America’s credit crisis should come as no surprise to anyone whose been paying attention. We discussed this about a year ago in our post “Inflation vs. Deflation,” and if you read that post, you will see links to discussions we’ve had on this topic that go back as far as 1998. Because this has been brewing for a long, long time. And the question still remains – inflation or deflation – pick your poison. Our belief is inflation is a far more palatable option.
Back around 2003 I remember debating economic policy with a business reporter for the Wall Street Journal. I still recall the shock this person displayed when I downplayed the mitigating value of the “current account” when discussing America’s trade deficit. Apparently the conventional wisdom held that since foreign investment makes up the difference between how much America pays for imports vs. how much America collects from exports, the trade deficit of some $60 billion per month that America has racked up now for years on end is of no consequence. The problem with that sanguine assessment of our trade deficit is the fact that Americans borrowed all this money to make all these purchases, and eventually there is no financial instrument left to facilitate more borrowing. Quite simply, we can no longer borrow at a faster rate than we can afford to make repayments.
America’s debt binge really began about 30 years ago, in the mid 1970′s, which is the last time Americans exported more than they imported – also about the time credit cards started to really get popular. For a long time, America’s trade deficit was relatively insignificant, and foreign investment indeed more than made up for the shortfall. And if the monthly trade deficits hadn’t widened precipitously over the last ten years or so, they might have been sustained indefinitely. After all, America provides an enduring safe haven for investors, and exports security to the world. We keep the sea lanes open, we have a democracy that works, we are stable, we are innovators. And our perennial trade deficits mean our dollars finance the industrialization of emerging nations. Almost everybody was happy.
|Alan Greenspan, Chairman
Federal Reserve Bank, 1987-2006
It isn’t possible to quickly summarize where things started to slip out of control, but in ticking through the factors, it is very, very important to recognize there was no single party, nor a single ideology, that ought to be held solely accountable.
The repeal of the Glass Steagall Act in 1999, which lifted crucial restrictions on the degree to which banks were permitted to make speculative investments, combined with the refusal of then Federal Reserve Bank Chairman Alan Greenspan to raise interest rates so as to contain “irrational exhuberance” (his words) in the stock market, probably started to accelerate the slide that has resulted in the current predicament.
When the internet bubble burst, which any financially literate curmudgeon would have seen coming for years, the damage to the economy was severe – but rather than endure a downturn, mortgage lending entered a dangerously aggressive phase to pick up the slack. Replacing the collateral of inflated internet stocks, without skipping a beat, came the collateral of inflated home equity. Some would call these loans predatory, and they would be right to say so, but these “no doc,” “introductory rate,” “negative amortization,” “fixed but resetting in 2-3 years,” loans were also permitted thanks to intense pressure from both sides of the aisle to make housing “affordable.” Since it was impossible to make home prices fall, the only solution was to make home mortgages cheap. And since there is no such thing as a cheap home mortgage, “introductory rates” were the only way left to “get people into a home.”
So who enjoyed this mess that it is so easy to blame on Wall Street? People who suddenly thought they needed a 3,500 square foot McMansion and didn’t care if they were borrowing 10x their annual income? People who thought they would borrow against their inflated home equity at a floating rate so they could drive around in a 6,000 lb. SUV? Economic planners in Washington who didn’t dare tell the American people that an economy can’t live forever on credit – that it doesn’t work that way in the real world? What about all the public employee unions who used the ersatz prosperity of the internet bubble followed by the housing bubble to negotiate pensions that have created another crippling liability for the American people – and who used their financial might to take control of our elections and politicians at the state and local level? Or who didn’t want to lobby for mortgage lending reform because that might lower home prices, which in turn would lower property tax revenues? There were a lot of pigs at the trough, and none of them apparently cared about what would happen when it was time to pay the piper. And plenty of them knew better.
For these reasons, blaming the “free market” is a futile, shallow, potentially dangerous exercise. Power corrupts equally, and if popular sentiment leads our politicians to thoughtlessly eviscerate the prerogatives of our free market while leaving big government and big labor more powerful than ever, it will be a mistake of historic proportions.
The solution is to regulate mortgage lending and derivative trading in measured, not draconian steps. And any “solution” to Wall Street “greed” is empty if done without also recognizing and attempting to regulate the greed that is endemic in all sectors. To nationalize the banking industry without merging every public employee pension fund with the social security fund – newsflash, at this point only social security is even slightly solvent – is almost as absurd as the proposed nationalization of our energy industry to supposedly fight an alleged climate crisis. In both cases the villian is the market, and the good guys – translation, beneficiaries – are the government and public sector labor. Such blind scapegoating ignores the nature of man. To embrace such simplicity would be tragic for the United States and the world.
We need free markets, and good regulations, and good deregulation. We need to recognize that inflation is our only way out of this, because only through inflation can we systematically and somewhat equitably erode the real value of these mountains of debt we’ve collectively incurred. Failure to avoid this calamity should not be another excuse to bash free markets because responsibility for this failure is shared by everyone in this imperfect world. To paraphrase Winston Churchill, free markets are the worst economic system known to man, except for all the other ones.