Fannie, Freddie, Basel, and the Fed

George Melloan's column in the Wall Street Journal discusses the new Basel capital standards and correctly observes that 22 years of global banking regulations have not generated good results. This is not because requiring reserves is a bad thing, but rather because such policies do nothing to fix the real problem. In the case of the United States, easy money policy by the Fed and a corrupt system of Fannie Mae/Freddie Mac subsidies caused the housing bubble and resulting financial crisis. Yet these problems have not been addressed, either in the Dodd-Frank bailout bill or the new Basel rules. Indeed, Melloan points out that Fannie and Freddie were exempted from the Dood-Frank legislation.

There's something to be said for holding banks to higher capital standards, even at the cost of more constrained lending and slower economic growth. But the much-bruited idea that Basel rules will make the world freer of financial crises is highly doubtful, given current political circumstances. The 2008 financial meltdown was not primarily the result of lax regulation but of co-option and abuse of the U.S. financial system by the political class in Washington. The federal government's "affordable housing" endeavors, beginning in the 1990s, allowed and even forced banks to make highly risky mortgage loans. Those loans were folded into mortgage-backed securities (MBS) sold in vast numbers throughout the world, most promiscuously by two government-sponsored enterprises, Fannie Mae and Freddie Mac. The Federal Reserve contributed a credit bubble that caused house prices to soar, a classic asset inflation. When the bubble began to deflate in 2007, the bad loans in mortgage securities became poisonous. The MBS market seized up, and financial institutions holding them became illiquid and began to crash. The Lehman Brothers collapse was the biggest shock. The only way Basel standards might have helped prevent this would have been if they had been applied to Fannie and Freddie as well as to banks. They weren't. President Bill Clinton exempted the two giants from Basel capitalization rules because they were the primary instruments of a federal policy aimed at helping more lower-income people become homeowners. This was a laudable goal that ultimately wrecked the housing and banking industries. Washington has learned nothing from this debacle, which is why the next financial crisis is likely to have federal policy origins and may come sooner than we think. Fannie and Freddie—now fully controlled by Uncle Sam and exempt from the Dodd-Frank financial "reform" legislation—are still going strong, guaranteeing and restructuring loans while they continue to rack up huge losses for taxpayers. ...The record since the Basel process began 22 years ago doesn't generate faith in banking regulation either. Basel rules didn't prevent the collapse of Japanese banking in 1990, they didn't prevent the 2008 meltdown, and they are not preventing the banking failures that plague the financial system even today.

P.S. The bureaucrats and regulators who put together the Basel capital standards were the ones who decided that mortgage-backed securities were very safe assets and required less capital. That was a common assumption at the time, so the point is not that the Basel folks are particularly incompetent, but rather that regulation is a very poor substitute for market discipline. Letting financial firms go bankrupt instead of bailing them out would be a far better way of encouraging prudence.

Check Out Ben Bernanke's Facebook Page

Actually, I suppose we should clearly state that someone is having some fun by mocking Helicopter Ben, but that person did a good job. Kudos to Tertium Quids for finding this gem.

Bashing Corrupt TARP Bailouts

Appearing on Fox Business News, I summarize the many reasons why the Bush-Paulson-Obama-Geithner TARP bailout was - and still is - bad policy.



I'm sure I have plenty of flaws, but at least I am philosophically consistent. Here's what I said about the issue more than 18 months ago. The core message is the same (though I also notice I have a bad habit of starting too many sentences with "well").

Alan Greenspan Should "Man Up" or Drop Out of Sight

John Stossel appropriately scolds the former Federal Reserve Chairman for blaming the financial crisis on the free market. I'll go one step farther and say that Greenspan's behavior is a reprehensible example of someone lacking the cojones to take responsibility for his mistakes. Greenspan is surely not responsible for the corrupt system of subsidies from the government-created nightmares known as Fannie Mae and Freddie Mac, but he definitely deserves the lion's share of the blame for the Fed's easy-money policy of artificially-low interest rates. Greenspan presumably knows he screwed up, which makes his attack on free markets especially despicable. The icing on the cake is that he's also sucking up to the political establishment by endorsing higher taxes. Hasn't he already done enough damage?

