Archive

Posts Tagged ‘free market’

What Caused the Financial Meltdown? A Guide to Understanding the Collapse in 3 Hours

March 31, 2010 3 comments

I have been trying to find an efficient way to communicate and explain the causes of the financial meltdown. I have been driven by the fact that properly understanding the causes is crucial to preventing them again (and because it’s related to things like the recent health care reform), and by the fact that people don’t have a ton of time to read lots of articles and put everything together. But I think I have finally found a very helpful way of explaining everything in about 3 hours by watching 3 videos and comparing some notes.

In my quest to provide a simple, streamlined explanation of the financial meltdown, I came across CNBC’s documentary “House of Cards.” It does a pretty good job of simplifying the chain of events and connecting them with every day Americans, rather than leaving it all in the mystifying world of Wall Street. So the first thing you should do is watch House of Cards. Below are notes to follow along/review.

House of Cards

Host David Faber begins the entire show with the following statement (@8:30):

The economic crisis finds its roots in the U.S. housing market.

The entire financial meltdown is directly tied to the housing market. The remainder of the documentary attempts to show what happened in the housing market (and Faber’s thesis is that greed, specifically Wall Street greed, is to blame – but that’s only a half truth). The whole documentary is helpful in getting you to understand the links in the chain, you could really watch about 4 minutes of the beginning and end to learn all you need to know:

@10:00 [After 9/11] the outlook was bleak. The economy was still reeling from the dot com bust. And what the country needed was for Americans to start spending. Alan Greenspan made that easier. As Fed Chairman he controlled the country’s short term interest rates. The lower the interest rate, the cheaper it was for people to borrow money.

@1:27:55 Fed Chairman Alan Greenspan retired in 2006. Within a year, the age of euphoria he’d helped unleash would come to an end.

If you want the simplest, most basic explanation, you can stop right here.
It was a result of the Fed.
If you want a more detailed explanation, read/watch on.

Here is the chain of events Faber describes (below it will be a modified list with comments):

  1. September 11, 2001 terrorist attack shocked the economy and essentially put it on hold. People stopped transacting.
  2. Lack of transactions – people saving rather than spending – will destroy the economy.
  3. @10:18 “The outlook was bleak. The economy was still reeling from the dot com bust. And what the country needed was for Americans to start spending. Alan Greenspan made that easier. As Fed Chairman he controlled the country’s short term interest rates. The lower the interest rate, the cheaper it was for people to borrow money.”
  4. The Fed sharply lowered the interest rate.
  5. As a result, borrowing money became cheaper than it had been in a generation.
  6. President Bush told people to go out and spend money. If you don’t spend your money, the terrorists win.
  7. Americans took advantage of the lowest mortgage rates since 1971 and they started buying houses.
  8. This increased demand for houses drove the price of houses up. (This is the law of supply and demand)
  9. This increased cost of houses meant fewer people could afford them.
  10. Banks decided to make loans to these people.
  11. Getting a housing loan used to be very, very difficult (@14:30). People were subject to incredible scrutiny to decide if you could pay back the loan.
  12. “Our industry… has been driven by small and medium sized mortgage bankers that deal with Fannie and Freddie.”
  13. Fannie and Freddie, created by Congress, buy home loans from mortgage lenders.
  14. Fannie and Freddie then receive the mortgage payments from people. They pool this money and sell it in shares for investment called the “Mortgage Backed Security” that big institutions like pension funds learn to love.
  15. @16:50 “We were used to being led by Fannie and Freddie. We got our rules from those guys, and that’s what we did.”
  16. Fannie/Freddie in penalty box, Wall Street took over so that small mortgage loaners could “bend the rules” and make loans to people who couldn’t pay them.
  17. @18:40 “The mortgage market caught fire (grew) because the world was flushed with cash.” (It was flushed with cash because foreign countries who used to be poor became rich by being productive)
  18. Dallas the lender gave people loans that he knew couldn’t afford it. The only thing stopping him from doing it before was Freddie/Fannie’s rules. Wall Street didn’t have those rules.
  19. @23:00 In 2002 Bush pushes for more people to own homes.
  20. @24:30 “I didn’t actually understand all the terms in the paperwork, but I just trusted the broker.”
  21. @27:44 “I did ask, ‘How exactly is this going to work?’ She said ‘Oh we’re going to refinance in 5 years. You’ll be fine.’ Did I get more information? No.” -Her mortgage lender lied on the application about her income
  22. @28:30 Wall Street was profiting and so were these new home owners with cash from their homes, “thanks in large part to interest rate cuts engineered by Fed Chairman Alan Greenspan.”
  23. @33:30 “part of the problem here” is that “loan officers” had no training and were not regulated by the state
  24. @38:15 “It was a pretty shocking claim – that Wall Street would knowingly create a market for the worst kinds of mortgages.”
  25. “Wall Street became intoxicated by the sheer volume of mortgages they could repackage and sell, no matter how toxic the loan.”
  26. 39:25 Bush brags about new home construction highest in 20 years. “Home ownership rates the highest ever.”
  27. Greenspan encouraged mortgage industry to come up with new kinds of loans.
  28. which resulted in “Pay Option Negative Amortization Adjustable Rate Mortgage”
  29. @41:20 Mantra was that housing prices had not gone down one year since the Great Depression
  30. In order to divide up and sell loans, Wall Street had to get them rated
  31. AAA -> BBB, change in housing market made BBB “safer” – so they lowered standard for AAA
  32. Rating agency conflict of interest – paid by banks they were rating
  33. Nobody was paying attention to reliability of rating agencies
  34. Banks created “Collateral Debt Obligation” CDO – small pieces of lots of different mortgages. They were all betting on the continuing rise of housing prices.
  35. Norway bought CDOs.”The contents of which were a mystery to them.”
  36. @55:30 Fannie/Freddie plunged into the loans they once shunned (sub-prime).
  37. @56:30 “Why didn’t you stop yourself from giving out bad loans?” “Because I wouldn’t be able to compete because my volume would go to zero.” “Greed is hard to control, huh?” “There’s nobody there saying, ‘Stop it! We can’t do this anymore, even if we go out of business.”
  38. @1:01:34 There’s nothing the Fed could have done to prevent a collapse – that is aside from stopping the growth and causing a recession.
  39. Warning sign #1 – it was unregulated market
  40. Warning sign #2 – housing prices rising much faster than income
  41. Wall Street sellers were fresh out of college. When asked “What if these are bad and you can’t sell anymore?” He said “It will never stop.”
  42. @1:08:30 How do banks get people to buy CDOs with bad loans? Get them a AAA rating.
  43. @1:09:30 No one I met with thought it was remotely possible home prices could go down.
  44. @1:10:00 It was easy to break the rating rules and make a crappy loan a AAA. “There was not a lot of sophistication involved.”
  45. @1:11:40 Alan Greenspan couldn’t understand CDOs.
  46. Sub-prime loans started going bad.
  47. Wall Street stopped buying.
  48. Sub-prime lenders stopped lending.
  49. Nobody could get a loan.
  50. Which resulted in decreased housing demand.
  51. Which stopped rising housing prices.
  52. Which meant people could no longer refinance to keep up with their loans.
  53. @1:19:45 black woman “I’m being held accountable for my bad choices. But who in that industry is being held accountable?… I’m stupid, but you’re guilty. You’re literally guilty.”
  54. @1:22:45 “Norwhich still has no clue what they invested in.”
  55. @1:23:05 Wall Street sold all kinds of CDOs, not just mortgage backed CDOs. But when the mortgage CDOs went bad, people started to doubt, and their value went down.
  56. @1:23:40 Norway: “We have learned a lot. If things sound too good to be true, they are. I have learned not to trust nice man in Armani suits.”
  57. @1:24:46 “People borrowed too much. Lenders loaned too much. That will not correct itself until the Darwinian flush. Until there is a flush of people that can’t afford to pay these loans and they get wiped out and home values get back to a level people can afford them.
  58. Banks began failing.
  59. @1:28:00 Greenspan retired in 2006. “Within a year, the euphoria he helped unleash would come to an end.
  60. “They knew what they were doing. They weren’t dumb. It was simply a failure to get out at the right time.”
  61. Greenspan: We will be having this conversation again in the future. It will be a long time, but it will happen again. There is no law you can pass to stop it because the flaw is in our human nature.

