Ezra Klein and the Ongoing Myth of America’s Financial Markets

Liberal pundit Ezra Klein continues to attempt to make it look like he knows what he’s talking about in a recent response to a New York Magazine blog.  Perhaps it’s because he thinks that Libertarians are just Republicans that like smoking pot might explain a lot where he is coming from and how he continues to be wrong, plus his otherwise ignorance in understanding just how libertarian solutions would actually apply to our currently-broken system.

One flaw in particular is the following:

Desperate storytelling about Fannie Mae and Freddie Mac aside, the financial crisis was, in large part, the product of the idea that massive financial markets that we didn’t understand would effectively regulate themselves.

That was the argument made by Alan Greenspan and perhaps a few other Republicans at the time.  Because what Ezra still doesn’t know (or maybe he does as is being disingenuous) is that if a Federal Reserve Chairman truly believed markets can regulate themselves, that person would have abolished the Federal Reserve system entirely, then resign from their position.

The Federal Reserve system is an organization delegated by an act of Congress to control the money supply and set interest rates for those seeking their services to inflate, guarantee, loan and borrow at will.  They have the power to generate credit at will.  They not only control the banks, they can control the government’s line of credit (and as of right now they are an even bigger holder of government debt than the country of China).

How can anyone possibly put fault on any policy of self-regulating free markets when our system never had a policy of free markets in the first place?

Furthermore, there is strong evidence showing that it was not deregulation that caused the financial crisis in the first place.  George Mason University Economic Professor Tyler Cowan explains how, as well as FactCheck.org

The bill in question is the Gramm-Leach-Bliley Act, which was passed in 1999 and repealed portions of the Glass-Steagall Act, a piece of legislation from the era of the Great Depression that imposed a number of regulations on financial institutions. It’s true that Gramm authored the act, but what became law was a widely accepted bipartisan compromise. The measure passed the House 362 – 57, with 155 Democrats voting for the bill. The Senate passed the bill by a vote of 90 – 8. Among the Democrats voting for the bill: Obama’s running mate, Joe Biden. The bill was signed into law by President Clinton, a Democrat. If this bill really had “stripped the safeguards that would have protected us,” then both parties share the blame, not just “John McCain’s friend.”

The truth is, however, the Gramm-Leach-Bliley Act had little if anything to do with the current crisis. In fact, economists on both sides of the political spectrum have suggested that the act has probably made the crisis less severe than it might otherwise have been.
Last year the liberal writer Robert Kuttner, in a piece in The American Prospectarguedthat “this old-fashioned panic is a child of deregulation.” But even he didn’t lay the blame primarily on Gramm-Leach-Bliley. Instead, he described “serial bouts of financial deregulation” going back to the 1970s. And he laid blame on policies of the Federal Reserve Board under Alan Greenspan, saying “the Fed has become the chief enabler of a dangerously speculative economy.”

What Gramm-Leach-Bliley did was to allow commercial banks to get into investment banking. Commercial banks are the type that accept deposits and make loans such as mortgages; investment banks accept money for investment into stocks and commodities. In 1998, regulators had allowed Citicorp, a commercial bank, to acquire Traveler’s Group, an insurance company that was partly involved in investment banking, to form Citigroup. That was seen as a signal that Glass-Steagall was a dead letter as a practical matter, and Gramm-Leach-Bliley made its repeal formal. But it had little to do with mortgages.

Thus, evidence has shown the repeal of Glass-Steagall in the early 90’s did little to nothing to contribute to the crash of 2008, but rather it actually mitigated the damage from the bursting bubble.  If Glass-Steagall was not repealed we would have seen a likely more-severe bailout needed due to banks inability to merge and go into any private receivership.

The truth in the matter is that we had a housing crisis caused by those great enablers – the Federal Reserve, and the United States government – who guaranteed the bad mortgages to happen.  In fact Ron Paul – the person whom New York Magazine blogger Ross Douthat talks about which triggered Ezra Klein’s response – tried to remove the government guarantees in 2003, right before the bubble was going to spurn into full gear.  His speech on the Congressional floor – made on the eve of the two-year anniversary of 9/11 –  is so spot-on in it makes Nostradamus look like a pretender:

I hope this committee spends some time examining the special privileges provided to GSEs by the federal government. According to the Congressional Budget Office, the housing-related GSEs received $13.6 billion worth of indirect federal subsidies in fiscal year 2000 alone. Today, I will introduce the Free Housing Market Enhancement Act, which removes government subsidies from the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the National Home Loan Bank Board.

One of the major government privileges granted to GSEs is a line of credit with the United States Treasury. According to some estimates, the line of credit may be worth over $2 billion. This explicit promise by the Treasury to bail out GSEs in times of economic difficulty helps the GSEs attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital. More importantly, the line of credit is a promise on behalf of the government to engage in a huge unconstitutional and immoral income transfer from working Americans to holders of GSE debt.

