Tuesday, October 28, 2008

Whose Economic Policies are at Fault Again?

Obama asks US voters to “turn the page” on Bush’s economic policies.

Barack Obama would have you believe that the Democrats have the solution for the economy, if only those rascally Republicans would stop getting into office and messing everything up.

Now just a cotton-pickin’ minute here! Let’s just review some basic economic facts before we start pointing fingers. I know a bunch of people voting today really don’t remember the 1970’s,   so hang on, kids, it’s time for a history and economics lesson.

In the last 40 years, we’ve had economic ups and downs. The seventies were marked by an astonishingly bad economy – bad enough that the present crisis looks like a spectacularly good day. The Democrats controlled congress, and President Nixon was a social liberal. Wage freezes were in effect (Can you imagine? The Federal Government making it against the law to give someone a raise?). Oil prices were causing lines at the gas pumps that were miles long at times.

Enter Jimmy Carter, and things got worse. A lot worse. Carter raised taxes and increased social security benefits. The Dow lost 25% of its value in the first two years of his presidency, and we were introduced to a term called stagflation – double digit interest rates, coupled with double-digit inflation. Economists assured us this was impossible, except it was happening! The media coined a new term, called the misery index, which coupled the unemployment rate to the inflation rate.

Carter did one thing of particular note during his presidency. In 1977 he signed into law the Community Reinvestment Act. This gave incentives to banks to help low-income borrowers get a home. Not a bad idea. Remember this, we’re going to come back to it.

Because of the dismal economy at home and a general indecisiveness abroad (remember the Iranian hostage crisis?), Carter lost his job to Reagan after one term. Reagan proceeded to slash corporate taxes, capital gains taxes, and the marginal tax rate. Nay sayers scoffed at “Reaganomics”, and “Trickle-down economics.” They still do, in spite of the overwhelmingly positive results.

You see, Reagan was a visionary who implicitly understood that the way to build the country’s wealth was to let the people who were wealthy create more wealth! Wealthy people don’t store their wealth in a shoe or under the mattress, they invest it! They use it to buy things. They use it to employ people! In short, they put their money to work making more money! If you don’t believe this would have a positive effect on the economy and put the nation back to work, then just answer one question: When was the last time you drew a paycheck from a poor person?

The economy started grinding ahead under Reagan. It was a slow recovery, but it was sustainable. By the end of Reagan’s first term, the Dow had more than doubled its value. There was a huge hiccup in October of 1987, which was not so much a case of weakness of the economy, except a literal financial fumble. New computerized trading systems had no safeguards, and a sudden sharp sell off created a computer-driven panic that crashed the market 20% in a single day. Stop orders were tripping, causing computerized sell orders, which drove the market down and caused more stop orders to trigger. The wheels fell off, and no one could do anything, because they couldn’t get in front of the computers. The panic was short-lived, and by the end of the month, the market had resumed it’s steady climb upward, albeit from a more subdued starting point.

The Bush administration was unremarkable. The Iraq invasion of Kuwait caused the market to react negatively, but as Bush got control of the situation, the market recoverd quite nicely.

All the while, under the hood of the economy where no one could see, some things were happening.

  • First, Reaganomics were still at work. The money that companies saved under the Reagan tax cuts was going to work. Infrastructure was being laid, buildings and factories were being built. The machines that would make the machines which would make the goods of the nineties were being designed and built. All of this took money – money made available by Reagan leaving it in the hands of the very people who knew how best to use it.
  • Second, we had won the Cold War. Reagan, Thatcher and John Paul II had rocked the Communist monolith and discovered it was a house of cards. The vast sums of money that was essentially flushed down the economic toilet to maintain military parity with the Communist block were cut back to a trickle, and the resulting proceeds became available for reinvestment into growing the economy. Call it a Peace Dividend.
  • Third, a strange new technology called the microprocessor was about to revolutionize the economy of the USA. This technology would become a gigantic force multiplier for the US worker, and to feed the huge demand for it, whole new industries were laying down foundations. This technology would create a huge vacuum full of unexplored opportunity in just about any field of endeavor you could imagine.
When Bill Clinton took office, these three things were set to explode and carry the economy forward on a literal tidal wave of prosperity. And Clinton, in his usual style, surfed this tidal wave of prosperity and claimed credit for every bit of it, even though he had nothing to do with it (of course he did have the creator of the internet as his vice president. . .).

During the economic boom of the Nineties, set off by a triple fuse that Reagan had lit ten years earlier, Clinton could pretty much do what he wanted and could do no wrong economically. One thing he did do was to revamp the regulations regarding the Community Reinvestment Act (remember that?). Under new regulations, banks faced stifling penalties if they did not expand their role in lending money to borrowers with low down or no down payments. Banks were basically forced to issue $1 trillion in new “subprime” loans to people that they would not have loaned to in a free market, because these people were credit risks. Failure to do so would be noted when the banking regulators reviewed applications to branch and grow.

During March 1995 congressional hearings William A. Niskanen, chair of the Cato Institute, criticized the proposals for political favoritism in allocating credit and micromanagement by regulators, and that there was no assurance that banks would not be expected to operate at a loss. He predicted they would be very costly to the economy and banking system, and that the primary long term effect would be to contract the banking system. He recommended Congress repeal the Act.

The banks swallowed this poison pill and smiled, because what the hell, the economy was doing great, so the risk was theoretically still manageable, right?

