Let me drive this point home. Without Fannie and Freddie’s certification of millions of bad loans as safe, other banks both domestic and foreign wouldn’t have bought them. More importantly, world financial markets wouldn’t have relied on those packaged loans as collateral and collapsed when they went bad. Fannie and Freddie, both government-sponsored enterprises that are guaranteed and funded by U.S. taxpayers, committed fraud so massive it dwarfs the Enron scandal.

We Austrian economists saw this coming three decades ago. I warned in the 1980s that government involvement in the housing market would inevitably produce catastrophe. Even Republicans attacked me as an enemy of home ownership. The theory, held by many in both parties, was that owning a home made Americans stakeholders in the system and stabilized our economy. Others pushed the envelope further, using Fannie and Freddie as a way to give homes to low-income individuals. All very noble, of course, but it was always doomed. I hate to say I told you so but… well, actually, I don’t.

Our current administration is, of course, sticking to the story line that this “great recession” is a failure of capitalism. This won’t change because so many high-ranking administration officials profited from the mortgage fraud business.

The beginning of the Fannie and Freddie fraud that Pinto documents took place under the watch of Jim Johnson. You may know Johnson as the “trusted adviser” to the president who helped pick his running mate, Joe Biden.

While few know about Johnson’s role in the financial collapse, many know him for his legendary generosity with Fannie’s fake profits. As CEO of Fannie, he bestowed fortunes on his favorite causes, which made him one of the most popular people inside the beltway. Many of my colleagues spoke out against this laundering of the public’s money for personal and political purposes, but were ignored or attacked.

Rep. Barney Frank was the chief defender of Fannie and Freddie, accusing anyone who wanted more oversight of the out-of-control institutions of being heartless, racist or both. While I’m not a huge fan of the Bush administration, the truth is that it made multiple attempts to rein in Fannie and Freddie. Unfortunately, they were successfully parried by Frank.

Over the weekend, administration talking heads were sticking to the line that they have deterred financial disaster with bailouts and stimulus spending.

I was not as worried about the initial financial collapse and resultant recession as I was worried about the so-called fixes. I predicted then that those programs, along with efforts at massive restructuring of the economy, would not only fail to create the jobs and upturn we were promised. I told you they would slow the recovery. I include, incidentally, President Bush’s contribution to our debt and deficit as part of the problem.

Now you can read how this has actually come to pass in a great article by three University of Chicago economists, “Uncertainty and the Slow Recovery,” by Nobel laureate Gary Becker, Steven Davis and Kevin Murphy, in The Wall Street Journal online.

“In terms of U.S. output contractions, the so-called Great Recession was not much more severe than the recessions in 1973-75 and 1981-82.Yet recovery from the latest recession has started out much more slowly. For example, real GDP expanded by 7.7% in 1983 after unemployment peaked at 10.8% in December 1982, whereas GDP grew at an unimpressive annual rate of 2.2% in the third quarter of 2009. Although the fourth quarter is likely to show better numbers — probably much better — there are no signs of an explosive takeoff from the recession.

“We believe two factors are behind this rather tepid rebound. An obvious one is the severe financial crisis that precipitated this recession, with many major financial institutions receiving large bailouts from the federal government. The confidence of bankers and venture capitalists has been shattered, at least for a while, and it will take time for them to recover from the financial turmoil of the past couple of years. The household sector also faces a difficult period of financial retrenchment in the wake of a major collapse in home prices, overextended debt positions for many and high unemployment.

“The second factor is less obvious, but possibly also of great importance. Liberal Democrats won a major victory in the 2008 elections, winning the presidency and large majorities in both the House and Senate. They interpreted this as evidence that a large majority of Americans want major reforms in the economy, health care and many other areas. So in addition to continuing and extending the Bush-initiated bailout of banks, AIG, General Motors, Chrysler and other companies, Congress and President Obama signaled their intentions to introduce major changes in taxes, government spending and regulations — changes that could radically transform the American economy.”

