New Jersey Survival

Ask yourself this question: was the housing price bubble, which has burst, caused by (a) a Fed policy of too much liquidity, which caused artificially low interest rates, which in turn caused a great deal of malinvestment, or (b) a Fed policy of too little liquidity which caused high interest rates and a credit-starved economy? If you chose answer b, congratulations, you may have a future as a celebrated author, historian, and Wall Street Journal commentator.

Answer b is a theme of a truly ridiculous article by John Steele Gordon in the October 10 issue of the Wall Street Journal online entitled “A Short Banking History of the United States.” The article is an attempt to defend the Fed, its founding father, Alexander Hamilton, and the regime that it finances. (Gordon is the author of a book entitled Hamilton’s Blessing which sings the praises of a large public debt, something that Hamilton himself called a “public blessing.”)

Rather than faulting the Fed for creating yet another boom-and-bust cycle, Gordon blames the current economic debacle on “the baleful influence of Thomas Jefferson.” Jefferson was the foremost opponent of a bank capitalized with tax dollars and operated by politicians and their appointees from the nation’s capital — Hamilton’s Bank of the United States (BUS), a precursor of the Fed. Thus, despite the fact that the real blame for the current economic crisis lies squarely in the lap of the Fed and its ideological underpinnings — particularly the legends and myths surrounding Hamilton — Gordon attempts to convince us that opposition to politicized, centralized banking is the real problem. Anyone who believes this could easily be persuaded that up is down, white is black, and day is night. The purpose of the Fed, according to Gordon, is to serve as a sort of a monetary benevolent despot: “To guard the money supply … regulating the economy thereby.”

Right-wing statists like Gordon, like left-wing statists, have adopted the custom of smearing Jefferson as a slave owner not so much because they are appalled that he owned slaves, but because their objective is to denigrate his laissez-faire/limited-government political philosophy. Gordon includes the Jefferson slavery smear in his article, but fails to mention that his hero Hamilton also owned “house slaves,” which were brought into his marriage by his wife Eliza; he once purchased six slaves at an auction; and he supported the return of runaway slaves to their “owners” under the Fugitive Slave Clause of the original Constitution.

Indeed, nearly all of the “first families” of the New York City of Hamilton’s time — his main social and political circle — were slave owners. As Hamilton biographer Ron Chernow has written, during Hamilton’s time, “New York City, in particular, was identified with slavery … and was linked [economically] through its sugar refineries in the West Indies” (where Hamilton was born and raised). By the late 1790s slaves were “regarded as status symbols” by the wealthiest New York families.

Gordon spreads several other falsehoods about Jefferson in the leading paragraphs of his article. This in itself is telling, for it shows that court historians like John Steele Gordon fully understand the importance of Hamilton’s statist political philosophy in propping up the Fed and the regime that it finances. Gordon claims that Jefferson, a lifelong businessman, “hated commerce,” “hated banks,” and “may not have understood the concept of central banking.” He also argues that Hamilton, by contrast, had a “profound understanding of markets” because he worked as a bookkeeper for British slave-owning sugar-plantation operators and exporters as a teenager on the Caribbean island of St. Croix. This is nonsense on stilts, as the philosopher Jeremy Bentham is supposed to have said with regard to another spurious claim.

What Jefferson opposed was Hamilton’s mercantilist policies of government-controlled banking, corporate welfare, protectionist tariffs, heavy excise taxation, excessive public debt, and other interventions. Unlike Hamilton, Jefferson had read and understood Adam Smith’s Wealth of Nations and his Theory of Moral Sentiments, as well as the work of David Ricardo, Jean-Baptiste Say (who Jefferson tried to get to join the faculty of the University of Virginia), Richard Cantillon, and other economic theorists of that era. Hamilton was ignorant of or ignored all of this. His major intellectual influence was a propagandist for the British mercantilist regime named Sir James Steuart.

As Murray Rothbard wrote in an article entitled “A Future of Peace and Capitalism,”

Jefferson was very precisely in favor of laissez-faire, or free-market, capitalism. And that was the real argument between [Hamilton and Jefferson]. It wasn’t really that Jefferson was against factories or industries per se; what he was against was coerced [economic] development, that is, taxing the farmers through tariffs and subsidies to build up industry artificially, which was essentially the Hamilton program. Jefferson … was a very learned person. He read Adam Smith, he read Ricardo, he was very familiar with laissez-faire classical economics. And so his economic program … was a very sophisticated application of classical economics to the American scene … classicists were also against tariffs, subsidies, and coerced economic development…. The Jeffersonian wing of the founding fathers was essentially free-market, laissez-faire capitalists.

