As the market continues to unravel and the socialist agenda of the current political administration moves farther along its path, my source of solace has been the late, great Milton Friedman. “Uncle Milty,” as he’s known throughout economic circles, had much to say regarding socialism, the government’s constraint on markets, and American business.
Socialism in the United States
Back in a 1975 interview hosted by Richard Heffner on “The Open Mind,” Friedman stated that the natural order of mankind is movement toward socialism. Human nature pulls us toward group behavior and collectivism, and while well-intended, we often establish laws and regulations in haste whose end result rarely (if ever) meets their initial objectives. It’s natural for people to look to a central authority to establish rules and guidelines designed to protect their interests and propagate desirable behavior. If a condition or situation arises that negatively affects a minority group (that is numerically, not racially per se…), the initial response is to say – “That’s terrible – there ought to be a law.”
(The interview referenced here was conducted in 1975. Discussion topics focused on individual freedoms and the inefficiency of strong government intervention to solve social and economic issues. Here’s a link to the 30 minute interview.)
In economic and financial circles, Milton maintained that free markets and permitting individuals to pursue their own self-interests is the most efficient way for societies to operate. This is clearly results in a duplicitous state of being – we know that the pursuit of individual self-interest is more efficient means to maximizing outcomes, yet our human tendencies move us to collectivism and socialism. Most importantly, the implementation of regulatory burdens by our socialist self results in exactly the opposite of its intended effect. As Friedman illustrated, consider any social program introduced by government – minimum wage laws, protective tariffs, or welfare. In every case, these enacted social programs resulted in ultimately hurting the very minority groups they are intended to protect, and can be proven to have done so using the most rudimentary technical economic models.
The long term effects of continued regulations and government intervention will lead us to the path of socialism, and eventually tyranny and serfdom under the weight of self-imposed governance. Friedman shared the view of Friedrick Hayek, who authored “Road to Serfdom” earlier in the 20th century. Given these natural human tendencies, Friedman estimated that there was only a 15-35% chance that we, as Americans, had the posterity to avoid complete socialism by taking the proactive measures necessary to enable individual freedom and resist our natural tendencies for collectivism, a state that which would evolve to the condition of serfdom and tyranny.
Fortunately, as Friedman explained, there are two situations that support the maintenance and protection of a free society. The first is government’s inability to operate efficiently. As Friedman put it – “you almost never spend other people’s money as carefully as you spend your own.” Individually, we can examine nearly every social program at the most cursory level and quickly see the massive waste involved with its implementation. The second is the American commitment to finding loopholes and to circumventing laws.
The Housing Market: A Textbook Case of Government Inefficiency
The Community Reinvestment Act was enacted in 1977 and designed to encourage depository institutions (banks) to meet the credit needs of the communities in which they operate, with credit including home mortgages. In 1992, then-President Clinton signed the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 which eventually authorized and capitalized Fannie Mae to purchase mortgage loans granted by banks to credit-risky individuals as a means to expand home ownership opportunities to low- and moderate-income individuals. Sounds noble – enabling the financial market to provide credit and mortgages to individuals that they would normally reject under financial guidelines. But what were the long-term net results?
The banking institution is inherently risk averse. They have liquidity guidelines that require cash to be readily available to the depositors. Traditionally, banks required a 20% down payment for home purchases and approved only those individuals with credit-worthy histories. There are sophisticated, mature industries along the risk spectrum – Hedge Funds, Private Equity Funds, Venture Capitalists, and industry-specific investment funds and private investors. Banks are not part of this cohort.
When banks were coerced into participating in higher risk activities, their response was to dispense of these risky loans in the form of mortgage-backed securities (MBS) to those in the marketplace better poised to take higher risks with the objective of higher returns. Seeing a demand for these assets, the banks accommodated by increasing the supply of risking loans. The mortgage broker industry, including firms such as DiTech, Ameriquest, and Countrywide, saw an opportunity to facilitate these loans on behalf of the banks, providing an avenue to banks to increase the supply of these MBS to meet the increased demand. Eventually, as is clear now, we see that many of the high-risk borrowers are unable to repay the mortgage payments due, are moving into default, or are going into foreclosure. This is causing a major increase in the available housing supply and reducing the housing market’s equilibrium price.
As prices continue to fall and interest rates adjust upwards, more and more high-risk individuals are either deciding not to make their mortgage payments in protest of their poor decision-making process to purchase an over-priced asset, or are simply unable to continue making mortgage payments at today’s adjusted interest rates. Shocking revelation – those with poor credit don’t pay their bills or live beyond their means. This adds to the housing supply, further exerting downward price pressure on homes. “Wait a minute,” you say, “when prices fall, shouldn’t that mean that more people should be able to afford a home, especially those in the low and moderate income brackets?” Yes, the should… But now that banks are restricting access to credit to meet more traditional criteria, even restricting credit access to those that meet traditional credit ratings such as a +700 FICO score and 20% down payment available. Lending levels have fallen drastically, and thus those especially in the low to moderate income bracket are unable to receive approval for home purchases because the market for high-risk MBS dissipated.
This case illustrates exactly what Friedman stated – the same rules and regulations designed to promote home ownership has worked to the ultimate detriment of those they were intended to help. The “greed of banks and Wall Street” didn’t create the housing market crisis. These market players acted exactly as they should under the rules of game placed upon them by government regulation.
And what makes greed so bad in the first place (Gordan Gecko notwithstanding)? Even Uncle Milty favored greed in its pure sense. Ask Phil Donahue what he thought after this interview with Friedman.
Baseball, Apple Pie & Avoiding the Law
The second salvation that we have as Americans to avoid complete socialism lies in our burning desire to take mulligans and interpret 55 to mean 64 on the highway.
With the monetary allocations to the bank bailout initiatives, it’s been a popular mandate to require that CEOs of banks receiving bailout funding may not receive a salary about $500,000. Even with the newly-imposed executive compensation limits, there’s evidence of loopholes. Check out this story in the LA Times.
And what about the new tax plan designed to pay for nationalized health care by taxing those earning more than $250,000 per year? Check out this article from the Associated Press. The tax plan is designed to increase government revenues by taxing the “rich.” The net result – the “rich” decide to work less and pay fewer taxes. It’s better to make $249,999 than it is to earn $250,000. Only the government could invent such as system that would actually encourage Americans to work less. Why would someone opt to earn less than more? Because it’s in his individual self-interest to do so. The net result in weighing higher taxes on the wealthy? Lower revenues – the exact opposite result from the original objective.
These simple cases highlight that regardless of the laws and regulations instituted under a socialist agenda, Americans will find a way around the regulations. However, it’s vital to understand the long-term effects of placing these institutional burdens on an economy. Finding a loophole comes with a cost as time, legal counsel, and accounting fees to name a few. These transactional costs eat into the ability for individuals and the marketplace to act efficiently. Slowly the regulations erode the foundation of a free marketplace, only to have it crumble beneath itself under the weight of collectivism.
Life, Liberty & The Pursuit of Happiness
Economic freedom is difficult to achieve and maintain. That’s why individuals throughout the course of history have died to enjoy and preserve freedom. That’s why Cubans try to swim 90 miles to Florida. That’s why we all recognize the image of Tiananmen Square from 20 years ago.
It’s difficult to take personally responsibility for your actions and outcomes, and easy to blame the rules of game for your failures. But it’s those failures that spawn new efforts and eventual gains. I’d rather have the choice of failing 1000 times than abetting the singular failure of our free market system in America. How about you?