Credit Diverts Production

0:00This is Jeffrey Tucker. I'm at the Mises Institute, and it's my great pleasure to introduce Tom Ludz. We're talking about his book, Economics in One Lesson. Oh, wait a minute, that's not yours. It's one of the books you didn't write. A rare case. So this was written long before Before You and I Were Born, 1946. I wish I'd written it, though. What is it? Sold two million copies? That'd be it. That's a serious wrong thing if you don't negotiate a contract. And so we're talking about just one chapter, and it occurs fairly early in the book, and it concerns government loans.

0:47So the idea is that if the private markets will not, will not suffice to fund a particular program or project or service, so we have to get the government involved in it, and this is 1946, and my goodness, these government loan markets have vastly expanded in that time, haven't they? Sure, with the same rationale and everything, to boot, that's right. Well, it's useful to bear in mind the theme of the whole book here for this chapter, which is emphasis on what is seen versus what is not seen, that if you're going to think like Like an economist you have to think of the consequences for everybody over the long term of whatever it is the government is doing. So he gives the example of a farmer who's applying for some loan so that he can buy a tractor or some such thing and he contrasts the situations of farmers A and B. A has a track record for honesty and paying his debts and being credit worthy and he's also got

1:46some assets that can be used as collateral but then you've got B who has no assets, he's He's got no track record. He might even be on government relief. And so the argument is, well, why shouldn't B get a chance, you know? And the only chance he could possibly have is if the government lends him the money, intervenes in the credit market to lend him the money. And Haslett's argument is to note that we should remember that what's really being lent here isn't so much the money as it is the tractor. And then he's going to pay back once he can. But there's a fixed number of tractors at any given time. So if I lend a tractor to one person, There's somebody else who can't get the tractor. And so what he suggests is that when you lend this additional money, this government provided credit to this one guy, you are depriving somebody else of this same property.

2:33You're depriving somebody who has worked to build up a reputation for honesty and a credit rating and so on. And so he keeps it in that light, that why is it morally preferable that this person should get this and crowd out this person out of the market? So that's the type of argument. And then he also reminds us that the private banking industry has every reason to be careful, under normal conditions by the way, let's abstract from the Fed, but to be careful in how it makes loans because if it makes a bad loan, well, then it's in big trouble. So it has to become very skilled at determining who is a reliable and a good credit risk and who isn't. Whereas, as I say, if they make a mistake, they lose their own funds, whereas a government bureaucrat typically has no experience here, has taken some civil service exam in which he's got to write about hypothetical people in hypothetical situations.

3:31And if one of these loans goes sour, well, there are no consequences, nobody's fired. If anything, it just goes to show just how bad the situation is. We've got so many unfortunate people, even this amount of government money hasn't helped them. We need even more. You know, you cannot get the government into this business because it winds up making bad loans that for good reason the private sector didn't want to make. And isn't it really something that in recent days has all this housing calamity that's going on, that people are asking the question, well, what is it with the banks? You know, they seem to have lent money where they shouldn't have. These people weren't credit worthy. And yet, the whole of government policy for the last, I don't know, umpteen decades, whatever, has been designed to badger them into doing exactly this.

4:19Yeah, of course. Well, I mean, there's the one argument is the Community Reinvestment Act, which requires banks to make loans against their better judgment to groups that are perceived as having been discriminated against. But as the record shows, in fact, just look at the statistics, if you look at various and other various racial groups who are assumed to be discriminated against, there is no evidence for this, that in fact they have the same default rates as anybody else. If they were being held to some higher unreasonable standard, they wouldn't be defaulting as much. And then we also have the fact that Asian Americans get loans at a considerably higher rate than whites, and one assumes there's no particular reason for there to be a pervasive pro-Asian bias in the banking community. So in other words, the Community Reinvestment Act is based on a fallacy right off the bat involving discrimination.

5:08But it's intended to make loans to people who don't have very good credit ratings. And of course, the egalitarian mind hates the credit rating, which is the one great criterion of trustworthiness when it comes to money. So banks have been required to make these loans. The Federal Reserve system pumps all this additional money and credit into the system, and as a result, banks pretty much at any one time have made the loans they can make. So if they find themselves now with all this new money on their hands, they've got to either lower the requirements, lower the qualifications to get the loan, or lower the requirements to get the loan, or lower the requirements to get the loan, or lower the requirements to get the loan, or lower the requirements to get the loan, Money on their hands, they've got to either lower the requirements, lower the qualifications to get the loan, and or lower the interest rate, and so what they wind up doing is again making loans that under normal conditions they wouldn't have made,

6:04and then beyond this we have these weird government sponsored enterprises they're called, Fannie Mae and Freddie Mac, and Fannie Mae was once a full-fledged government agency, Agency, and then these things really only came into their own as major players in the mortgage market about 10 or 15 years ago, and they, because they're privatized, even though they enjoy tax benefits no other comparable institution would enjoy, they have regulatory benefits, they also enjoy the status of having everyone basically know that if they get in trouble they'll be bailed out. Socialized losses. Exactly, so the risk is socialized, and so therefore that's another incentive for banks to make risky loans, because they know that Fannie and Freddie will just buy up these mortgages from them and assume the risk.

6:51And so, you know, as Lew Rockwell points out, if you're inclined to say, well, wait a minute, you know, the banks shouldn't be making these shaky loans in the first place, regardless of whether or not they can socialize the risk, Lew points out, well, look, the fact is all your competitors are going to be doing this. All your competitors will be making these loans and making money, at least in the short run on them, and you'll get eaten for breakfast if you don't play the game. The government has so corrupted the system that even somebody who wants to be an honest banker can't do it. And of course it's in the government's interest always to distract attention from its own responsibility to think. So it's not our price controls that are causing the meat shortages, it's the farmers hoarding the meat. We're not responsible for high oil prices, it's the price gougers at the pump, it's the oil companies, the evil oil companies.