I'm getting tired of Alan Greenspan. First, the former Federal Reserve chairman blamed an allegedly unregulated free market for the housing and financial debacle. Now he favors repealing the Bush-era tax cuts. ...During a congressional hearing two years ago, Greenspan shocked me by blaming the free market -- not Fed and housing policies -- for the financial collapse. As The New York Times gleefully reported, "(A) humbled Mr. Greenspan admitted that he had put too much faith in the self-correcting power of free markets." He said he favored regulation of big banks, as if the banking industry weren't already a heavily regulated cartel run for the benefit of bankers. Bush-era deregulation is a myth perpetrated by those who would have government control the economy. We libertarians were distressed by Greenspan's apparent abandonment of his free-market philosophy and his neglect of the government's decisive role in the crisis. ...now Greenspan, going beyond what even President Obama favors, calls on Congress to let the 2001 and 2003 Bush tax cuts expire -- not just for upper-income people but for everyone. ...the stupidest thing said about tax cuts is the often-repeated claim that "they ought to be paid for." How absurd! Tax cuts merely let people keep money they rightfully own. It's government programs, not tax cuts, that must be paid for. The tax-hungry politicians' demand that cuts be "paid for" implies the federal budget isn't $3 trillion, but $15 trillion -- the whole GDP -- with anything mercifully left in our pockets being some form of government spending. How monstrous!

A Victory Against the Federal Reserve

Kudos to the federal appeals court that just ruled that the Federal Reserve has no right to hide the sordid special handouts it provided to well-connected financial firms. Here's an excerpt from a report about the decision:

The Federal Reserve must reveal documents identifying financial companies that received Fed loans to survive the financial crisis, a federal appeals court ruled Friday. A panel of the 2nd U.S. Circuit Court of Appeals in Manhattan said in two separate opinions that such information isn't automatically exempt from requests under the Freedom of Information Act. News Corp.'s Fox News Network LLC and Bloomberg L.P. sued separately for details about loans that commercial banks and Wall Street firms received and the collateral they put up. Other news agencies, including The Associated Press, filed briefs with the appellate court in their support. The Fed argued that if it identified banks that drew emergency loans, it could cause a run on those institutions, undermine the loan programs and potentially hurt the economy, and lower-court judges were split on the issue. The Federal Reserve said it's studying Friday's ruling.

On a broader note, I'm periodically asked about monetary policy, the Fed, and the financial crisis. I do my best to stay away from the first two topics, largely because my interests are elsewhere (though I did handle the Federal Reserve for the Bush/Quayle transition team, many years in the past). But that does not mean the issues are unimportant. For those that are interested, I recommend two articles, one by George Selgin and the other by Gerald O'Driscoll.

Federal Reserve Chairman Wants Central Bank to Be Rewarded for a Crummy Job

We've all heard the joke about the guy who gets convicted of murdering his parents and then asks a judge for mercy because he's an orphan. That same kind of chutzpah was displayed in a recent column by Fed Chairman Ben Bernanke is the Washington Post. In an attempt to preserve some of the Fed's regulator powers (which are not necessary for, and may be harmful to, the central bank's ostensible mission of price stability) and dodge accountability and oversight, Bernanke warns that, "These measures are very much out of step with the global consensus on the appropriate role of central banks, and they would seriously impair the prospects for economic and financial stability in the United States. The Fed played a major part in arresting the crisis, and we should be seeking to preserve, not degrade, the institution's ability to foster financial stability and to promote economic recovery without inflation." These two sentences would be laughable if it wasn't for the fact that Fed policy mistakes have caused so much misery. At the risk of stating the obvious, the Fed's easy-money policy was the main reason for the financial crisis. Bernanke's argument is akin to an arsonist expecting praise for calling the fire department after setting a house on fire. But Bob Higgs, the highly-regarded economic historian, had the best analysis:

And about this “economic and financial stability in the United States” that a Fed audit would threaten: Is Bernanke thinking about the stability we enjoyed between the world wars, when the Fed managed to bring about the onset on what proved to be the greatest depression in world history (an accomplishment for which he has previously accepted responsibility on behalf of the Fed)? Or perhaps he is thinking instead about the stability we enjoyed since 2001, when the Fed pushed the Fed funds rate quickly from 6.5 percent to 1 percent, held it at a negative real rate for several years, then pushed it up quickly to 5.25 percent in 2006-2007, then shoved it down quickly to almost zero in the past year? Zounds. It would certainly be tragic if the American people had to give up such remarkable stability. Or perhaps he is thinking about the fact that before the Fed was created, the dollar had retained its purchasing power more or less constant for more than a century, except for transitory war-related ups and downs, but since the Fed’s creation, the dollar has lost more than 95 percent of its purchasing power. Who calls this degree of debasement stability?