Why the Meltdown Should Have Surprised No One

Now compare what you have just watched with Peter Schiff’s video. Take special note of his explanations as to why things happened. That is the most important question. Why? (After the video is my CNBC outline with added notes that implement Schiff’s insights)

Transcript of Schiff’s lecture: http://mises.org/daily/3493

CNBC Chain of Events + Notes

  1. September 11, 2001 terrorist attack shocked the economy and essentially put it on hold. People stopped transacting.
  2. Lack of transactions – people saving rather than spending – will destroy the economy. This assumption is the result of a particular economic theory called Keynesian. This has been the standard U.S. government theory for the last 100 years – but it is defunct. The assumption is false, but all that follows below is a result of this faulty assumption. The theory believes that the Federal Reserve plays an important role in getting people to spend, and thus saving the economy. This theory is most strongly opposed by Austrian economic theory.
  3. @10:18 “The outlook was bleak. The economy was still reeling from the dot com bust. And what the country needed was for Americans to start spending. Alan Greenspan made that easier. As Fed Chairman he controlled the country’s short term interest rates. The lower the interest rate, the cheaper it was for people to borrow money.”
  4. The Fed sharply lowered the interest rate.
  5. As a result, borrowing money became cheaper than it had been in a generation.
  6. President Bush told people to go out and spend money. If you don’t spend your money, the terrorists win. This is Keynesian economics rearing it’s ugly head again.
  7. Americans took advantage of the lowest mortgage rates since 1971 and they started buying houses.
  8. This increased demand for houses drove the price of houses up. (This is the law of supply and demand) Note this carefully. Normally housing prices rise because incomes rise. Increased productivity = higher incomes = more demand for housing = higher house prices. That is the normal market function. However, the Fed artificially raised house prices by creating an artificial demand. No one increased productivity. No one actually earned more money to buy a house with. Instead, the Fed interfered by injecting more money into the economy, making it seem like people had earned more. Also, some important steps are missing in the CNBC chain of events. Credit became cheaper everywhere, so why did demand and thus prices only rise in the housing market? In other words, why was this new influx of money all directed towards the housing market? Because 1) Interventions in the market by government creations like Fannie Mae and Freddie Mac had already started artificially raised housing prices, making it an attractive option, and 2) Fannie and Freddie, plus other government agencies had made access to credit for home mortgages easier (ie. They had lowered lending standards, not Wall Street)
  9. This increased cost of houses meant fewer people could afford them.
  10. Banks decided to make loans to these people. The question that must be asked here is why? Why would banks make loans to people who couldn’t pay them back? Furthermore, there have always been people who want a house but can’t afford it. So what is different about this situation? See #16 below
  11. Getting a housing loan used to be very, very difficult (@14:30). People were subject to incredible scrutiny to decide if you could pay back the loan. What changed this?
  12. “Our industry… has been driven by small and medium sized mortgage bankers that deal with Fannie and Freddie.
  13. Fannie and Freddie, created by Congress, buy home loans from mortgage lenders.
  14. Fannie and Freddie then receive the mortgage payments from people. They pool this money and sell it in shares for investment called the “Mortgage Backed Security” that big institutions like pension funds learn to love.
  15. @16:50 “We were used to being led by Fannie and Freddie. We got our rules from those guys, and that’s what we did.” Note what a big player Fannie/Freddie are. And note that they set the rules.
  16. Fannie/Freddie in penalty box, Wall Street took over so that small mortgage loaners could “bend the rules” and make loans to people who couldn’t pay them. There’s no other way to put this: CNBC is lying. Fannie and Freddie, and other government agencies, were the ones who “bent the rules.” See this 1999 NYTimes article talking about Fannie/Freddie’s push to lower standards http://www.nytimes.com/1999/09/30/business/fannie-mae-eases-credit-to-aid-mortgage-lending.html Read Ron Paul’s warning before Congress about Fannie and Freddie in 2003 http://www.lewrockwell.com/paul/paul128.html In addition, banks were threatened with discrimination lawsuits if they did not lend to minorities they felt did not meet lending requirements: http://www.independent.org/pdf/policy_reports/2008-10-03-trainwreck.pdf
  17. @18:40 “The mortgage market caught fire (grew) because the world was flushed with cash.” (It was flushed with cash because foreign countries who used to be poor became rich by being productive) This is an important point. Why was the world flushed with cash? Was it because the world had suddenly become more productive (as Faber suggests)? No. The world was flushed with cash because the Fed flushed the world with cash. The Fed is connected to the entire world economy, not just the U.S. See Schiff’s video @27:50
  18. Dallas gave people loans that he knew couldn’t afford it. The only thing stopping him from doing it before was Freddie/Fannie’s rules. Wall Street didn’t have those rules. See #16
  19. @23:00 In 2002 Bush pushes for more people to own homes. Did Bush just say ‘Hey, it would be nice if more people owned homes?’ No. He, and Congress, and other government agencies interfered in the market to get people into homes (people who couldn’t afford those homes). See Thomas E. Woods’ “Meltdown” and the links in #16
