A Failed Monetary Policy

So, in between work and tutoring, I was rereading the rules to the 5th edition of Warhammer 40K, and listening to the news in the background, when I heard one of the most inane blurbs from Hillary Clinton. I don't know who was interviewing her, but her response to the "financial crisis" was twofold. I didn't have time to write as I heard it so I filed it in a mental inventory with the Obama quote I mentioned a few days ago, and decided that tonight was the night.

Hillary said something to the effect of their should be a freeze on interest rates and a moratorium on foreclosures. Now either this perspective represents profound naivete about our fiscal system (which I doubt), or it is designed to garner accolades for her and her party because clearly she cares about the little guy (far more likely). Whether or not she meant it, I felt that I could devote a paragraph or two to destroying this extremely foolish notion.

First, if we institute a government freeze on interest rates, how exactly do we think that will impact struggling financial markets - gee, do you think it will cause the businesses to stop lending money, even to each other. Perhaps, because you will not be able to make money on your investment. Effectively, that move would freeze capital in the US, and we don't actually control the worldwide lending market, so nothing would force them to freeze. Patently stupid. Nuff said.

The profoundly idiotic statement about a moratorium on foreclosures simply hurt my brain. On an emotional level, this sounds great - people won't lose their houses, good for them. Pardon me for sounding cruel, but if you over-extended yourself to get into a house and you screwed up in doing that, deal with it. Yes, it sucks, but you should have known the risks going in. Beyond that, if you do put this kind of moratorium in, why would anyone pay their mortgage at all? If a bank can't foreclose, and you can't lose your house, why bother to pay the money back at all? That kind of moratorium would be catastrophic - and I am pretty sure Hillary is smart enough to know that, but she is also savvy enough to know that such a good-hearted statement will never be questioned, so politically it is a brilliant move, and if she were actually running for office it may have garnered her a few votes.

But to go back to a couple of days ago, when Freddie Mac and Fannie Mae were "taken over" by the government (something of a misstatement, as they were already privately owned government agencies - a weird kind of hybrid that was probably doomed to failure from the start), I heard Obama say that it was time that we "...crack down on reckless borrowers and help homeowners..."

It is my fervent hope that in a moment of confusion, he switched up a couple of words. I am sure that he must have meant reckless lenders, not reckless borrowers. Probably an honest misstatement because people in politics talk a lot, and it is not uncommon for all of them to slip a word now and again. In fact, we make too much of these subtle slips in most cases. Obviously, one cannot simultaneously crack down on reckless borrowers and help homeowners because they are one and the same. But even if he did mean lenders, he still shows a fundamental misunderstanding of a failed monetary policy that has been in place for about 15 years. Not to mention the fact that he would be rewarding inappropriate risks - helping people with houses they should have never bought while screwing over people like theGM, who has saved money to get in to a house when the timing was right. If this bailout happens in full, then housing prices will remain artificially high, and the market will have to correct later. In other words, this bailout would forestall the inevitable, and make the next crisis even worse because of the feeling that the government should bail us out of any foolish action.

A brief explanation of the history of the failed policy. It does go back to Bill Clinton, and, no, I am not using him as a scapegoat - I saw this coming a long time ago, and it is an inevitable result of the way that he addressed the economy.

But first, a brief aside. My view of the economy is this. It is, because of the fundamental relationship that our government has with the people (that is we are allowed independence, property rights, etc.), the most vibrant and long-term stable economy in the history of the modern world. One could make the argument that Rome was more stable for longer, but they relied on conquest and slavery. Our economic vitality springs from freedom and opportunity, and while we had a slave economy for a long time, we did not experience true economic expansion until the late nineteenth and throughout the twentieth century. But economies are cyclical - there will be periods of high and low points (for the mathematically minded, it is like a sinusoidal graph that has a positively sloped line as its axis rather than a horizontal axis). The best thing that government can do is adopt policies that slightly alter the course of the economy in a positive long term trend. This requires careful analysis and long-term perspectives. However, being that politicians are up for elections regularly, these incremental positive changes are not sexy enough to garner votes (wonder why fiscal conservatives don't often win reelections? - there's a big part of the reason). We demand (foolishly) immediate action, immediate recovery, and no possible impact on our behavior from standard economic fluctuations. In fact, we are so spoiled by the strength of the country for the last 28 years that many of us cannot remember true economic hardship - try bracket creep, 15-25% inflation, 23%+ home loan rates, gas prices that hit about $1 per gallon when the median income was $15,000 per year (by comparison, $4 a gallon with a median of about $55,000 now, gas prices are slightly worse now than they were then, but they are not coupled with crippling inflation, COLA raises putting you into a higher tax bracket thus reducing your total worth, and ridiculous interest rates bordering on usury). Welcome to the late seventies, and that was not the worst economic time the country has ever had.

