2008 Housing Bubble: Four Popular Tools to Solve the Economic Crisis

In addition to bailout, the US government took four more tools from its arsenal to solve the financial crisis. Prohibition on short-selling is the first of these four.

Short-selling is the exact opposite of "buy low and sell high" strategy used by investors. Instead, traders "sell high and buy low" and they do this by borrowing stocks from a broker and sell them from their perceived "overvalued" price and buy them again when the price is down. These traders then return the borrowed stocks and keep the gain for themselves.

Thomas Woods is opposed to this kind of restriction. He thinks that traders are doing service to investors by giving them important information about sound firms. Without this information, investors might place their money on unsound firms. This wastes scarce resources and deprives sound companies of the necessary funds to finance their projects. 

Regulators do not like short-sellers for the latter exposed their failure to do their job to identify companies, which resort to fraudulent accounting practices to exaggerate profitability and fool investors. This is the reason why short-sellers are doing great service for the good of economy by alarming investors. 

Another tool to aid the economy was the increase of insurance of depositors' money "from $100,000 to $250,000" "without considering the soundness of the bank's finances" (p. 45). For Woods, this was an additional "layer of moral hazard" for such action on the part of the FDIC removes from the banks the "need to become more cautious and conservative" (ibid.). Woods notes that in reality, the FDIC can only insure .5% of all the depositors' money. And so in case banking crisis occurs, the ultimate solution is to return to the old trick of printing USD. 

Still another solution was "foreclosure holidays" (p. 46). For Woods, this would aggravate the problem for this would entice the marginal borrowers to stop their mortgage payments. This would result to lesser credit, thereby depriving the common man to avail a mortgage loan, an unfortunate outcome that will be blamed on free market's "inefficiency".

And finally, we come to more regulation. For Woods, it is crucial to understand the basic framework how this talk on regulation and deregulation is taking place, which is the act of transfering the risk of unsound companies to taxpayers. Woods indicates that this debate on "deregulation" is actually anomalous for how can one talk of it when the government allows firms to make riskier investments with the guarantee of taxpayers' money. This is not deregulation. Genuine deregulation entails the removal of monopoly and free competition. For Woods, the real problem is "a system that artificially encourages indebtedness, excessive leverage, and reckless money management" (p. 47). And so the passing of Sarbanes-Oxley, which demands higher financial requirement from firms would actually prevent the creation of new firms. This would protect big firms from competititon and that's why Woods believes that they would join the "choir" of those who are singing for more government regulation. Woods agrees with Michael S. Malone that this kind of regulation would result into further economic anomalies. Quoting Malone, Woods describes these results:

"'. . . fewer new companies are going public; economic power is being concentrated in the hands of fewer companies; competition is reduced; new wealth is less widely distributed; the rich are getting richer; fewer talented people want to join entrepreneurial ventures; and corporate boards are getting more stupider and more paranoid'" (p. 48). 

Guide Questions:

1. Enumerate the five mainstream solutions to economic crisis. Briefly explain each.

2. Why is it that restricting short-sellers would harm the economy?

3. Are depositors' money completely safe in the bank? How many % of it is actually insured. How can FDIC keep its insurance policy in case of a bank collapse?

4. How would foreclosure holidays shift the blame to free market?

5. Identify the long-term results of more government regulation. 

Source: Wood, T. E. Jr. (2009). Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Washington, DC: Regnery Publishing, Inc.

2008 Housing Bubble: The Bailout Bonanza!

Prior to 2008 global economic crisis, American officials assured the public that there was nothing to worry about the state of the economy. This was the message of both Henry Paulson, the US treasury secretary and Ben Bernanke, the chairman of Federal Reserve. The popular financial advice was "Don't panic. Don't stop investing. Don't stop borrowing to buy homes. Spend like you're Paris Hilton. Everything is just fine (p. 38)." But after the advice was proven wrong, these officials instead of losing credibility were even demanding greater power.

And so the demand for greater power was granted. It was believed that bailouts can solve the world's economic troubles. The US government took over Fannie Mae and Freddie Mac, which "held $5 trillion in mortgage liabilities" (ibid.). What came next was the "Bank of America's purchase of Merrill Lynch" (p. 39) with the influence of course of the Fed. And then the US treasury secretary came up with "ten financial institutions to work out a bailout for Lehman Brothers" (ibid.). But the solution did not work out and so the "Lehman Brothers was ultimately allowed to go bankrupt" (ibid.). However, the bailout magic continued. AIG received a total of $125 billion bailout, which the New York Times describes the initial bailout of $85 billion as "'the most radical intervention in private business in the central bank's history'" (p. 40). The government was hailed as the savior of corporations at the expense of the productive sector of the economy, the taxpayers. 

