The Economic Crisis and the Cause of Freedom

October 1, 2008

The Economic Crisis and the Cause of Freedom

This has been a difficult time for those of us who extol the merits of a free market system. The current housing crisis and the strain it is putting on our banking system has nearly caused the financial system to collapse. Unfortunately, those who advocate for a larger role for government in our daily lives will be able to point to the Crisis of 2008 as "exhibit A" for why we should not be left alone to pursue our own best interests.

However, this criticism misses a critical assumption that we make when advocating a free-market economy - it requires a virtuous people who are willing to assume personal responsibility for their actions. Without right behavior, liberty quickly descends into license.

For some time now, even a casual observer would have to be concerned about increasingly broad-based imprudent or indeed immoral behavior in the economic life of our society. While the increased incidence of this poor behavior has been disappointing, those of us who are troubled by it have taken solace in the fact that the free-market is pretty efficient at recognizing mistakes in judgment or dishonest behavior. If you cheat your customers, employees, or shareholders, you will eventually go out of business and likely to jail. If you take imprudent risks in the market, you will eventually lose money.

This current crisis is different. Instead of a situation where individuals exercising poor judgment are corrected on a case-by-case basis, this crisis has evolved into a situation where poor judgment by a sizable minority is at risk of shutting down the financial system. And as you might expect with a crisis of this magnitude, there is plenty of blame to go around.

Wall Street is the obvious and almost too easy place to start. The managers of these institutions, the stewards of our financial system, have a profound responsibility to maintain the public's trust and confidence. Collectively they have not done so. For years it has been obvious to all, except perhaps those reaping the gains, that executive compensation in many cases has been outrageous and perhaps nowhere more so than on Wall Street. Bloomberg news reports that Wall Street's five biggest firms paid more than $3 billion in the last five years to their top executives. Apparently these executives allowed their firms to take excessive risks in order to generate these gains because today two of the five are out of business and the other three no longer exist as stand alone investment firms.

Lenders have also shown signs of poor judgment. Lending provides a vital and necessary function in our economy. However, some lenders have lost sight of the fact that they have a responsibility -- to those who provide the capital they loan if to no one else - to verify that borrowers can support the debt they take on. The record level of defaults indicates that this responsibility has been shirked.

Consumers are portrayed as victims in all of this. This is a mistake, absolving them of personal responsibility. A free system of exchange will reflect whatever values we bring to it. Today the values we bring to the market are often too materialistic. A sufficiently large minority of consumers, desiring to have more material goods than they could afford, borrowed enough money to help bring down the system.

Need a bigger house or a vacation home? No problem, just take out a floating rate negatively amortizing loan. By the way, we'll let you self-verify your employment history. Need a new car? Just sign up for these extended lease payments. Want a big screen flat panel TV? Just sign up for another credit card.

None of these purchases are bad in themselves, but if we push ourselves into financial ruin to obtain them, there is something disordered in our desires. There is only one thing that will fill our desires and, to borrow from Augustine, our hearts will be restless until they rest in Him. This society seems to increasingly lose focus on that truth.

The collapse in the real estate market triggered this crisis, but it was the behavior of market participants that laid the groundwork. As people working to advance the cause of freedom, we have to continue our efforts to explain the merits of a free economy. But we also have to think more creatively and work a little harder to emphasize the importance of virtuous behavior.

Comments

Roger D. McKinney: rdmckinney@cox.net

I have to respectfully disagree. Immorality is a constant. It’s always with us because it is mankind’s nature. Someone has said that blaming greed for the current crisis is like blaming gravity for airplane crashes. To find the cause of the crisis we have to look at what policies allowed immorality to gain the upper hand.

But to back up a bit, we should also look at the scope of the crisis. It’s nowhere near as bad as the media or Washington makes it out to be. In fact, many of you have probably already read the assessment of the situation from the Minneapolis Fed in which no evidence of a national crisis existed. The crisis was limited to a few banks, the heads of whom were buddies of Paulson. In hind sight, I’m confident that economists will find that Paulson and Bernanke overreacted like teenage girls at a haunted house.

We do face a downturn in the business cycle, but it’s a downturn very similar to all other business cycles that have taken place like clockwork roughly every decade for the past 400 years. To understand this downturn, we have to have a theory of business cycles that encompasses past business cycles and we have one in the Austrian Business Cycle Theory, or ABCT. We have competing cycle theories in other schools of economics, such as the Real Business Cycle theory, but I think you’ll find that the ABCT incorporates all of the other theories and integrates them.

