Reason Foundation - Policy Areas > Economics, Bailouts, Stimulus

Mises Predicted the Crisis

anthony.randazzo@reason.org (Anthony Randazzo) — Sat, 07 Nov 2009 22:21:00 EST

In this weekend's WSJ, Mark Spitznagel, founder and chief investment officer of the hedge fund Universa Investments LP, writes that, in the 1920s, German economist Ludwig von Mises predicted how our crisis would evolve:

Taking his cue from David Hume and David Ricardo, Mises explained how the banking system was endowed with the singular ability to expand credit and with it the money supply, and how this was magnified by government intervention. Left alone, interest rates would adjust such that only the amount of credit would be used as is voluntarily supplied and demanded. But when credit is force-fed beyond that (call it a credit gavage), grotesque things start to happen.

Government-imposed expansion of bank credit distorts our "time preferences," or our desire for saving versus consumption. Government-imposed interest rates artificially below rates demanded by savers leads to increased borrowing and capital investment beyond what savers will provide. This causes temporarily higher employment, wages and consumption.

Ordinarily, any random spikes in credit would be quickly absorbed by the system—the pricing errors corrected, the half-baked investments liquidated, like a supple tree yielding to the wind and then returning. But when the government holds rates artificially low in order to feed ever higher capital investment in otherwise unsound, unsustainable businesses, it creates the conditions for a crash. Everyone looks smart for a while, but eventually the whole monstrosity collapses under its own weight through a credit contraction or, worse, a banking collapse.

Read the whole piece here.

Another $24 Billion Stimulus: President to Sign Extension of Homebuyer Credit

anthony.randazzo@reason.org (Anthony Randazzo) — Fri, 06 Nov 2009 12:15:00 EST

Yesterday, the House passed a bill that extends the homebuyer credit an extra six months by a vote of 403-12. The Senate passed the same bill on Wednesday 98-0. Overall, the tax credit stimulus is expected to cost $24 billion:

Under the measure, an $8,000 tax credit for first-time homebuyers would be extended for seven months and expanded with a $6,500 credit for some prospective homebuyers who already own homes. [...]

The IRS says some 1.4 million people applied for the homebuyers credit through August, helping enliven the moribund housing market. The legislation would extend the program through June of next year, as long as the buyer signs a contract by the end of April. It also offers a $6,500 tax credit to those who have lived in their current residence at least five years.

The measure doubles the income ceiling for eligible individuals to $125,000. Homes must cost less than $800,000 to qualify.

See CNBC's full article on this here. President Obama is expected to sign the bill later today.

As I wrote about at the end of last month, with all of the problems in the housing market, the last thing we need is Congress propping up housing prices and stealing demand from the future. Even The New York Times understands the extended credit is problematic:

The vote gives campaigning lawmakers something to crow about on the stump. But the new tax credit appeals primarily to affluent voters who do not need the government’s help buying property. And encouraging buyers to leave one house for another does nothing to reduce the glut of homes on the market, which is an important factor driving down housing prices. Finally, the tax credit does nothing about the central housing problem, which is foreclosure.

Read NYT's whole op-ed here.

And none of this is to mention the continued spending in a supposed age of fiscal responsibility. The president wants health care to be deficit neutral because his preferred price tag is a whopping $900 billion. But $24 billion here and $24 billion there adds up in the end, creating just as many deficit problems as the spending coming all in one chunk.

Faux-Recovery: Unemployment Hits 10.2 Percent

anthony.randazzo@reason.org (Anthony Randazzo) — Fri, 06 Nov 2009 11:36:00 EST

Unemployment continued to rise in October, a sign that the highly touted recovery isn't all the administration and Wall Street would like us to believe. From Reuters via Yahoo! finance:

The U.S. jobless rate unexpectedly jumped to a 26-1/2-year high of 10.2 percent last month, adding to pressure on the Obama administration to do more to tackle unemployment even as signs of recovery mount.

The Labor Department said on Friday that employers cut 190,000 jobs in October, more than the 175,000 markets had expected but fewer than the 219,000 lost in September.

Economists had been predicting a rise to around 9.9% from September's 9.8%. But the percentages are worse than that, hitting the highest percentage we've seen in over a quarter of a century. While actual number of jobs lost is less than last month, there is a greater number of Americans out of work. That speaks negatively about the reality of economic recovery. Again, from Reuters:

"Unfortunately, the problem is becoming deeper and more protracted," Mohamed El-Erian, chief executive of bond giant Pacific Investment Management told Reuters. "It's not just the increase in the headline number. ... It's also about the longer-term nature of unemployment, the increase in underemployment, and the prospect for only a very gradual recovery."

Even with the stock market up from its low in March, and positive GDP growth in the 3rd quarter this year, recovery in the real economy is anything but thriving. GDP growth in the third quarter was based largely on government subsides, not stable earnings. Wall Street has come back on confidence that the big boys will be bailed out if necessary by the Obama administration. But there are still severe problems in the housing market, and those problems are keeping the banking industry down as well.

The government needs to tout a recovery for political purposes. Wall Street would like us to think there is a robust recovery so we'll buy stocks. But unemployment numbers like these don't speak of real recovery, only the continuation of economic problems:

Unemployment Percentages from the Past Year

October-08 | 6.5%
November-08 | 6.7%
December-08 | 7.2%
January-09 | 7.6%
February-09 | 8.1%
March-09 | 8.5%
April-09 | 8.9%
May-09 | 9.4%
June-09 | 9.5%
July-09 | 9.4%
August-09 | 9.7%
September-09 | 9.8%
October-09 | 10.2%

Source: Bureau of Labor Statistics

FOMC Remains Optimistic on Inflation

anthony.randazzo@reason.org (Anthony Randazzo) — Thu, 05 Nov 2009 13:38:00 EST

The Federal Open Market Committee released its November statement yesterday. There was little change from the September statement, and interest rates remain at 0 to .25 percent. However, the FOMC did indicate what it was watching in terms of inflation indicators. We see it in the changed language between statements:

September 23: "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

November 4: "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

The statements are exactly the same, with the addition of this line: "including low rates of resource utilization, subdued inflation trends, and stable inflation expectations." Those three things are what the Fed is watching, and if there is a significant swing in those categories, we can probably expect a rate change. WSJ writes:

The Fed has been running full throttle for an entire year, while the financial panic has subsided, credit markets are healing, and third quarter GDP growth was 3.5%. The Fed is nonetheless focused principally on the "output gap," by which it means "low rates of resource utilization" and the high jobless rate. As long as the economy isn't going at full capacity, the governors believe, there's no danger of price increases and thus we need "exceptionally low levels of the federal funds rate for an extended period."

(Also, see here for the Goldman analysis of these indicators.)

The FOMC at present remains convinced inflation will remain subdued. The November statement repeats September's position verbatim:

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

Time will tell if they are right, and if Bernanke can keep his word that he's got inflation under control. But even if inflation isn't about to rise, we are creating an artificial subsidy for companies right now by maintaining cheaper than would be credit.

Senate to Move on CFPA, Regulation Reform

anthony.randazzo@reason.org (Anthony Randazzo) — Wed, 04 Nov 2009 18:04:00 EST

With financial services reform put on a fast track out of the House Financial Services Committee, the Senate is preparing to move as well. From Bloomberg:

Senate Banking Committee Chairman Christopher Dodd said he will unveil legislation next week to overhaul regulation of U.S. financial markets without Republican support after failing to reach a compromise.

