Current Market Conditions: 6 Oct. 2008

0:00Robert Higgs, author of Crisis and Leviathan, many other books, a great scholar of what government does in times of calamity and also the editor of the Independent Review and we are living in interesting times as they say. I suppose for many people this is a shock. For you, having studied this your whole life, how does it make you feel? Well, both good and bad, Jeff. I think a lot of extremely unfortunate things are being done by the government right now, so I feel bad about that. But at the same time, there's a kind of exhilaration for the scholar who studied the history of such episodes to be to be living in the midst of one and to see so many of the common patterns showing up again this time.

1:07What's the most closest historical parallel I suppose you would point us to the New Deal? Well in some ways there are parallels to the New Deal, certainly one important aspect of The Great Depression was a financial collapse. Of course, the banking catastrophe of the early 1930s was many, many times worse than what's happening right now. Between 1930 In 1934, inclusive, more than 10,000 commercial banks failed, so we're certainly not witnessing anything like that right now, but there have been some bank failures, including some large bank failures, and especially in the housing sector, we see some parallels because many, Too many people found themselves in the early 1930s unable to make their mortgage payments or in some cases unable to pay the taxes on their property and as a result lenders foreclosed on them, they lost their homes or tax authorities.

2:30And so we're seeing certainly a rerun of some of those housing sector difficulties Right Now. Although, again, I would emphasize that what has occurred thus far is not nearly as extreme as what happened in the early thirties, and of course nowadays people are much, much richer than they were at that time, and so losing a home or losing employment does not leave people in the same situation that they were left in the early 1930s. But there are these parallels and now as then the government purported to come in and rescue people from these unfortunate circumstances by a variety of measures.

3:25A number of states put moratoria on foreclosures of mortgages, as I recall about 30 states that did that. The federal government, after Roosevelt's election especially, created a number of programs to adjust mortgages, to refinance mortgages, to steer public money to lenders to help people pay or to have taxpayers pay in their stead so that they could retain possession of their homes. So some of what we see in this bailout has parallels in the early 30s and also of course even before Roosevelt's election we had measures especially including the Reconstruction Finance Corporation which was created in 1932 to bail out big failing firms including banks and insurance companies so there are all sorts of parallels between now and the early 1930s with regard to what's going on in housing and banking and what the government is doing about it.

4:45What you're describing is, well let me ask it this way, are you surprised at what sounds like a disproportionate response by Washington relative to the crisis as it's developed so far? I am a little surprised, Jeff, because as I've been writing in the recent weeks, It seems to me that this so-called crisis is in large part bogus, which is to say not that nobody is in a bind. Certainly some of these big lending institutions, Fannie and Freddie for certain, and some of the big banks are in a lot of trouble, that is to say they're actually bankrupt.

5:34I think what has happened is that because these people have a lot of political clout, they've, as it were, joined forces to represent their difficulties as systemic or as portending some generalized economic collapse in order to frighten people and frighten members of and then to propose or to have proposed on their behalf rescue measures like this bailout law passed on Friday that the government claims will prevent or ameliorate recession or even worse developments but which in effect simply amounts to to taking money from taxpayers and using it to give to lending institutions that hold more or less worthless assets.

6:40So it's rewarding the very people who acted most imprudently in the past five or six years of the Real Estate Run-Up and the Credit Bubble and penalizing the massive people, including all those people who were prudent, who did not get themselves into situations they couldn't deal with, and it is the worst imaginable kind of incentive situation and if you wanted to create a program to maximally encourage moral hazard, you couldn't beat this current bailout program.

7:26It's tailor-made to reward the unwise and the imprudent, people who entered into undertakings that they, in many cases, didn't even understand in mortgage-backed securities and derivatives and what have you, and to reward them for their foolishness by penalizing taxpayers. And, of course, the fact that taxes may not be increased, but the government simply borrow The money to pay for these goals to lending institutions doesn't mean taxpayers aren't being put on the hook, of course.

8:12They're going to have to be responsible for servicing this increased debt and ultimately for paying it off in one way or another. I noticed, by the way, just this morning reading that between now and the end of December, People are saying the Treasury is going to have to, in that period, that's just three months. The Treasury is going to have to sell an additional $500 billion worth of debt. That's just extraordinary amount of additional debt. And that's on top of all the debt they were having to sell already because of the large government deficit.

9:01So amazing things are being done right now and every episode is a little different from every other one, but there are many parallels, particularly in the way that the government is exploiting frightened people and actually cultivating that fright in order to justify extreme measures which purport to be aimed at helping everybody but which on the face of them amount mainly to robbery, to taking from taxpayers and giving to privileged recipients. It does seem like the bailout and all the hysterical rhetoric coming from Washington and Wall Street has actually panicked people to the point that they're taking the inherently unstable system of banking and the highly leveraged corporate sector and actually exacerbating all the problems.