With the exception of the Lehman Brothers, which situation was beyond recovery, the popularized reason why the identified firms were not allowed to go bankrupt was to prevent the domino effect of their collapse upon other firms that would seriously harm the economy. 

In reality, it was the act of bailing out these firms that harm the economy. Allowing them to go bankrupt would result into an opportunity for the economy to recover through market forces. For Thomas Woods, bailing out those firms "discourages rather than encourages capital formation and economic recovery" (p. 41). 

To make the situation more serious, as if the previous bailouts were not sufficient enough to ruin the economy, a bill, "the Emergency Economic Stabilization Act of 2008" was passed. This bill gave the US treasury secretary the authority to buy $700 billion in assets "'at any time'" (p. 42). 

Guide Questions:

1. What does it tell about the current system when those in authority who failed in their public pronouncement were entrusted with greater power rather than losing their credibility?

2. What was the perceived solution to global economic crisis? Briefly explain your personal understanding of this solution.

3. Who were the firms that the US government bailed out? What was the justification for doing so?

4. What do you think would be the long-term impact on global economy of this bailout bonanza? Why?

Source: Wood, T. E. Jr. (2009). Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Washington, DC: Regnery Publishing, Inc.

2008 Housing Bubble: Blaming Financial Deregulation and the "Too Big to Fail" Mentality

Another pretext the Obama administration used to shift the attention of the public to Bush administration is financial deregulation. Since deregulation is what the currrent administration wants the American public to believe that was responsible for the economic meltdown, what is needed is greater "government oversight." For Woods, to emphasize financial deregulation as the reason for the collapse of the housing market obscures the real issue for the "lenders were doing exactly what the federal government and its central bank wanted them to do" (p. 29). 

Both the Democrats and the Republicans were guilty of abandoning the "traditional lending practices" (ibid.). In the case of Bush administration, it was responsible for the removal of the required down payment "for 150,000 new homeowners" (ibid.). Such action is part and parcel of the realization of the American dream that would include increasing number of the American people. So deregulation is actually out of the question for it was the president himself who gave approval to riskier lending practices. 

Nevertheless, the financial regulators prior to the bursting of the real estate bubble were all in agreement about "the fundamental soundness of the system" (p. 30). Both Allan Greenspan and Ben Bernanke and two other unnamed Fed economists shared the perspective that the housing bubble didn't exist. Moreover, "some of the major financial institutions" think that the growth of the real estate industry was actually based "on real factors" (ibid.). Again for Woods, blaming deregulation is misleading for one can traced the hand of the US government everywhere prior to the collapse of the housing market with its consent to the action of the Federal Reserve in increasing the money supply and reducing the interest rates. 

"Too big to fail mentality" became popular after the crisis. This idea does not allow giant financial firms to go bankrupt though their practices and continued existence would actually harm the economy. "Bailout" was the name of the game and Alan Greenspan was exalted as its great champion. For Woods, bailing out these firms simply meant transfering the financial burden to the unsuspecting taxpayers. 

Greater government regulation and bailout are the hailed solutions to the housing crisis. Woods believes that the US government would consider other tools to solve the crisis except the solution that comes from the market. 

Another card allowed by the government to utilize was the offer of financial assistance to distressed homeowners. The government GSEs that shared the responsibility in the crisis, Fannie and Freddie offered homeowners a financial aid to avoud foreclosure. This aid includes "reductions in principal owed, lower interest rates, and a longer payoff term" (p. 33). However, those who resort to minimize their loss through responsible decision such as transfering to smaller houses would not be included in this assistance program. 

And so after 7 years, the best solution the US government could come up with is the same action that caused the crisis in the first place. And so in the coming years we could not expect for a genuine global economic recovery but an expansion of the crisis. 

Guide Questions:

1. Why blaming financial deregulation obscures the real cause of the housing bubble?

2. Prior to the collapse of the housing market, what was the popular opinion among regulators?

3. What is "too big to fail mentality"? How is it being implemented? And what is the real nature of such implementation?

4. So far, what solutions the US government agreed with in order to address the 2008 crisis?

5. What do you think should be the market solution? 

6. With the existing US government solutions, what do you think will happen to global economy in the near future? 

Source: Wood, T. E. Jr. (2009). Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Washington, DC: Regnery Publishing, Inc.