This created subprime mortgage securities. Bear Stearns was the first to do it. Mortgage underwriter Fannie Mae added fuel to the fire, and subprime mortgages started to grow.

Okay, here’s where it starts getting a little tricky, so stay with me here. More money made available for loans to buy homes increases competition for those homes. House prices rise. Market speculators see this and start buying homes as short term investments, further fueling the pressure for prices to rise.

Banks see this trend, and are under pressure to make a profit. They begin developing designer loan packages, with outrageous variable interest rate schemes. The idea is that the investor could get a low introductory rate which would eventually reset to a usuriously high rate. This didn’t concern the investor, because his plan was to sell into the hot market and catch a quick profit and flip the house before the interest rate reset. He’s like the family who always uses a credit card, and doesn’t worry about the interest rate, because he pays off at the end of the month – always.

The gun was cocked and aimed at the economy’s head. And it was Democrat legislation that cocked it.
George Bush took office at the beginnings of an economic decline. Clinton had steered the booming economy perilously close to the rocks, and handed the wheel to Bush just before it hit. The economic downturn actually had begun to be felt in October of 2000, a mere month before the election. Bush took immediate action to right the course and steer the economy back on track. He cut taxes, which quit putting a brake on the economy, and allowed the productivity that had begun to falter under Clinton to begin regaining speed.

Then 9/11 happened. International terrorism struck right at the heart of our financial system. Fortunately, the terrorists didn’t understand that Wall Street is just a reflection of the economy. The real wealth is made in the factories, not on Wall Street. Under the Bush tax plan, the economy shrugged off the damage and surged forward once again.

Meanwhile house prices (yes, we’re revisiting the growth of the mortgage bubble) were accelerating. For the first time in history, house price appreciation was no longer tracking the Consumer Price Index, but was surging way ahead of it. Responsible politicians began to get alarmed.

In 2003, the Bush administration recommended the housing finance industry be overhauled. But the democrats stopped it: “Supporters of the companies said efforts to regulate the lenders tightly under those agencies might diminish their ability to finance loans for lower-income families.”

 “The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.” – Barney Frank (D-MA)

 “…And in the process weakening the bargaining power of poorer families and their ability to get affordable housing, “–   Melvin Watt (D-NC)

In 2005, John McCain warned of mortgage collapse and he co-sponsored “The Housing Enterprise Regulatory Act Of 2005”. Democratic opposition ensured it never got out of committee. There might be thousands of reasons for this. But something smells bad: the top three recipients of campaign finance contributions from mortgage lenders Freddie Mac and Fannie Mae for the last 20 years?

  • Christopher Dodd, (D-CT), chairman of the Senate Finance Committee. 
  • Barack Obama, (D-IL)
  • John Kerry, (D-MA)
I don’t know, I’m just sayin’. . .

So in spite of the Bush administration and John McCain’s efforts to disarm the financial gun that was pointed at the economy’s head, the Democrats earned their money by keeping things as they were.

Then something else happened, something that neither Democrat or Republican had any control over.
There are a billion Chinese in China. And a billion Indians in India. And all these people started exhibiting an unusual behavior. You see, they were working, too. A lot of their work was building things to sell to America to support its booming economy. And all these workers were making money, and then they were spending that money to buy . . . cars.

And cars need gas.

And gas needs oil.

Except that the oil producing cartels weren’t opening the spigots to meet demand. And oil prices went up. This is economics 101: Supply and demand. Even a Democrat can understand this. Oil is a fungible commodity: The consumer doesn’t really care about where it comes from, and the supplier doesn’t really care who buys it. Basically suppliers sell their oil into the world market, and consumers buy it off the world market. To try to regulate oil prices for domestic oil companies merely punishes them and prevents them from competing in the global market.

So gas prices started rising. And that affects everything. It takes oil to produce food. It takes oil to get the food to market. It takes oil to move goods from factory to consumer. All these things cost more, and the prices get passed on to the consumer, putting a brake on personal income just as bad if not worse than raising taxes.

Now, suddenly, the guys who never should have gotten a loan in the first place could no longer make payments and keep gas in their cars and buy food. Mortgage defaults began to rise. As foreclosures become more common, the housing industry faltered. House prices flattened out and began to fall in some places. The investors looking for a quick flip watched in horror as their equity evaporated, and their adjustable rate mortgages started to reset to fantastically higher rates – rates that couldn’t be sustained. The investors started lose money, and either dumped their houses for what they could salvage, or rode them down to foreclosure.

Banks had been forced by regulatory requirements to give out risky loans by Democratic legislation, supported by Democratic stonewalling against reform. Those loans were now defaulting, and the banks were collecting collateral that was no longer worth the money which had been loaned.  The trigger had been pulled.

The free market had not failed, because it hadn’t been free.

To quote a Chicago pastor, “Them chickens have come home to roost!”

Failure of banks is not a good thing. It smacks too much of the Depression. But government money to bail them out, without reforming the very artificial condition that led to this mess is like fighting a fire with gasoline.

Economics is not hard, but the Democrats want you to think it’s hard so they can confuse you. The architects of this mess want your vote this November. Vote for free markets. Vote for lower taxes. Vote for economic prosperity. History shows which party has been the champion of these.
If you haven't seen it, there's a video that describes some of this in more detail, without the overall economic framework.  Here's a transcript of the video.

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