The more cloistered Senate bill is likely to differ in significant ways from the House bills that have already reach the house floor. Nevertheless, reform could pick up in speed over the next few weeks, as word has come down from the White House that something needs to be passed. Anything really. Just something to get the president a policy win that he can tout before the year is up.

Dodd has complained that GOP members haven't been willing to deal. But it doesn't appear that he has been willing to budge much either. On the issue of consumer protection, left-wing democrats in the House and Senate seem dead set on a stand alone agency. Blue Dogs are getting strong armed into it. But there isn't any reason for one other than the political gain. From Bloomberg again:

Senator Richard Shelby, the committee’s top Republican, opposes a standalone consumer agency, which is a priority for Dodd and the administration. The agency would police banks for lending abuses in mortgage and credit-card lending. [...]

Shelby, of Alabama, today said he could support a consumer agency if it is part of a bank regulatory agency, rather than a separate entity proposed by Obama and backed by House Democrats. “That would be something we could discuss very positively,” Shelby told reporters in Washington. A separate agency is “a dangerous thing for safety and soundness.”

A stand alone consumer financial protection agency of any kind could be extremely damaging to the country, especially small businesses. (See here for my host of reporting on CFPA.) Banking and consumer issues are very complimentary, and should be kept together. Taking them away from the Fed and put into a stand alone agency isn't a bad idea in principle, though it could turn south quickly if handled improperly.

Dodd says he wants to have the bill out of committee by December. If that happens, financial services reform may be complete by year's end. It has seemed unlikely until the past few weeks with the White House now breathing heavily down Dodd and Frank's necks.

The Secret Message of Stimulus Spending

vdereugy@gmu.edu (Veronique de Rugy) — Tue, 03 Nov 2009 12:42:00 EST

The idea behind the $787 billion stimulus bill is that government can create jobs by spending money. For now, let’s ignore fact, history, and economic theory and assume that government spending can actually create jobs.

In that case, we should expect the government to invest relatively more money in the states that have the highest unemployment rates and less money in the states with lower unemployment rates. So let’s check the data.

Using numbers from President Obama’s website Recovery.org and the Bureau of Labor Statistics, this chart plots the amount of stimulus funds spent per person in each state and the corresponding unemployment rate in that state. The solid blue line shows what the allocation of funds should look like if the administration was allocating relatively more money to the states with higher unemployment rates.

Yet, with a few exceptions, the data show that this is not the case. Many higher-unemployment states are getting far fewer stimulus dollars than lower-unemployment states.

Take Michigan, for instance. Michigan’s 15.2 percent unemployment rate is the highest in the country. So far, it has received $403 per person in stimulus funds. That’s above the average stimulus per person across all states ($326). However, it’s lower than the $409 per person that the state of Vermont, a state with relatively low unemployment (6.8 percent), has received so far. Michigan's per-person take is also much lower than the $707 per person the District of Columbia received. D.C.'s unemployment rate is 9.9 percent.

Now look at the state with the lowest unemployment rate in the country: North Dakota. It’s getting $253 per person with a 4.3 percent unemployment rate. Many other states are receiving roughly the same amount of stimulus funds per person despite much higher rates of unemployment.

Which suggests that stimulus funds are being allocated without thought to the level of unemployment within states. If government spending could in fact create jobs, then the problem of unemployment could be mitigated by distributing funds to states based on their relative unemployment levels.

But that's not being done at all. Instead, funds are being distributed randomly, as quickly as possible, among the states. That in turn suggests something else: Even the federal government doesn't believe the myth that government spending can actually create jobs.

Veronique de Rugy is an economist at The Mercatus Center at George Mason University and a columnist for Reason. This column first appeared at Reason.com.

Atlas Shrugged, Railroads and Warren Buffet

sam.staley@reason.org (Samuel Staley) — Tue, 03 Nov 2009 08:53:00 EST

I couldn't help but notice the irony of Berkshire Hatthaway's $34 billion offer to take Burlington Northern Santa Fe railway private. Berkshire Hathaway is the investment arm of financial mogul Warren Buffet, widely regarded as one of the world's most prescient investors ("The Oracle of Omaha"). Railroads were also the central business of the Taggart family in the famed Ayn Rand novel Atlas Shrugged.

So, is Warren Buffet showing entrepreneurial leadership during a period of increasing government intrusion into the economy? According to the New York Times:

The deal, which will also include the assumption of $10 billion in Burlington Northern debt, represents what Mr. Buffett said was a big bet on the United States. He told CNBC in an interview that railroad operators cannot do well unless American businesses were producing goods and customers were buying them.

“It’s an all-in wager on the economic future of the United States,” he said in a written statement. “I love these bets.”

Only time will tell, but railroads are also slated to be beneficiaries of government largesse as we enter a new era of federal subisidy to support intercity passenger rail (and high-speed rail in particular). Railroads will benefit directly from federal and state taxypayer subidies that upgrade track and operations. So, Buffet's investment makes sense from the view that paper profits will increase because of these subsidies even as the basic economic viability of the industry deteriorates.

So, we actually may be witnessing the further erosion of private industry via railways similar to the way Rand characterized the process in her novel.

Reason Foundation is devoting the entire week to the legacy of Ayn Rand, including an overview of her impact on popular culture and insights from co-founder Bob Poole.

Rand: Don't Drive Away the Producers in Society

anthony.randazzo@reason.org (Anthony Randazzo) — Mon, 02 Nov 2009 14:20:00 EST

In this weeks' WSJ weekend interview (which I blogged yesterday), NYSE CEO Duncan Niederauer lamented that excessive regulation was putting a strangle hold on the American economy. And it is true that the more oppressive the government becomes, the more lawmakers seek to redistribute from the successful to pitied, the more policymakers direct private business operations, the more social entitlement mentality increases, and the more the producers of society are looked at with disdain for their supposed lack of communal charity, the closer we get to a society that does not advance, does not create, does not grow, and slowly withers away.

Niederauer says the way society is suppose to operate is: "the entrepreneur gets rewarded for taking personal risk, borrowing capital, taking an idea, starting a new business from scratch. That's America the last time I checked." But now, the ability to take risks is being stripped by Congress. The ability to find new capital is being strangled away. The incentive to create and grow is being legislated into oblivion by "reform" ideas. And those who took risks and failed continue to be supported by the rest of society.

All of this has eerily similar tones as the world Ayn Rand constructed in her novel, Atlas Shrugged. She writes of a world where it is no longer valuable for the producers to pursue financial and personal gain, and those who employ, design, and create wind up leaving civil society. Rand's ideas were fully captured in this book that makes one of the most profound cases for pure, uninhibited, politically incorrect, radical capitalism. These are the ideas that we celebrate this week at Reason, in our Radicals for Capitalism week.

In Honor of Ayn Rand: Alan Greenspan on the Gold Standard and Economic Freedom (1966)

adam.summers@reason.org (Adam Summers) — Mon, 02 Nov 2009 14:12:00 EST

Earlier I wrote a post on the gutting of Rep. Ron Paul's bill to audit the Federal Reserve. In honor of Reason's Radicals for Capitalism spotlight on Ayn Rand this week, allow me to expand on the topic of monetary policy by using the words of a member of Rand's social and intellectual circle: Alan Greenspan.