  20. @24:30 “I didn’t actually understand all the terms in the paperwork, but I just trusted the broker.” That’s stupid. This guy deserves what came to him. He’s not a victim. He was greedy. And the market (though not entirely free) did its job by punishing him for that.
  21. @27:44 “I did ask, ‘How exactly is this going to work?’ She said ‘Oh we’re going to refinance in 5 years. You’ll be fine.’ Did I get more information? No.” -Her mortgage lender lied on the application about her income. Same thing here. This lady got what she deserved for being greedy and lying. She signed the paperwork. She lied right along with whoever helped her. Did the government regulate her bad behavior by punishing her? No, government rewarded her mistake. See point #53
  22. @28:30 Wall Street was profiting and so were these new home owners with cash from their homes, “thanks in large part to interest rate cuts engineered by Fed Chairman Alan Greenspan.” Note this well. It is impossible to argue that what happened was the result of the free market because of this point.
  23. @33:30 “part of the problem here” is that “loan officers” had no training and were not regulated by the state. No, the problem was that fear of losing money – which is what regulates bad decisions like this in the market, was inhibited. See Schiff @32:15
  24. @38:15 “It was a pretty shocking claim – that Wall Street would knowingly create a market for the worst kinds of mortgages.” Yes, it is a shocking claim. And it’s also not true. See #16
  25. “Wall Street became intoxicated by the sheer volume of mortgages they could repackage and sell, no matter how toxic the loan.” Which was stupid. See Schiff @7:40 But note two important points: 1) This sheer volume was a direct result of the Fed’s injection into the economy, and 2) They got burned (or would have without government) for their intoxication – which is the market working.
  26. 39:25 Bush brags about new home construction highest in 20 years. “Home ownership rates the highest ever.” Why is Bush bragging if he had nothing to do with the market? He has a lot to do with it. See this very important 2002 speech here http://www.ronpaul.com/2008-09-26/gw-bush-on-the-housing-boom-oct-2002/ Note Fannie and Freddie’s role in Bush’s speech: “And so what are the barriers that we can deal with here in Washington? Well, probably the single barrier to first-time homeownership is high down payments. People take a look at the down payment, they say that’s too high, I’m not buying. They may have the desire to buy, but they don’t have the wherewithal to handle the down payment . . . I’m proud to report that Fannie Mae has heard the call and, as I understand, it’s about $440 billion over a period of time. They’ve used their influence to create that much capital available for the type of home buyer we’re talking about here.” Fannie and Freddie were the super-weights in the housing industry. None of this could have happened without them – and they were created by Congress (ie. they simply would not exist in a free market). Here is a helpful 2002 article showing how Freddie/Fannie distorted the housing market http://mises.org/daily/986
  27. Greenspan encouraged mortgage industry to come up with new kinds of loans.
  28. which resulted in “Pay Option Negative Amortization Adjustable Rate Mortgage”
  29. @41:20 Mantra was that housing prices had not gone down one year since the Great Depression See Schiff @28:10
  30. In order to divide up and sell loans, Wall Street had to get them rated You should be aware that these rating agencies are a cartel created by government regulation. There is no competition.
  31. AAA -> BBB, change in housing market made BBB “safer” – so they lowered standard for AAA
  32. Rating agency conflict of interest – paid by banks they were rating Same as Review magazines who carry ads by companies they review. This is a common problem – but the market solves that problem. See Schiff @36:55
  33. Nobody was paying attention to reliability of rating agencies And guess what? Capitalism worked and those companies paid the price (or would have if they hadn’t been bailed out by the government)
  34. Banks created “Collateral Debt Obligation” CDO – small pieces of lots of different mortgages. They were all betting on the continuing rise of housing prices. Again, see Schiff @28:10. This dependence on rising house prices is a result of the Fed and Fannie/Freddie interfering in the market.
  35. Norway bought CDOs.”The contents of which were a mystery to them.” Are you noticing a theme here? Making dumb investments that you don’t understand, in the end turn out to be too good to be true and you pay the price. That is the market working, not failing.
  36. @55:30 Fannie/Freddie plunged into the loans they once shunned (sub-prime). See #16. Faber is lying. Fannie/Freddie never shunned bad loans. They pioneered it.
  37. @56:30 “Why didn’t you stop yourself from giving out bad loans?” “Because I wouldn’t be able to compete because my volume would go to zero.” “Greed is hard to control, huh?” “There’s nobody there saying, ‘Stop it! We can’t do this anymore, even if we go out of business.” This is the exact opposite of how a free market works. In a free market, you don’t go out of business for making wise choices. Instead you go out of business for making bad business choices like lending to people who can’t pay back. So again, what was interfering with this natural free market function? See Schiff @32:15
  38. @1:01:34 There’s nothing the Fed could have done to prevent a collapse – that is aside from stopping the growth and causing a recession. Which is what the Fed should have done. WE NEED A RECESSION to recover from the artificial booms created by the Fed.
  39. Warning sign #1 – it was an unregulated market This is not a warning sign. Government regulation provides a false sense of security. Regulated markets prevent people from worrying. It makes them think it’s safe. See Schiff @39:50