10:02Doesn't it seem that way to you? Can you say that the bailout in a way is actually getting worse even in the short run? I think that's true, Jeff, and you look at things like the sort of runs on these money market funds, that looks to me like evidence for what you're saying, that the measures the government is taking are spooking people and making them think the sky is falling. What I've been saying for months is that when you step back from the financial sector and perhaps also from the housing sector and look at the rest of the economy, the sky is not It doesn't mean all is well out there, but this is a big productive economy that's clicking along pretty well. It doesn't mean it can't be dragged down, but the idea that somehow we stand on the brink of a collapse akin to the early 1930s is, in my mind, a preposterous idea.

11:01But is it possible that this kind of behavior and these sort of assumptions will actually cause the sky to fall after all? It can move us in that direction. It just depends on what the government continues to do in reaction. What happened in the 1930s that turned that situation into a Great Depression was that rather than doing nothing, rather than actually acting as a laissez-faire government, which later people accused it of being, I mean, the government under Hoover did all sorts of things that in almost every instance made the situation worse than it otherwise would have been. And then when you put all of those things together, their aggregate effect and their cumulative effect was to turn a recession that probably would have been over in a year into this enormous economic collapse that was not only generalized in our economy but dragged practically the whole world down with it.

12:08Well, it seems like all the stuff is going on fast forward if you read the headlines from Europe over the weekend. Yeah, the Europeans seem to be following along with a lag. I don't pretend to be expert on conditions in Europe, but from what I've read it looks to me as if They've made a lot of the same mistakes, but not to the same extent that these mistakes have been made in the United States. Right now, of course, the Fed is conspiring constantly with the European Central Bank and with other central banks in the world to try to throw new money at this problem, as if you can take problems of specific localized insolvency, which is what we have here, and solve those problems by creating a lot of liquidity, and I think it's an idiotic approach to these problems. The fact that you've got millions of people who've taken out mortgages and can't make the payments, it really isn't going to be changed significantly by flooding

13:30the world with money. You've got a lot of bad securities. You've got all these derivatives that were in effect represented on the basis of theoretical arguments to be sort of secure within limits that turn out to be even unpricable, unsaleable. Nobody knows what to offer for these things. And so that's created a certain amount of uncertainty in turmoil in financial markets, at least in part of those markets. But that problem won't be resolved by flooding the world with new money. That problem will only be resolved by letting markets find ways of pricing those securities.

14:17If it turns out the market price is zero, well, that's the market price and we're going to have to adjust to that. But if it's not zero, if they actually have values, the only way we know to converge on those values is through the operation of free markets. Right now we've got this situation where the Treasury is going to hire a bunch of financial management contractors, and you can just imagine who these guys are going to be, you know, relative to Hank Paulson. They're going to hire these guys and they're going to set them loose to go out and, as it for creating their own algorithms for how much they pay for what and this to me looks like a recipe for just creating a massive amount of noise in the financial markets, this is not a true market process and of course when you're dealing in funds that have been extorted from taxpayers in the first place, you can never have a true market process.

15:27So I think the upshot of this bailout procedure is potentially very, very, very harmful because it's an attempt to centrally plan the pricing of financial instruments and we know that can't be done. Isn't it remarkable? Through my whole life I've heard these campaigns for cheap housing. This has been a top part of Washington. We need to make sure the houses are available to the poor and to the lower middle class. Here we have a chance to actually make that reality happen through all of these foreclosures and what are they doing? They're blowing it. Now we can't have cheap houses. Well, as you know, Jeff, we live in a world where letting any asset price fall is viewed as catastrophic. No matter how high it's run up in a bubble or a boom, somehow the The idea that it starts coming down portends generalized disaster.

16:30And I think this is just a cock and bull story that the owners of these assets circulate. But it's remarkable how well it works. In fact, I mean, the past month has just astonished me at how the press in particular has fallen And for every anecdote some Wall Street trader has been willing to spout and there's been really no effort at all to look at broader measures or more substantial data and they've just repeated these sky is falling stories they've got from Wall Street and then the The media repeat what the media say and it's very incestuous, you've probably noticed how often different sources of news have identical verbiage, so they're obviously cannibalizing one another, but very often if you go back to the source of these stories they have extremely flimsy foundations.

17:45I was reading this morning in the New York Times about the collapse in consumer spending that are being reported by specific sectors, among which the airline industry, which made me wonder how long the airlines are going to be able to last under a situation in which consumers are unwilling to spend money on flights. We can see there are already very precarious positions as a result of all the regulation that's gone on since 9-11. There are also historically chronic feeders at the public trough. You may remember they went and got an infusion of $5 billion in grants and $10 billion in loan guarantees right after 9-11.