Ironically enough, before becoming chairman of the Fed, Greenspan was an avid proponent of a gold standard and critic of the government fiat money system (a system based on paper money rather than backed by a precious metal such as gold, in which paper money can be created "out of thin air," thus causing inflation and the erosion of the value of the dollar). Greenspan contributed to Rand's newsletter and other publications.

In a 1966 essay entitled, "Gold and Economic Freedom," reprinted in Rand's Capitalism: The Unknown Ideal, Greenspan wrote:

Gold and economic freedom are inseparable, . . . the gold standard is an instrument of laissez-faire and . . . each implies and requires the other.

What medium of exchange will be acceptable to all participants in an economy is not determined arbitrarily. Where store-of-value considerations are important, as they are in richer, more civilized societies, the medium of exchange must be a durable commodity, usually a metal. A metal is generally chosen because it is homogeneous and divisible: every unit is the same as every other and it can be blended or formed in any quantity. Precious jewels, for example, are neither homogeneous nor divisible.

More important, the commodity chosen as a medium must be a luxury. Human desires for luxuries are unlimited and, therefore, luxury goods are always in demand and will always be acceptable. . . .

The term "luxury good" implies scarcity and high unit value. Having a high unit value, such a good is easily portable; for instance, an ounce of gold is worth a half-ton of pig iron. . . .

Under the gold standard, a free banking system stands as the protector of an economy's stability and balanced growth.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. . . .

The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the "hidden" confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.

One might wonder how a man who wrote so passionately in opposing a monetary scheme that allows the government to print money backed by nothing, engage in deficit spending and the expansion of government, and erode the value of the dollar through the hidden tax of inflation could effectively become the nation's economic dictator-in-chief. Rep. Paul is as confused by this as any other gold standard and free banking advocate. In a 2008 interview with The Daily Reckoning, Paul discussed this apparent enigma.

Q: You and former Fed Chairman Alan Greenspan have famously knocked heads over the years. Can you tell me a little about that? Why it is that you seemed to be at times the only person that seemed to be keeping a very close eye on the goings-on at the Federal Reserve?

Ron Paul: Alan Greenspan from '87 up to over a year ago was the Chairman of the Federal Reserve Board, the U.S. central bank. I see the central bank and the Federal Reserve System as unconstitutional in that they have this tremendous power and a monopoly control over money and credit, which is an ominous power. Greenspan, or any chairman of the Federal Reserve, is more powerful than even our president because he has so much control over the economy. But the interesting thing about Alan Greenspan was that he was a true believer in Austrian economics and in the gold standard. So in a private conversation I had with him I told him that I followed what he taught. In the 1960s he was very clear on his position on gold, that he liked gold and rejected the fiat monetary system, because if you have fiat money it leads to deficits and to the expansion of government - all of which he opposed.

So it's rather ironic that now that Dr. Greenspan accepts the paper monetary system (which is a fiat system). He literally was the participant in these deficits, and I would bring this up to him in the committee because the Federal Reserve Board's chairman always condemn deficits; it's always Congress's fault. But my point was Congress couldn't do it if they weren't complicit: If we don't want a tax and we can't borrow and then they have to print the money in order to accommodate the big spenders. If the Federal Reserve couldn't do that, interest rates would go up and there would be restrain on spending. So he literally became one who once believed in the restraints of the gold standard to one who was converted into becoming the Federal Reserve Board Chairman - the one that ran this whole system of fiat money and central economic control. I would chastise him quite frequently about how can he be for a free market when he endorses a system of central economic planning by controlling the money? And when you think about it, the monetary unit is used in every single transaction, so if you can control one half of every single transaction you have a lot of power, and a lot of control.

Q: There is a story you are asked to tell often, about having Alan Greenspan sign a copy of a book called Gold and Economic Freedom. What happened there?

Ron Paul: In the 1960s, I was studying and reading Austrian economics and I received the Objectivist newsletter that Ayn Rand put out. Alan Greenspan had a piece in the newsletter and it was a delightful article - it said all the things I believed in. One day, we had a personal meeting with Greenspan just to get our pictures taken and chat for a few minutes, and we knew that was coming up. So I dug out my original copy, and I took that with me, so when we were getting ready to get our picture, I flipped it open to his article and said, "Do you remember this?" and he said he did. Then I asked him to autograph it, so he got out his pen and he was signing it, and I said, "Do you want to write a disclaimer on this article?" He said, "No, I wouldn't do that. I just read this recently and I fully support everything I wrote." Which is interesting because you don't know exactly what he means. If he fully supports what he wrote, why was he managing a monetary system that was exactly opposite of what he wrote in 1966?

Rep. Ron Paul's Bill to Audit the Federal Reserve 'Gutted' in Committee

adam.summers@reason.org (Adam Summers) — Mon, 02 Nov 2009 14:03:00 EST

A WorldNetDaily story reports that the bill sponsored by Rep. Ron Paul (R-TX) that would call for an audit of the Federal Reserve has been "gutted" in a congressional committee. The legislation, H.R. 1207, would also close loopholes that prevent transparency of Fed actions. It currently has over 300 co-sponsors in the House.

In a telephone interview with a Bloomberg reporter, Paul said that the bill had been stripped of measures closing loopholes that protect the Fed and blamed Rep. Melvin "Mel" Watt (D-NC), chairman of the House Financial Services Committee's Subcommittee on Domestic Monetary Policy and Technology, for ripping the teeth out of the legislation. Watt has significant ties to the banking industry and received the largest share of his 2008 campaign contributions—over one-third of his total contributions for the cycle—from the finance, insurance, and real estate industry. Watt's four largest contributors were Bank of America, headquartered in Watt's district in Charlotte, Wachovia Corp., American Express, and the American Bankers Association.

Paul vowed to try to restore the gutted provisions of the bill through an amendment when it comes to the House floor for a vote.

The veil of secrecy that shrouds the Fed has only made it more mysterious, and monetary policy that much more complex and obscure, to the average American taxpayer. Political discourse over subjects like deficits and inflation tends to focus on fiscal policy, but this is only one half of the equation. It is time for more people to ask why the Fed should have a government-granted monopoly for the creation of money and what it does with its powers to alter the value of money and interest.

Below is an excerpt of the WND article quoting Rep. Paul on some of his criticisms of the Fed:

Paul long has been a critic of the secrecy of the Federal Reserve.

"Throughout its nearly 100-year history, the Federal Reserve has presided over the near-complete destruction of the United States dollar," he said earlier. "Since 1913, the dollar has lost over 95 percent of its purchasing power, aided and abetted by the Federal Reserve's loose monetary policy."

"Since its inception, the Federal Reserve has always operated in the shadows, without sufficient scrutiny or oversight of its operations," Paul said when the plan to audit the Fed was introduced. "While the conventional excuse is that this is intended to reduce the Fed's susceptibility to political pressures, the reality is that the Fed acts as a foil for the government. Whenever you question the Fed about the strength of the dollar, they will refer you to the Treasury, and vice versa. The Federal Reserve has, on the one hand, many of the privileges of government agencies, while retaining benefits of private organizations, such as being insulated from Freedom of Information Act requests."

