Study their behaviors. Observe their territorial boundaries. Leave their habitat as you found it. Report any signs of intelligence.

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Thursday, October 09, 2008

A Bailout Hair Of The Moral Hazard Dog That Bit You

[This is the director's cut of today's joint press release from 18 California Libertarian candidates for Congress.]

The current mortgage crisis is the direct and predictable result of the government protecting borrowers and lenders from their own unwise choices. Only one party in America — the Libertarian Party — is willing to say who caused this crisis and to consistently follow the principle of holding such people responsible for their own choices.

This all happened before in the Savings and Loan crisis of the 1980s, when the government increased the level of deposits it insures from $40K to $100K, and the "Keating 5" senators (including John McCain) were interfering in the fraud investigation of an insolvent S&L whose chairman later ended up in jail for five years. When the resulting real estate bubble burst, the government used $160B of taxpayer money to bail out the borrowers and lenders who had made bad decisions.

When government socializes losses, the resulting incentive for excess risk-taking is called "moral hazard". After the precedent of the 1989 bailout of the S&L industry, the government fed a new real estate bubble with several more kinds of moral hazard. There had always been an implicit government guarantee behind the alleged "independence" of Fannie Mae and Freddie Mac, allowing them to sell mortgage-backed securities at prices beyond their underlying risk. In 1992, Congress passed a law requiring Fannie Mae and Freddie Mac to devote part of their lending to support affordable housing. In 1994, Congress gave advocacy groups the power to interfere with mergers among lenders who the groups think aren't lending enough to low-income borrowers. In 1995, the Clinton Administration created rules under the Community Reinvestment Act to further encourage such lending, including letting advocacy groups market such loans and then bill lenders for any marketing costs. In 1999, Fannie Mae created yet another program to encourage banks to extend home mortgages to individuals whose credit was generally not good enough to qualify for conventional loans. The New York Times quoted an economist's reaction: "This is another thrift industry growing up around us. If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry." The tech bubble burst in 2001 and the Federal Reserve responded with even easier credit than it had been providing before. Artificially low interest rates fed the bubble in real estate prices, and encouraged the perception that the Fed would protect such asset prices with its interest rate policies. However, the Fed could only delay the day of reckoning, and in so doing made it worse.

Now the Republicans and Democrats have intervened again in the credit markets, by using $700B of taxpayer money to bail out Wall Street firms holding non-performing mortgages. This is a recipe for continuing the cycle of bailouts. If the S&L bailout cost $160B 20 years ago, and the current bailout costs $700B, then what will the next bailout cost?

The Libertarian Party says it's time to stop the insanity. Economic expansion is currently sluggish, but America is nowhere near the 45% contraction and 24% unemployment of the Great Depression. Talk of a general economic "crisis" is fear-mongering designed to justify more looting from current and future American taxpayers. If, as bailout advocates claim, there is potential for the government to profit from buying non-performing mortgages, then let private investors (including bailout advocates!) pursue these opportunities with their own money instead of with your tax dollars.

We already have a mechanism to sort out the assets and liabilities of a troubled company — it's called bankruptcy. Bankruptcy doesn't mean that assets get torched or employees get blacklisted from all future employment. Bankruptcy just means that assets and employees are taken away from those who failed to manage them wisely, and made available for more productive employment.

We already have a mechanism to punish those who deceived borrowers or lenders — it's called prosecution for fraud. The Libertarian Party's presidential nominee Bob Barr, a former federal prosecutor, has called for vigorous prosecution of anybody who practiced deceptive lending or who deliberately overvalued mortgage-backed securities. He says we need to clean up the marketplace, not cover up financial crimes with a deluge of taxpayer money.

Most importantly, we already have a mechanism to punish the politicians who worked so hard to help create this mess — it’s called an election. This November, don’t bail out the incumbents who are using your tax dollars to bail out their irresponsible friends on Wall Street. Instead, vote for the only party in America that believes people should be free to make their own choices in their personal and economic lives — and should bear the responsibility for those choices. Vote Libertarian, and send the message that Washington should be in nobody’s pocket.


Reuven said...

Thanks Brian! You have my vote.

Please! Everyone needs to fight back against the Government! They've declared War on Savings! Don't let them give free houses to deadbeats.

Reuven said...

That's all well and fine, but what about the IRRESPONSIBLE BORROWERS, too?

70% of people who got mortgages they can't afford LIED on their mortgage applications. And now they're treated as victims and get HUGE tax breaks. (No income tax on forgiven mortgage debt.)

Please, Libertarians, call for the prosecution of deadbeat borrowers too...even if we need to jail 1,000,000 people.

Andrew said...

Brian, I'm glad to see that you are running for Congress again.

I'm curious about the libertarian position on bankruptcy.

Is the federal government the appropriate arbitrator for bankruptcy? If not, how should it be managed?

Should bankruptcy be easier or harder on the business or person who is filing than it is today?

To me, bankruptcy is a way of socializing risk, and does create moral hazard. It is certainly beneficial overall, but I'm not sure how it can morally be justified, or why it should fall under the purview of government.

On a micro level, a lot of the problem with investment banks appears to be that bankers are rewarded for taking risks, and receive the reward long before their risk has been proven to pay out. The reward for doing well, huge amounts of cash, is far higher than the loss of taking a bad risk, maybe losing a job sometime down the road.

The limited liability corporation is a method of socializing risk. It's especially troubling in the finance world, because of the reasons i described here, and because the huge potential for losses given massive leverage. Do you think it would be a good idea to increase the liability of banking executives? I think that would make banks act more responsibly, and is a bit of a throwback to pre-government-regulation corporations.