The Social Imperative of Sound Money

0:00This last week the U.S. government announced that it would take Freddie Mac and Fannie Mae, the mortgage giants or what we used to think of as the mortgage giants, under conservatorship, which is a nice way of saying they will be nationalized. We don't use the word nationalize much anymore. We can try and experiment and read the term conservatorship back into history. In fact, we might say that Stalin and Lenin put Russia's industries under a kind of conservatorship. Or we might say that Mao pushed a kind of land conservatorship. Or that Hitler's policy was one of national conservatorship. Marx's little book could be retitled, The Conservatorship Manifesto.

0:47You see, the government keeps having to make up new names for these things, Because the old policies, which were not that different in content, failed so miserably. The old terms become discredited and new terms become necessary in an effort to fool the public. It's as if a restaurant served a shrimp dish that gave all the customers food poisoning. And so each night it decides to serve that same shrimp, but name the dish something new. Crangon cocktail, prawn pasta, scampi salad, or what have you, but no matter what they call it, it's still poison. Such a restaurant would be out of business very quickly. People would not be fooled. But the government gets away with it mainly because, of course, we have no real choice about the matter, because people are predisposed to believe the government far more than they ought to.

1:40It doesn't help that the media are willing to echo the government line on this, adopting every new phrase as if it were the gospel. Hence the same is true of the word bailout, which you might think an unexceptional description of this move by the government to protect Fannie and Freddie from further losses. No, that word is not allowed either. President Bush informed us the other day, don't call it a bailout, I'd call it a stabilization. We're soon putting on a new edition of Mises' 1922 book, Socialism, so I think maybe we should keep up with the time we're going to call it, stabilizing conservatorship. What I also find striking is the way this move was announced. Here's what the New York Times said, quote, the Bush administration seized control of the nation's two largest mortgage finance companies on Sunday.

2:32It could become one of the most expensive financial bailouts in American history. Even the most sophisticated observers of our present scene had to blink their eyes in reading such words. Without debate, without votes, without anything other than executive fiat, the White House decided on its own to seize the mortgage markets. Harry Truman, who seized the steel industry, would be proud. Actually, this is an action to excuse dictators the world over, past, present and future. The sort of thing makes a mockery of the Constitution and the very idea of freedom and free markets. To say nothing of the myth that we have a limited government. What's more, if we can believe press reports, President Bush had little to do himself with the decision.

3:19It was the work of Henry Paulson, the Secretary of Treasury and former head of Goldman Sachs, working on behalf of the nation's most well-connected financial elites. Nobody elected this guy. Most Americans don't even know his name. Look at how he throws around trillions of tax dollars. The New York Times says that it will be expensive. Well, that's one way to put it. Makes the SNL bailout look like a warm-up. Freddie and Fannie carry about $5.3 trillion in mortgage commitments and another $2.4 trillion in financial exposure. The total cost of this operation is unknown, but it could easily reach two trillion and untold amounts of future exposure as well.

4:05These two New Deal institutions were founded to speed up the home ownership process for people the banks otherwise considered unqualified. In time, both Lyndon Baines Johnson and Richard Nixon were given legal permission to expand without limit these institutions in the name of privatization of all things. The motive was a classic bipartisan effort. Universal home ownership. The left favored the redistribution. The right favored the support of moral virtue associated with the nuclear family in its suburban house. Thus was born the greatest wealth transfer in American history outside of Social Security and the warfare state. In a free market with sound money, borrowing is connected to the ability to pay.

4:53At first, this is only available to the rich. As prosperity spreads, so does creditworthiness. Any government intervention designed to inject steroids into this process is going to end in what Rothbard, as Doug and others have pointed out, call a cluster of errors. It's completely disingenuous that so many people are today decrying the banking system's failure to discriminate between those who should and should not be carrying a mortgage. The banking system in a free market handles this just fine. Varying out the difference between those who can handle loans and those who cannot is the main job of the competitive system. The market precisely calibrates this. If one lender fails in assessments of borrowers, another is there to correct the problem.

5:40If you rush the process of prosperity and insist that everyone who wants a loan should get one, If you had one, you end up in a situation with problems down the line. And of course that is precisely what the regime has given us. It created Freddie and Franny to subsidize loans. It engaged in a phony privatization that secretly socialized losses. The legal status of these privately owned, publicly traded and government protected agencies was always unclear, There was a moral hazard at the heart of this policy, but the real point is that the free-market judgment about who should get what was being overwritten.

6:25Of course, surely that was not a problem when it came to promoting the alleged American dream. In fact, we are paying for this mistake a half a century after the policy became a national priority. As the Evangelical ministers like to say, the wheels of justice grind slowly, but they grind mighty fine. Might be one problem with applying this principle to this case, where is the justice? If justice prevailed, the losses would be borne by those directly responsible. If we pursued a free market policy from here on, the answer would not be complicated. The assets and liabilities of Freddie Mac and Fannie Mae would be auctioned today in the free market. It's true that many loans would be defaulted on.