Paul has warned, "The Federal Reserve can enter into agreements with foreign central banks and foreign governments, and the GAO is prohibited from auditing or even seeing these agreements. Why should a government-established agency, whose police force has federal law enforcement powers, and whose notes have legal tender status in this country, be allowed to enter into agreements with foreign powers and foreign banking institutions with no oversight? Particularly when hundreds of billions of dollars of currency swaps have been announced and implemented, the Fed's negotiations with the European Central Bank, the Bank of International Settlements, and other institutions should face increased scrutiny, most especially because of their significant effect on foreign policy. If the State Department were able to do this, it would be characterized as a rogue agency and brought to heel, and if a private individual did this he might face prosecution under the Logan Act, yet the Fed avoids both fates."

My So-Called Stimulus Job: Higher Education Edition

lisa.snell@reason.org (Lisa Snell) — Sun, 01 Nov 2009 22:58:00 EST

Via College Life blog at the Orange County Register, UCI folks question the Governor's claim about the number of jobs the stimlus created for California colleges:

Governor Arnold Schwarzenegger says Congress’ federal stimulus program has saved or created 8,356 jobs in the University of California system, a claim that comes as a surprise at UC Irvine, Orange County’s largest employer.

Schwarzenegger’s claim was made by his California Recovery Task Force,which also says the stimulus created or saved 26,156 jobs in the California State University system, bringing the total for the two systems to about 34,500.

“We can’t figure out where the governor’s office got the data to support saying 34,000 jobs have been saved in the CSU and UC systems. No such data has been forwarded by our campus to the state,” said Cathy Lawhon, director of media relations at UCI.

And in other education stimuls news, Politics K-12 reports that VP Joe Biden says 325,000 education jobs have been created or saved. Let's go with saved, because in the education sector there was much more state budget fill than new job creation. As Governor Schwarzenegger explained:

"Those teachers would have been gone if it hadn't been for the stimulus money."

Joe Biden real man of genius here.

NYSE CEO Says the Future of American Competition Depends on Congress Getting Reform Right

anthony.randazzo@reason.org (Anthony Randazzo) — Sun, 01 Nov 2009 12:54:00 EST

In The Wall Street Journal weekend interview, New York Stock Exchange CEO Duncan Niederauer says the reforms being debated in Congress could make or break the competitiveness of America:

"New York City's ability to compete is largely out of its immediate sphere of influence," he says. "A lot is going to have to do with what changes come out of Washington and what their regulatory and legislative response to the crisis is." Washington's response is "going to determine New York's ability to continue to compete in a world that we all know is in the process of a pretty transformational rebalancing." [...]

Mr. Niederauer says Washington is casting a shadow of uncertainty over the market. Exhibit A is the possibility that "the boardroom and corporate governance" could be "federalized." And he warns that "we don't need acts of Congress to talk to us about what board composition or decentralization should look like." [...]

At bottom, Mr. Niederauer is worried about what government is doing to risk takers. "It was striking if not staggering that virtually no companies [backed by venture capital] came to market last year. I didn't want to hear that it was just because the market was bumpy and valuations weren't that good." He says that until late in the year that was not a valid excuse. [...]

Remember how it's supposed to work: "the entrepreneur gets rewarded for taking personal risk, borrowing capital, taking an idea, starting a new business from scratch. That's America the last time I checked. When they get big enough, they've proved the idea works, they want to grow, they come to the equity market because it's an efficient way to raise more capital to grow and the next thing you know Microsoft starts in a recession and now employs 95,000 people around the world, 25 to 30 years later. That's America, that's what we're supposed to stand for, and if we're not careful that virtuous circle is going to go backward and it's going to be a vicious circle."

With the health care debate dominating the public consciousness right now, we should be aware of the long-term ramifications financial services reform will have for America. The decline of New York would be felt by everyone around the country.

Bogus Stimulus Jobs

sam.staley@reason.org (Samuel Staley) — Fri, 30 Oct 2009 09:42:00 EDT

Using statistical slight of hand to accomplish political goals is one of the fastest ways to create cynacism in the political system. No better example of that may be playing out as the press reports the so-called job creation from the stimulus plan.

Take the following lead paragraph from a USA Today article (October 27, 2009) on the release of the state job creation data:

States have reported using stimulus money to create or save more than 388,000 jobs so far this year, buttressing the Obama administration's claim that the $787 billion plan has had a significant impact on the economy.

That total, based on a USA TODAY review of reports from 33 states and Puerto Rico, includes teachers, construction workers, and others whose jobs were funded by stimulus money awarded to states. The administration plans Friday to release reports from all 50 states, providing the broadest accounting yet of the stimulus plan's impact.

What's the problem with this?

The numbers of jobs created or "saved" are simply counts provided by state agencies spending stimulus money. They simply record the number of people hired under the contract or for the project. They are not the result of investigative follow up, or a consistent methdology for identifying real jobs created or saved. (Indeed, these methodological problems have plagued economic development program evaluations for decades as states have claimed jobs were created by various tax incentive programs but no real way to verify the accuracy of the numbers.)

As a practical matter, it's virtually impossible to distinguish between a job saved or created. (I discuss this problem in a forthcoming feature article in the 2 November 2009 issue of National Review titled "Naive Statistics.") How do you know, for example, that an construction company hiring a worker for a sidewalk repair project is hiring someone that would not have gotten a job somewhere else? Or that the worker would have been laid off and unable to find another job? In truth, you can't, and the agencies reporting these job counts don't try. (It would, in fact, be very costly to do this.)

At least some people are honest about this, as the USA Today story reports at the end of the article:

The states' reports suggest the biggest impact has been at schools. Twenty-three states that have reported school job numbers said more than 156,000 jobs had been created or saved.

Carol Bingham, director of fiscal policy for the California Department of Education, estimated the stimulus saved about 20,000 teaching positions. But she and others warn that precisely counting saved jobs has proved almost impossible. "It was intended to be a count. The way it was done, I think it's going to end up being an estimate," she said.

Indiana officials reported that the stimulus had created or saved about 13,000 school jobs. Asked whether he had any idea how many layoffs the plan had prevented, state Education Department spokesman Cam Savage replied: "I really don't."

There's the rub: If the jobs reporedly created or saved are estimates, and you don't really know how many people would have been layed off without the money, how can anyone claim that the program is working? (See also my blog post on 16 October on this subject here.)

Stop Artificially Propping Up Housing Demand

anthony.randazzo@reason.org (Anthony Randazzo) — Fri, 30 Oct 2009 09:19:00 EDT

Lots of information has been brought forth recently as discussion of extending the $8,000 credit for buying a home has heated up. And with results like these, how could they not extend it? From WSJ:

It's hard not to laugh when viewing the results of the federal first-time home-buyer tax credit. The credit, worth up to $8,000 for the purchase of a home, has only been available since April of last year. Yet news of the latest taxpayer-funded mortgage scam has traveled fast. The Treasury's inspector general for tax administration, J. Russell George, recently told Congress that at least 19,000 filers hadn't purchased a home when they claimed the credit. For another 74,000 filers, claiming a total of $500 million in credits, evidence suggests that they weren't first-time buyers.

Among those claiming bogus credits, at least some of them were definitely first-timers. The credit has already been claimed by 500 people under the age of 18, including a four-year-old. This pre-K housing whiz likely bought because mom and dad make too much to qualify for the full credit, which starts to phase out at $150,000 of income for couples, $75,000 for singles.

