Economic Crisis Via Massive Consumer Debt

Two economists explain their hypothesis about the current economic crisis in today's WSJ:

The 2001 recession might have ended the [housing] bubble, but the Federal Reserve decided to pursue an unusually expansionary monetary policy in order to counteract the downturn. When the Fed increased liquidity, money naturally flowed to the fastest expanding sector. Both the Clinton and Bush administrations aggressively pursued the goal of expanding homeownership, so credit standards eroded. Lenders and the investment banks that securitized mortgages used rising home prices to justify loans to buyers with limited assets and income. Rating agencies accepted the hypothesis of ever rising home values, gave large portions of each security issue an investment-grade rating, and investors gobbled them up.

But housing expenditures in the U.S. and most of the developed world have historically taken about 30% of household income. If housing prices more than double in a seven-year period without a commensurate increase in income, eventually something has to give. When subprime lending, the interest-only adjustable-rate mortgage (ARM), and the negative-equity option ARM were no longer able to sustain the flow of new buyers, the inevitable crash could no longer be delayed.

The price decline started in 2006. Then policies designed to promote the American dream instead produced a nightmare. Trillions of dollars of mortgages, written to buyers with slender equity, started a wave of delinquencies and defaults. Borrowers' losses were limited to their small down payments; hence, the lion's share of the losses was transmitted into the financial system and it collapsed.

A few things to note: 1) the government loosened credit to those who shouldn't have received it, thus sowing the seeds for the credit swaps; 2) the Fed was too slow to recognize and thus respond to the problems that the Congressionally encouraged behavior caused; and 3) while bubbles occur in the market, they are usually self-correcting and don't inflict catastrophic damage on the greater economy when left to themselves (i.e., without government-sanctioned market manipulation). Yet, the lesson the left seems to have learned from this is to manipulate the market, like a kid who keeps touching a hot stove.

Whole piece in its wonky glory here.

Quick Take on the Bailout

While most of my libertarian friends are behind the "failout"--it probably won't last. And, as often happens in Washington, the second version is likely to be worse than the first. So much for small victories...

But I wanted to address the few friends of mine who actually support the bailout--specifically a self-proclaimed anarcho-capitalist/anarchist friend of mine who works in the finance sector. We'll call him "Jim."

Jim tells me yesterday that while the bailout may not work, it may slow the domino effect of "runs on the bank" that we're seeing as Wachovia, WaMu, Merrill Lynch, etc. all fall. Apparently, Jim explained, they all lent money to each other while hiding the riskier sides of their holdings and now when that risk bites them in the ass it's the least the government can do to infuse $700 billion into proven bad investments. And, he argues, because of their holdings, all these failures could collapse the economy because, well, the banks don't trust each other anymore. So, in short, we should limit the consequences of those hidden shady investments by giving them more money so they can...do more of the same again?

Um, excuse me for not being sympathetic.

Broke people borrow and lend money all the time. The difference being is that they don't have the federal government backing their bad loans/defaulters in case things go wrong. Often, the loans are illegal and thus not enforceable by law; often resulting in--shall we say?--alternative punitive techniques.

People will be ok, bailout or no. (But a bailout is coming in all likelihood.) We're not going to see breadlines and 30% unemployment--but if we, as libertarians, back "shock therapy" for other economies when they need to get their houses in order, I see no moral reason we should expect any different for our own ( lest we only support creative destruction for brown people). If we are opposed to bailouts and government intervention on principle, then we must face the consequences of shady trading and lending which shouldn't have been going on in the first place. The proverb that you shouldn't rob Peter to pay Paul applies--the fact that (apparently) so much of our economy is based on such practices is disturbing and those involved should get what's coming to them.

Such is the destructive power of the market.

Effectively, the debate comes down to the consequentialists versus the natural rights folks within the broader "movement" and illustrates my problem with the former: it's the principle, stupid. (Small "l")Libertarians disregarding their long-held and strident principled opposition to redistribution is just as bad as the hypocrites on Capitol Hill who only espouse limited government when it suits them and chuck it out the window when it benefits them. I thought we were better than that.

And forgive me, Jim, for saying this: but an anarchist supporting government bailouts is akin to a praying atheist. There's nothing wrong with it, per se, but it doesn't make a whole lot of sense.

On the Failed Bailout

White reaction: Oh my god! They're not gonna help us!

Black reaction: Welcome to our world.