18:38We can certainly expect the airlines, whenever they get in serious trouble, to be appealing for taxpayer money in some fashion. And I wouldn't be surprised, because their fortunes are highly cyclical, so that during the boom, airlines tend to do pretty well, and then during every recession, a bunch of them go bankrupt. You've written several books that try to link economic calamity with bad foreign policy and war. Do you see a linkage here? Well, in some ways I do.

19:26One of the most basic aspects of the artificial boom of the past seven, eight years is very easy credit, particularly between 2001 and 2005. And of course, those are the years when the Bush administration launched its wars in Afghanistan and Iraq, which turned out to be much more expensive than expected, certainly much more expensive than anyone in the administration ever indicated they expected. Maybe they're just very good at keeping their expectations to themselves, but it does look as if they, too, were shocked because the cakewalk didn't occur, of course, and when the wars got extended and they required more troops, more equipment, lost equipment, damaged equipment had to be replaced and so forth, these wars became extremely expensive.

20:41And so the government's deficit got very big. Now, it's generally the case that when the federal government is running a big deficit, the Fed is working hand-in-glove to ease credit conditions, to make the government's borrowing easier. And so, I think that was part of the reason why the Fed was so extraordinarily careless, Reckless between 2001 and 2005 or so. But that recklessness, of course, had effects other than making government borrowing easier. It had all these effects in promoting terrible investments and the purchase of subprime and and all-day mortgages and derivatives based on those, and a great deal of over-building in housing and even to some extent in commercial real estate and real estate development.

21:48All the things that Austrian economists expect to be the form that malinvestment takes when Interest rates are artificially shoved below market levels, so I think we can track some of this ease in Fed policy to the Fed's desire to facilitate the government's big deficits that arose from the expenses of those wars. So there's that connection, and there are many other connections, of course. The U.S. government and the Fed are part of an international establishment, if you want to call it that.

22:34What that means is that considerations having to do with foreign economies and foreign governments always enter to some extent into U.S. government policy making, and it certainly was the case in the past few years. The way the war, the way the depression finally came to a sort of culminating moment was in catastrophic World War II. Looking way down the line, if the U.S. government manages to make this crisis much worse through its interventions and it doesn't seem to be any other way out, can we expect to see more foreign policy belligerence from the state?

23:20I don't know, Jeff, they're going to have to work pretty hard to be more belligerent than they have been in recent years. They haven't attacked Iran yet, they still may, but if they should, and I personally If the U.S. or its proxy, Israel, attacks Iran, I think the consequences are going to be just horrendous worldwide, both economic and political.

24:06Certainly, if we think we cultivated a lot of new terrorists by occupying Iraq, I don't think we've seen anything compared with what will happen if there's an attack on Iran, especially if nuclear weapons are used. So I think the reaction will be great and terrible, and I don't know what would unravel from all of that. But right now, we're in a little different situation from the United States circa 1939 because one of the things that almost everybody thought was a silver cloud of hearing up for war at that time was that the U.S. had massive unemployment and right now the country does not have massive unemployment and if the government grows even more than it has in the military buildup under the Bush administration to fight some Iran-related massive war in various parts of the world.

25:21It's not going to have the same effect. It's going to have more of an effect of probably creating very, very high rates of inflation. and that of course will be the trigger for price and wage controls and with those have to come all kinds of other controls so we we may be looking at at something if if we get into a much wider war that leads to a kind of controlled economy something like we saw in the early 1970s. I never would have imagined and that five years ago, now it seems eminently plausible. Yeah, I think both parties have shown that they have no regard for free markets, economic liberty at all, and almost none, except for a few people in the Democratic Party for personal liberty.

26:25So the idea of a full-fledged kind of fascism being fastened on this country, I don't think is cookie stuff anymore, I think it's within the realm of imagination, without imagining a whole lot of things that don't have a basis. Cheered by left, cheered by right, cheered by the business class, everybody. Yeah, everybody wins except the masses who get screwed by everything this government does. I must tell you, I spent the weekend reading Crisis of Leviathan. That's old news. I've read it several times before, but somehow it all took on a special vibrancy that it hadn't had before. Every paragraph was magnificent and oddly provides something like, I don't know, I don't want to describe it as hope, but there was some solace associated with knowing that we've been down this road before and more or less come out of it.

27:22Well, one of the things about knowing some history is that one knows that terrible times have occurred before, very, very terrible times have occurred before, and mankind survived. So, you know, we can hope that things don't get as terrible as they were at their darkest moments in the past, but if they should, we may still survive. Well Dr. Higgs, all lovers of liberty are grateful to you for all of your great work in the past and also for this interview today. Thank you so much. Thank you, Jeff.