When the housing bubble finally burst in 2008, predictably, the media began to blame freedom and Capitalism. Like dogs barking at their own shadow, they howled against nothing more than the specter of what makes all countries great and prosperous. Conclusions such as these are nothing more than the result of people placing political ideology above plain and simple facts that lead any thinking individual to an inevitable conclusion - this was not the failure of a free market.
We are under constant barrage by people claiming to be fighting for freedom yet simultaneously decrying Capitalism. To what do we owe this stupendous amount of cognitive dissonance? To anyone that knows the definition of Capitalism and Socialism, the people blaming the market would seem quite clearly delusional. The origins of this psychosis would seem to have come from Karl Marx and his complete mangling of language. By redrawing the definitions of words, he created a mass of confused, blind and angry people that knew they were being robbed but were totally unable to identify the true criminals. The Communist/Capitalist dialectic implemented by Marx is simply code for Socialism and Fascism, superficially different political systems that are functionally identical. The extent to which this dialectic has permeated our society is truly disturbing and has been enshrined in the mainstream definition of the political spectrum. No matter which side of the spectrum they place themselves on, the Statists win and the people lose.
Statists lament the elimination of the Glass-Steagall bill and associate its repeal with our current economic crisis. The irony could not be more evident, for it was Senator Glass himself whom we have to thank for the existence of the real culprit, the Federal Reserve, which came into being upon the passage of HR 7837, commonly called the Glass-Owen Bill. The details of this bill were created in secret and surreptitiously snuck through congress in 1913. Once this system was in place, America had been conquered.
The big banks are the state apparatus which we need to bring about socialism, and which we take ready made from capitalism... A single state bank, the biggest of the big, with branches in every rural district, in every factory, will constitute as much as nine-tenths of the socialist apparatus. This will be... so to speak, something in the nature of the skeleton of socialist society.
The truth of the matter is that the repeal of Glass-Steagall had very little to do with generating a housing bubble, and no amount of regulation of banks would have prevented it because it was regulations that created the problem in the first place. After the repeal of Glass-Steagall, which prohibited any one institution from acting as an investment bank, commercial bank, and/or insurance company, we saw no flurry of activity to take advantage of this. Should we have really expected to? Does it really matter to the shareholders if the financial services their companies offer are forcefully split into three organizations or allowed to combine into one?
What about all the deregulation that supposedly occurred throughout the Bush presidency? Well a quick look at the amount of pages in the Federal Register, which records all the regulations passed by every branch of the Federal Government, quickly reveals this fallacy. The Register grew from 64,431 pages in 2001 to a record-setting 79,435 in 2008, a 23% increase in the volume of regulations! The fact of the matter is that the government more heavily regulates the financial sector than any other sector of the economy, with healthcare a close second (As a side note, one must begin to wonder if it’s really just coincidence that all the sectors of industry that are most tightly controlled by government are the ones that society complains the most about). This is further compounded by the fact that it is the Federal Reserve, a quasi-government institution, which has total control over the money supply in the country. Bubbles only form if there is an excess of credit available in the monetary system and when Alan Greenspan set interest rates to 1% for a protracted period, credit expanded to stratospheric heights.
Truth be told, it was far more than simply Federal Reserve policy that created this bubble. It was a direct consequence of a concerted effort by government to increase home ownership rates throughout the country. They systematically rigged the financial system in favor of making loans to people looking to buy homes regardless of their credit-worthiness. A review of housing price indices shows an explosion of housing prices beginning in 1997. The timing perfectly coincides with the passage of the Taxpayer’s Relief Act of 1997. It contained several items in it that would make owning a home significantly more attractive.
For instance, it reduced the top capital gains rate from 28% to 20% and the 15% bracket was slashed to 10%. The Government also increased the home sale exemption to $500,000 for couples and $250,000 for individuals. In the past, exclusions of only $125,000 were available and only to those aged 55 and over. With the incredibly low interest rates being offered through the Federal Reserve, banks were able to employ huge amounts of leverage in order to make these loans. The housing market became increasingly lucrative for investors to make tax-free gains of up to half a million dollars as prices continued to be driven upwards. No-money down loans and no income verification made it easy for anyone to speculate on housing and it created a nation of house flippers, eager to make a quick buck out of real estate. The last decade was reminiscent of the roaring 20’s, where credit expansion by the Fed once again set the nation up for ruin.
