Why We Should Take a Solutions Approach to the Crisis and Look at Some Things Differently

The following is an excerpt from The Little Book of Bull Moves in Bear Markets: How to Keep Your Portfolio Up When the Market is Down (Little Books. Big Profits) by Peter Schiff. I am NOT endorsing this book and I'm sure many of you will disagree with this piece. That said, I'm always open for new thoughts/ideas/comments, and I felt his writing was good enough to share.

I don't think we're going to see any light at the end of the tunnel until we have a clear, objective understanding of how we got into this mess in the first place. There is a tendency whenever major problems occur in the economy to place blame on external factors and to assume that the external factors can be prevented from causing similar problems in the future by expanding the government's
regulatory powers. The problem I have with this kind of thinking is that it makes government bigger and more intrusive without ever getting at the root of the problem, which is usually the government itself. The other thing it does is reduce the sphere in which market forces move freely and would otherwise prevent the problem from recurring. Finally, as we face the challenge of rebuilding an economy, whatever lesson might have been learned from the government's role in the problem is lost on us because it was never brought to light in the first place.

The real estate meltdown provides an excellent example. Here we are about to give the Federal Reserve Board new powers to regulate mortgage lenders, appraisers, and other parties to a crisis that would never have occurred if the Fed hadn't taken upon itself the responsibility, better left to the free market, of determining what interest rates should be, particularly true with the absurdly low rates set after the bursting of the tech bubble and the tragedy of September 11, 2001.

The Fed's decision to set rates at artificially low levels to stimulate activity and growth in the real estate sector was directly responsible for the environment that naturally spawned such innovations as teaser rates, negative amortization loans, and other variations on adjustable-rate mortgages, which in turn had consequences that were extremely problematic. But the mortgage brokers and lenders weren't responsible for the root cause of the crisis, nor were the investment banks that securitized the mortgages, nor the hedge funds and institutions that purchased them. The Federal Reserve was. Yet the Fed is now being rewarded with additional powers to regulate Wall Street as well. So the fox ends up guarding the henhouse, which is bad enough, but anybody looking for the guiding lesson of the crisis probably wouldn't find it. The real lesson is this: Interest rates represent the price of money (or more precisely, the price of credit). A government agency has no more business deciding what the price of money should be than it has deciding the price of a pair of tennis shoes. Why are we so surprised that central government planning works no better when it comes to setting the price of money than it does in setting prices for other goods?

The price of oil is being blamed on speculators, big oil companies, environmentalists, and other external factors -- but never on the Federal Reserve, which created the inflation that debased the dollars in which oil is traded and is thus principally responsible for increased oil prices. Priced in gold, which adjusts for inflation, oil has actually changed very little in price.

What worries me most, however, is the almost automatic backlash that attributes the present economic collapse to a failure of capitalism and free-market economics and turns it into an argument for expanded government. Never mind that government created a crisis that the free market would have avoided altogether; the problem with this case of mistaken identity is that it almost certainly will result in expanded government, much as the New Deal did during the Great Depression. Of course, the greater problem today is that we can barely afford the old New Deal, let alone the modern version we're about to be dealt!

The approach we need to take to our present crisis is not to expand government, but rather to understand government's role in creating the problem. The solution is to limit and control the power of government, not to create more unnecessary regulation to interfere with the free market forces that would have prevented the problem.

Thoughts on the Upcoming Presidential Election and How It Might Affect Our Economy

I think what we've learned from this historic economic breakdown is that it represents a colossal failure of government planning. When you have the government taking control of something as important as setting interest rates, this is the kind of disaster you get.

At this critical political juncture, are we going to compound the problem by giving the government even more power, making it even bigger, and putting it in a position to do even more damage? The alternative, of course, is letting the free market self-correct, which I believe in strongly but which is not, I'm afraid, the way Americans are inclined to lean in a time of economic crisis.