Compared to Jefferson, Hamilton was an economic ignoramus. His reputation as some kind of financial genius has been greatly exaggerated and fabricated, as the great late-nineteenth-century Yale sociologist William Graham Sumner wrote in his 1905 biography of Hamilton. In his Report on Manufacturers, for example, Hamilton presented the cockeyed notion that international competition would cause higher prices and protectionism would cause lower prices by causing domestic producers to compete more vigorously with each other. History had proven this to be an absurd idea long before Hamilton’s time.

Hamilton also condemned transportation costs, calling them “an evil which ought to be minimized” through protectionism. Of course, transportation costs also affect interstate trade, but Hamilton never voiced his opposition to them in that context. Hamilton was such a mercantilist that he even argued in favor of “a monopoly of the domestic market” by banning all imports altogether. It is little wonder that William Graham Sumner referred to Hamilton’s Report on Manufactures as a mass of economic confusion, just the opposite of a “profound and practical understanding of markets.”

Jefferson was not the only prominent opponent of Hamilton’s scheme to establish a bank operated by politicians out of the nation’s capital. James Madison also opposed the First Bank of the United States (BUS). The Virginia Senator John Taylor was as learned on the subject of political economy as Jefferson was, and immediately recognized the danger of imitating the Bank of England as a financier of mercantilist subsidies. “What was it that drove our forefathers to this country?” he asked. “Was it not the ecclesiastical corps and perpetual monopolies of England and Scotland? Shall we suffer the same evils in this country?” Hamilton’s answer would have been “why yes, we shall, for it is the surest route to accumulate power and wealth for myself and my fellow Federalists.” As Gordon wrote, “Hamilton wanted to establish a central bank modeled on the Bank of England.”

John Steele Gordon’s “short history” of banking is completely filled with falsehoods. Throughout his article, he blames Jefferson’s opposition to central banking for economic problems that were in fact created by Hamilton’s Bank of the United States.

As Murray Rothbard wrote in A History of Money and Banking in the United States (p. 69), as soon as Hamilton’s bank was established it

promptly fulfilled its inflationary potential by issuing millions of dollars in paper money and demand deposits, pyramiding on top of $2 million in specie. The Bank … invested heavily in loans to the United States government…. The result of the outpouring of credit and paper money by the new bank of the United States was … in increase [in prices] of 72 percent [from 1791–1796].

The BUS charter was not renewed after its first twenty years. Gordon blames Jefferson for this, but the above-mentioned economic instability that was caused by the BUS surely played a role. (And I’m sure Jefferson would have been proud to accept the credit for the demise of the BUS.) The BUS was revived after the War of 1812 (in 1817) and it immediately “ran into grave difficulties through mismanagement, speculation, and fraud,” wrote James J. Kilpatrick in his book, The Sovereign States. Consequently, “a wave of hostility toward the Bank of the United States swept the country,” which eventually led to President Andrew Jackson’s veto of the bank rechartering bill.

In 1817 the BUS quickly lent $23 million with a specie reserve of only $2.3 million. This flood of cheap credit created a brief economic boom, and then the inevitable bust, or depression, known at the time as the Panic of 1819. As Murray Rothbard wrote in The Panic of 1819, personal bankruptcies abounded, especially among farmers who had overextended themselves thanks to the BUS’s cheap credit; and there was for the first time large-scale unemployment in American cities, with manufacturing employment in Philadelphia falling from 9,700 employed persons in 1815 to only 2,100 in 1819. This was all Jefferson’s fault, says John Steele Gordon.