  40. Warning sign #2 – housing prices rising much faster than income This is a correct warning sign and, again, these rising prices are a direct result of government interference in the market (both the Fed lowering interest rates and the various direct government interferences in the housing market).
  41. Wall Street sellers were fresh out of college. When asked “What if these are bad and you can’t sell anymore?” He said “It will never stop.” And guess what? The people who hired that idiot paid the price (or they would have if the government had let capitalism do its job).
  42. @1:08:30 How do banks get people to buy CDOs with bad loans? Get them a AAA rating.
  43. @1:09:30 No one I met with thought it was remotely possible home prices could go down. And those people paid the price for their poor estimations. Those who saw that rising house prices were phony made a profit. That is capitalism rewarding safe practices and punishing unsafe practices. Government rewards mistakes like this, not the free market.
  44. @1:10:00 It was easy to break the rating rules and make a crappy loan a AAA. “There was not a lot of sophistication involved.” Again, they paid the price for that lack of sophistication.
  45. @1:11:40 Alan Greenspan couldn’t understand CDOs. Neither did Warren Buffet – which is why he didn’t invest in them and why he didn’t lose money in them. That’s the market working. See this 2003 article http://news.bbc.co.uk/2/hi/2817995.stm
  46. Sub-prime loans started going bad. A very important point here: it was not just sub-prime mortgages that were going bad. Contrary to Faber’s entire premise, sub-prime loans were not the root problem. Prime loans were defaulting as well, and for the same reason – they were depending on the continued, unsustainable, artificial rising price of houses. See “Anatomy of a Train Wreck” PDF link above and “Meltdown” pp.22-23
  47. Wall Street stopped buying. (ie. The market was working)
  48. Sub-prime lenders stopped lending.
  49. Nobody could get a loan. Good.
  50. Which resulted in decreased housing demand.
  51. Which stopped rising housing prices. Faber has this backwards. He says sub-prime defaults brought housing prices down. This is not true. Falling housing prices caused both prime and sub-prime defaults. If housing prices had continued to increase at the same rate, sub-prime mortgages would not have defaulted.
  52. Which meant people could no longer refinance to keep up with their loans. For #46-52 see Schiff @59:00
  53. @1:19:45 black woman “I’m being held accountable for my bad choices. But who in that industry is being held accountable?… I’m stupid, but you’re guilty. You’re literally guilty.” Wow. And she’s not guilty for lying? It is this absolute lack of personal responsibility that creates this mess in the first place. People naively think we have reached a certain place in the progress of society where we should no longer have to actually worry about making catastrophic, bad decisions. There will always be a safety net, so I don’t have to worry. This is what “moral hazard” refers to. It is this idea that you are not really at risk for decisions that you make in life. There will always be a safety net to catch you or a safety regulation to keep you from making bad decisions. For example, see Schiff’s comments about FDIC @38:13. Also, Wall Street was held accountable by the market, which is why some banks were going to fail without government intervention – and that would have been a healthy thing.
  54. @1:22:45 “Norwhich still has no clue what they invested in.” Which is a good lesson.
  55. @1:23:05 Wall Street sold all kinds of CDOs, not just mortgage backed CDOs. But when the mortgage CDOs went bad, people started to doubt, and their value went down. Again, this is the market working. Companies mixed good investments with toxic ones and it destroyed their companies (or should have if government didn’t interfere with a bailout)
  56. @1:23:40 Norway: “We have learned a lot. If things sound too good to be true, they are. I have learned not to trust nice man in Armani suits.” And there you go my friends. That is capitalism.
  57. @1:24:46 “People borrowed too much. Lenders loaned too much. That will not correct itself until the Darwinian flush. Until there is a flush of people that can’t afford to pay these loans and they get wiped out and home values get back to a level people can afford them. Absolutely. That is always the case. However, the government will not allow this to happen. They will come up with some way to help citizens for making stupid decisions, and the big companies are just “too big to fail.” There will be no Darwinian flush because the government will not allow it. There should have been flushes like this after every bubble – but the government prevented it. See Schiff’s comments @14:08
  58. Banks began failing. As they should.
  59. @1:28:00 Greenspan retired in 2006. “Within a year, the euphoria he helped unleash would come to an end.
  60. “They knew what they were doing. They weren’t dumb. It was simply a failure to get out at the right time.”
  61. Greenspan: We will be having this conversation again in the future. It will be a long time, but it will happen again. There is no law you can pass to stop it because the flaw is in our human nature. Greenspan is half right. He is right to say there is no law you can pass to prevent people from making stupid choices. It is impossible. Only the market can properly provide the necessary disincentive to making stupid choices. However, he is wrong to say that these booms and busts and meltdowns are the natural result of the free market. They are not. He, as Chair of the Fed, was the direct cause. People will make bad decisions in the free market, but it will not result in “systemic failure.” Only an economy being orchestrated by one entity can cause “systemic failure.” See Schiff @32:15 regarding the “trigger” and see below.