The impending failures of Freddie Mac and Fannie Mae, events I forecast in my book Crash Proof, in commentaries on my web site, and on television, and the government's intention to bail them out, is a huge step in the wrong direction. These quasi-governmental agencies, with their implied government guarantees, provided much of the air that inflated the housing bubble, and should be
allowed to fail. Instead, they will be pumped up with more government money, compounding the fundamental problems in the housing market and worsening inflation.

In fact, early on in the housing crisis, most in government and on Wall Street were still so clueless that these agencies were actually touted as being the solution to the problem. In sharp contrast, I wrote in an August 2007 commentary entitled "It's a Shoo-In":

"In order to breathe life into the dying secondary market for nonconforming mortgages, some have suggested that Fannie Mae and Freddie Mac be allowed to buy jumbo mortgages. This overlooks the problem that many of these larger mortgages also feature adjustable rates that will likely show greater default levels when payments reset higher. Allowing Fannie and Freddie to buy larger loans now merely sets up a more expensive federal bailout down the road, as both of these entities themselves will likely need to be bailed out when the conforming ARMs they already insure go bad as well."

Bailing out Freddie and Fannie, as well as all schemes to bail out overextended homeowners and artificially prop up home prices are doomed to failure, and will only compound the problems they are attempting to solve. The recent failure of California-based IndyMac, a former leader in nontraditional mortgage lending, resulting in long lines of angry depositors, is but the tip of the iceberg. As more banks fail and the FDIC runs out of funds, the Fed's printing presses will be operating until they run out of ink.

Without getting into a contentious political discussion, I do see a parallel between the 1976 election of Jimmy Carter and the Reagan succession in 1980. Carter had taken office at a time when inflation and unemployment were issues. Voters were disenchanted by Gerald Ford and alienated by his pardon of Richard Nixon, whose abuses of power were still very much on their minds, and whose failed policies led to higher inflation and unemployment. The mood was very strong for a change from the traditional ways of Washington. The economy was so bad that Gerald Ford was even challenged in the primary by Ronald Reagan, who at the time was dismissed by the media and the party elites as too outside the mainstream to be electable. Carter ran as a Southern modernist and Washington outsider. He promised change and won. A similar situation exists today.

The Carter administration proved to be a turnoff and a disappointment for a majority of Americans, as the bad economy he inherited got even worse under his stewardship. As a result, the emergence of Ronald Reagan, an improbable candidate under normal circumstances, was actually welcomed as a timely alternative. Voters generally bought his mantra that government was the problem, not
the solution, and he won the election. Reagan and Federal Reserve Chairman Paul Volcker took on double-digit inflation with double-digit interest rates, inflation was pronounced dead, striking air controllers were simply fired in a no-nonsense way, and the Reagan years generally got high marks. The mainstream world was now finally safe for a conservative promising limited government, provided his predecessor had exhausted the public's tolerance for big government. Unfortunately, Reagan never really followed through with his promise to rein in government spending, the consequences of which we are struggling with today.

Similar to Gerald Ford, John McCain had one challenger in particular whose message of limited government and sound money resonated with a small but organized minority. I am referring to Congressman Ron Paul, who, despite being marginalized by his other opponents and the mainstream media, struck a chord unheard elsewhere in modern politics, and managed to raise more money than any of the mainstream Republican alternatives.

The 2008 election features two candidates likely to make the current problems worse. Ironically, Barack Obama, whose policies would likely prove even more disastrous than McCain's, probably represents the lesser of the two evils. This is because Obama is perceived to be the candidate of big government, while McCain has wrapped himself in the false trappings of small government.

In the unlikely event McCain wins, he will be the Herbert Hoover of the modern era, completely discrediting capitalism in the minds of the electorate and setting the stage for a disastrous ideological counterreaction in the election that follows.

If Obama wins, however, while the economy will fare even worse, it will at least be clear that big government is to blame. By the end of Obama's term, the voters will have had such a bellyful of noxious government solutions that the mere thought of any more will put them squarely at the wheel of the porcelain bus. In such an environment, a Ron Paul type of Republican, dismissed as unelectable à la Ronald Reagan in 1976, may actually be in a position to capture the White House in 2012 and finish the job Ronald Reagan started.