Yep, four-year-olds are buying homes. Let's keep this sure fire, really helpful program going. Since cash for clunkers did really well in building long term demand for cars, there is no way extending this program wouldn't do the same.

Oh, wait, C4C caused a spike in automobile sales in a short window that cleared some inventory but has left a dark hole of depressed demand in its wake. If you were gonna buy a car now, why not few months ago when the program was hot?

The crazy thing is that, even with the housing credit, which has been snapped up readily, the housing market faces a seriously troubled road ahead. While home sales picked back up in January (before the credit) and have slowly climbed this year, there are signs of that leveling off, even given the seasonal adjustment. And in the west, where the sales decline bottomed out first, it looks like there is another decline forming—and that is not good news for the rest of the country, since the West is a leading indicator on housing.

Of course, Washington's answer to this problem seems to be giving money away to increase demand. But this ignores two critical points: first, the cost of the program is adding billions to our national debt, about $1 billion a month at this point. Second, why would we create an artificial demand for housing when a government supported artificial demand for housing is what was a major cause of the crisis in the first place?

Taxpayer Cost for Cash for Clunkers: $24,000 Per Car Sold

sam.staley@reason.org (Samuel Staley) — Fri, 30 Oct 2009 02:25:00 EDT

Alas, we thought it might be too good to be true: The Cash for Clunkers program wasn't the runaway success elected officials claimed it was. Who knew?

Edmunds.com estimates that only 125,000 of the 690,000 cars bought during the program were actually tied to the program. Based on trend analysis by makes and models, the other cars would have been bought anyway. Many of those cars were really justed advanced sales of future cars, a stimulus version of robbing Peter (October) to pay Paul (July). That works out to $24,000 per car for taxpayers according to CNNMoney.com:

"The average rebate was $4,000. But the overwhelming majority of sales would have taken place anyway at some time in the last half of 2009, according to Edmunds.com. That means the government ended up spending about $24,000 each for those 125,000 additional vehicle sales."

What was the response from the White House (the one that promised evidence-based policy decisions)? According to CNNMoney.com:

"It is unfortunate that Edmunds.com has had nothing but negative things to say about a wildly successful program that sold nearly 250,000 cars in its first four days alone," said Bill Adams, spokesman for the Department of Transportation. "There can be no doubt that CARS drummed up more business for car dealers at a time when they needed help the most."

New Book from Charlie Gasparino Details How Government Housing Policies Have Contributed to the Crisis

anthony.randazzo@reason.org (Anthony Randazzo) — Thu, 29 Oct 2009 12:55:00 EDT

One of the last people you’d expect to be a catalyst for the near collapse of history’s most advanced financial system is the secretary of Housing and Urban Development. Though not the masterminds of the nation’s economic woes, Andrew Cuomo and Mel Martinez were willing musclemen for the Congressional and White House driven mandates that housing be made more affordable to all through government subsidy. Those mandates, policy stemming back to the 1960s, were driven by compassion, but have turned out to be the chief cause for the current rampant rates of default, foreclosure, and economic pain striking particularly hard at low-income families.

Such is the story Charlie Gasparino, CNBC analyst, tells in his new book, The Sellout: How Three Decades of Wall Street Greed and Government Mismanagement Destroyed the Global Financial System. Gasparino notes that Cuomo as much as boasted in the late 1990s about forcing Fannie Mae and Freddie Mac to expand their subprime mortgage portfolios. Not slowing down, the George W. Bush appointed Martinez carried the ball forward with great speed, presiding over a period of time where Fannie and Freddie grew to hold a combined $1 trillion in subprime mortgages.

These government-sponsored entities were the tools the government used to try and expand housing opportunities to more and more Americans. A noble goal, but one executed by disastrous means. To begin with, the policies—explicitly set forth by members of Congress and the executive branch—were directly a part of creating the housing bubble. Gasparino nails it in his book, saying:

One of the ironies of the bubble Fannie and Freddie helped create through their guarantees and purchase of subprime loans is that it made housing less affordable, not more so. To own a home, working-class and poor families were now more reliant than ever before on the various gimmicks the mortgage business offered—the adjustable-rate mortgages and “no-money-down” loans that allowed families to live in their homes at minimal initial cost, only to have their mortgage payments skyrocket later.

Government housing policies of the past several decades were the cause of other problems as well, including creating incentives for banks to over securitize mortgages. The implicit support Fannie and Freddie had allowed it to borrow cheaply, spend freely, and act irresponsibly. You, the taxpayer, had their back.

All the while, corruption at the highest levels was rampant. Gasparino also writes of the “Friends of Angelo” scandal, where the CEO of Countrywide gave sweetheart deals to allies on Capitol Hill—including the top Senate banking and housing overseer, Chris Dodd.

Ultimately, the story of The Sellout might be summed up by this line from President Bush at the height of the bubble about the goal of expanding homeownership to more low-income families, particularly minorities:

There’s all kinds of ways that we can work together to meet the goal. Corporate America has a responsibility to work to make America a compassionate place.

That is the attitude that has sunk us today. The crisis started with compassion, it was driven by excessive confidence, and we are paying the price today.

Pre-buy The Sellout from Amazon here.

A Hard Pill to Swallow

jsullum@reason.com (Jacob Sullum) — Thu, 29 Oct 2009 12:05:00 EDT

In August, Christina Romer, chairwoman of the White House Counsel of Economic Advisers, suggested that we think of the $787 billion American Recovery and Reinvestment Act as an extremely expensive course of antibiotics. “Suppose you go to your doctor for a strep throat,” Romer said in a speech to the Economic Club of Washington, “and he or she prescribes an antibiotic.” If your fever goes up after you take the first pill, just as unemployment rose after the stimulus bill was enacted, that doesn’t mean “the medicine is useless,” Romer noted. It could simply be that “the illness was more serious than you and the doctor thought.”

But it’s also possible that your sore throat and fever are caused by a virus, not a bacterium, in which case the antibiotic will not help. Eventually, though, you will recover on your own, and you may mistakenly conclude that your doctor’s prescription did the trick.

Such erroneous causal inferences are always a hazard when it comes to government spending aimed at alleviating a recession. Even if most or all of the money is disbursed after the recession has ended (which is typically the case), stimulus advocates can say the recovery would have been weaker without the spending. Since there’s no readily available parallel universe in which to test that counterfactual hypothesis, it can never be conclusively disproved.

Still, Romer seemed unreasonably sure that Dr. Obama’s medicine was already kicking in. Although she conceded that “the evidence from the path of the economy over time can’t settle the issue of what the effects of the Recovery Act have been,” her answer to the question posed in the title of her speech—“Is It Working?”—was “absolutely.”

I guess that depends on how you define “working.” No doubt spending billions of dollars in borrowed money has some impact on the economy. But the idea that the stimulus package had much to do with an incipient recovery that may have begun in June is belied by a couple of inconvenient facts.

First, since World War II the length of recessions has ranged from six to 16 months, with an average of 10. The current recession officially began in December 2007, so a recovery by the second half of 2009 is what you would expect.

Second, according to ProPublica, only $73 billion of the $580 billion in stimulus spending had been disbursed at the time of Romer’s speech. Another $37 billion or so had gone out in the form of tax cuts.

Romer conceded the latter portion of the stimulus did not seem to be very stimulating. She said “consumption fell slightly in the second quarter after rising slightly in the first quarter,” which “could be a sign that households are initially using the tax cut mainly to increase their saving and pay off debt.”