Another one of Gordon’s false claims is that “The Civil War ended … monetary chaos when Congress passed the National Bank Act,” which would become the state’s monopolistic monetary regime until the creation of the Fed in 1913. In reality, the so-called Independent Treasury System that existed from the early 1840s to 1863 was arguably the most stable monetary system in US history. Modern economic scholars have evaluated the Lincoln regime’s National Currency Acts and have arrived at the opposite conclusion of Gordon’s. In an article entitled “Money versus Credit Rationing: Evidence for the National Banking Era, 1880–1914″ (in Claudia Goldin, ed., Strategic Factors in Nineteenth-Century American Economic Growth) Michael Bordo, Anna Schwartz, and Peter Rappaport concluded that this Hamiltonian system “was characterized by monetary and cyclical instability, four banking panics, frequent stock market crashes, and other financial disturbances.”

Gordon notes that “inflation took off in the 1960s” but does not blame the actual cause of the inflation — the Fed and its legalized counterfeiting operations. He concludes by praising the regime’s current plans to nationalize the financial markets by assuming stock ownership in banks and appointing the US Treasury secretary as the nation’s first financial dictator. He thinks this will finally, at long last, achieve Hamilton’s dream of a “unified and coherent regulatory system free of undue political influence.”

Of course, no government institution in the history of the world has ever been free of political influence, due or undue. This is perhaps Gordon’s most spectacularly stupid remark.

“Unified” or centralized regulation of industry has long been a goal of statists who favor regulatory dictatorship as opposed to a governmental regime that delegates “too much” regulatory power. Gordon himself bemoans the “conflicting” regulations on the banking industry that have been imposed by the Fed, and the FDIC, FSLIC, SEC, and other federal regulators.

The system of financial regulatory dictatorship that Gordon praises, and which is about to be forced down the throats of the American public, has been tried before in other countries. During one of its own periodic financial crises, Italian government officials complained bitterly, as Gordon does, of regulation that has been “disorganic” and “case by case, as the need arises.” The Italian regime altered its regulatory system so that it could pursue “certain fixed objectives,” just as Gordon argues for a “unified and coherent regulatory system.” This highly centralized or even dictatorial regulatory system, the Italians argued, would supposedly “introduce order in the economic field” and achieve the goal of “unity of aim” with regard to government regulation of industry.

All of the words in quotation marks in the preceding paragraph, except for the last ones, are the words of Benito Mussolini. The “unity of aim” phrase was from Mussolini apologist/propagandist Fausto Pitigliani. There is, after all, a very keen similarity between Hamiltonian mercantilism — or an economy directed and controlled by government, supposedly “in the public interest” but in reality for the benefit of a privileged few — and the economic fascism of Italy (and Germany) of the 1920s and ’30s.

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Thomas DiLorenzo is professor of economics at Loyola College and a member of the senior faculty of the Mises Institute.

It is 79 years since the Great Depression. Some fear that this week’s chaos in the financial world means that the curtains are rising on Great Depression II. I don’t have a crystal ball, but I’m sure the immediate future is grim. At the very least we are in for a long and deep recession and our medicine will be very bitter indeed.

Clearly the style of capitalism which has dominated world markets for the last 20 years or so is flatlining. The question now is whether it is worth resuscitating. The answer must be Yes – but only if we jettison the “greed is good” ideology made famous by the slimy character Gordon Gekko in the 1987 film Wall Street. That was a movie. In real life it was the philosophy of Nobel Prize-winning economist Milton Friedman.

Friedman was probably the greatest economist of the 20th century. He influenced Ronald Reagan in the US, Margaret Thatcher in the UK, Brian Mulroney in Canada, and Paul Keating in Australia and his ideas led to critical economic reform in each of their countries. These economies were made stronger by following much of Friedman’s economic rationalism.

But at the heart of Friedman’s thought was the idea that greed is good, that greed works because it drives people to succeed. The reality, as we can now see, is that greed, in its truest sense, does not work.

A deadly sin

I have no doubt that greed is the cause of the current crisis. It was the greed of those who took easy money to buy houses beyond their means and the greed of bankers who lent to people borrowing beyond their means. The depth of this depravity can be seen in the Wall Street bankers who were collecting salaries over US$100 million per year even as their banks were collapsing.

Right now, even as the dominoes fall, disciples of Friedman are still contending that the culprit is not capitalist greed but excessive government regulation. However, while poor legislation and regulation may have contributed to the subprime mortgage market crisis that sparked the conflagration, it is absurd to suggest that the solution is merely a less regulated market.