7:40It's, we're not responsible for the mortgage mess, it's these irresponsible lenders, it's never the government, so it's incredible, isn't it, over the years, what an absolutely pristine track record government has, it's never been responsible for anything, amazing, yeah. And all of its regulations will always fix the problem. We should just give all our money to the government, in fact, you know, one of my favorite old shows was The Honeymooners, and a lot of times Jackie Gleason would sort of improvise when he would do his lines, and there was one show where at the end, you know, And at first he was criticizing the government about taxes, and at the end he actually says, we've got the best government in the world, we should give all our money to the government. I said, oh no, Jackie Cleason, no, come on. So Hazlett nailed it in 46, and I suppose that there wasn't this big national priority yet that every person should own a mansion, a plywood palace.

8:34But it was soon to happen, a few years later, that somebody decided that the very definition of being American is that you don't own a home. And it took all these years for it to become this absurd bubble that's now exploded and is causing great financial difficulties for us. So there might be other things out there. Now we've got the student loan problem, of course, that emerged sometime between the time I wrote the book and today. And maybe we can address that. Well, sure, in the interest of full disclosure, I took out some student loans, but I'm one of the suckers who actually paid them back. Unlike the deadbeats who are running around all over the country going to Hawaii or something, not paying them back. But the fact is, though, that these student loans, first of all, the ready availability of all this free credit, is itself at least largely responsible for inflating the price of a college education.

9:28Because if the institution knows you're bringing all this heavily subsidized loan money with you, well, the price is going to go up. I mean, if we funded the purchase of potato chips in the same way, it would cost, you know, $100,000 for a bag of chips, you know? So it shouldn't be a surprise. And, you know, I like what a lot of financial advisors are starting to say, which is that young kids are putting themselves in an impossible hole at the very beginning of their lives. You know, they start off in debt $160,000 or something. That's how they start their lives, and I've heard it said that if you were to take your money and put it in almost anything, and just let it grow, it would have been better for you, even when you count the human capital you're building, it would have been better than if you went to college with it.

10:14So arguably the best thing you should do is either if you can possibly in high school get a year's worth of college in with your AP courses, cut that down somehow, or finish college a year early, or spend five years there but work part-time, and learn something. Exactly. But I mean, if you can get out a year early, then there's an opportunity cost there that you no longer have to bear. You have an extra year's salary. I mean, you have to think of, you know, Gary North has a lot to say about this, but you have to think of unorthodox solutions to the price of an education. But the student loan situation is not helping young kids. It's absolutely burying them. Right. So it really is a calamity. I mean, you've got this argument that, well, the government has to give these loans because private enterprise will not.

11:03And yet, it seems as if private enterprise will not, then they shouldn't be given at all. Yeah, that's right. That's an indication that society in some way is making clear through the market the type of risks it's willing and interested in taking. I mean, it's somewhat analogous to the fact that suppose in 1974 we had known how to make an iPod, let's say, but of course we just weren't We weren't at the level, the ability to produce the stuff was just still way, way beyond us. We could probably have produced an iPod in 1974, but when you think of all the resources that would have been required to extract from society toward this project, it would have been totally out of line with consumer desire. The market has a way of balancing the fact that yes, we'd all like iPods in 1974, or Or we'd all like every single human being to have a four-year education, you know, heavily subsidized, but the fact is we can't have all these things, there's a trade-off involved,

12:03and the market helps us to balance these things out rationally. You've written a lot about economics and morality, and your comment earlier about credit ratings being an indication of trustworthiness, and I wonder if you could elaborate on that, the The extent to which credit and credit ratings actually help shape our characters. Well, the way you put it, I'd love to hear you elaborate on this, as a matter of fact. Well, no, just encourage me when you say that. I mean, this is one way that the market helps train us. Yes, no, absolutely. In fact, if you follow your credit rating, if you subscribe to any kind of service, it'll actually tell you this is why your score is what it is. You've got these positive elements, but you've got these negative elements. Developments, you keep opening up new credit accounts, you keep doing this or that, or you won't pay this bill, you're being a bum or something, and it tells you this.

12:53If you want people to interact with you on the best possible terms, then you know exactly what you need to do, basically to improve your own character, not to take on purchases that you can't possibly really meet the cost of. You do learn these things, and these are good qualities that you should have as a human And also, we should bear in mind, we're not saying that, you know, therefore, you know, very, very few people should have houses. There's no way to know, there's no non-arbitrary way to determine how many people should live in homes they own, how many should rent. You know, the market has to determine that, but I do think that maybe a lot of people should just have smaller homes. You can still own your own home, but not everybody has to have a gigantic mansion. And I do kind of like Karen DeCoster's term that she invented that's now in the Urban Dictionary.

13:43It's the 2000 Air. It's the guy, he's got the brand new home, the two beautiful cars. He goes on great vacations with his wife and they've got $2,000 in the bank. One even the slightest calamity and they are wiped out. And the credit rating is there in effect to force you to, best it can, to try to prevent this thing from happening. to plan your life more sensibly and responsibly. And it isn't interesting, too, that the more irresponsible you are, the more short-term you're thinking, the higher an interest rate you're going to pay. So at least there's a little bit of a punishment. Yes, that's right, that's right. The market is good all around, in a sense. We've made a good case, Dr. Woods. Okay, pleasure being with you, Jack.

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