But back to my main point, the fact that our failed money policy does stem from the early nineties. Bush (92) was presiding over an economic slowdown that was inevitable after the rampant growth of the late eighties, and the resonating phrase from the Clinton vs. Bush election was "It's the economy, stupid" (ah, for the days when politics was civil, eh supergoober). That and we had such quotes as "I will focus on the economy like a laser beam", and after his election, "I have worked harder than I ever have before, but I cannot find a way to get a middle class tax cut" (despite his election promise). Anyway, idiotic campaign slogans aside, because you all know my political affiliations, I couldn't resist a few pot shots, his solution for a lagging economy was a soft money policy.

Basically a soft money policy is one where you free up a lot of capital by keeping interest rates low and encouraging borrowing. This was a key part in keeping the economic growth going in the nineties, and this policy, plus another one, led to a couple of major economic downturns that we alleviated by engaging further in soft money policies. I do not put all the blame on Clinton for this. Yes it was his policy, but many Republicans in the post 1994 elected Congress did nothing to stop the shifting of regulations on lending industries. This was probably due to two reasons - deregulation is near and dear to fiscal conservatives, and they mistook what was happening for deregulation, and they probably knew the short term economic gains would result in them looking good. So they steered clear of the issue entirely, and let it happen. This does make them at least partly to blame.

If you remember, people were taking out loans and investing them in companies that were shoddily defined and somehow had to do with the "INTERNET". This was perceived as a guaranteed money-maker, and I was even saying then, as I was in college, that the whole situation reminded me of the twenties, when people took out loans to invest in companies that existed only on paper - and we all know what happened next in that little situation, just a small worldwide depression that only WWII pulled us out of (nope, I don't credit FDR, that's for another blog). Anyway, we had this big crash, and soft money helped us out of that, rates were still low, people could borrow to cover their losses and were encouraged to do so by shifting regulations to encourage riskier and riskier loans. People were using the money to invest in the stock market as well, because even if the stocks for Internet companies took a huge hit, other stocks were still good. Except:

In 1996, (I believe the year is correct, I am doing all of this from memory, yes I am online and I could look it up, but I just don't feel like it. You do some damn work and fact check for me - do you expect me to do everything for you?!) another piece of Clinton era legislation came into being - I don't recall the name, but I remember exactly what it did. It capped executive salaries at $1,000,000 per year. It did this indirectly by disallowing any greater salary to be written off as a business expense. I know some of you think that this is a "fair" thing, why should anyone make that much, but there were a couple of exceptions, oddly enough for major contributors to the Democratic Party. The two businesses that were exempt from this were sports organizations and film companies. Punish those dirty CEOs who are running companies that actually provide goods and services for the country, but give a little kickback to your contributors. This was not the first dalliance the country has had with wage controls (an earlier one with Dwight D. Eisenhower, a republican, resulted in our current health care insurance system instead of the old fee-for-service model, basically freezing wages for a given job, a company still wants to attract the best people; to do so it starts to offer "benefits" that are not actual wages, but insurances, and, voile, modern health insurance - wage controls can do a lot to f*** things up). Anyway, companies wanted to keep compensating valuable people, so rather than give more money, totally impractical under the new tax structure, they started offering more and more stock options. The CEOs, CFOs, etc. had already had an interest in keeping stock prices up, but now their compensation was directly tied to the value of the stock. That is a recipe for disaster - whereas before, a high stock price meant more capital influx to the business along with a better image in national and international trading, now it meant how much you were worth personally. That is a pretty extreme temptation - imagine realizing that if you just skewed some numbers a little bit, fudged a bit of data here and there, gave a bit of a rosy forecast where it wasn't really appropriate, and your personal value would skyrocket. That is a temptation that not too many businessmen could pass up, especially because there seemed to be no consequences. Other employees got stock options, too - if the stock went up everyone would gain - the investors, the workers, the management. It would be a difficult temptation to resist - it didn't seem illegal or too unethical, and everyone benefited, so why not. Obviously, Bill Clinton is not to blame for their specific actions, but clearly those actions would not have been taken had that fundamental shift in compensation not taken place. It's like placing a huge pile of candy in front of someone with an impulse control problem and then wondering why they gorged themselves sick.

So we get a major market crash as stocks readjust to realistic levels. The best bet would have been to let it alone, let the market readjust, and sort itself out. A historic example of this - 1987, October, we had the single biggest loss in a day in the stock market ever. Larger than the crash in 1929, if memory serves correctly. What was Reagan's decision - do nothing. Let the market rebound on its own, the economy on that level will take care of itself. Of course, there was a hue and cry about this apparently ludicrous policy, but it worked. We did not go into a long term recession, and the market worked itself out. Instead, however, we furthered the soft money policy, loosening up restrictions on lending even more, putting regulations in that force Fannie Mae and Freddie Mac to make riskier loans. This was about the time that negatively amortized loans were getting big, and there was a big push in the housing sector.

