Ethereal

Commentary: Bailouts will lead to rough economic ride - CNN.com
By Ron Paul
Special to CNN

Editor's note: Ron Paul is a Republican congressman from Texas who ran for his party's nomination for president this year. He is a doctor who specializes in obstetrics/gynecology and says he has delivered more than 4,000 babies. He served in Congress in the late 1970s and early 1980s and was elected again to Congress in 1996. Rep. Paul serves on the House Financial Services Committee.


Rep. Ron Paul says the government's solution to the crisis is the same as the cause of it -- too much government.


(CNN) -- Many Americans today are asking themselves how the economy got to be in such a bad spot.

For years they thought the economy was booming, growth was up, job numbers and productivity were increasing. Yet now we find ourselves in what is shaping up to be one of the most severe economic downturns since the Great Depression.

Unfortunately, the government's preferred solution to the crisis is the very thing that got us into this mess in the first place: government intervention.

Ever since the 1930s, the federal government has involved itself deeply in housing policy and developed numerous programs to encourage homebuilding and homeownership.

Government-sponsored enterprises Fannie Mae and Freddie Mac were able to obtain a monopoly position in the mortgage market, especially the mortgage-backed securities market, because of the advantages bestowed upon them by the federal government.

Laws passed by Congress such as the Community Reinvestment Act required banks to make loans to previously underserved segments of their communities, thus forcing banks to lend to people who normally would be rejected as bad credit risks.

These governmental measures, combined with the Federal Reserve's loose monetary policy, led to an unsustainable housing boom. The key measure by which the Fed caused this boom was through the manipulation of interest rates, and the open market operations that accompany this lowering.

When interest rates are lowered to below what the market rate would normally be, as the Federal Reserve has done numerous times throughout this decade, it becomes much cheaper to borrow money. Longer-term and more capital-intensive projects, projects that would be unprofitable at a high interest rate, suddenly become profitable.

Because the boom comes about from an increase in the supply of money and not from demand from consumers, the result is malinvestment, a misallocation of resources into sectors in which there is insufficient demand.

In this case, this manifested itself in overbuilding in real estate. When builders realize they have overbuilt and have too many houses to sell, too many apartments to rent, or too much commercial real estate to lease, they seek to recoup as much of their money as possible, even if it means lowering prices drastically.

This lowering of prices brings the economy back into balance, equalizing supply and demand. This economic adjustment means, however that there are some winners -- in this case, those who can again find affordable housing without the need for creative mortgage products, and some losers -- builders and other sectors connected to real estate that suffer setbacks.

The government doesn't like this, however, and undertakes measures to keep prices artificially inflated. This was why the Great Depression was as long and drawn out in this country as it was.

I am afraid that policymakers today have not learned the lesson that prices must adjust to economic reality. The bailout of Fannie and Freddie, the purchase of AIG, and the latest multi-hundred billion dollar Treasury scheme all have one thing in common: They seek to prevent the liquidation of bad debt and worthless assets at market prices, and instead try to prop up those markets and keep those assets trading at prices far in excess of what any buyer would be willing to pay.

Additionally, the government's actions encourage moral hazard of the worst sort. Now that the precedent has been set, the likelihood of financial institutions to engage in riskier investment schemes is increased, because they now know that an investment position so overextended as to threaten the stability of the financial system will result in a government bailout and purchase of worthless, illiquid assets.

Using trillions of dollars of taxpayer money to purchase illusory short-term security, the government is actually ensuring even greater instability in the financial system in the long term.

The solution to the problem is to end government meddling in the market. Government intervention leads to distortions in the market, and government reacts to each distortion by enacting new laws and regulations, which create their own distortions, and so on ad infinitum.

It is time this process is put to an end. But the government cannot just sit back idly and let the bust occur. It must actively roll back stifling laws and regulations that allowed the boom to form in the first place.

The government must divorce itself of the albatross of Fannie and Freddie, balance and drastically decrease the size of the federal budget, and reduce onerous regulations on banks and credit unions that lead to structural rigidity in the financial sector.

Until the big-government apologists realize the error of their ways, and until vocal free-market advocates act in a manner which buttresses their rhetoric, I am afraid we are headed for a rough ride.


The opinions expressed in this commentary are solely those of the writer.

Scucca

"Many Americans today are asking themselves how the economy got to be in such a bad spot."

Capitalism instability theory has been available for yonks! Tell them to get reading

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Ethereal

Most people prefer reality over socialist sophistry.

Scucca

You need to do some reading yourself. I'm sure you'll embrace the concept. I chose my vocab carefully in order to embrace both Marxist crisis theory and orthodox analysis

Ethereal

Your abstract models and theories are not necessary to explain the current status of our economy. Everything you posit is a gross violation of parsimony. Perhaps, instead of derailing the thread like you always do, you could deign to adress, in a specific manner, the explainations put forth by Congressman Paul; I'm not holding my breath.

Metropolis

Capitalism has it's ups and downs. Unfortunately, we have hit rock bottom (or are close to it). In due time, and hopefully without any more government intervention, we will be heading back up the hill.

SouthernDemocrat

Basically, it seems that the libertarian contention is that if we did not have government intervention into the markets, we would still have business cycles, yet avoid financial crisis like the one we are currently in. Basically, the argument is if we do away with the Federal Reserve, Subsidies, Regulation, and oversight, we will have a virtual utopia under absolute Free Markets and a Gold Standard.