Friedmanistas claim that the US subprime mortgage crisis didn’t happen in markets like Australia and the EU because their consumers are more sophisticated. Nothing could be further from the truth. Australians and Europeans are not smarter; they were protected by more stringent regulatory frameworks. If foreign banks have been dragged into the American crisis, it was mainly because they had joined the orgy on Wall Street.

Less regulation may be a good thing; but good regulation trumps it any day. How many ordinary Americans have to lose their jobs and homes before the ideology of laissez-faire capitalism is finally debunked?

Greed needs to be kept in check. Governments the world over should take the matter of bank regulation more seriously. The US’s subprime mortgage mess was created by politicians pandering to the not-unreasonable desire of Americans to own their own homes. But Congressmen who are currently skewering greedy Wall Street bankers should have protected ordinary consumers aspiring to home ownership. Their negligence points to a failure of leadership that reaches to the very top of the American political totem pole.

Tough choices

So, should governments be putting together rescue packages like the US Federal Reserve’s US$800 billion one to save the banks? Aren’t these rescue packages throwing good money after bad? After all, it was bad, even unethical, business decisions that have sunk the biggest financial institutions. If only that money were available now to help the people who are losing their homes, who face unemployment and who need to feed and educate their children.

But leaving the financial institutions that created the mess to stew in their folly is not a solution.

The viability of the world’s banking system needs to be ensured. If the banking crisis gets worse and more banks go under, it will be harder for businesses, big and small, to expand. Markets — which ultimately thrive on confidence — will shrink. That will mean more job losses and more pain. It could bring the world to Great Depression II, complete with soup kitchens and Hoovervilles. Right now, not bailing out the banks and other financial institutions is unthinkable.

Modern day capitalism may well be wanting. But – to paraphrase Winston Churchill’s description of democracy – it is the worst economic system except for all the others. The Great Depression played a part in the rise of communism, socialism, fascism and Nazism in the 1930s. That is, I am sure, not an outcome many would want from this crisis.

Saving the financial institutions that caused this crisis is the only way to keep the world from sliding into worse turmoil. But we have to learn from this calamity. Greed is not good. We need to inoculate our children against idolising Gordon Gekko. And we need to demand that governments regulate the markets more tightly . Capitalism works; but not when it is based on every man for himself. We need to find our way to a capitalism based on values and virtue.

Alistair Nicholas lives in Beijing where he runs a consultancy firm. He has been an economic researcher, political adviser, and Australian diplomat. In his consultancy he advises international corporations on business ethics and communications in China. He is the co-author of a study on the privatisation of welfare in Australia.

Caveat Emptor!     http://www.nakedcapitalism.com/

Jeffey Frankel
Politicians have always faced the temptation to give their constituents tax cuts. But in recent decades “conservative” presidents have enacted large tax cuts that have been anything but conservative fiscally, and have justified them by appealing to theory. In particular, they have appealed to two theories: the Laffer Proposition, which says that cuts in tax rates will pay for themselves via higher economic activity, and the Starve the Beast Hypothesis, which says that tax cuts will increase the budget deficit and put downward pressure on federal spending. It is insufficiently remarked that the two propositions are inconsistent with each other: reductions in tax rates can’t increase tax revenues and reduce tax revenues at the same time. But being mutually exclusive does not prevent them both from being wrong.

The Laffer Proposition, while theoretically possible under certain conditions, does not apply to US income tax rates: a cut in those rates reduces revenue, precisely as common sense would indicate. As detailed in a new paper of mine “Snake-Oil Tax Cuts,” for the Economic Policy Institute, this conclusion was the outcome of the two big experiments of recent decades: the Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03. It is also the conclusion of more systematic scholarly studies based on more extensive data. Finally, it is the view of almost all professional economists, including the illustrious economic advisers to Presidents Reagan and Bush, even though it contradicted the views of their employers. So thorough is the discrediting of the Laffer Hypothesis, that many deny that these two presidents or their top officials could have ever believed such a thing. But abundant quotes show that they did.