The essence of the ABCT is that the Fed artificially lowers interest rates below the rate that would exist in a free market and thereby distorts prices in a variety of industries. Businessmen, such as bankers, respond rationally and ethically to those distorted prices as if they weren’t distorted because prices are their only guides. But those distorted prices cause overinvestment in specific industries, such as housing, that doesn’t show up until years later. When it does, it makes the investors appear foolish and/or greedy when they weren’t. They simply got fooled by the Fed’s distortion of market prices.

Immorality did play a role in the current business cycle downturn, but not where people are looking. Not with bankers and businessmen. The immorality exists on a daily basis with the Federal government controlling what should be private property—money. When the Feds force interest rates below the market rate they act unjustly because the market rate is the only just price according to the Scholastics, as the Journal of Markets and Morality demonstrate in the previous issue. In addition, the Fed has distorted an important measure upon which all businessmen rely heavily. The Bible is very clear about God’s attitude toward people who have unjust weights, a lighter one for buying and a heavier one for selling. Just as the Biblical weights were measures of goods, so interest rates are measures of savings. By manipulating interest rates, the Feds are guilty of unjust measures that cheat people as surely as corrupt merchants in the Bible cheated people.

Steven Yde: stevenyde@hotmail.com

There is a fantastic article by George Reisman on this topic. http://mises.org/story/3165 As a Catholic and a libertarian I realize that man is flawed and there are men without conscious in all walks of life. Was there corruption by some on Wall Street? Sure. But, I also believe there are good men there as well. Where anti-capitalists fall short is their lack of understanding that Megalomania is the root cause of this crisis not greed or unbridled capitalism. Megalomania can not occur in a free society. Liberty gives us checks and balances to people wanting to exercise power over others. The fact our government and wall street are tied at the hip, gives ample evidence that where there is Authority, there is corruption. Wall Street loves big government and there is a close link between government and Wall Street. Look who the bailout was for and after all the spin, look who is lining up lobbyists right now for the bail out money. Do you think that is planned? When the government is not involved, free markets are able to sort themselves out, but when left to the complexity of bureaucracy, bad men gain favor. Without transparency, evil can lurk in shadows. The welfare at the top is as bad is it is on the bottom. Neither is productive or fair and against the tenants of liberty. But let's go back to root cause. The desire to offer low mortgages and sudo-government backed loans of Fannie and Freddie, was redistribution at its best and was a classic example of the road to hell paved with good intentions. Personal responsibility falls on both the lender and lendee, but the root cause was our own government. The fact that many of our congress were in the back pocket of Fannie is sickening. Beyond that, the false distortion of our money supply had a direct effect on the financial crisis. When the government continues to allow a false distortion of credit, there is a boomerang effect on hard currency, which creates a ripple effect that cripples the market. Many people, of whom my favorite is Ron Paul, called this over a year ago. I am uncomfortable with the term greed. By its vary definition that says having more than one deserves or needs, bothers me. Who decides who has too much? In a free society people are paid by others according to their value or opportunity cost. Unfortunately, those CEO's that appeared to take ridiculous amounts of money could do so by again a lack of transparency in the market and meddling of our government.

Luigi Murtas: aloimur@tiscali.it

Well told. We have to insert loto of virtues and moral behaviours in our economic life.
Let's rediscover "relational goods" and their highest amount.

Antonio Hautle: hautle@fastenopfer.ch

Interesting, but one big question remains: The US Deficit and the wall street is at the origin of the financial crisis and the swiss banks are also well involved into it.
But we have to explain to the poor in Africa, Asia and elsewhere, why they have to pay our bills of excessive consumption and speculation. The US-tradedficit and other failures in the intetrnational tradesystem are a real danger to the whole world's common good.
Idividual moral behaviour is god and necessary, but history shows, that morals alone will not change the free market into a just society. We need to ask other critical questions. The encyclicals of our Popes give some indications - for the free market shows it's limits right now. Reguations will neither resolve all the problems. We have to learn to live with the limits of all human based systems. Also free markets have their limits - and neoliberal free markets are not the "end of history". Let's look for better solutions. That's not easy but it's necessary!

Antonio Hautle, Director Swiss catholic lenten fund (Fastenopfer)

Dennis Milroy: milroyd@cox.net

I absolutely agree with my cousins (2nd) well written assessment of our financial problems. I think I saw it coming several years ago when people were allowed to borrow 110% of a homes value.
Years ago, I was in the real estate business (Broker, owner) and dealt with many home buyers who had difficulty in getting a loan. In those days they required a pay check stub as proof of employment, and the lender asked to see 6 months of bank records. They also required that the debt to income (mortgage and taxes payment) not be higher than 28%, and the combined income to debt be no higher that 35% of their income. Needles to say, many folks didn't qualify.