Faber concludes: “Greed runs all through this.” That may be the case, but is that really the answer to why? A few questions would have to be answered first.

  1. What exactly is greed? Is it the same thing as profit? Is it the same thing as self-interest? (see my post on self-interest https://contrast2.wordpress.com/2008/10/02/self-interest-2/ )
  2. Was greed somehow involved here where it is not everywhere else, including in government?

The reality is that blaming the crisis on “greed” is like blaming plane crashes on gravity. Certainly planes wouldn’t crash if it wasn’t for gravity. But when thousands of planes fly millions of miles every day without crashing, explaining why a particular plane crashed because of gravity gets you nowhere. Neither does talking about “greed,” which is constant like gravity. (T. Sowell)

Q & A

Q: Did the free market fail in 2008?

A: No.

Q: Then why did all the experts in Washington tell Congress they had to bail out banks or the economy would collapse?

A: Because they’re politicians.

A2: Because they are driven by Keynesian economic theory, which, as stated above, believes that the heart of a good economy is lots and lots of consuming. This false theory believes that if people save their money instead of spend it, then the economy will decline and fail. Thus under the Keynesian view, if big banks failed and therefore caused people to be more careful with their money, people would stop spending and therefore the economy would fail. But this is a false theory. It is good to be wise and to save money. In fact, after an artificial boom created by the Federal Reserve, it is very necessary for there to be a recession where people start saving their money. It is the only way to recover from the government’s manipulation of the market.

A3: Even the specific evidence the Fed brought forward to support their claim that the economy would collapse turned out to be untrue. The Fed said bank lending had frozen, along with interbank lending. This, along with other claims, simply were not true as a study by some economists for the Federal Reserve Bank of Minneapolis showed: http://www.minneapolisfed.org/research/WP/WP666.pdf

A4: A great quote from Thomas Woods: “For whatever reason, Secretary Paulson suddenly decided that this (purchasing toxic assets) was not the way to spend the hundreds of billions of dollars he had asked for. Instead, it was now the consumer credit markets that needed to be propped up. “Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards,” Paulson warned. Because if there’s one thing Americans need more of, it’s credit card offers. And the cruel fate of having to keep your car for an additional year or two instead of buying a new one – it’s just too terrible to contemplate.
Should consumer credit actually become slightly more difficult to come by, full-fledged panic does not seem like the sensible response. The market would thereby be saying that Americans needed to start saving a little, instead of buying another plasma TV on credit. But our rulers cannot leave well enough alone. The very thought never occurs to them. If they weren’t looting the general public to bail out some wealth destroyer they would hardly know what to do with themselves.”

Q: So you think its good for big banks to fail?

A: Yes. If they have made bad business decisions, then they should pay the price. That is the sign of a healthy free market. Isn’t this exactly what people are complaining about? Aren’t people saying the free market failed because greedy Wall Street wasn’t punished? Well they were, except that government stepped in and prevented them from receiving the consequences for their decisions (like big boys). The economy would not stop. See Schiff’s comments

Q: But what about all those innocent people who had their retirements invested in Wall Street?

A: Those people are not innocent. They chose to place their savings in Wall Street. They took a risk. There is no such thing as a free lunch. There is no such thing as a safe investment. Every investment is a risk. No one has a right to retirement just because they invested in the stock market. It is a very sad thing to see happen, but the fact that so many people think Wall Street is a relatively safe investment is because the government has continually intervened to protect it from the consequences of bad decisions. The effect is cumulative. (The same is true for our trust in banks for simply keeping our deposits secure. The FDIC creates a false sense of security. Whether or not a bank conducts trustworthy business should be a factor in our choosing a bank – rather than if the bank lets you put your favorite picture on your debit card. See Schiff)

Q: Is Wall Street the heart of the free market?

A: No.

Q: But aren’t all these booms and busts proof that the free market is unstable?

A: No. Those booms and busts are a direct result of the Federal Reserve’s manipulation of the market.

Q: You seem to place a lot of blame on the Federal Reserve. Are you one of those weirdo conspiracy theorists?

A: No. Some people believe the creation of the Federal Reserve was part of a global conspiracy. That may or may not be true. It could just as easily have been the creation of Wall Street bankers who wanted a way to cheat the market, or maybe it was even created by well-intentioned, but mistaken politicians. Either way, the Federal Reserve is to blame for the boom and bust cycle.

Conclusion

So, the problem, and the real problem that we have, of course, is now that the bubble has burst — first from the stock market, now the real-estate market — and now that we’re having this massive recession, which is just getting started, we’ve barely gotten a taste of it. But, unfortunately, all the blame is on the free market. All the blame is on capitalism. It’s because there wasn’t enough regulation. There was too much greed. Right?

And Alan Greenspan, or, not Alan Greenspan. President Bush, in one of his speeches, said that Wall Street got drunk. And he was right, they were drunk. So was Main Street. The whole country was drunk. But what he doesn’t point out is, where’d they get the alcohol? Why were they drunk?

Obviously, Greenspan poured the alcohol, the Fed got everybody drunk, and the government helped out with their moral hazards, and the tax codes, and all the incentives and disincentives they put in — all the various ways that they interfered with the free market and removed the necessary balances that would have existed, that would have kept all this from happening.