The Starve the Beast Hypothesis claims that politicians can’t spend money that they don’t have. In theory, Congressmen are supposedly inhibited from increasing spending by constituents’ fears that the resulting deficits will mean higher taxes for their grandchildren. The theory fails on both conceptual grounds and empirical grounds. Conceptually, one should begin by asking: what it the alternative fiscal regime to which Starve the Beast is being compared? The natural alternative is the regime that was in place during the 1990s, which I call Shared Sacrifice. During that time, any congressman wishing to increase spending had to show how they would raise taxes to pay for it. Logically, a Congressman contemplating a new spending program to benefit some favored supporters will be more inhibited by fears of constituents complaining about an immediate tax increase (under the regime of Shared Sacrifice) than by fears of constituents complaining that budget deficits might mean higher taxes many years into the future (under Starve the Beast). Sure enough, the Shared Sacrifice approach of the 1990s succeeded. Compare this outcome to the sharp increases in spending that took place when President Reagan took office, when the first President Bush took office, and when the second President Bush took office. As with the Laffer Hypothesis, more systematic econometric analysis confirms the rejection of the hypothesis.

These matters are not solely of interest to historians or economists. The presidential campaign of Senator John McCain appears set to drive its wagon down the same road in which Reagan and Bush have already worn deep ruts. The candidate is apparently selling the same snake oil: he says he believes that tax cuts increase revenues. His principle policy director disavows the Laffer Principle, just as the economists who advised Presidents Reagan and Bush did. But the views of the economic advisers are not what determines what these presidents do.

“The Queen in Alice in Wonderland said that, with practice, she was able to believe as many as six impossible things before breakfast. Most of us are more limited in our capacity for credulity. If John McCain believes both the Laffer Proposition (tax cuts raise revenues) and Starve the Beast (higher revenues lead to higher spending, anathema to conservatives), then as a good conservative, his duty is clear. He ought to run on a truly novel platform of higher tax rates! Why? Higher tax rates would reduce revenues (this is what Laffer says would happen) and thereby reduce spending (this is what Starve the Beast says would happen).

Seriously folks. If McCain continues to propose extending the Bush tax cuts, he should at least be forced to choose between the Lafferite defense and the “Starve the Beast” defense. Only then can the rest of us know which of the two mutually inconsistent propositions to refute.

A recent study from the Congressional Budget Office (CBO) has zero credibility. It pegged likely taxpayer losses in the Fannie Mae and Freddie Mac bailouts at $25 billion. For those with a sense of history, it is worth remembering that the S&L bailout had a $160 billion price tag. The numbers diverge so far from reality as to be laugh-out-loud funny. Funny, that is, except that the CBO estimate demonstrates a willful disconnect with the actual consequences of federal government actions.

CARTOON CAPITALISM
by Bill Bonner

Last week, purely in the spirit of mischief, we brought up a sore subject: America’s largest mortgage finance companies, Fannie and Freddie. The two have so much water in their lungs it will take at least $25 billion of the public’s money to save them. Possibly $300 billion. Were it up to us, we’d leave them on the beach.

But, last week, the U.S. Senate bent down and pressed its large mouth onto those gaping traps of the mortgage twins - gurgling into them a corrupt breath of life. Since the two hold one out of every two mortgages in the nation, in effect, Congress is nationalizing the U.S. housing stock itself. Henceforth, citizens will pay not only their taxes to the government, but their mortgage payments too.

In America itself, how this came to be is the subject of little concern. But despite the lack of interest, it is the subject of the next 500 words or so.

At a speech in Vancouver, James Kunstler seemed positively delighted. Finally, gasoline over $4 a gallon was going to do what generations of artistic scorn could not - destroy Fannie and Freddie’s collateral. Kunstler’s critique of American suburban vernacular architecture is that its products are not real houses at all - but “cartoon houses.” They have porches that look like real porches from a distance, but they are too narrow to sit on. They have shutters too - nailed to the wall, making them completely useless. They may have “picture” windows…looking out on nothing…or no windows at all. And they wouldn’t exist at all were it not for cheap credit and cheap gasoline.

Of course, the same may be said of America’s - and Britain’s - entire economies during the last 20 years. The loose credit that built cartoon houses also constructed cartoon economies; they look like real economies, but they are essentially perverse, consuming wealth rather than creating it.

For proof, we return to Fannie and Freddie. Here were two companies that appeared to be helping Americans own houses. But since they were created, homeowners’ equity - that portion of the house actually owned and paid for by the homeowner - fell from 70% to below 50%. Currently, Americans’ total equity is lower than their mortgage debt. As a whole, the nation’s homeowners are “upside down,” in other words. Nearly 9 million Americans have zero or negative equity already - and house prices are still falling.