Those changes, the Chicago Boyz say, have inspired hesitation, uncertainty and fear in employers and investors. As a result, they’ve waited on the sidelines to see how things play out. Not very cheering, is it? The result is that while the administration takes credit for “jobs saved,” actual unemployment figures in some areas are at Great Depression levels.

Yes, yes, yes, Obama inherited a mess. The problem with that thinking is that Congress makes policies, not presidents. When government is split, the most a president can do is use the veto, something Bush should have done regularly. For the last two years of his presidency, Democrats had the power of Congress. For two additional years, Congress was split. Democrats who now blame him for the totality of the financial failure are saying, implicitly, that he should have opposed Congress more vigorously, and I don’t think that’s their real message.

Anyway, I’m telling you that I was right about the all the ridiculous big-government solutions for a reason. I am fundamentally an optimist, and I am forecasting remarkable things in the not-so-distant future. I’m not, however, a blinkered Pollyanna like certain high-profile analysts whom we will not name.

My point is this: If someone doesn’t have a history of accurate predictions, he has no right to ask others to believe him when he makes forecasts. And I’m forecasting that the recovery, delayed as it is, will be historically unprecedented. And if you don’t want to believe me, believe Dr. Gary Becker, who has said to me, in both conversation and writing, the same thing. More importantly, he forecasts that the recovery will be driven by the breakthrough technological innovations that we are talking about and investing in now.

For transformational profits,
Patrick Cox

January 14, 2010

Fannie, Freddie, Fraud was originally featured on Whiskey and Gunpowder

“Owners of capital will stimulate the working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and the State will have to take the road which will eventually lead to communism.”

- Karl Marx, 1867, Das Kapital

That quote is almost assuredly bogus. We haven’t tormented ourselves by re-reading sections of Das Kapital. Once in college was enough. This quote, though, has been making the rounds on the Internet, as if Marx and his minions somehow knew all this was coming.

Whether the analysis is accurate is a separate question from whether Marx ever wrote it. German is a torturous language to read in translation, full of compound sentences and words. And it’s highly unlikely, writing in the late 19th century, that Marx would have referred to the working class buying houses and technology. The horseless carriage hadn’t even been invented yet, much less the iPod, the BlueRay, or the George Foreman grill.

Nope. This is a clever bit of revisionism by some unemployed Marxist student or tenured professor trying to discredit the free market while rehabilitating the Marxist playbook. Marx did indeed say capitalism would eventually evolve into socialism and finally communism. He claimed it was riddled by contradictions which made the system inherently unstable.

But his theory was evolutionary, based on his views of human nature and a rational “homo economicus.” Like Adam Smith, Marx was a materialist who defined wealth in terms of physical goods. Thus, his view of human nature is rather material too, which explains his atheism.

In any event, the Austrians (especially Rothbard) would point out that the boom-bust feature of capitalist economies is not inherent in the system, but is actually a product of the government’s manipulation of interest rates. This changes the price of money and causes risk-taking entrepreneurs to miscalculate the underlying demand for their production.

Thus, you get a massive, credit-induced production bubble, global in scale with resources devoted to supplying a fictional demand. It happened with residential real estate in the U.S. and Europe. It’s happened with commercial real estate in China. And it probably happened all along the commodity supply chain, as raw material demand increased for the production of finished goods made in China for Americans who bought on credit.

That isn’t to say you wouldn’t have normal cycles of growth and recession in an economy with natural interest rates. But in an economy with natural interest rates, the cost of capital would go up during a recession. Bankers would get more prudent with their lending as the market place sorted out which lending resulted in productive new enterprise and which businesses failed.

The bad investments would be written down and eventually new demand for capital from entrepreneurs would resume. At least, that’s how the Austrians drew it up. Today, of course, we are engaged in the great global project of trying to prop up investments gone bad, whether they be in residential American real estate or the collateralised bonds based on that real estate that currently reside like dead weight on balance sheets all over the globe.