We’ve always had greedy people. Everybody’s been greedy, not just Wall Street. But all of a sudden everybody was greedy all at the same time? Can’t they understand there’s a trigger for this, there’s a reason that everybody acted this way?

Normally, when people are greedy, they’re also fearful of loss, and people’s fear of loss overcomes their greed and checks their behavior. But what the government did, repeatedly, was try to remove the fear — they tried to make speculating as riskless as possible.

First, they provided us with almost costless money with which to speculate. And then they created the idea or the Greenspan Put. But whenever there’s a problem, don’t worry, the government is going to rescue you.

The government’s not going to let the stock market go down. The government’s not going to let your bets go bad, so go ahead and keep placing them. That was the idea, that was the mentality. It was nothing that the free market did.

Additional Resources:

Please let me know if you have found this helpful and if I can clarify anything.

Self-Interest

October 2, 2008 4 comments

Our nation’s current distress has provoked many to consider the sinful nature of man.  Some believe that the problems we are facing are the inevitable result of an economy founded upon self-interest. Richard Dahlstrom, Senior Pastor of Bethany Community Church in Seattle, WA says:

What else could you expect from an economic system predicated on the notion that everyone acting in their own self-interests will always lead to a win/win situation. Somehow, I wonder: WWJT. What would Jesus think?

http://www.conversantlife.com/life-with-god/no-surpise-but-wwjt

Dahlstrom is referring to Adam Smith’s “invisible hand.” In his “Wealth of Nations,” Smith said:

…he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention… By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.

To put it more simply, he said:

It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own self interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

In other words, the butcher isn’t motivated by how his meat will help you, he is motivated by the money that you give him in exchange for it. Furthermore, the more money he desires to earn, the harder he works to provide you with whatever you want. Thus out of his own interest he provides for you.

As for the win/win aspect of it, it’s simply the result of a voluntary exchange. The only reason that two people volunatrily choose to trade is because the trade will make both of them better off. No one trades in order to lose. Now, it may be true that they don’t get everything they want out of the trade, but, if they voluntarily make the exchange, it is because they believe they will be better off by doing so. Thus it is a win/win situation.

The alternative to this system of voluntary exchange is force, which is what Dahlstrom and others like him are in favor of. When force is involved, it is not a win/win situation. Someone is losing because they are being forced to do what they would not want to do.

Mother Teresa

Ah, you say, but what about Mother Teresa? Well, I’m convinced Mother Teresa was paid by philosophy professors across the world so they would have something to talk about when they get to the topic of altruism in class. Hitler got a check too as he is the go to when any topic of evil is mentioned.

But was Mother Teresa really motivated by a sense of altruism? A sense of abandoning her own interest for the sake of the poor?

No.

She was deceived by Rome’s false gospel. She spent her life living in the most miserable conditions because she was taught that her personal suffering would bring her closer to Christ. Furthermore, she intentionally deprived suffering people of relief because she wanted to be in a community of suffering.

For more on Teresa:

Mother Teresa’s Redemption
The Myth of Mother Teresa
Penn & Teller on Mother Teresa (a heavy dose of profanity)
Is Mother Teresa a Saint? Part I
Is Mother Teresa a Saint? Part II
The Missionary Position (A Review)

Scripture

That’s interesting, you might say, but my morality isn’t derived from some 18th century economist. My sense of right and wrong comes from the Bible and the Bible says self-interest is sinful.

Does it?

Dahlstrom makes only one reference to Scripture, Matthew 6:33:

But seek first the kingdom of God and his righteousness, and all these things will be added to you.

In regards to this verse, he says Jesus would “think we should put the interests of the kingdom before our own.” The error here is that Dahlstrom thinks that the interest of the kingdom is not our own interest. He thinks we should put aside our self-interest for food, drink, and clothing, and pursue something that is not in our self-interest at all. I’m not sure how he feels, but the kingdom of God is very much in my self-interest.

Rather than teaching us to pursue things that are not in our own self-interest, the verse directs us to what is truly in our highest interest.

John Piper has much to say about this:

When you have the notion that high moral acts must be free from self-interest, then worship, which is one of the highest moral acts a human can perform, has to be conceived simply as duty. And when worship is reduced to a duty, it ceases to exist. One of the great enemies of worship in our church is our own misguided virtue. We have the vague notion that seeking our own pleasure is sin and therefore virtue itself imprisons the longings of our hearts and smothers the spirit of worship. For what is worship if it is not our joyful feasting upon the banquet of God’s glory?

Worship: The Feast of Christian Hedonism

By Christian Hedonism, I do not mean that our happiness is the highest good. I mean that pursuing the highest good will always result in our greatest happiness in the end. But almost all Christians believe this. Christian Hedonism says more, namely, that we should pursue happiness, and pursue it with all our might. The desire to be happy is a proper motive for every good deed, and if you abandon the pursuit of your own joy you cannot love man or please God – that’s what makes Christian Hedonism controversial.

Christian hedonism aims to replace a Kantian morality with a biblical one. Immanuel Kant, the German philosopher who died in 1804, was the most powerful exponent of the notion that the moral value of an act decreases as we aim to derive any benefit from it. Acts are good if the doer is “disinterested.” We should do the good because it is good. Any motivation to seek joy or reward corrupts the act. Cynically, perhaps, but not without warrant, the novelist Ayn Rand captured the spirit of Kant’s ethic:

An action is moral, said Kant, only if one has no desire to perform it, but performs it out of a sense of duty and derives no benefit from it of any sort, neither material nor spiritual. A benefit destroys the moral value of an action. (Thus if one has no desire to be evil, one cannot be good; if one has, one can.)2

Against this Kantian morality (which has passed as Christian for too long!), we must herald the unabashedly hedonistic biblical morality. Jonathan Edwards, who died when Kant was 34, expressed it like this in one of his early resolutions: “Resolved, To endeavor to obtain for myself as much happiness in the other world as I possibly can, with all the power, might, vigor, and vehemence, yea violence, I am capable of, or can bring myself to exert, in any way that can be thought of.”