How comes this to be? The answer is simple: lenders lent more than the houses were worth to people who couldn’t pay it back anyway. This Looney Tune approach to finance radiated to all points of the economy. People pretended that they earned more - spending more and more money to buy more and more goods and services - but wages did not really increase. Then, they bought houses - believing the roofs over their heads were investments, rather than consumer items. With no down payment, no proof of income, and zero interest loans - for most of the new buyers, home ownership was merely a dangerous conceit. Now that the roofs have caved in, it is a staggering burden.

The “consumer economy” was always a mockery. No serious economist ever suggested that you could get richer by consuming wealth. But that didn’t make consumerism unpopular. The more people consumed, the more GDP went up. GDP measures output, not wealth creation; but who could tell the difference? In a cartoon economy - no one. Besides, spending made people feel as though they were getting richer.

Then, whenever the consumer threatened to come to his senses, the feds rushed to “stimulate” him - by giving him more of what he least needed, more credit. More spending kept the cartoon economy running - allowing the consumer, the businessman and the speculator to add to his burden of debt. In 1971, when the United States went off the gold wagon, household debt was less than 50% of GDP. Now, it is more than 100%. And now, the poor consumer’s knees buckle; he will be forced to work the rest of his life just to keep up with his debt burden, let alone pay it off.

Even the rentiers were bamboozled by their own claptrap. Stocks rose from ‘82 to 2000…fell heavily to 2002 and bounced back. For the last 10 years, shareholders have gotten little for their effort. In July of ‘98, the FTSE hit a high of 5,458. This month, it has reached 5,625. And in America, if stock prices were quoted in gallons of gasoline, the Dow would take the driver no further in 2008 than it did 40 years ago.

The cartoon capitalists did it all backwards; they are supposed to exploit the workers, not be exploited by them. But while consumers and investors were going nowhere, corporate managers and Wall Street hustlers were getting rich. The two Bozos running Fannie and Freddie, for example, pocketed about $32 million between them last year - during a period in which the companies lost almost $5.2 billion - not to mention the losses to shareholders. And on Wall Street, managers paid out $250 billion in bonuses in the 4 years leading up to the credit crunch. The firms declared a profit and paid bonuses when the bets were made; they didn’t wait to see how they turned out. Thus did the big banks and big brokers become capitalists without capital, dependent on the gullibility of investors to keep them in business. And when investors began to wise up, they turned to the public for capital support.

What kind of scam is this? It may look like capitalism from a distance. But this is not real capitalism; this is cartoon capitalism - run by clowns, who sell freak investments to chump investors, and encourage the lumpen householder to ruin himself.

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now by clicking here:

Mobs, Messiahs and Markets

http://www.dailyreckoning.com/

Ludwig von Mises had a theory about interventionism:It doesn’t accomplish its stated ends. Instead it distorts the market. That distortion cries out for a fix. The fix can consist in pulling back and freeing the market or taking further steps toward intervention. The State nearly always chooses the latter course, unless forced to do otherwise. The result is more distortion, leading eventually, by small steps, toward ever more nationalization and its attendant stagnation and bankruptcy.

When you think about the current Fannie Mae-Freddie Mac crisis, you must remember Mises’s theory of intervention.

Reporters will not, but you must, provided you want to understand what is going on. President Bush is considering a fateful step in a 60-year-old problem: the nationalization of these mortgage companies. He wants to guarantee the $5 trillion (that’s trillion with a “t”) in debt owned by these companies. Another option would be to put these monstrosities under “conservatorship,” which means that you and I will pay for their losses directly.

Either way, it turns out that there is no magic way to put every American citizen, regardless of financial means or credit history, in a 3,000 square foot home. Someone, somewhere, sometime has to pay. No matter what rescue plan they are able to cobble together, that someone is you.

The heck of it is that any option would be devastating to the already-suffering housing market. The reason this sector was so wildly inflated is that banks knew that Fannie and Freddie were capable of buying any mortgage debt created by the banking industry. For these companies to be nationalized would effectively end their capacity to do this on a market basis. That means banks would suddenly have to act responsibly.

