Wednesday, November 12, 2008

Did Capitalism Fail or Did Our Government Fail?

In September our great nation was faced with a financial crisis not seen since the 1930’s. In response to this financial crisis, President George W. Bush called for a bill to save our financial markets. On September 28, 2008 America passed the “Emergency Economic Stabilization Act of 2008”. This bill provides over 750 billion dollars of tax payer dollars to attempt to restore credit and regain confidence in a downward economy that has grown to epic and global proportions. In essence the bill will allow the federal government to buy into the financial system through the ownership of preferred stock. I firmly stand against this action and have concerns about the federal government buying ownership into the financial district.

First lets go over how all this happened. In a nutshell this all leads back to the "Community Reinvestment Act" which forced banks to comply with Fannie Mae and Freddie Mac by giving out loans to people regardless of whether or not they could pay for them. Fannie and Freddie, partly owned by the federal government, offered to back these bad loans if any of them were to foreclose. With the government backing these loans, banks felt they had nothing to lose since they had to comply with the federal mandates or face costly lawsuits. So banks got creative with how they issued loans (Arm, interest only, no money down, etc.). Fannie and Freddie continued to make money as long as home values increased and as long as more loans were issued. The more loans the more money Fannie and Freddie made. Fannie and Freddie then bundled these mortgage loans into "mortgage backed securities" and sold them as investments to other banks who bought them. Next came high oil prices and inflation started to rise. Interest rates went up and more people started to foreclose. With too many foreclosures at one time, Fannie and Freddie couldn't back these loans and the downward spiral continues to this day.

What happened was not the result of the free market or deregulation, as the left would have you believe. What happened had everything to do with the fact that a bad government policy failed. Fannie and Freddie removed an important element of capitalism…..the element of risk. When risk is removed there is no fear and therefore there can be no failure. Risk is an essential part of capitalism. The old saying “the higher the risk, the higher potential for return” still holds true today as it did hundreds of years ago. In this case there was no danger in giving out risky loans because banks were assured they would be backed by the government. For example, let’s say you and I go to a casino, and I force you to play the slot machines. Then I tell you not to worry because if you lose any money I will cover your losses. Are you going to behave differently in that casino if I tell you I am going to back your gambling that day? Of course you will, and our financial markets are no exception.

So what does our government do? They buyout Fannie and Freddie so they are completely owned by the federal government, and bailout our banks by buying shares of preferred stock as collateral. Our federal government failed us by trying to make everything fair instead of letting the market determine who can pay back a loan. In a normal market banks all take a reasonable amount of risky loans, but too many can jeopardize their business. The federal government failed to regulate Fannie and Freddie and failed to enforce the existing laws we already have in place. As a result the federal government now has complete ownership of Fannie and Freddie, as well as a substantial stake in our largest banks.

So what should our government have done? For starters our government had no business mandating companies to take bad loans in the first place. I would love to see everyone own a home, but as we have seen too many people owning houses they cannot afford can lead to a disaster. I would like to see the government dramatically change the “Community Reinvestment Act” and reduce the power Fannie and Freddie have in the marketplace. Next, I would like to see the government stay out and not offer any tax payer money to financial institutions. However, as I stated above our government broke capitalism so now our government believes they have to come in and fix it. I am against the government owning any shares in our financial sector. If it is decided that federal help is mandatory then I would rather they issued bonds or loans coupled with legislature that completely changed the way Fannie and Freddie operate.

As a free market capitalist I am weary whenever the government buys into the private sector to “help out”. Usually when the government gets involved with anything they cause more problems than they solve. When this is all over is our government going to sell those shares back and get out of the private sector? That remains to be seen, but I have my doubts. What voice is our government going to have now that the government has a direct steak in the financial world? What kind of new regulations are going to be put in place while they are partial owners? Is the government going to mandate how these companies invest their money? I don’t recall hearing GW Bush say a bad government policy had a hand in causing the financial crisis. As other industries fall on hard times as a result, is the government going to bail them all out? The fact is we do not have the money to subsidize the private sector, and our federal government shouldn’t be in the business of running it in the first place.


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