Is it plausible to suggest that $73 billion in stimulus spending over five months had a decisive impact on a $14 trillion economy? I say “decisive” because President Barack Obama, back in February, presented the stimulus package as the only alternative to a never-ending recession, and in August he claimed, “We’ve rescued our economy from catastrophe.”

Even if we accept the Obama administration’s numbers, taxpayers do not seem to be getting much employment bang for their buck. Romer estimated that “employment is now about 485,000 jobs above what it otherwise would have been.” That comes out to more than $200,000 per job, which seems pretty pricey, especially since many of these jobs are temporary.

Here is where the “reinvestment” part comes into play. Administration officials say the stimulus package is all about putting Americans back to work. When asked whether this is an efficient way to do that, they claim all the work needs to be done anyway. Conversely, when asked whether all the projects are really worth the money spent on them, they cite jobs “created or saved” as a backup justification. Stimulus means never having to admit you’re wasting money.

Senior Editor Jacob Sullum (jsullum@reason.com) is a syndicated columnist. This column first appeared at Reason.com.

Self-Governance Works

info@reason.org (John Stossel) — Thu, 29 Oct 2009 11:19:00 EDT

Much of what government does is based on the premise that people can't do things for themselves. So government must do it for them. More often than not, the result is a ham-handed, bumbling, one-size-fits-all approach that leaves the intended beneficiaries worse off. Of course, this resulting failure is never blamed on the political approach—on the contrary, failure is taken to mean the government solution was not extravagant enough.

We who have confidence in what free people can achieve have long believed that government should not venture beyond its narrow sphere of providing physical security. It should not attempt to cure every social ill. So it's good to learn that serious scholars have demonstrated that our intuitions are right. Free people, given the chance, solve what many "experts" think are problems that require state intervention.

For that reason, Elinor Ostrom's winning of the Nobel Memorial Prize in Economic Sciences ought to kindle a new interest in freedom. (See my earlier column here.)

Ostrom made her mark through field studies that show people solving one of the more vexing problems: efficient management of a common-pool resource (CPR), such as a pasture or fishery. With an unowned "commons," each individual has an incentive to get the most out of it without putting anything back.

If I take fish from a common fishing area, I benefit completely from those fish. But if I make an investment to increase the future number of fish, others benefit, too. So why should I risk making the investment? I'll wait for others to do it. But everyone else faces the same free-rider incentive. So we end up with a depleted resource and what Garrett Harden called "the tragedy of the commons."

Except, says Ostrom, we often don't. There is also an "opportunity of the commons." While most politicians conclude that, depending on the resource, efficient management requires either privatization or government ownership, Ostrom finds examples of a third way: "self-organizing forms of collective action," as she put it in an interview a few years ago. Her message is to be wary of government promises.

"Field studies in all parts of the world have found that local groups of resource users, sometimes by themselves and sometimes with the assistance of external actors, have created a wide diversity of institutional arrangements for cooperating with common-pool resources."

She has studied, for example, self-governing irrigation systems in Nepal and found successes never anticipated in the textbooks. "Irrigation systems built and governed by the farmers themselves are on average in better repair, deliver more water, and have higher agricultural productivity than those provided and managed by a government agency. ... (F)armers craft their own rules, which frequently offset the perverse incentives they face in their particular physical and cultural settings. These rules may be almost invisible to outsiders. ..."

In Governing the Commons, she writes about self-governed commons in Switzerland, Japan, the Philippines, and elsewhere that date back hundreds of years. For example, in the alpine village of Tobel, Switzerland, herdsmen "tend village cattle on communally owned alpine meadows" under rules of an association created in 1483. The rules govern who has access to the grazing lands and how many cows a herdsman can place there, preventing overgrazing. The cattle owners themselves run the association and handle the monitoring. Sanctions are imposed for violation of the rules, but compliance is high.

Don't mistake the association for government. Rather, it is a private co-op designed for a narrow purpose. "All of the Swiss institutions used to govern commonly owned alpine meadows have one obvious similarity—the appropriators themselves make all the major decisions about the use of the CPR."

She found something similar in Japanese villages, where residents use private property for some agricultural purposes and self-managed common forests for others.

Solutions imposed by external authority were not necessary—and usually self-defeating: "Academics, aid donors, international nongovernmental organizations, central governments, and local citizens need to learn and relearn that no government can develop the full array of knowledge, institutions and social capital needed to govern development efficiently and sustainably. ..."

How about that? Freedom works.

John Stossel will soon host Stossel on the Fox Business Network. He's the author of Give Me a Break and of Myth, Lies, and Downright Stupidity. This column first appeared at Reason.com.

U.S. Economic Growth: Too Fast, Too Soon?

sam.staley@reason.org (Samuel Staley) — Thu, 29 Oct 2009 09:53:00 EDT

The U.S. Bureau of Economic Analysis has released preliminary estimates of the U.S. economy's growth in the third quarter of 2009. The BEA reports third quarter growth of 3.5%, a far cry from the negative growth during the second quarter and 6.4 percent drop during the first quarter. The news is good...sort of.

One quarter's estimates are not necessarily a sign of good times. As I point out in this guest blog post for the National Review's blog "The Corner," lots of uncertainties surround the stability of the estimate, whether the spending that drove these growth numbers was "real," and whether these trends are long-term. I conclude:

We need to remember it took the National Bureau of Economic Research 12 months to officially declare that the economy was in recession because the data were so hard to read. It's no different now. So, we will need to wait at least until Fourth Quarter GDP results are in before we can even make reasonable speculations about the economy's health.

The complete numbers and estimates can be found in an excel file at the U.S. Bureau of Economic Analysis.

Also, my colleague Anthony Randazzo legitimately questions whether we may actually be entering a "lost decade" of variable but stagnant economic growth similar to Japan in the 1990s.

Another GMAC Bailout? Yay...

anthony.randazzo@reason.org (Anthony Randazzo) — Wed, 28 Oct 2009 12:58:00 EDT

In today's smack of the forehead news:

GMAC Inc., the lender that received two government bailouts totaling $13.5 billion, is in talks with the Treasury Department to receive a third lifeline, a person familiar with the matter said. The U.S. government may inject an additional $2.8 billion to $5.6 billion into GMAC, the person said, declining to be identified because the transaction hasn’t been completed.

Read the whole article from Bloomberg here.

'The Last Gasp of the Dinosaurs'

matt.welch@reason.com (Matt Welch) — Wed, 28 Oct 2009 11:11:00 EDT

In the April 1996 edition of reason, then-Editor Virginia Postrel wrote a column arguing that “Steve Forbes is a serious candidate” for president. “Not because he’s a rousing speaker,” Postrel observed, “but because he believes in the open-ended future, in the creativity of free people, and in the importance of clear, simple, limited rules within which individuals can shape their own decisions.”

Of those “clear, simple, limited rules,” the most famous was a flat and reduced personal and corporate income tax, an idea that, while never coming close to adoption at the federal level, nonetheless propelled a long-shot magazine publisher with no political experience into a third-place finish in the Republican primaries, including wins in Arizona and Delaware. In 2000 a flat tax song and social conservative dance helped Forbes whisk into second-place at the Iowa caucus, but he quickly dropped out after finishing third in New Hampshire and Delaware. In 2008 Forbes was a strong backer of the doomed Rudolph Giuliani.