Ultimately, we are going to need a free-market president, who understands sound money and Austrian economics and has the toughness, courage, and leadership talent to take the bull by the horns and begin the process of shrinking government, dismantling programs we can't afford, minimizing regulation and taxation so businesses can operate without competitive disadvantages, and generally taking the steps that will put us on a path to becoming a nation of savers and producers once again. If suffering though four years of hellishly misguided big government is the price we pay for true reform, it may in the end be worth it.

Comments

[Kevin M]

Pretty good write up, I agree with a lot of it actually.

I think what's making me most sick about this whole stock market mess is the government's (over)reaction to it all. I loathe the thought of bailing out people who made horrible choices in the first place and giving them no incentive to change.

[Apex]

I am a small govt conservative, however ....

To say that pure unregulated capitalism will always self regulate ignores human greed and corruption. What part of govt regulation caused the dot com bubble of the late 90s and the fraudulent corporate earnings statements and the illegal shell companies and the fake sales of products from one false company to another to stuff the sales pipeline?

What part of govt regulation caused banks to move away from sound lending practices that required proof of income and to start using stated income loans, to move away from down payments in exchange for zero down loans, to move people from 2% of loans being ARMS to over 50% being ARMS with half of those being interest only option ARMS. And what part of govt regulation then caused rating agencies to take packages of these securities and rate them AAA which then allowed them to be sold to investors as quality when they were truly high risk junk.

Certainly low interest rates contributed to the mess but if the lending standards of the past had been forced by law then most of this stuff still could not have happened even with low interest rates.

And in this process who won and who suffered? The mortgage brokers who sold these loans got their big commissions. The bank executives got their big stock options and big compensation parachutes. And who lost, the shareholders in the companies who had no idea what was going on and the common people as it rippled through the economy.

I have come to believe that pure unregulated capitalism will lead to survival of the most corrupt at the expense of those who play by the rules. From a Christian perspective it is clear that human failings (Greed and Corruption) are very real and will always exert themselves where ever possible.

If some rules are not put in place to prevent Greed and Corruption from manipulating the system, eventually collapse results. The system can run great for a long time but eventually these excess overwhelm the system and we see that what it was based on was more hype than substance (same as the dot com boom).

The sad thing is the banking and mortgage system had great standards for decades. 12-1 bank leverage maximum (recently this was allow to go as high as 30-1). 10-20% down payments required to buy a house but then came the 80-20 and 80-10-10 loans and then it got lowered to 5% and then down to 0% down required becausee houses always go up. 25-30% of gross income used to be the limit they would loan you for a mortgage, but that went up into the high 40s.

All of these standards were meant to stop the banks and consumers from taking on risks that might seem ok in good times but could be catastrophic when times turned down and lead to a cascade affect. The problem is when times get too good people see lost opportunity and want those standards relaxed. They profit off the extra risk and eventually it leads to imbalances that exacerbate the downturns and turn them into collapses that cascade.

I believe thats where and mostly why were are where we are now.

Even greenspan himself said in his testimoy before congress yesterday that he has found a flaw in his belief against regulation and effectively admitted that in this instance the lack of regulation was partly to blame for this problem. Now those who want to blame greenspan ala rates would probably argue he was deflecting blame but I think there is some validity in what he was saying (and I do think he lowered rates too low for too long and is also partly to blame).

This has been something I have worked out in my thinking about this over the past years since the 2000 stock market crash. I would like to hear any other thoughts or critiques of my thinking here as I am trying to work it out in my mind. I am still a small govt conservative and do not want obtrusive govt control, regulation, or involvement. However I think often times the conservatives go to the extreme that says no regulation is the best, and every level of regulation makes it worse. I don't think thats right. I think you do need the right amount or regulation. Not to make it fair, not to make it equal, but to protect against human greed and corruption. In my view the whole point of the regulation is to prevent human greed and corruption from taking advantage of the system.

I would welcome any thoughts on these ideas.