7:11What level of crisis would be precipitated by such a genuine privatization policy? It's true the press would be screaming bloody murder and the big players in finance would suffer. But in time the markets would re-evaluate the resources and an important lesson would be learned. Sound loans would be picked up by financially responsible firms and carried to term. Home values would fall. Many people would have to move to cheaper homes. We would then be back on a sound footing again. From an administration that reports to favor free markets, this possible solution, of course, was not considered. Instead, they proclaimed their regrets that they would have to spread the cost of this error to the entire population. Association. Instead of fixing the problem, however, they only worsen it, underscoring the principle that America will not tolerate failure in business, and the bigger the failure, the more likely it is to be bailed out. Note that this socialistic bailout and nationalization, to use two forbidden words, were enacted by a Republican administration. It's ironic that

8:19when you look back at big upticks in government intervention over the economy, you often find and Republicans at the helm. As for McCain and Palin, they wrote in the Wall Street Journal that this bailout quote is sadly necessary, even as they promise reforms that will quote, require the highest standards of accounting, reporting and transparency ever demanded in government. Well here's the thing, no one demands high standards like the market, but you have to to turn these institutions over to the market in order to have such standards. Congress's role has, of course, been to yammer. Only Ron Paul will have anything sensible to say about this fiasco. In fact, it was more than five years ago that Ron said the following, quote, If Fannie and Freddie were not underwritten by the federal government, investors would demand that Fannie and Freddie provide assurance that they follow accepted management and accounting procedures.

9:18By transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. Going on, Ron Paul says, as a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the It's remarkable to observe that hardly anyone dares be against this policy. On the day following the nationalization, a day that will live in infamy, the Wall Street Journal editorialized against the Democrats, but didn't oppose the bailout. The New York Times called it a, quote, reasonable and reassuring move. The Los Angeles Times said, It's inevitable.

10:16Steve Forbes in his magazine wrote that, quote, drastic action had to be taken because the default would have, quote, triggered the worst financial meltdown since the Great Depression. It's interesting, isn't it, that all these people believe that waving the magic money wand can make reality go away. That incredible superstition seems to be the official position of the entire U.S. establishment. And we'd like to flatter ourselves into believing that we live in an age without illusion. As for those who should know better, Greg Mankiw, author of the leading economics textbook, writes that it, quote, because it was likely to happen, it's better to get on with it, unquote. The supposedly free market economics blog, Marginal Revolution, warns that without the bailout, quote, most of the U.S. banking system would be insolvent.

11:08failing to point out that a system that needs a bailout with fiat money is already insolvent. Econlog had lots of good thoughts, but didn't oppose the bailout either. The Cato Institute argues that the Treasury had to bail out the mortgage industry because it was, quote, forced to do so, and that Fannie and Freddie indeed are, quote, too big to fail. The Heritage Foundation agrees that it was a necessary step and a vital move towards reform. Sure, these people have plenty of recommendations about what should have been done in the past and lots of ideas about what should be done in the future. As for the present, they are ready to propagandize for the largest socialist operation in American history.

11:54In all of these latter cases, we are looking not at a problem of economic education, but rather the courage to stand up to the state when it is needed most. They didn't do so after 9-11, and now they have caved again. Part of the problem is the belief in the great myth propagated by Milton Friedman. As good as he was on many issues, he was not correct, as Murray Rothbard used to point out on his specialty of American monetary history. His view was that the depression was caused by a Fed that failed to fully bail out the banking system. Ben Bernanke and many others are pleased to accept this view of history and they are determined, they say, not to let it happen again. In fact, of course, the Fed did attempt to bail out the banks and was far too successful.

12:42This is the basis of the problem. In the end we are talking about a price system that has rendered a verdict on the housing market. Prices don't lie, and there is nothing we can do to reverse them. Even the most powerful governments in the world cannot do so. The attempt, however, causes calamity. The Austrians understand this, whereas it seems as if hardly anyone else does. Pretty much alone in predicting the calamity and actually opposing the bailout are those who have learned from the Misesian tradition. And they've said plainly and clearly that this is a terrible error, one in Jim Rogers' words, that makes the U.S. seem more socialistic than Communist China.

13:29Let us address this claim that not bailing out the system and not nationalizing the mortgage market would lead to a financial meltdown on the level of the Great Depression. People talk as if the Depression were some sort of natural disaster that the government had to fight. In fact, it was the very fighting of the depression that deepened it and caused it to last all the way through World War II. Instead of letting prices fall and letting the bad investments wash out of the system, the government tried for years and years to keep prices high, to employ people in make-work programs and generally to centrally plan the economy. In 1920-1922 we had a financial meltdown just as bracing and systematic as the one in 1929.