Malcolm Stevenson Forbes Jr., 62, is the third Forbes to publish the successful business title of the same name. Founded in 1917, Forbes has gleefully billed itself as the “Capitalist Tool,” lionizing the entrepreneurs who make the world a richer place. In addition to producing its signature lists of the country’s (and globe’s) richest capitalists and companies, the 900,000-circulation magazine has been a staunch opponent of antitrust enforcement, an aggressive supporter of anti-totalitarian movements abroad, and a stubborn purveyor of a sunny, market-based optimism. Last November, at the height of political panic over the financial crisis, Forbes put Forbes himself on the cover, explaining “How Capitalism Will Save Us.”

In July, Editor in Chief Matt Welch interviewed Steve Forbes at the annual FreedomFest conference in Las Vegas.

reason: People know you as Steve Forbes, flat taxer and presidential candidate, but you’re also publisher of Forbes magazine in an era when magazines are struggling. How is Forbes responding to the economic crisis, the publishing crisis, and the transformation of the print industry?

Steve Forbes: When you have a severe recession and you have something transformational as we now see un-folding with the Web, you have to do two things. One, you have to address the immediate circumstances, which means belt tightening, which we did—and we did after 2001, when the economy also went temporarily off of the cliff. But at the same time, you have to invest for the future. And thankfully, 12 years ago, when we went online as did everyone else, we did not make the mistake that many print publishers made, and that was to think you take the printed page, throw it online, and have your electronic publishing. When Thomas Edison invented movies, some people thought you’d film a stage play and that was a feature film. No. It’s an entirely different medium.

We’ve always focused on entrepreneurs, on investors—on capitalist people who want to get ahead, people who want to do things in business. So we saw the website as another platform to reach the same constituency. Our value added is information, insights, and analyses, plus our profound belief in the moral basis of capitalism, which is meeting the needs and wants of other people. If you have that, you don’t get hung up on what the particular platform is.

reason: David Carr had a piece about you guys in The New York Times—a little snarky, but it was interesting. One thing he posited is that in 2009 this whole “Capitalist Tool” stuff is out of fashion; it’s out of step with the times. What’s your broad response to the notion that your stance or ethos is out of step and anachronistic?

Forbes: Well, capitalism—entrepreneurial capitalism, democratic capitalism—always goes through phases where it’s, quote, “out of fashion.” And it’s usually because of catastrophic mistakes made by government. The victim is blamed for it.

But you don’t abandon your mission or your core values because a crisis has put capitalism under a cloud. We went through it in the ’30s, we went through it in the ’70s, the greedy decade of the ’80s. These things do happen. But I think what’s happening in Wash-ington is the last gasp of the dinosaurs of the 1930s. It’s Jurassic Park statism. Oh! Franklin Roosevelt again! Wow! But it’s not working. It didn’t work in the ’30s.

So here we are today, and what’s the response? More spending, more taxes, and the economy is not responding the way it should. But while we’re getting assaulted now, it’s also a chance to regroup and hit these people back, because they are going against human nature, they are going against the impulses that come out of true entrepreneurial capitalism. While they seem to have the commanding heights at the moment, it’s only temporary.

reason: Do you see, to borrow a phrase, some green shoots, not necessarily in the economy, but in the citizen response to Washington economics right now?

Forbes: You see it with the tea parties, and you saw it in the state of Illinois, where the governor proposed tax increases, but the Democratic legislature ended up defeating them. The most amazing thing is now unfolding in California, where they’re seriously considering a flat tax because they’re beginning to realize—the Democrats!—that a highly progressive system doesn’t produce the revenue they need for their progressive programs.

reason: Have you seen an uptick in interest in the flat tax idea? Have people been knocking on your door and saying, “Oh yeah, about that thing.…”

Forbes: It’s not so much knocking on the door as people asking, when you face a severe crisis, what do you do? That’s one contrast between the political world and the commercial world. In the commercial world, failure happens all the time. It’s part and parcel of the system. You try something; it works or doesn’t work. In politics, you often have to go to the cliff before something is done. California’s at the edge of a cliff. They can’t print money. IOUs are not quite the same as legal tender. And so that’s why they’re considering something like the flat tax. Both [Gov. Arnold] Schwarzenegger and now Democrats in the legislature are starting to brood about the idea in sort of sheer desperation. It’s a version of what Ronald Reagan said: You don’t change minds on Capitol Hill through sweet reason; you do it through the heat of public opinion.

reason: Do you see a reawakening of those values, a reawakening in the Republican Party specifically, after eight years of a presidency when government was expanded hysterically, regulation was expanded hysterically? Do you see Republicans rediscovering their limited-government roots?

Forbes: I think it’s beginning to happen. Certainly among the newer, younger members. Or ones such as Paul Ryan from Wisconsin, who gets it on monetary policy, gets it on what’s happening with entitlements. Because, clearly, trying to be a Democrat Lite is not the way to perpetual power. Power does corrupt, and the GOP began to believe that pork will buy you happiness. It didn’t. And in fact, it demoralized the base of the party.

So now we have pork squared with the Obama administration, and it’s an opportunity for the Republicans to quickly regroup and find their voice again. The Obama administration is making a classic mistake of leadership: They feel they have to do it now, but they’re trying to do too much too quickly. It’s going to blow back on them.

reason: Looking at the 2012 Republican presidential hopefuls, especially after Mark Sanford started flying to Argentina a bit too much, do you see any individuals out there who look promising? Are you still considering yourself a candidate? Will you run again?

Forbes: I’m an agitator now, so I’ll leave the running to others. I’ll watch them exercise. But I think in 2010 we’ll get a very clear picture of the field. Right now there’s just too much going on. Too much ferment. If you look at a poll, probably Mitt Romney would be at the top, just because of name recognition. But whoever would have thought three years ago that Barack Obama would beat the Clintons at their own game and win the presidency? So it’s idle speculation.

But there are some names out there—[Louisiana Gov. Bobby] Jindal, Romney, who knows what [Mike] Huckabee might do, maybe [Minnesota Gov. Tim] Pawlenty will get a little more conservative and make a move for it. So who knows, maybe Paul Ryan might emerge, maybe somebody else from the House might emerge.

The key thing is don’t depend on one person. Have many Reagans out there, doing it on the state level, on the local level, and we’ll be OK.

reason: Talking of the “Democrat Lite” characters out there, [New York Mayor Michael] Bloomberg is a favorite of mine. He just announced an eight-point proposal to create or save media jobs on the island of Manhattan. You see a lot of proposals to have the government become involved with bailing out or somehow giving new assistance to legacy print media companies on the theory that they are fundamental to our democracy. What do you think about these initiatives and the ideas behind them?

Forbes: To really survive, newspapers, each one in each city, have to figure out what is their true value added. And it’s not going to be one blueprint for all. They’re each going to have to do it differently. You mentioned David Carr, who wrote a piece a couple months ago about this crazy paper in Boston that is doing very well focusing totally on local events in an iconoclastic way. People read it, whereas traditional newspapers are withering. So you’re going to see not one-size-fits-all but each one trying to pick out the particularities that can enable it to survive.

