when they argue that workers and capitalists are enemies. Heck, look around the world and compare the prosperity of workers in market-oriented nations with the deprivation of workers in statist economies.
 
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