It wasn’t just the greedy mortgage lenders; it was the poor judgment of borrowers that got this mess started in the first place. In Southern California many people re-financed every year so that they could buy the “toy” they deserved, now many owe much more that their home is worth.

In 1999 bill Clinton told the Fanny and Fred to ease up on lending requirements, and here we are.

Dennis Milroy

SteveD: steved7@mail.saabnet.com

I agree with both D.Hoffer and Dave Milroy. The market must have integrity -- fiduciary trust must be upheld, statements must be true (and verified), and compensation should be tied to performance. The government's role is to be the final line of defense when moral, ethical, and long-term pragmatism fail to insure honesty. This is exactly what the police power is for -- to protect life and property from violence, theft, and fraud. The problem is that the government has been manipulating markets for decades -- indeed, this is a fundamental view of Progressive thought (the dominant mindset of socialists, liberals, New Deal Democrats, and the so-called Neo-Cons). It is not just the Carter and Clinton Administrations -- it was also the Bush Sr and Bush Jr Administrations, several Congresses (some Republican-"led" some Democrat-"led") and quite a few federal judges who each played their part. For many, the intent was admirable -- to help more Americans own their own homes. (Fannie Mae's advertising on the radio emphasized this as their goal up until about 4 months ago.) But what was forgotten was that government cannot generate wealth, and that government demands (legislative, regulatory, and court ordered) to expand home ownership, be non-discriminatory in granting loans even on properties or to borrowers who were poor risks pushed the banks to be very "innovative" in developing adjustable rates, second mortgages to cover equity requirements, etc., nominally covered by insurance and implicit federal backing. Like every government effort to create wealth, all that was created was a speculative bubble. When a sudden rise in oil prices punctured the bubble, the entire artificial expansion of wealth began to disappear with a great whoosh! No $700 billion bailout will solve the problem -- all it does is transfer it from being a business and consumer problem to be dealt with individually into a national problem to be paid for by the taxpayers. NOT the way a free market OR an honest one should work.

Bill: c141nav@yahoo.com

Dave may not be a housing market expert, but he hit the nail on the head with his analysis.

One must read the Investor's Business Daily series about this loan crisis.

Jim:

Now we know why the first $700B bail-out plan didn't pass; it wasn't big enough. I give it 2 weeks before they are back for more. I am voting straight Libertarian until sanity returns to the Republican party, and I do not believe that will be for a long time.

Daniel McLaughlin: djmclaughlin@roadrunner.com

While the comments you say are true about a free market needing an ethical people, the foes of a free market have nothing to say about the current situation. the present circumstances have arisen precisely because we have lacked a free market for a long time. The fractional reserve banking system has distorted the market, given non market incentives and the wrong signals to entrepreneurs and investors. Fractional reserve banking is not a free market institution, but rather government protected embezzlement. The business cycle is not a free market phenomenon, but rather a fractional reserve banking phenomenon.

It is very important for all free market people to stand firm and resist all attempts to blame this situation on the free market. If there was truly a free market, rather than a government money monopoly, this would not have happened.

We need to document all of the the intrusions into the market over the last decades and build an unbreakable case for breaking the government stranglehold on the economy.

Don Gesink: dgesink@comcast.net

A quick review of terms seems in order. Socialism is a system where the government owns and controls the means of production. Capitalism (a Marxist term) is a system where private individuals (often acting in association) own and control the means of production. A system where the means of production is owned privately but controlled by the government is properly called fascism, not quasi-socialism.

Dave: dhoffer6@gmail.com

I don't claim to be a housing market expert but as I understand the situation, it is not a free market.

Starting with the Carter administration and then greatly advanced by the Clinton administration the government forced banks into providing loans to people that otherwise could not afford them. This was done as a social experiment to increase home ownership by the poor. In a normal market this would only happen with higher interest rates to offset for higher risks. However since the housing market has implied government support (this has turned out to be not just implied but actual) through Fannie May and Freddie Mac investors where more than happy to make the loans. This is not capitalism but quasi-socialism. Now this trillion dollar social experiment has blown-up; it seems the social engineers never dreamed that home prices could fall since they hadn't since the Great Depression. This seems to teach again a fundamental problem of market planners; no matter how smart they are they will not think of everything.

What you say is true but if this would have been left to pure markets, yes fewer homes would have been sold but the risks of making loans would never have spread to those that did not partake in these risky loans.

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