As featured on p. 218 of "Bloggers on the Bus," under the name "a MyDD blogger."

Tuesday, December 23, 2008

Friedman, In The Study, With The Manifesto Of Laissez-Faire Capitalism

The New York Times had a great article about how the President and his philosophy of the "ownership society" inflated the housing bubble and caused the historic collapse in the market. And I guess this is true to an extent, and the article doesn't presume that encouraging homeownership is solely responsible. But the article only skirts around the edges of why this was dangerous.

From his earliest days in office, Mr. Bush paired his belief that Americans do best when they own their own home with his conviction that markets do best when let alone.

He pushed hard to expand homeownership, especially among minorities, an initiative that dovetailed with his ambition to expand the Republican tent — and with the business interests of some of his biggest donors. But his housing policies and hands-off approach to regulation encouraged lax lending standards.

Mr. Bush did foresee the danger posed by Fannie Mae and Freddie Mac, the government-sponsored mortgage finance giants. The president spent years pushing a recalcitrant Congress to toughen regulation of the companies, but was unwilling to compromise when his former Treasury secretary wanted to cut a deal. And the regulator Mr. Bush chose to oversee them — an old prep school buddy — pronounced the companies sound even as they headed toward insolvency.

As early as 2006, top advisers to Mr. Bush dismissed warnings from people inside and outside the White House that housing prices were inflated and that a foreclosure crisis was looming. And when the economy deteriorated, Mr. Bush and his team misdiagnosed the reasons and scope of the downturn; as recently as February, for example, Mr. Bush was still calling it a “rough patch.”

The result was a series of piecemeal policy prescriptions that lagged behind the escalating crisis.

The focus on Fannie and Freddie is kind of ridiculous, as I've gone over on this blog time and again. They were a symptom and not a cause, entering the toxic market well after it had gotten out of control. What the article described, but not boldly enough, is that Bush's crusade for homeownership, a POLITICAL strategy designed to win the hearts of minorities and low-income Americans who could realize their dreams, was achieved through a crusade for deregulation, an IDEOLOGICAL strategy designed to allow financial executives the most leeway possible to conduct their sophisticated Ponzi schemes. Bush and his advisors would never interfere with the inflation of the bubble, because it won them a rhetorical victory, and they laughed off suggestions that the crash would be extremely dangerous. So they allowed lenders to come up with instruments that basically pushed the global economic system to the brink of collapse.

While much of this is the same old story of politics over policy - Bush could go around and say "Owning your own home is the greatest gift of all" and feign obliviousness to the chicanery used to get people into these homes - I don't want to divorce the ideology from the politics. The President was always a laissez-faire capitalist and a free market fundamentalist, using government to encourage homeownership, in this case, but essentially eliminating the rules that would create any barriers to making that a reality. And that was by design.

The president’s first chairman of the Securities and Exchange Commission promised a “kinder, gentler” agency. The second was pushed out amid industry complaints that he was too aggressive. Under its current leader, the agency failed to police the catastrophic decisions that toppled the investment bank Bear Stearns and contributed to the current crisis, according to a recent inspector general’s report.

As for Mr. Bush’s banking regulators, they once brandished a chain saw over a 9,000-page pile of regulations as they promised to ease burdens on the industry. When states tried to use consumer protection laws to crack down on predatory lending, the comptroller of the currency blocked the effort, asserting that states had no authority over national banks.

The administration won that fight at the Supreme Court. But Roy Cooper, North Carolina’s attorney general, said, “They took 50 sheriffs off the beat at a time when lending was becoming the Wild West.”

While it's important that the President tells the whole country that you can own a home no matter how much money you make, it's far more important that he create conditions where lenders can actually give those kinds of mortgages out. The lenders were of course responding to demand for mortgage-backed securities and derivatives and threw away lending standards so they could print up more and more of them. Barry Ritholtz gets this right - the problem was that Bush was an avowed deregulator.

That Bush had as a goal increased home ownership is, quite bluntly, irrelevant. It is a worthy goal, and certainly one that could be achieved without forcing the collapse of the financial system.

Indeed, as the chart at right shows (source: NYT), home ownership has increased every year since 1994. Funny, from that year and for each of the next 10 years, there was no collapse. You have to ask yourself why. No, the 1997 Tax Break, did not, as the NYT implied yesterday, Help Cause Housing Bubble. Home ownership was rising years before that went into effect.

What Bush did differently than prior Presidents was that he genuinely believed that regulations proscribing bad corporate behavior were unnecessary. It was that ruinous belief system, one he shared with other key players, that led to the crisis [...]

Increasing home ownership in America is a legitimate political goal. Waiving down-payments requirements, dropping lending standards, allowing predatory lenders to flourish — that is what is the underlying cause of boom bust and collapse.

You're seeing this similar dynamic now in the revelations that Chris Cox sought to dismantle the SEC while he was the chairman of it, allowing traders free reign and hewing to the anti-regulation mantra of the Bush Administration. This mania was not limited to the housing sector (check out the Consumer Products Safety Commission, for another example). If you want to go all the way back, the culprit is Milton Friedman.

For half a century, Chicago’s hands-off principles have permeated financial thinking and shaped global markets, earning the university 10 Nobel Memorial Prizes in Economic Sciences starting in 1969, more than double the four each won by Columbia University, Harvard University, Princeton University and the University of California, Berkeley.

Chicago’s laissez-faire imprint underpins everything from U.S. President Ronald Reagan’s 1981 tax cuts and the fall of communism that decade to quantitative investment strategies.

In 1972, Friedman helped persuade U.S. Treasury Secretary George Shultz, former dean of Chicago’s business school, to approve the first financial futures contracts in foreign currencies.

Such derivatives grew more complex after Chicago economists created the mathematical formulas to price them, helping spawn a $683 trillion market that’s proved to be a root of today’s financial system breakdown.

On Dec. 16, the U.S. Federal Reserve cut its target lending rate to as low as zero for the first time and said it will buy mortgage- backed securities [...]

Joseph Stiglitz, who won one of Columbia’s economics Nobels, says the approach of Friedman and his followers helped cause today’s turmoil.

“The Chicago School bears the blame for providing a seeming intellectual foundation for the idea that markets are self- adjusting and the best role for government is to do nothing,” says Stiglitz, 65, who received his Nobel in 2001.

University of Texas economist James Galbraith says Friedman’s ideology has run its course. He says hands-off policies were convenient for American capitalists after World War II as they vied with government-favored labor unions at home and Soviet expansion overseas.

“The inability of Friedman’s successors to say anything useful about what’s happening in financial markets today means their influence is finished,” he says.

Instead, Galbraith, 56, says policy-makers are rediscovering the ideas of his father, Harvard professor John Kenneth Galbraith, and economist John Maynard Keynes of the University of Cambridge.

Keynes, who died in 1946, argued that governments should spend to combat the unemployment that free markets tolerate. Galbraith, who died in 2006, rejected mathematical models and technical analyses as divorced from reality.

The Chicago Boys brought us to this moment of crisis. Their radical theories have ruined the global economic system. I don't know whether having a former University of Chicago professor (whose economic advisors come from that school as well) as the President-elect is a good thing, in that he's been close enough to that heart of darkness to see its flaws, or a bad thing, in that he still holds the vestiges of their theories of deregulation. If Obama is a pragmatist, as he claims to be, he will recognize that Friedmanism must be totally repudiated, buried, locked up and forgotten.

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