Now, you might say, if that’s true, the real blame is with the individual bankers that had been making irresponsible loans under the condition that these government-sponsored enterprises would absorb them. But that’s not right. Put yourself in the shoes of a banker over the last twenty years. You have competitors. You have a bottom line. If you don’t extend these loans, you come off as a fool. Your competition eats your breakfast. To stay ahead of market trends means that you have to play the game, even though you know it is rigged.

Place the blame not only on the banks, but also on the institutions that are siphoning off their liabilities for irresponsible behavior, and that would be Freddie and Fannie. And who created these? Travel back in time to the New Deal. Here is an article about the creation of Freddie Mac. And here is another about Fannie Mae.

They were created by FDR in 1938 to fund mortgages insured by the Federal Home Administration. They were used by every president as a means to achieve this weird American value that every last person must own a home, no matter what. So they were given the legal permission to purchase private mortgages and make them part of their portfolios. Still later, under LBJ and Nixon, they became public companies and sold stock. People called this privatization, but that isn’t quite right. They had access to a guaranteed line of credit creation with the US Treasury. They had lower borrowing costs than any private-sector equivalent.

Government-sponsored enterprises are not subject to market discipline like regular private-sector companies. Their securities are listed as government securities, so their risk premiums were not dictated by the free market. They could leverage themselves at 50-, 75-, 100-1, pyramiding debt on a tiny foundation of equity. The financial markets have long believed that the GSEs would be bailed out no matter what. And so this put them in a completely different position from a company like Enron, which the markets watched closely. What’s causing the current panic is that the markets have wised up and started evaluating these institutions by market standards. Freddie and Fannie have collapsing market prices, and their bonds are carrying ever-higher risk premiums.

In other words, we are not talking about market failure. If you have a housetop you can shout that from, please do so, because the press and the government are going to make every effort to blame private borrowers and lenders for this calamity. But the origin of both these outfits is with federal legislation. They are not market entities. They have long been guaranteed by you and me. No, they have not been socialist entities either because they are privately owned. They occupy a third status for which there is a name: fascism. Really, that’s what we are talking about: the inexorable tendency of financial fascism to mutate into full-scale financial socialism and therefore bankruptcy.

Mr. Bush might have prevented this meltdown by curbing the privileges of Freddie and Fannie long ago. But no, he had another plan, one which was assisted by the Republican think tanks in Washington (the curious can Google it up). The idea was a new slogan called the “ownership society.”

Sounds nice, doesn’t it? Sounds like free enterprise. But if you think about it, there is nothing particularly free market about the demand that everyone should own anything in particular. The idea of free markets is that your rights to own justly are not to be infringed by public or private criminals. The suggestion that everyone should own some particular thing, by whatever means, can only be funded through financial socialism or mass theft. The claim on the part of a government that it will create an “ownership society” can prove to be highly dangerous.

As for the future, Mises’s theory that the government will always favor more government seems wholly sound.

Here is John McCain:

Those institutions, Fannie and Freddie, have been responsible for millions of Americans to be able to own their own homes, and they will not fail, we will not allow them to fail … we will do what’s necessary to make sure that they continue that function.

Not a single Democrat disagrees.

As with the S&L fiasco from years ago, the case of the housing bust followed by the trillions in taxpayer liabilities for the disaster will again be cited as a case of “the shock doctrine” and “disaster capitalism” in which the elites make fantastic amounts of money at the expense of the little guy. The critique will be mostly solid but for the one most important point: this kind of fiasco would not happen in a free market. It happens because government, through credit creation and guarantees, makes it possible.

Look down the road a bit here. What happens when banks won’t lend for houses anymore? What will government do then? We might as well prepare for a future in which applying for a housing loan will have similar features to getting an SBA loan. This is where we are headed.

Government intervention is like a vial of mutating poison in the water supply. We can get by for a long time and no one seems really worse off. One day we wake up and everyone is desperately ill, and blaming not the poison but the water itself. So it is with the housing crisis. Lenders are being blamed for the entire fiasco, and capitalism is going to be subjected to a beating as usual, since Freddie and Fannie are traded in public markets. But the fact remains that there is only one reason that this went on as long as it did and became as bad as it is. It was that vial of government poison.

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