[Rick]

Apex, I'm with you in your general point regarding human greed (basically man's sin nature). But I think there's a difference between government regulation, and active government involvement.

I too am a fiscal conservative and a small government advocate. But I still see a need for laws and regulations. We can see what happens when man is left to his own doings. Just look at the book of Judges, where "every man did what was right in his own eyes." Eventually, things got so bad that they needed to have a judge to "rule" over them. Likewise, look what happened in the aftermath of Katrina. In teh absense of law, looting and pillaging was rampant. There was no law, and there was nothing to prevent people from engaging in their sinful inclinations.

However, it is clear that government policies did in fact cause this bubble, as well as the last one (the dot com one, which you doubt). In 1995, Alan Greenspan basically started to flood the market with cheap money. Venture capitalists threw this cheap money at anything they could. The Internet, being this promising burgeoning new technology, was a prime target for this money. It just so happens that human greed played into it as well. And with all these factors converging, we saw the dot com boom, and then the subsequent bust.

It happened again in 2001 and following. Again, the market was flooded with cheap money. This time the boom manifested itself in real estate markets. But again, it was caused by both human greed and the Fed's poor monetary policy. Yes, it can be blamed by both of these. However, I don't think we can do away with human greed. Man's nature such as it is, greed will always be present. And so that leaves us with the blaming the Fed. It was indeed the Fed's poor policies that caused both these bubbles. And now, the Fed is left to fix the problem it itself caused.

The reason I'm such a strong small-government advocate, though, is because government is still just human. We can either leave the guarding of our economy to the free market (hopefully, a real free market, and not the psuedo-"free" market practiced by Bush and his goonies). Or we can leave it up to the government. But look at what we get by leaving it up to the government. We still get greed and corruption. Look at Paulson, who put his fellow Goldman-Sachs executive in charge of the $700B bailout. GS will be one of the biggest benefactors of the bailout. Various Wall St. firms will reap billions in fees from administering the bailout, to fix the problem they themselves created. Or, consider the fact that the Treasury really has no idea what they're doing with the bailout, so they're hiring other Wall St. firms to consult in the bailout. Tell me there's no conflict of interest, no greed.

No, I'd rather have a truly free market than this hullabaloo.

Finally, the article's point about Obama vs. McCain does ring true. At least Obama agrees he's big government. McCain and Bush both believe they're small-government, free market advocates. But the opposite certainly proves true. This is why I won't vote for McCain. I'm going to be voting third party this election.

[Bronco]

Rick, I agree with you. McCain and Obama are two different flavors of socialism. It was a difficult choice but I finally went with......... Ron Paul over Bob Barr.

[Tony]

Personal responsibility and accountability is what is lost here. While the main stream media focus on "homeowners" being victims (most were only victims of their own stupidity and greed), we have the government doing everything possible to bail these people out as well as banks who made bad business decisions. Many of the people who bought homes in the past 5 years put none of their own money down, and when they default, they get to live in the house rent-free for a year or more. Then, the government steps in and gives them a reduced loan balance or 4% interest rate. Meanwhile, responsible people like me who lived within my means gets to absorb huge stock market losses vis a vie 401(k) which was MY money, from my paycheck, not some phantom "equity" or banks' money. I also get to enjoy absurdly low savings rates and my tax dollars go to help those who lived beyond their means.

All these measures serve to delay the inevitable. Artificially propping up home prices only ensures that new prospective buyers can't afford housing and that the irresponsible who get to keep their houses will continue to make bad economic decisions and be an economic burden for society.

[Bronco]

well stated, Tony!

[Anom]

All this talk of "free markets," yawn.

A purely capitalist economy will not work, just as a purely socialist economy would not work.

We are in a mixed economy, and we all just disagree on which way it should lean.

Bronco,
If I understand your post, you plan to vote for Dr Paul. I hope you're aware he did not register (in any state) as a write-in candidate.

[Apex]

Rick and Tony,

I agree with much of what both of you said.

