Expecting the federal government to bail us out of the current economic crisis is like expecting a pyromaniac who sets our neighborhood on fire to extinguish the flames. The truth is that the federal government created this mess, and every one of the interventions it has proposed – especially the bailout of Wall Street millionaires and big investment banks – will only make things worse.
The root cause of the crisis is the Greenspan Fed, whose expansionary monetary policy of the past decade created a typical boom-and-bust cycle. By pushing interest rates to historically low levels for many years, the Fed caused what the Austrian economist Ludwig von Mises called “mal-investment” in a number of industries, particularly real estate. The bust always comes once it is realized that too much capital has been invested compared with the actual level of consumer demand. A liquidation of all that mal-investment is necessary in order to return to economic reality. The proposed bailout seeks to slow down or stop this necessary restructuring.
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The federal government has also spent the past 30 years pressuring, threatening and ordering mortgage lenders to make bad loans to unqualified (“subprime”) borrowers under the auspices of the 1977 Community Reinvestment Act. The CRA allows various “community groups” such as ACORN (Association of Community Organizations for Reform Now) to formally protest bank mergers, expansions, and branch openings if the bank had not made “enough” subprime loans – according to the criterion established by the Fed, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Office of Thrift Supervision. Banks would often pay the community groups millions of dollars in return for the withdrawal of their protests, along with promises of more bad loans, in a form of legalized extortion. Recent news reports contend that at least half of all the defaulted subprime loans are CRA loans.
In order to diversify the risk of all these bad loans, the government-sponsored Federal Home Loan Mortgage Company (Freddie Mac) pioneered the “securitization” of bundles of these high-risk loans and then sold them on secondary markets. So-called securitization exploded during the 1990s because of a 1992 law that required Freddie Mac and Fannie Mae “to devote a large percentage of their activities to meeting affordable housing goals” (i.e., subprime loans), according to Fed Chairman Ben Bernanke. The “community groups” greatly expanded their legalized extortion activities and the number of subprime loans exploded.
But even that was not enough. In 1995 the federal government allocated billions of tax dollars to so-called “community development financial institutions” to make even more subprime loans. The Fed then instructed banks that proof of income was not necessary for subprime loan applications; enrollment in a “credit counseling program” would suffice. Thousands of low-income families were financially ruined when the housing price bubble burst.
Just as the housing bubble was about to burst the Fed congratulated itself for all its efforts, along with one particular bank that it held out as a model of CRA compliance: Countrywide, which had committed some $600 billion in subprime loans. Shortly after that Fed announcement Countrywide went bankrupt.
The Fed, Fannie Mae and Freddie Mac, and other federal regulatory institutions exist as a means of dispensing corporate welfare to the banking industry and other special-interest groups. In the late ’80s the taxpayers were put on the hook to bail out banks that made bad loans to Third World dictators. Then there was the “Mexican bailout” (of the same American banks) during the ’90s, the Asian bailout, and now the subprime bailout. There’s a pattern here. Each bailout encourages banks to be even bolder in the future in making more and more risky loans, with the implicit guarantee of yet another bailout. Economists call this the “moral hazard problem.” Normal people call it theft, and would like to see the perpetrators thrown in jail.
Thomas DiLorenzo is professor of economics at Loyola College in Maryland. His latest book, to be published on Oct. 21, is “Hamilton’s Curse: How Jefferson’s Archenemy Betrayed the American Revolution – And What It Means for America Today.”