We still have not even begun to address the massive distortions created by the government-sponsored enterprises Fannie Mae (FNM) and Freddie Mac (FRE), who were explicitly mandated to drive the policy of increasing homeownership throughout the country. How were these entities able to accomplish this? If you’ve ever heard of a mortgage backed security a.k.a. collateralized debt obligation then you know precisely how because these instruments, largely blamed for the crisis, were the bread and butter of these institutions. Their primary activity was to purchase bundles of mortgages from banks and issue these securities in exchange.
The banks could then sell the securities through Wall Street for the cash required to go out and make even more loans to unqualified homebuyers. These institutions served as a black hole for debt that allowed the lending to proceed at a pace no free market could ever sustain. Both companies were created by congress, given lines of credit with the US Treasury, and operated with an implicit guarantee that should they ever lose on the mortgages that they purchased that they would be bailed out. Should we then be surprised then that this is exactly what happened?
The corruption and incompetence at these institutions was stunning. In December 2004, the chief accountant for the SEC issued a statement regarding Fannie Mae’s improper accounting of deferred purchase price adjustments and derivatives used in hedging activities. The scandal forced CEO Franklin Raines out of the firm but not after taking millions of dollars in bonuses. A hearing was sparked by these revelations and a report issued by the Office of Federal Housing Enterprise Oversight. Increased regulations were proposed as a solution to reign in the obvious problems with Fannie Mae. However, Fannie Mae was a very large contributor to the Democratic Party and under no circumstances were they going to let their gravy train slow down. Barney Frank even went so far as to say that he had absolutely no concerns over the safety and soundness of Fannie Mae.
In 2006, after further investigation into Fannie Mae’s accounting activities, the SEC finally charged a $400 million penalty to the firm. It was revealed that the manipulations of earnings stretched back to 1998 and allowed senior management to pay themselves huge bonuses over the same span of time. By misstating earnings, the executives were also hiding the problems inherent in Fannie Mae that were pointing to a potential collapse. In a concluding statement made in June 2006, Christopher Cox, Chairman of the SEC stated:
The significance of the corporate failings at Fannie Mae cannot be overstated. The company has said that it estimates the restatement of its financial statements… will result in at least an $11 billion reduction of previously reported net income. In all likelihood this will be one of the largest restatements in American corporate history.
Despite these accounting frauds, no criminal charges have been filed against a single Fannie Mae officer or executive. Here we have in plain sight exactly what we can expect from government power and no accountability. Between Fannie Mae and Freddie Mac, the two firms owned or guaranteed $5.3 trillion worth of home loans – more than half of the entire mortgage market. Nothing else can even begin to compare to the role these two government-sponsored enterprises played in the housing bubble.
Is this even a new or unique occurrence in the United States? An examination of history puts us face to face with a very similar event, the panic of 1819. After the chartering of the Second Bank of the United States, there was another period of credit expansion that encouraged speculation in land. This lending allowed nearly anyone to borrow money and the result was the doubling and even tripling of the price of land. There was widespread fraud at the Bank that went unnoticed due to the rampant speculation. Eventually, like all bubbles, this all came to an end.
The banks themselves were doing business on capitals, three-fourths of which were fictitious; and to extend their profit they furnished fictitious capital to every man, who having nothing and disliking the labors of the plow, chose rather to call himself a merchant, to set up a house of $5,000 a year expense, to dash into every species of mercantile gambling, and if that ended as gambling generally does, a fraudulent bankruptcy was an ultimate resource of retirement and competence.
– Thomas Jefferson
The corruption and scandal at the Second Bank was the main reason it was attacked so ferociously by Andrew Jackson, who now rests with the triumphant epitaph ‘I killed the bank.’ In the present day we will all need to take up the same battle as the late President with the same vigor. We face the same issues and the same fight against similar, corrupt bureaucrats.
Disclosure: No positions