Anarchy Without Bombs

Cooperation Without Coercion

Housing Crisis and Credit Meltdown

Many people say the housing crisis and subsequent credit meltdown were caused by inadequate regulation: they’re right. In a free market, business behavior is severely regulated by the potential to lose money when bad decisions are made.  What the government did was eliminate that regulation by guaranteeing people against losses, thereby encouraging outrageously risky behavior:

(1) Two government-sponsored enterprises, Fannie Mae & Freddie Mac, bought mortgages from banks, eliminating the risk to banks of lending to people with poor credit and inadequate down payments.

(2) An implicit guarantee by the government that it would bail out the FMs (make up your own obscene alternative meaning for the initials), allowed them to borrow at extremely low rates and profit from accumulating TRILLIONS of dollars of debt to acquire mortgages: they were able to borrow amounts equal to FORTY TIMES their net worth.

(3) FDIC insurance has caused depositors to pay no attention to the soundness of the banks where they keep their money. Thus, prudent behavior by banks not only isn’t rewarded, but is actively discouraged, as they make more money by taking on risk and don’t need to fear a loss of confidence when they engage in irresponsible behavior.

(4) Having a central bank (the Fed) with the power to create money in unlimited quantities creates a false sense of security throughout the banking industry, one which will last until a hyperinflation that destroys the buying power of those dollars makes it clear that the government can’t create wealth just by printing it.

The bottom line is that past government interventions have destroyed the regulatory nature of markets, and the current proposed ones only make it worse.  We SHOULD regulate bankers and punish bad behavior.  By ENDING government intervention.


Written by Less

October 10, 2008 at 8:16 am

Posted in Economic freedom

Tagged with ,

5 Responses

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  1. Not that I disagree with any of this, but the financial side of the real estate business is hard to do liberatarianly, given the community side of real estate. For instance:

    Homeowners in a particular community therefore become eligible (and usually active) voters, and one of the things they do is distort the supply of housing by putting up barriers to building more of it. It was as if Ford, GM and Chrysler could vote the Japanese out of the car market. Libertarianism in local zoning and other planning issues is a non-starter.

    The FMs were set up to encourage ownership, partly because owner neighborhoods are more stable and induce better communities than renters do. It’s not just a financial matter.

    I don’t think FDIC insurance is a bad thing to make people’s savings secure. Sometimes the federal government violates libertarian economics to act as the only entity large enough to provide a service the market would provide if there was anyone big enough to do it. Insuring the deposits in banks is one such service.

    Along the same lines, the fact that there are such things as risk-free government bonds is frequently used as the starting point against which every other type of investment is measured (i.e. stock return 7% more over time, but with high annual volatility). I think the whole investment universe would be a lot less “measurable” and hence plannable, if it weren’t for Treasuries to compare against.

    Thanks Less for your good insights.
    Doug O

    Doug O

    October 11, 2008 at 7:07 am

  2. You brought up a lot of issues, and I’ll try to offer a reply in a reasonable amount of space (no promises on the latter). Future posts may expand on these as I find the time.

    (1) Local tyranny certainly exists today in much of the country when it comes to land use, but competition for revenues also does, so I think there is more hope than you do. Municipalities are starting to struggle with their debt load, and if they continue to interfere with the economic base of their population, they will default. That is why many coastal cities in California are in trouble financially and are having their bonds downgraded. So I’m more of an optimist, since I believe that parasites understand the importance of not killing their hosts. In any event, I wasn’t addressing local land use controls in my post.

    (2) Home ownership increases with wealth: the best way to support the former is to support the latter. Moreover, you’re not a homeowner when you put no money down and sign a 30-year mortgage: you’re a renter with a 30-year lease plus a speculator on future housing prices. Home ownership is being redefined into a parody of itself. Home equity as a percentage of GDP has dropped: what has been promoted is home ownership by bankers. In the pre-FM days, mortgages typically lasted 7 years, and then you ACTUALLY owned the home free and clear. Moreover, in the 10-plus years since the revisions to the Community Reinvestment Act, the percentage of mortgage loans going for NON-owner occupied homes has risen from 6% of the total to 17%, so they’re actually increasing the number of landlords and speculators.

    (3) The FM has subsidized mortgage lending, which is good for mortgage lenders, but not the general public. Virtually every staple of life takes fewer hours of the median worker’s income than it did when Fannie Mae was started by the government: food, clothing, utilities, transportation all cost less in those terms. Housing has massively increased relative to income. Some assistance. (The government has done the same with subsidized student loan programs, massively increasing tuitions and making it possible for every student in America to graduate from college up to their eyeballs in debt.)

    (4) Your case for the FDIC proves too much: how do we manage to have private companies providing life insurance when there isn’t a single company in America with the financial ability to sell a policy to everyone in America who wants one? Since when does an industry need a single monopoly provider? A competitive insurance market would be far healthier, and would reduce the moral hazard problem, since insurers would have the incentive to monitor bank behavior and set conditions for insurance.

    (5) Government securities are NOT risk-free. Are you aware that international traders take out insurance against defaults by governments, and that over the past month the cost of that insurance on 10-year US Treasuries has risen to 30 basis points of yield, which is far higher than the cost of insuring, for example, German or Japanese government securities? Thanks to the bailouts, US Treasuries are no longer even close to being considered the safest investment in the world, and default in about a decade or so is now considered a significant risk (0.30% per year is a lot of yield to give up for a security that supposedly has no risk of default).

    Besides, even if they could technically honor all debts by printing money, after taxes and inflation, they still provide no assurance. Sorry, but governments, even if they have a printing press for money, are NOT risk-free: they depend entirely on the economic base of the country. This has been proven by economic collapses in government after government after government throughout history, and if people take for granted that the government can insure everybody against everything, the end is nearer than we think.

    [Just as an aside: in the 1920s, German sovereign bonds were essentially wiped out by a 4 trillion per cent inflation. The repayment was a bad joke, since the bond holders lost 99.9999999975% after inflation (I wonder if they had to pay tax on the money they received!). Over that same period, German stocks rose 7 trillion per cent, returning 75% after inflation, or a respectable real rate of return of nearly 6% per year.]


    October 12, 2008 at 4:22 am

  3. […] tasty sample: Many people say the housing crisis and subsequent credit meltdown were caused by inadequate […]

  4. […] liked this post by Less Antman and the comments following it, explaining some of the basics of the housing market crisis and its […]

  5. re: risk free government bonds. Don’t forget that the United State government already defaulted on its debt obligations in 1971 when it was required to pay its foreign debt obligations in gold and Nixon decided to give creditors paper instead.


    October 21, 2008 at 9:44 am

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