So do you not agree that if regulation had prevented banks from going beyond 12-1 leverage, had prevented them from putting sub-prime borrowers into ARMS, had prevented them from allowing zero down and stated income mortgages but rather required the normal ratios of provable income to loan amount that this bubble would not have occurred regardless of the easier monetary policy?

[Gagi]

Who do you think is responsible for our crisis?

545 PEOPLE

Politicians are the only people in the world who create problems and then campaign against them.

Have you ever wondered why, if both the Democrats and the Republicans are against deficits, WHY do we have deficits?

Have you ever wondered why, if all the politicians are against inflation and high taxes, WHY do we have inflation and high taxes?

You and I don't propose a federal budget. The president does.

You and I don't have the Constitutional authority to vote on appropriations. The House of Representatives does.

You and I don't write the tax code, Congress does.

You and I don't set fiscal policy, Congress does.

You and I don't control monetary policy, the Federal Reserve Bank does.

One hundred senators, 435 congressmen, one president, and nine Supreme Court justices 545 human beings out of the 300 million are directly, legally, morally, and individually responsible for the domestic problems that plague this country.

I excluded the members of the Federal Reserve Board because that problem was created by the Congress. In 1913, Congress delegated its Constitutional duty to provide a sound currency to a federally chartered, but private, central bank.

I excluded all the special interests and lobbyists for a sound reason. They have no legal authority. They have no ability to coerce a senator, a congressman, or a president to do one cotton-picking thing. I don't care if they offer a politician $1 million dollars in cash. The politician has the power to accept or reject it. No matter what the lobbyist promises, it is the legislator's responsibility to determine how he votes .

Those 545 human beings spend much of their energy convincing you that what they did is not their fault. They cooperate in this common con regardless of party.

What separates a politician from a normal human being is an excessive amount of gall. No normal human being would have the gall of a Speaker, who stood up and criticized the President for creating deficits. The president can only propose a budget. He cannot force the Congress to accept it.

The Constitution, which is the supreme law of the land, gives sole responsibility to the House of Representatives for originating and approving appropriations and taxes. Who is the speaker of the House? She is the leader of the majority party. She and fellow House members, not the president, can approve any budget they want. If the president vetoes it, they can pass it over his veto if they agree to.

It seems inconceivable to me that a nation of 300 million cannot replace 545 people who stand convicted -- by present facts – of incompetence and irresponsibility. I can't think of a single
domestic problem that is not traceable directly to those 545 people. When you fully grasp the plain truth that 545 people exercise the power of the federal government, then it must follow that what exists is what they want to exist.

If the tax code is unfair, it's because they want it unfair.

If the budget is in the red, it 's because they want it in the red.

If the Army & Marines are in IRAQ , it's because they want them in IRAQ .

If they do not receive social security but are on an elite retirement plan not available to the people, it's because they want it that way There are no insoluble government problems.

Do not let these 545 people shift the blame to bureaucrats, whom they hire and whose jobs they can abolish; to lobbyists, whose gifts and advice they can reject; to regulators, to whom they give the power to regulate and from whom they can take this power. Above all, do not let them con you into the belief that there exists disembodied mystical forces like 'the economy,' 'inflation,' or 'politics' that prevent them from doing what they take an oath to do.

Those 545 people and they alone, are responsible.

They and they alone, have the power.

They and they alone, should be held accountable by the people who are their bosses provided the voters have the gumption to manage their own employees.

We should vote all of them out of office and clean up their mess!


What you do with this article now that you have read it is up to you, though you appear to have several choices.
1. You can send this to everyone in your address book, and hope they do something about it.
2. You can agree to vote against everyone that is currently in office, knowing that the process will take several years.
3. You can decide to run for office yourself and agree to do the job properly.
4. Lastly, you can sit back and do nothing, or re-elect the current bunch.
YOU DECIDE, BUT AT LEAST SEND IT TO EVERYONE IN YOUR ADDRESS BOOK,
MAYBE THEY WILL ALL DO THE 4 THINGS!
By somebody else