Christian Hedonism

Sin

In his lecture on “The Ethics of Self Interest and Profit”, part of his “Introduction to Economics” series, John W. Robbins points out that self-interest is not sinful. What is sinful is mistaking what is truly in our self-interest. Man’s chief end is to glorify God and enjoy Him forever. It is in our highest interest to do so. Because we are sinful, we think it is better for us to sinfully break God’s moral law and rebel against Him.

I have read much from Robbins on a variety of topics and he has continually brought fresh insight from the Bible to bear on the topics. His method is to start with a topic, then start at the beginning of his Bible and read it all the way through, making note of every passage that has any relevance to the topic. This can be a tedious task, but it is very rewarding.

A short cut is to simply start with a concordance. If we look up the word profit, we get a few results that are worth discussing:

1 Samuel 12:21 And do not turn aside after empty things that cannot profit or deliver, for they are empty. 22 For the Lord will not forsake his people, for his great name’s sake, because it has pleased the Lord to make you a people for himself.

Here we are instructed to turn to God because He can profit us, unlike the kings Israel sought after instead of God.

Proverbs 3:13 Blessed is the one who finds wisdom,
and the one who gets understanding,
14 for the gain from her is better than gain from silver
and her profit better than gold.

We are to seek wisdom because we can profit from it, because it is in our self-interest.

Proverbs 11:4 Riches do not profit in the day of wrath,
but righteousness delivers from death.

This verse illustrates Robbins’ point above. The riches of this world do not profit anyone in the day of wrath, but those who trust in Christ profit from His righteousness. Thus we are to seek Christ, not riches, because it is in our self-interest.

Next we come to perhaps the strongest verse in support of Dahlstrom:

Matthew 16:24 Then Jesus told his disciples, “If anyone would come after me, let him deny himself and take up his cross and follow me.

This would seem to be an airtight argument that we should not do anything out of self-interest. But let’s continue reading the passge:

25 For whoever would save his life will lose it, but whoever loses his life for my sake will find it. 26 For what will it profit a man if he gains the whole world and forfeits his soul? Or what shall a man give in return for his soul?

Here, again, we see that it is not sinful to act out of self-interest. What is sinful is thinking that gaining the whole world is in our highest self-interest.

1 Cor 13:1 Though I speak with the tongues of men and of angels, but have not love, I have become sounding brass or a clanging cymbal. 2 And though I have the gift of prophecy, and understand all mysteries and all knowledge, and though I have all faith, so that I could remove mountains, but have not love, I am nothing. 3 And though I bestow all my goods to feed the poor, and though I give my body to be burned, but have not love, it profits me nothing.

Paul is appealing to self-interest. In fact, Paul condemns these actions that are devoid of love precisely because they do not profit.

Renewing our Minds (Rom 12:2)

Dahlstrom closes his note by saying: “If Christians, who have the very words of Christ about money refuse to altar their view of self-interest economics, how will the rest of world do?”

To that I say, if Christian pastors, who have the very words of God about everything in life, refuse to transform their minds, how will their sheep do?

I pray that God will give us all wisdom as we seek understanding from His Word.

Hans Herman Hoppe on Empiricism

The Mises Institute has recorded audio books of several of it’s publications. They have been publishing some of them on their podcast. I listened to some of Murray Rothbard’s Conceived in Liberty (text version) and found his account of Purtian New England very interesting. The most recent book on the podcast is Hans Herman Hoppe’s Economic Science and the Austrian Method (text version).

Hoppe’s book is an explanation and defense of the Austrian method of economics, as opposed to all other methods. What distinguishes Austrianism is that it is not empirical. It is rational, or as Mises put it, a priori. Hoppe quotes Mises explanation:

Its statements and propositions are not derived from experience. They are, like those of logic and mathematics, a priori. They are not subject to verification and falsification on the ground of experience and facts. They are both logically and temporally antecedent to any comprehension of historical facts. They are a necessary requirement of any intellectual grasp of historical events.

Hoppe further explains the situation:

It is this assessment of economics as an a priori science, a science whose propositions can be given a rigorous logical justification, which distinguishes Austrians, or more precisely Misesians, from all other current economic schools. All the others conceive of economics as an empirical science, as a science like physics, which develops hypotheses that require continual empirical testing. And they all regard as dogmatic and unscientific Mises’s view that economic theorems?like the law of marginal utility, or the law of returns, or the time-preference theory of interest and the Austrian business cycle theory?can be given definite proof, such that it can be shown to be plainly contradictory to deny their validity.

Hoppe then begins a critique of empiricism, especially in regards to economics.

Moreover, even if we have observed some definite outcome, let’s say that mixing the two materials leads to an explosion, can we then be sure that such an outcome will invariably occur whenever we mix such materials? Again, the answer is no. Our predictions will still, and permanently, be hypothetical. It is possible that an explosion will only result if certain other conditions?A, B, and C?are fulfilled. We can only find out whether or not this is the case and what these other conditions are by engaging in a never-ending trial and error process. This enables us to improve our knowledge progressively about the range of application for our original hypothetical prediction.