It seemed like the next big thing - housing prices always go up long term, and typically outpace inflation. If you could get into a home with a low interest rate loan, then do it. With the negative amortization phenomenon, you actually paid less than you owed each month, so the principal of the loan kept growing. Your house value had to increase faster than your loan value did so you could turn over the house and move to a better house, having generated a tidy profit just by living in the house. Again, it seems like a good move unless you realize that house values do not steadily increase, they increase in a jagged line with periodic peaks and troughs. With a traditional loan and don payment structure, this is not a problem, you can weather any market inconsistencies. But with a lot of adjustable rate negatively amortized loans being packaged a few years ago, the current crash was eminently predictable. In fact, I mentioned to several different people a few years ago that I figured the market was due for a shakeup because of that (I know I talked about this with my wife, with supergoober as he bought his house, with themightymook as he helped me refinance, and with many others - probably theGM and NTT'SBrain as well).

Funny thing, however is that George W. Bush was trying to put in regulations on lending to reduce this policy in September of 2003. He did use this policy to try and help an economic recovery post 9/11, but his tax policy helped out with that as well (more on that later, but if you want info now, just do a google search on "The Laffer Curve" for the basics of tax policy and economic growth - while it is a gross oversimplification, it gives a light mathematical perspective and a common sense underpinning to economics - this curve is inordinately more complex under a "progressive" tax structure like we have now - detractors say that tax revenues grow with GDP, but ignore the fact that the policy itself can impact the GDP - more on that later). Anyway, Bush has long been trying to regulate Fannie Mae and Freddie Mac back into some semblance of reality, but this has been continually stymied in the last five years or so by the likes of Barnie Frank and Chris Dodd. Interestingly enough, the larger portion of the lobbying largess from these companies has gone to Democrats this election cycle (but only slightly, 53%, and the last election cycle saw Republicans getting 53% - both sides have their hands in the cookie jar), and Obama used a former CEO of Fannie Mae to vet vice presidential candidates, but what is really interesting is the chart below, listing the order from highest to lowest recipients of contributions:

Top Recipients of Fannie Mae and Freddie Mac Campaign Contributions, 1989-2008
Recipient Office Party/State "Cash Monee Son" ;)
1. Dodd, Christopher J Senate D-CT $133,900
2. Kerry, John Senate D-MA $111,000
3. Obama, Barack Senate D-IL $105,849
4. Clinton, Hillary Senate D-NY $75,550
5. Kanjorski, Paul E House D-PA $65,500
6. Bennett, Robert F Senate R-UT $61,499
7. Johnson, Tim Senate D-SD $61,000
8. Conrad, Kent Senate D-ND $58,991
9. Davis, Tom House R-VA $55,499
10. Bond, Christopher S Senate R-MO $55,400
11. Bachus, Spencer House R-AL $55,300
12. Shelby, Richard C Senate R-AL $55,000
13. Emanuel, Rahm House D-IL $51,750
14. Reed, Jack Senate D-RI $50,750
15. Carper, Tom Senate D-DE $44,389
16. Frank, Barney House D-MA $40,100
17. Maloney, Carolyn B House D-NY $38,750
18. Bean, Melissa House D-IL $37,249
19. Blunt, Roy House R-MO $36,500
20. Pryce, Deborah House R-OH $34,750
21. Miller, Gary House R-CA $33,000
22. Pelosi, Nancy House D-CA $32,750
23. Reynolds, Tom House R-NY $32,700
24. Hoyer, Steny H House D-MD $30,500
25. Hooley, Darlene House D-OR $28,750

Includes contributions from PACs and individuals in the 2008 cycle. Totals based on data downloaded from the Federal Election Commission on June 30, 2008. Data retrieved by me from http://www.opensecrets.org/news/2008/07/top-senate-recipients-of-fanni.html. So sue me, I guess I went ahead and did some of the research for you.

What I find interesting is that perrenial insider, Chris Dodd, senator since 1980, has aquired about $134,000 in donations over 20 years ($6,700 a year average), Hilary Clinton had $75,550 in 8 years (just over $8,400 a year average), while Barak Obama had $106,000 in 4 years ($26,500 a year average).

Hmm... I guess he has more experience than I realized (sorry, couldn't resist the cheap shot). Anyway, he obviously did have an interest in making sure Fannie Mae and Freddie Mac could keep doing whatever the hell they wanted - they kept contributing to him, you don't throw around that kind of cash for no reason. I just wanted to make the point that before someone starts pointing the finger of blame at whose fault it is that we are in the curent "crisis" (which I don't really see as a crisis, if you hadn't already divined that) we should actually try to remember things that have lead up to current events - remarkable how the past can be a lens through which we can observe the present and the future - at least until 2012 when the Mayans predicted the world would end. We are all dead in 4 years anyway, so who cares (BTW this is a huge joke - all you Mayan believers out there, tell me why you believe their prediction of the end, but not their description of the beginning - 15,000 years ago, with no evolution - just another creation myth - but it does use the same calender, so if the one is true, shouldn't the other be as well?)

That's it, this took me 2 + hours to write, much longer than I wanted, and I am sure that my wife is wondering why the hell I am taking so long to come to bed. Another early day tomorrow, so see you later.