The Old-School Liberal

“Freedom granted only when it is known beforehand that its effects will be beneficial is not freedom” — Friedrich Hayek

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On the Wall Street Bailout

Posted by dagnygalt on October 3, 2008

The recent legislation passed in efforts to ease the tight credit markets may in fact create legislation which makes it more difficult for the economy to revive and sustain growth. Analysts and voters should consider the role of the Federal Reserve in keeping interests rates artificially lower than the naturally market set rate in encouraging mal-investment and ultimately significantly contributing to the unwise investments made by banks and lenders. In addition, government policies benevolently aimed to increase home-ownership among low and moderate income groups likely provided extra incentives for banks and lenders to invest in areas they normally would not have considered.

Over the past year we’ve seen our financial markets uncomfortable sway until in recent months we’ve seen the stock market plunge downward. Mistakes have been made and most people in the United States, and likely even the world, will experience the consequences of these mistakes. When discussing possible causes of the financial crisis, National Public Radio, CNN, MSNBC, and many more have repeatedly discussed the role of deregulation and greed as a cause of the crisis. I pose a question to them: “Do you really think that there was a sudden increase in the amount of pervasive greed in Wall Street in the past decade?” It is extremely unlikely that human nature among a specific group of people could have systematically changed without cause. Deregulation could certainly be a cause; however, one convinced of this cause should take an objective step back and examine the evidence.

Research has shown that low interest rates stimulate investment. (1) This is likely the reason the Fed kept the rate low for so long. However, much research has shown that interest rates artificially kept low also tend to encourage mal-investment. Harvard’s Joint Center for Housing Studies also explained in The State of the Nation’s Housing 2008 (2)  report how the Fed’s low interest rates encouraged the housing market bubble, an expansion of risky loans in subprime mortgage market, and ultimately lead to a derivation of complicated and very risky mortgages repackaged and purchased by large banks. In addition, an prevalent ideology existed (and still exists) among policy makers and legislatures that homeownership creates wealth. Thus, they create policies which incentivized banks to lend to people who the bank might not normally lend to because of risk. For example, the Community Reinvestment Act of 1978 mandated that banks lend to families that in many cases couldn’t afford the loan payments. Thus, the combination of government policy making and encouragement of home ownership among those who could not afford homes and artificially low interest rates ultimately lead to the bad investments (3) which are highly contributing to the economic problem our country currently faces.

The bailout plan was indeed deliberated over, which is good. However, given the urgency and the emotional pressure put on government “to act” may indeed have prevented policy-makers from analyzing the true causes of the crisis. In addition, regulation enacted through the bailout passed this morning may in not at all decrease the likelihood of mal-investment and instead create new unforeseen problems that will prevent the economy from competing globally.

In conclusion, I hope voters will recognize that the economic problems we face today may in fact be a result of poor government policies. In addition, we should be not allow our fear and emotion detract from our ability to see evidence clearly. In efforts to “do something” we may in fact not be doing what is in our best interest in the long run.

BLUE: Real Yr/Yr GDP Growth
RED: Real Effective Fed Funds Rate

Source: Compiled by Robert P. Murphy, http://mises.org/story/2728

1 The New York Federal Reserve http://www.newyorkfed.org/education/level.html
2 Harvard’s  Joint Center for Housing Studies,  The State of the Nation’s Housing 2008, at http://www.jchs.harvard.edu/son/index.htm
3 Sechrest, LJ. 2006. “Explaining Malinvestment and Overinvestment,” Quarterly Journal of Austrian Economics 6, 4:27-38.

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Land Regulation Fosters Pricing Bubbles

Posted by Poorsummary on April 6, 2008

“In places with fewer building restrictions, like Atlanta and Dallas, housing price volatility is moderated by a construction sector that supplies extra houses during booms and ratchets back building during downturns. In California and Massachusetts, where abundant land use restrictions keep new construction low, any uptick in demand translates into higher prices, which then come back to earth. If an area’s prices go up by an extra $100,000 over five years, then, on average, those prices fall by an extra $32,000 over the next five years.”