So lets look at history as a guide. In the 100 years prior to the establishment of the Federal Reserve we had 4, yes thats 4, Economic Depressions. We have had one since.

Prior to our mixed economy around 30% of Americans lived below the poverty line, seniors made up the single largest demographic living in abject poverty, there little to no middle class, median income growth was absymal, and we were not even a first world nation.

The crisis today is the direct result of a lack of oversight and regulation. The sectors in crisis were almost invariably lightly regulated. What happened was that conservatives bought into this idea back in the early 80s that the economy had changed considerably since the New Deal, and thus the idea of market regulation was antiquated and no longer relevant the world we find ourselves in today.

Well, the thing is, they were right that the economy had changed a lot since then and the regulatory structures in place were built around the old industrial economy of the 30s, 40s, and 50s. Their mistake was believing that human nature had changed since the New Deal, that we had left behind all of the faults of man that made market regulation necessary in the first place. So the answer was to modernize market oversight and regulation, not abolish it.

We need to learn the lessons of history. No one likes regulation, but no one likes spending what may be a trillion dollars before its all said and done bailing out a financial system in crisis either. Had adequate regulation been in place, this would not have happened. The unregulated Derivatives Markets are entirely to blame for the crisis we find ourselves in and we will have to take action, whether we like it or not, in order to not find ourselves in the same situation the Japanese found themselves in throughout the 90s.

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Charles Krauthammer describing Obama:

"He's got both a first-class intellect and a first-class temperament."

Metropolis

No. It was pure stupidity.

Why? So the economy can be like it was during the 50s? When there was little prosperity and everyone had the same boring, suburban, perfect little life style? What about the lack of innovation? What about the lack of economic prosperity and profits?

We are now on a global scale. We are competing against economies that are booming and capitalizing on behalf of us choking our corporations. It's time that we take our hands off each and every business' neck and let them decide their fate.

Enough of trying to be that older brother that cares - Why care when the rest of the world does not? In the end, we are only hurting ourselves. As more economies boom, the more stable the conditions are to move out of country, and the more likely they are to move over there. Small towns depend on factories, they depend on that local corporation that moved there because land was cheap and labor was even cheaper - But, now - Now that we are regulating even more, the more the company is like "Screw small town America. Let's just go to China and hire a bunch of ten year olds for 1/100 of the cost and double the efficiency."

What more regulation can you get? If a bank wants to give a loan out to people who cannot pay - That's their decision. That is their problem. Not the rest of the US. Are we going to create another useless government organization that watches loans and can stop banks from giving people money?

-x-

The government just needs to stay out of business. That's all. Sure, there needs to be basic regulations to keep the economy in check. But, in no way, should they need to watch the move of every corporation and breath down their neck.

obvious Child

SD,, I'm not sure I buy the lack of regulation was the problem. From what I can tell from going back to 2002 and 2004, nothing changes except for the administration and congress's intiatives to remove obstacles to buying a house, namely down payments and income. Freddy and Fannie conformed to such policies and we got screwed. So perhaps lack of regulation was at least part of the problem but that ignores the fact that the GOP effectively neutered the obstacles that prevented the poor people from buying houses back in 2002.

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"Maybe God doesn't care how you say your prayers, just as long as you say them" - Jeffery Sinclair

SouthernDemocrat

Lets look at historical trends and correlation then:

Real GDP Growth 1950-1980: 3.62%

Real GDP Growth 1981-1992: 3.01% (Reagan - Bush years)

Real GDP Growth 1993-2000: 3.86% (Clinton years)

Real GDP Growth 2001-2007: 2.58% (Bush II)

So right there, we see where the progressive era (1950 - 1980) and the Clinton years just kicked the Deregulatory - Supply Side Economics years ass in terms of GDP Growth.

Lets not stop there though. The same is also true of job creation, poverty reduction, median income growth... basically any measure one wants to put on economic growth, the Free Market Cult comes lags.

Forbes did a great comparison a few years ago:

President Term Years In Office GDP Rank Real Disposable Personal Income Rank Employment Rank Unemployment Rank Inflation Rank Deficit Reduction Rank Average Rank Bill Clinton 1993-2001 8 3 5 2 2 6 1 3.2 Lyndon B. Johnson November 1963-1969 5.1 1 1 5 3 8 4 3.7 John F. Kennedy 1961-November 1963 2.9 2 2 8 1 5 6 4.0 Ronald Reagan 1981-1989 8 5 4 3 4 2 8 4.3 Gerald R. Ford August 1974-1977 2.4 6 6 6 10 1 2 5.2 Jimmy Carter 1977-1981 4 4 8 1 5 10 7 5.8 Harry S. Truman April 1945-1953 7.8 9 9 7 6 3 3 6.2 Richard M. Nixon 1969-August 1974 5.6 7 3 4 8 9 9 6.7 Dwight D. Eisenhower 1953-1961 8 8 7 9 9 7 5 7.5 George H.W. Bush 1989-1993 4 10 10 10 7 4 10 8.5 GDP: Gross Domestic Product. Sources: U.S. Bureau of Economic Analysis, U.S. Bureau of Labor Statistics, White House Office of Management and Budget

Presidents And Prosperity - Forbes.com

Of course this one does not include Bush II, he is bound to come in behind his daddy before its all said and done.

We know what works, and we know what doesn't work.