14:17The difference was that the government didn't do anything to try to fix it. As a result, it solved itself and is a forgotten event. Herbert Hoover and Franklin D. Roosevelt, in contrast, intended to use their power over the economy and the monetary system to keep prices from falling and to keep liquidity in the banking system, precisely as everyone is attempting now. The result was to forestall the inevitable readjustment process. They believed that low prices were the cause and not the effect of the recession. Sound familiar? In other words, the Great Depression only became the Great Depression because the government followed the exact same policies the Bush administration is following now with regard to the mortgage market. It makes no sense To avoid another depression-sized downturn, we need to avoid the mistakes of the past, among which were the policies that attempted to keep failing firms and industries afloat in difficult times.

15:27What should have happened in 1929 is precisely what should happen now. The government should completely remove itself and let markets re-evaluate resource values. It means bankruptcies, yes. It means bank closures, yes. But these are part of the capitalistic system. They're part of the free market economy. What is regrettable is not the readjustment process, but the process was ever made necessary by the preceding central bank inflation and other government interventions. Let me state this very plainly. I do not believe for one second that if the government fails to nationalize Fannie and Freddie, that the world as we know it will come to an end. Those who are saying that are simply trying to scare the population. It was the same with every other major demand by the regime.

16:18It was the same with NAFTA, the WTO, the war on terror, the war on bird flu, the nationalization of airport security and everything else. If the government did nothing but sell off the assets of the mortgage diets, we do not know for sure what would happen, but the market has a way of finding value and readjusting. My guess is it would take about 18 months. Banks would fail, just as many businesses in the free market fail every day. Housing prices would fall more, just as all market prices are subject to change. But the process of readjustment would be smooth and rational, and we would all stop living a lie and believing in an illusion.

17:03Contrary to what the blogging heads say, there is nothing that makes this nationalization inevitable. If we had leaders, opinion leaders who had courage, who understood economics, and who could think about the long run, We could let the market handle the entire process, come what may. I guarantee that this solution is a better one than creating trillions more to bail out failing enterprises. And yet this is not just another longing for courageous leaders. We can't hope for that. We need a guarantee. We need a system that would make it impossible for government to do these things even if it wants to. Think about the preconditions that made it possible for the Bush administration to decide one evening to dump a trillion plus to guarantee three quarters of the home mortgages in the U.S.

17:59It is a system that is premised on the government's capacity to print unlimited amounts of money. If it could not do that, no one would be talking about conservatorship. No one would be talking about guaranteeing the liabilities of the automotive industry either. Wars on Afghanistan, on Iraq, on Iran, on Russia, and troops in another 100 plus countries would be out of the question. These wouldn't even be issues. If government had to tax people directly for all its spending priorities, we would see Washington's ambition in every area scale back dramatically. Every suggestion of a new program would be met with demands as to how it would be funded.

18:44Fiat money and central banking, on the other hand, tempts corrupt politicians and bureaucrats, and it further corrupts them. It is the great occasion of sin in our public life. The tragedy is that their use of the printing press not only corrupts them, It imposes dreadful and intolerable costs on the rest of society in the form of price inflation and business cycles. We've seen the corruption grow worse over time. In the U.S. we are now living in the 37th year of fully fiat money with central banking. The politicians of the past seemed a bit reticent to use all the power they had. But they're becoming ever more brazen. their sense of shame seems to be gone forever their conscience completely papered over by the ominous power they possess the pundit class is following them believing there are no limits in truth all these bills must be paid to realize that is to realize the necessity of radical reform it can be overwhelming to contemplate the glorious results of a full gold standard

19:55Reform. Inflation would stop eating away at our purchasing power. The business cycle would be tamed. International trade would not be disrupted by wild swings in currency values. But of all benefits, this one is the greatest. It would stop arbitrary rule dead in its tracks. It would force the government to curb its ways. It would shore up our freedoms. For this reason the policy of son money is very much linked with morality. The Hebrew scriptures in the 19th chapter of the book of Leviticus warn, quote, you shall have just balances, just weights. The 25th chapter of Deuteronomy issues a similar warning, you shall not have in your bag differing weights, a large and a small.

20:42Proverbs says the same, a false balance is abomination to the Lord, but a just weight is his delight. Another passage says, diverse weights and diverse measures, both of them alike are abominations to the Lord. All of these relate in some degree to the need for sound money and condemn the act of fraud and monetary debasement. The consequences of monetary sin cannot be contained to the sinners only. They are spread out over the whole of society, destroying its economic basis and corrupting the morals of society. They foster crazed illusions that we can magically generate wealth through the act of printing money and the attempt to do so brings catastrophic consequences.

21:29As Mises wrote, inflation is the physical complement of statism and arbitrary government. It is a cog in the complex of policies and institutions which gradually lead towards totalitarianism. I find it sickening that there are so few voices, except in the Austrian School, that will stand up to this policy. And I fear the consequences of this policy will be felt for many decades into the future. But there is still time to reverse course. There is nothing inevitable about despotism. We are not being forced down this road. We can embrace freedom. If we understand that freedom is inseparable from sound money, we can embrace that too.

22:14Until then, we will continue to place our trust in the political establishment to do what is right. Call me a gold bug, if you will, but I trust hard money far more than I trust our rulers. And that, ultimately, is the choice we must make. Thank you.