No amount of rearranging is going to improve the quality of those debts. But that won’t keep political busy bodies from trying—and wasting even more time and capital.

Stocks in the U.S. were up overnight. Here in Australia, the blind are following where the deaf boldly lead. But is anyone listening? Or is everyone too busy hoping?

What we’re talking about are Ben Bernanke’s comments. The news headlines read that he predicted the recession will end later this year and the American economy will recover in 2010. But that’s not exactly what he said.

Here exactly is what he said, “If actions taken by the Administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stabilityand only if that is the case, in my viewthere is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery.”

If you wanted to put it another way, it might go like this: If our plan is successful to solve all the problems, then all the problems will have been successfully solved according to the plan.

How inspiring is that? Does it give you confidence that these guys have any idea what they’re doing?

What the system needs is more instability, not less. That is, prices and asset values need to fall to their real level to restore confidence. In this sense, a proper recession is the cure for uncertainty and instability.

Yes, we know this is in direct contradiction to what elected officials are telling you. But think for a moment of a man who’s done nothing but eat greasy and fatty foods for a year. He’s on his deathbed. His arteries are clogged with fat and cholesterol.

Now you couldn’t improve the man’s health by telling him to feel better about himself. “C’mon big fella. Buck up! Have another cheeseburger. With bacon. And avocado. This whole being morbidly obese and killing yourself thing is all in your head. You gotta get your mind right!”

You could tell him all that. But it would be bad medical advice. In the same way, our financial mal-practitioners have mis-diagnosed the economy. Confidence is not the problem. Bad credits and loans are the problem.
You restore confidence when you directly address the problem. Investors get out of cash and back into shares or property when they have demonstrable proof that the banks aren’t hiding/lying any longer.

Or, as Murray Rothbard puts it in America’s Great Depression, “The completion of liquidation removes the uncertainties of impending bankruptcy and ends the borrowers’ scramble for cash. A rapid unhampered fall in prices, both in general, and in particularly in goods of higher orders (adjusting to the mal-investments of the boom) will speedily end the realignment processes and remove expectations of further declines.”

But instead of realigning with economic reality, our policy makers are acting as if it is possible to sustain all the bad investments made during the credit boom. They want to save homeowners, shareholders, bondholders, and pretty much anyone who stands to lose from the risks gone bad.

That is not possible. Someone has to pay for the bad bets made in subprime loans, Eastern Europe, or the developing world. That someone is probably a) the guy who took out the mortgage he can’t repay, b) the bank who made the loan to the guy who took out the mortgage he can’t repay, c) the investor who bought the bond sold by the bank who made the loan to the guy who took out the mortgage he can’t repay.

Evading responsibility for one’s actions doesn’t solve anything. Making other people pay for them doesn’t help much either. Of course we’re all going to pay for it one way or another, through more bailouts or the general contraction in credit and growth that has to come during the “realignment process.”

But those appear to be the two choices: allow failure, which allocates resources from the bad debts and losers to those who can produce real wealth. Or, try to “stabilise” any inherently unstable situation (perpetuating asset values after the credit spigot has been turned off).

Not that we’re absolving market institutions for getting us into the problem. The credit ratings agencies essentially sold investment grade ratings on issues they didn’t or couldn’t understand. AIG sold default insurance on CDOs to make an easy buck. It’s now become a black hole for taxpayer capital.

But that is fictitious financial capitalism at work, or at waste if you prefer. That kind of financial capitalism is dead, and good riddance. But don’t mistake that episode of mismanagement and theft for conclusive proof that “capitalism” has failed. That would be a big mistake.

But the commies are feeling their oats these days. Yes, the commies are back in the DR mailbox. They’re in the paper. They’re even on TV. We saw a report on them last night and how their explanation of the financial crisis validates what they’ve been saying all along.

Regards,
Dan Denning

February 26, 2009

Here Come the Commies: Marxism Goes on the Attack was originally featured on Whiskey and Gunpowder