The Free Housing Market Enhancement Act also repeals the explicit grant of legal authority given to the Federal Reserve to purchase GSE debt. GSEs are the only institutions besides the United States Treasury granted explicit statutory authority to monetize their debt through the Federal Reserve. This provision gives the GSEs a source of liquidity unavailable to their competitors.

The connection between the GSEs and the government helps isolate the GSE management from market discipline. This isolation from market discipline is the root cause of the recent reports of mismanagement occurring at Fannie and Freddie. After all, if Fannie and Freddie were not underwritten by the federal government, investors would demand Fannie and Freddie provide assurance that they follow accepted management and accounting practices.

Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.

Despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government’s policy of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.

If Congress was not bought out by the bankers counting on the government to back them up (much like TARP-negotiating leader Senator Judd Gregg) and if our Treasury Secretaries did not have such a long history coming in from large corporate banks (like both past and current Treasury Secretaries Timothy Geithner and Henry Paulson, both alumni of Goldman Sachs) and they passed Ron Paul’s bill, we might have much more likely have seen smaller damage in the housing market, because both firms would then need to prove to the investing economy of being fiscally sound.  Thanks to being a government-sponsored entity (GSE), they don’t need to do so (at least not nearly as much as they should), and the moral hazard has been set to build a house of cards.

When government takes any position on what a practicing economic standard should be – even if that standard is less restrictive – the public is lead to believe that standard is acceptable.  For instance, if a minimum wage is set for waiters in a state, one can come to find that restaurants and bars will have their wait positions pay at that standard.  Much like how the government sets the liquidity ratio for banks and lenders.  Even if the government lessens the liquidity ratio from, say 10 to 3 (or 30% of liquid assets) to 300 to 3 (a 1% ratio), it’s still setting the standard for acceptable lending.   It’s an issue that runs into all sorts of problems, for instance the problem of allowing outright fraudulent practices as “Mark-to-Market” accounting to puff up stock prices, or when Alan Greenspan coerced banks to lend our Adjustable Rate Mortgages (ARMs’); the ones whom balloon over time leading to bankruptcy of small borrowers and homebuyers.

Considering the Federal Reserve’s lending menu, the government guarantees to bad loans, the coercion from the Federal Reserve and the government to make those bad loans, the false standards and signals sent out by the people put in power to regulate and govern financial markets, and lastly the bailouts distributed to all the culprits, this isn’t a system whom trusted people can “regulate themselves”, it’s a system of bad regulators setting false standards and creating false signals/malinvestment.

If we were to truly allow markets to regulate themselves, we would have passed Ron Paul’s Free Housing Market Enhancement Act, abolished the Federal Reserve, abolished the SEC and FDIC, eliminate fiat currency by establishing private competing currencies (like HR 4248), and states would eliminate any and all of their financial regulations.  Banking and financial transactions would then no longer be left up to central governing bodies to consider what is acceptable and what is not, but rather it would be left up to the people, and becoming a busy market of interaction making consensual exchanges where both parties benefit in each exchange.

Another piece of evidence that runs straight against Ezra’s statement: Canada got rid of their version of Glass-Stegall over 20 years ago, with Toronto-Dominion bank being one of the world’s largest holders of securitized assets (read: bad loans) normally used in default swaps like the ones bailout-queen AIG had. But they decided not to hold them anymore, because they became too complicated.

It’s proof that just because AIG over-leveraged themselves does not automatically mean everyone else will do the same.  Trying to associate libertarian thinking to corporate greed is, and will always be, the biggest symptom of naivete from the left on what libertarians are about.  Corporations love government.  They only hate government when they block them from making a profit, but love them when they give them free money and regulate the other guy out of business.  When that happens, that’s called Corporatism, which is nothing less than a light version of Fascism.

I fully admit unregulated markets will not be always efficient and there will always be problems in every solution, but to claim that regulated markets ARE more efficient ignores what has happened in areas that we keep thinking we can understand and control.  The housing bubble was a bubble by design of our Federal Reserve and United States government, to deter any economic damage of both the Nasdaq bubble of the 90’s (aka the “Dot Com” bubble) and the Iraq War.  The Nasdaq bubble was a voluntary bubble through natural means of voluntary deals and exchanges.

Which bubble was worse?   The voluntary one, or the coerced one? Economic bubbles will always exist no matter what, but when we start using our tax money and our fiat currency to manipulate them, we are thrown into a disaster far worse than anything the government tried to avoid.


About briandefferding

Brian works at a small pipe and tubing company by day, and freelance illustrates at night. He is the creator and self-publisher of the critically acclaimed independent horror comic book series "School: A Ghost Story." Brian currently resides in his birth town of Appleton, WI, enjoys whiskey and John Lee Hooker.
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