Weekly Economics Lesson: The "Sugar High" of Easy Money

Steve Pearlstein of the Washington Post has a common-sense column warning about the dangers of the Fed's easy-money policy. It is possible, to be sure, that the Fed will withdraw (or "soak up") all this liquidity as the economy recovers, but all the signs suggest that the central bank is kowtowing to the politicians and debasing the currency in order to help politicians create illusory growth. This is a recipe for a return to the 1970s. The bad policy started under Bush (and Greenspan) and is continuing under Obama (and Bernanke):

The Federal Reserve is still going through its "lessons-learned" exercise from the recent financial crisis, but there's one lesson it clearly has not yet absorbed -- the one about ignoring and enabling credit bubbles. That's the only conclusion that can be drawn from the Fed's decision last week to not only keep its benchmark interest rates at zero but also let everyone know that it intends to leave them there for a good long time. ...Not surprisingly, all of this sparked a week-long party in financial markets that had already experienced powerful rallies over the past six months. Even with Thursday's modest pullback on Wall Street, U.S. stocks are up 60 percent since March, and share prices in emerging markets have nearly doubled. Commodity prices are soaring once again, led by gold, which is now selling for more than $1,100 an ounce, and crude oil, which is up a whopping 126 percent since February. A rally in the junk-bond and third-world debt markets has driven interest rates back to where they were before the crisis. In urban China, India and Brazil, property prices have doubled in the past year. "The markets are on a sugar high," Mohamed El-Erian, chief executive of Pimco, the giant money manager, told Newsweek's Rana Foroohar last week. Judging from how sharply and quickly these prices have risen, it's a pretty good guess that most of the buying has not been done by long-term investors who are suddenly upbeat about the prospects of global economic growth. The better bet is all this is the handiwork of short-term speculation by banks, hedge funds, private-equity funds and other financial center wise-guys moving as a herd, financing their purchases directly or indirectly with some of that yummy zero-percent money provided courtesy of the Fed. ...There's no way to know how long all this can continue before one of these bubbles finally bursts, the dollar spikes upward and investors all rush to unwind their trades at the same time. But it is a good guess that it will last as long as the Fed and other central banks indicate there is no end in sight for the current cheap-money regime. The longer they wait, the bigger the bubbles, and the bigger the mess to clean up. All of which is why the recent statements by policymakers were so disappointing -- and so dangerous.

A Weak Currency Does Not Lead to a Strong Economy, Part II

Appearing on MSNBC, I engage in some wholesome Fed-bashing.

In my research before appearing on the program, the most shocking factoid I discovered is that the dollar has lost 95 percent of its value since the Fed was created in 1913.

But let's not forget that the Fed's accelerate-too-fast/brake-too-hard approach to monetary policy (with the first part generally being the result of trying to artificially goose the economy to help politicians get reelected) is largely responsible for disasters ranging from the Great Depression to the current financial crisis.

And now the Fed is turning the dollar into the Argentine peso by running the printing presses 24/7. What's not to love?

A Weak Currency Does Not Lead to a Strong Economy

Writing in the Wall Street Journal, David Malpass explains why the Fed's weak-dollar policy (supported by both Bush and Obama) is a recipe for economic decline:

Some weak-dollar advocates believe that American workers will eventually get cheap enough in foreign-currency terms to win manufacturing jobs back. In practice, however, capital outflows overwhelm the trade flows, causing more job losses than cheap real wages create. This was the lesson of the British malaise, the Carter malaise, the Mexican malaise of the 1990s, Yeltsin's Russian malaise through 1999 and the rest. No countries have devalued their way into prosperity, while many—Hong Kong, China, Australia today—have used stable money to invite capital and jobs. ...If stocks double but the dollar loses half its value, who beyond Wall Street are the winners and losers? There's been a clear demonstration this decade. The S&P nearly doubled from 2003 through 2007. Those who borrowed to buy won big-time. Rich people got richer, seeing their equity bottom line double. At the same time, the dollar's value was cut nearly in half versus the euro and other stable measures. Capital fled, undercutting job growth. Rent, gasoline and food prices rose more than wages. ...The solution is a strong U.S. jobs and wealth program. It has to include stable money, a flatter, more competitive tax structure, spending restraint, and common-sense bank regulation so small business lending can restart. ...Instead, Washington's current economic program pushes capital away by weakening the dollar, threatening higher tax rates, borrowing short (the Fed's near trillion-dollar overnight debt, Treasury's mounds of bill and note issuance) to lend long (mortgages, student loans, entitlements), doubling down on government subsidies, and rechanneling bank loans to governments and big businesses instead of the small business job-growth engine.