..Yet another example of the unintended consequences of government meddling (and yet another way the government shares in the blame of the housing bubble).

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The Federal Government Hurts the Environment and the Economy

Posted by Poorsummary on March 9, 2008

broke-sam.gif Surprising to hear a voice in Boston about how government meddling makes our lives worse, but props to Jeff Jacoby for this scathing article on how Big Brother screws things up. (Read Jacoby’s full article here.) First, consider ethanol subsidization:

The problem, laid out in two new studies in the journal Science, is that it takes a lot of land to grow biofuel feedstocks such as corn, and as forests or grasslands are cleared for crops, large amounts of CO2 are released. Diverting land in this fashion also eliminates “carbon sinks,” which absorb atmospheric CO2. Bottom line: The government’s ethanol mandate will generate a “carbon debt” that will take decades, maybe centuries, to pay off…

Now, consider the government’s role in bringing about the financial crisis of the era: the Subprime Mortgage problem:

The crisis has its roots in the Community Reinvestment Act of 1977, a Carter-era law that purported to prevent “redlining” – denying mortgages to black borrowers – by pressuring banks to make home loans in “low- and moderate-income neighborhoods.”…But to earn high ratings, banks were forced to make increasingly risky loans to borrowers who wouldn’t qualify for a mortgage under normal standards of creditworthiness…The financial fallout has hurt investors around the world. And all of it thanks to the government, which was sure it understood the credit industry better than the free market did, and confidently created the conditions that made disaster unavoidable.

And now Clinton wants to get the government involved in improving baseball. Yet another one of Hillary’s pipe dreams the country can certainly do without.

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Romney Ignores Economic Adviser, Supports Fiscal “Stimulus”

Posted by Poorsummary on February 3, 2008

MankiwAs even the casual observer would know, virtually all of the Republican candidates are in favor of Bush’s fiscal stimulus package (with one notable exception). After all, what politician in his right mind would vote against sending $1,000 to every voter? Given the political faux paus of such a move, it’s no surprise that focus-group-fueled political machine Mitt Romney has joined the ranks of the neoconservative yes-men in supporting such a measure, in spite of the advice of one of his own economic advisers. As you read Mankiw’s analysis, ask yourself whether Romney thinks he knows better than the Harvard PhD economist who literally wrote the book on macroeconomics, or if he’s simply saying what the focus groups want to hear (here’s the link):

When designing a tax system and evaluating tax proposals, policy analysts have at least four goals in mind:

  1. Efficiency: The tax system should distort incentives as little as possible (and, in the case of externalities and Pigovian taxes, correct incentives when necessary).
  2. Intergenerational equity: The tax system should raise enough revenue so current generations do not unduly burden future generations.
  3. Egalitarianism: The tax system should try to achieve a more equal distribution of after-tax incomes.
  4. Stabilization: The tax system should help maintain the economy at full employment.

The current debate over fiscal stimulus involves trading off these goals. The stimulus package being discussed is mainly aimed at achieving goal 4, but it does so at the cost of sacrificing goals 1 and 2 to some degree. Efficiency is sacrificed because the phase out raises effective marginal tax rates and because the higher future taxes that result from the extra government debt will likely be distortionary. Of course, the phase out is there in order to achieve goal 3: This is the classic tradeoff between efficiency and equality.

Differences of opinion arise when policy analysts weight these goals differently. Advocates of fiscal stimulus put a large weight on goal 4. Critics of fiscal stimulus come in two varieties. One type of critic discounts goal 4 entirely because they are skeptical of Keynesian theories that underlie this goal. A second type of critic admits that goal 4 is legitimate in principle but believes that in the current environment macroeconomic stabilization is best left to monetary policy so fiscal policy can focus on goals 1 and 2. I am in this latter category.

Romney supporters, add this to your list of Romney’s conveniently adopted views (hint: abortion, gay rights, and federal education policy should already be there). Of course, he could really believe all the things he claims to– the political convenience of his changes in position could just be a coincidence…

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