…the Ricardian law of association…minimum wage… marginal utility…

Considering such propositions, is the validation process involved in establishing them as true or false of the same type as that involved in establishing a proposition in the natural sciences? Are these propositions hypothetical in the same sense as a proposition regarding the effects of mixing two types of natural materials? Do we have to test these economic propositions continuously against observations? And does it require a never-ending trial and error process in order to find out the range of application for these propositions and to gradually improve our knowledge, such as we have seen to be the case in the natural sciences?

To use an analogy, it is as if one wanted to establish the theorem of Pythagoras by actually measuring sides and angles of triangles. Just as anyone would have to comment on such an endeavor, mustn’t we say that to think economic propositions would have to be empirically tested is a sign of outright intellectual confusion?

He continues in part II:

According to empiricism, to explain causally or predict a real phenomenon is to formulate a statement of either the type “if A, then B” …

As a statement referring to reality (with A and B being real phenomena), its validity can never be established with certainty, that is, by examining the proposition alone, or of any other proposition from which the one in question could be logically deduced. The statement will always be and always remain hypothetical, its veracity depending on the outcome of future observational experiences which cannot be known in advance. Should experience confirm a hypothetical causal explanation, this would not prove that the hypothesis was true. Should one observe an instance where B indeed followed A as predicted, it verifies nothing. A and B are general, abstract terms, or in philosophical terminology, universals, which refer to events and processes of which there are (or might be, in principle) an indefinite number of instances. Later experiences could still possibly falsify it.

And if an experience falsified a hypothesis, this would not be decisive either. For if it was observed that A was not followed by B, it would still be possible that the hypothetically related phenomena were causally linked. It could be that some other circumstance or variable, heretofore neglected and uncontrolled, had simply prevented the hypothesized relationship from actually being observed. At the most, falsification only proves that the particular hypothesis under investigation was not completely correct as it stood. It needs some refinement, some specification of additional variables which have to be watched for and controlled so that we might observe the hypothesized relationship between A and B. But, to be sure, a falsification would never prove once and for all that a relationship between some given phenomena did not exist, just as a confirmation would never definitively prove that it did exist.

He also notes:

However appropriate the empiricist ideas may be in dealing with the natural sciences (and I think they are inappropriate even there, but I cannot go into this here), [25] it is impossible to think that the methods of empiricism can be applicable in the social sciences.

**Update: I see that I’m getting some traffic from the Czech Republic. A helpful supplement to this post is an essay by John W. Robbins regarding economic methodology, analyzing Mises and Friedman, among others: The Failure of Secular Economics and an MP3 lecture of the same: The Failure of Secular Economic Theory (MP3)

Why I Loathe the USPS, Part 709

March 14, 2008 Leave a comment

In case you missed part 708 https://contrast2.wordpress.com/2008/01/15/not-so-gentle-reminders/

So, I had to make another visit to the Postal Service today for work. I had to mail 3 packages to Canada. I got there at 5:03. On the wall is the myriad of forms to fill out. There is a form for Customs Declaration for packages under 4lb and a different form for packages over 4lbs. I filled out 3 copies of the under 4lb form. I also needed them insured, so once again, I looked at my options: Domestic Insurance form, International Insurance form. I filled out 3 copies of the International Insurance form.

I waited in line for 30 minutes, with only 60% of the stations open (which is more than usual). I finally get to the front. I put my packages on the counter, hand her the forms, and tell her they are shipping to Canada.

“Oh, you need to fill out the other form for this package” (larger box, but lightweight)
“Why?”
“Because its too big”
“The sign says all packages under 4lbs.”
blank stare

She hands me the new form to fill out.

“I need these insured as well.” I hand her the insurance forms.
“We don’t use those anymore. You need to fill out this form for all of the packages (the over 4lbs form).”
“Why do you have the international insurance forms on the wall then?”
“We don’t.”
“Uhm…”
At this point homeboy at station #2 jumps in.
“We ony have domestic insurance forms”
“Then why does this one say international?”
“It’s not supposed to”
“Ok, well it does. You shouldn’t put them out here and make people fill them out”
“Hey, don’t blame us, its a printing mistake. It’s not our fault.”
The woman again. “I’ll need to ask you to step aside and fill out those forms.”

At this point I get a little aggravated.
“No thank you, I will wait here until I am finished”
homeboy “Hey man, why you gotta get all worked up and act like a child?”
By this point I’m starting to make a scene, so I just take my forms and filled them out. I got back in line and went through the process again. I left at 5:59. 1 hour to mail 3 packages.

Now, its hard to find a comparison in the private sector because no other business makes you jump through the hoops the government does. However, imagine you wait in line at Chipotle, you study the menu, then once you decide, you step up to the burrito bar and, rather than ordering, you are forced to make your own Chipotle burrito. After the mess you have created, you get to the cashier and he tells you they don’t sell Barbacoa anymore, you’ll have to go back in line and make a new burrito. Suppose even further that you raise a fuss about it and tell them they should take it off their menu and the cashier responds by telling you to stop acting like a child. Just accept it and get back in line.

In reality, if there was some kind of problem at Chipotle, they would immediately apologize and if they didn’t offer you a free burrito, they would quickly remedy the problem, because the customer is always right. Now what does homeboy’s response imply? It implies that I have no reason to make a fuss about waiting in line. Everyone does it. That’s what you do at the post office. You wait in line. For me to suggest that I shouldn’t have to wait in line that long is to suggest that I am a customer who can choose where to take my business. Obviously this is incorrect. I have no options when it comes to postal service. I have to use the USPS unless I want urgent delivery (see prior post).

Now, fortunately, I was only dealing with packages of minor importance, but what if we were talking about life or death health care? Advocates of socialized medicine take heed. When the government runs the ship, you wait in line and don’t ask questions. When the free market is allowed to operate, every penny is a vote and the customer is always right, whether they are shipping packages, or having heart surgery.

Categories: economics Tags: , ,