If the economy were a canary, we’d all be pointing our fingers at the yellow feathers poking out of the mouths of Wall Street’s fat cats. But it’s the owner who let the canary out the cage.
The U.S. government thinks that more regulation is the way to prevent a repeat of the financial meltdown we now face. In reality, too much regulation is what led us here in the first place.
Here’s the common storyline: unconscionable banks and financial institutions on Wall Street pushed hundreds of billions worth of mortgages onto high-risk borrowers with questionable credit history.
As more and more credit was available for mortgages the system drove home prices up. But, once credit got tight, the demand for houses in the U.S. plummeted and borrowers were left swimming in a sea of debt they could never pay back.
The U.S. housing bubble had finally burst.
In the fallout, the consensus has been almost universal – the free market, left to its own devices, allowed greed on Wall Street to reign supreme.
Now President Barack Obama is championing “tough, new common-sense rules of the road so that our financial market rewards drive and innovation, and punishes short cuts.”
However, greater regulation is not a real solution. It overlooks significant evidence pointing to the actual culprits of this financial mess: both the U.S. federal government and Federal Reserve. They laid the foundation that let greed flourish, creating incalculable risks otherwise impossible in a free market economy.
Peter Schiff, an economist who predicted the economic collapse, has argued for years that a true free market keeps people prudent in their financial risks because of the natural balance between greed and fear.
Greed, or the incentive to make profits by taking risks to invent and innovate, is the lifeblood of a thriving economy. Schiff argues that, “although few would ascribe their desire for prosperity to greed, it is simply a rose by another name.” But, greed is only beneficial to a society when it’s checked by fear – the fear of losing money from bad bets.
Financial and real estate markets are governed by these two opposing natural tensions.
But the balance of greed and fear was seriously disturbed when out-of-control government and monetary policies intervened in the market. These policies removed an element of fear crucial in keeping greed in check.
Although monetary policy is ‘independent’ of government policy, think of it as two sides of the same coin.
Government interference in the housing market became significant in 1977 when President Jimmy Carter enacted the Community Reinvestment Act, which pressured commercial banks and savings associations to lend to borrowers who would have trouble being approved for a credit card, let alone a mortgage.
In 1992, the U.S. Congress mandated government-sponsored enterprises Fannie Mae and Freddie Mac to meet quotas for purchasing mortgages from low- and moderate-income housing areas.
By 2005, they had to extend 52 per cent of their mortgages to borrowers below the local income median.
Economist Russell Roberts, in an op-ed piece for the Wall Street Journal, says Fannie and Freddie played a “significant role in the explosion of sub-prime mortgages and sub-prime mortgage-backed securities.”
Both of these quasi-government agencies had the implicit guarantee of government support.
Countless government policies, including tax incentives for those who bought expensive houses, worked to create moral hazards in the market and reduce the fear of losing money. These policies led people to take unimaginable risks that worked to drive up home prices to unsustainable levels.
On the other side of the coin is the Federal Reserve. The Fed – through ‘independent’ monetary policy – was eager to stimulate the economy.
The Fed cut interest rates from 6.5 to one per cent between 2000 and 2003, which created an incentive for commercial banks to lend money at a cheaper rate. The cheaper the rate, the easier it was to get a mortgage. The result was a house-buying binge that created a booming market and averted a recession.
“By slashing interest rates to one per cent and holding them below the rate of inflation for years, the government discouraged savings and practically distributed free money,” Schiff says in a Washington Post op-ed.
The ‘free money’ laid the foundation for no-money-down, interest-only mortgages. In turn, housing prices skyrocketed.
And all the while housing prices were booming, both government and monetary policies were being praised as a godsend. But, of course, this was no act of divine intervention, and eventually the house of cards collapsed.
The government and Fed had pushed fear right out of the market – while greed took control, inflating the biggest economic bubble in history.
Now that the bubble has burst, all that is left are mortgage defaults and a crumbling U.S. economy.
Schiff’s senior prom analogy demonstrates how these policies worked to remove fear in the free market. He says the government resembles a chaperone, who is responsible for supervising a dance – but, instead, decides to spike the punch bowl. Meanwhile the prom goers – or Wall Street – proceed to get drunk and act like hooligans.
Who are you going to blame: the drunken students, or the chaperone?