But nostalgia is a very strong human emotion. And so, you know, canals are preserved, and they’re wonderful tourist things now, even though they’re not real arteries for commerce the way that the railroads became and then highways became or air travel became. So it’s a natural reaction, but at the end of the day, it ain’t gonna get very far, because the world’s not going to stand still. Museums are very nice, but they’re not the way to a vibrant economy.

reason: Someone made the argument that the moment any industry becomes politically engaged, and starts lobbying a lot and starts getting targeted legislation, is not the moment that it becomes powerful but the signal that it’s stopped being powerful.

Forbes: Well it’s a peculiarity of the United States that it’s a sign that you’ve become successful that the government and the politicos go after you. And it does far more harm than any possible good.

You see it time and time again—G.M. in the ’50s and ’60s deliberately kept their market share below 50 percent for fear they’d get an antitrust suit and have to spin off Chevrolet. IBM got an antitrust suit in ’68 and 20 years later was on the verge of bankruptcy. Microsoft is not the feared Darth Vader that it was 10 years ago when the government went after them. One of the things that this administration doesn’t get is that the best antitrust policy is a vibrant marketplace. When profit gives you a message that something is lucrative, others will enter into it. They’re not just going to let you—“Oh, Matt’s doing very well, making a billion dollars on this thing. Good old Matt.” They’re going to say, “How do I get that?” And they’ll plunge in.

reason: What’s your assessment of Obama’s health care package?

Forbes: Well, let’s take the president’s word that health care should be universal and affordable. How is it best achieved? We know government achieves it by rationing. And the markets achieve it by creating more of it, and finding cheaper and better ways to deliver it. What people don’t fully grasp is we don’t have free enterprise in health care today in the United States. It is a hybrid system, because it’s third party. So you have a disconnect between providers and consumers. And what kind of market is it where the consumer doesn’t know what the thing costs? Anything else, you do. What is my hamburger going to cost? What is my car going to cost? But if you go to a hospital and ask what a procedure’s going to cost, they assume either you’re a lunatic or you must not have insurance. Why else would you want to know what the price is? How weird. How unusual. Why? Somebody else is paying.

So the system doesn’t work. And you don’t get the kind of productivity you get everywhere else. We use phones and emails for everything now. Do you do consultation with your physician or nurse by phone or email? Rarely. Or hospitals giving warranties, like you have everywhere else, where if they don’t scope your knee right, you go back and don’t have to pay for it again. Why wouldn’t that be their dime? Because it’s not real competition. They know you’re not writing the checks, so therefore they don’t have to please you; they just have to make sure they get a bureaucratic insurance company to approve it.

But we see from Lasik what happens when you get a real market. It costs a third less than it did 10 years ago. Cosmetic surgery hasn’t had inflation, like you have in the rest of health care, even though demand has increased sixfold in the last 15 years and even though there have been enormous technological innovations. Why? Because you pay for it.

reason: So what do you do? This is such a labyrinthine complexity that creates the sort of mixed market which you describe. Are there simple things that can be done to break the logjam?

Forbes: Yes. Equalize tax treatment. You’re going to give employers a tax deduction, why not individuals? And how about allowing you to shop across state lines for health insurance? Illegal now. If you live in California, want to buy a policy in Seattle, illegal. Interstate Commerce Clause, hello! You don’t need a government insurance company. Just get cross-state competition.

Allowing businesses to pull together. Why not remove barriers to that?

In terms of health savings accounts, if you want a higher deductible than X, you can’t get it. I forget what the number is now for a family plan; you can only go up so high. Remove those limits or substantially raise the caps on those.

If you want to set up a clinic or hospital, in a lot of states you have to get a certificate of need. Well, do you need a certificate of need to open up a grocery store if you want to go against Wal-Mart or Whole Foods? No. You just go and do it. See what happens. But because it’s all third-party paying, well, this is inefficient; it’s sort of a cartel system. Get rid of those kinds of things.

reason: Are you surprised by President Obama since he’s come into office? Anything about his comportment, his policy, the reaction to it?

Forbes: I was hoping he would defy my expectations and turn out to be what a lot of people thought—he’s smart, he’s moderate, he’ll do the right thing—instead of being what he has been so far, which is very much an ideologue. On the left, it’s all 1930s. You spend, you tax, you have government running things because we can do it more efficiently.

reason: I find it interesting that he still gives lip service—and gets away with giving lip service—to limited-government principles, saying things like, “Of course we don’t want the government running automobile companies.” And then in the same paragraph, he’ll say “but they need to consolidate their brands” and get very hyper-specific. He still says, “We don’t want to be in the banking sector; I’d rather be doing X, Y, and Z.” It’s as if he senses these things are unpopular out there.

Forbes: That’s why they have to do this by stealth, or semi-stealth. They know the American people are not in a mood for France North America or Germany North America. So they want to use the crisis to ram this stuff through before anybody realizes. Then you’re dependent and therefore, “Oh, they want to take this away from you”; it’s a fait accompli, it’s a coup. But thankfully the Founders devised a system where this stuff just bloody takes time. They didn’t confuse efficiency in the commercial sector with efficiency in government. We don’t want an efficient government in terms of making laws.

They feared passion. They saw what the wars of religion did to Europe and the bloodshed that engendered. They wanted a system where things could cool off before you did something.

reason: You have a new book out about historical figures and lessons that can be learned from them. What are some historical figures or moments of note that can apply to present-day circumstances?

Forbes: Take Alexander the Great. When Aristotle taught him as a young man, one of the things Aristotle tried to hammer home was you must learn to conquer yourself, i.e., control your passions. Alexander did not. He seemed to think that he was actually a living god, and he destroyed himself. He was immensely talented, but it all collapsed when he died. And that’s what I think may be happening with President Obama today. Putting aside what you think of his policies, he may end up getting very little.

For example, he didn’t realize with the stimulus package that Nancy Pelosi may have run up the limit on one of his credit cards. That $800 billion would have been very helpful from their point of view on trying to finance health care. But no, they spent that. It was overreach. No sense of what the real world is like.

reason: There’s been a lot of talk about the scattered state of the modern GOP, and a lot of discussion specifically about the big tent of Ronald Reagan with evangelical Christians and limited-government people. Is that a marriage that has run its course?

Forbes: No. There are two kinds of big tents. One is when you have mush, and so people come in because there’s nothing there. Another one is recognizing that one of the peculiarities of American politics is, because we are a heterogeneous nation, you have to put together coalitions of people who may not like each other much, and they have their own particular agendas and priorities, but you have to keep this thing together and maybe you can get some things done.

And so you’re always going to have tensions; it’s never going to be smooth. One tendency for parties is to just soften everything to oblivion. Another is where you have priorities, as Reagan did, and use a coalition where there are some basic shared values, but there are always going to be fights and tensions. That’s normal.

What helps keep the country together is that you’re not going to succeed by just being a narrow-based candidate, either geographically or ideologically. You’re always going to have to persuade. Like with a family. Families never agree on anything. Well, we’re like a family. And we have those kinds of disagreements. So be it.

Fed Up

bdoherty@reason.com (Brian Doherty) — Tue, 27 Oct 2009 15:17:00 EDT

Rep. Ron Paul (R-Texas), the libertarian-leaning congressman and failed 2008 GOP presidential candidate, has been suspicious of the Federal Reserve since before first entering Congress in 1976. In a 1981 article that mentioned the then-obscure legislator, United Press International reported that Paul “has proposed abolishing the Federal Reserve, repealing laws which make the dollar legal tender, and switching to currency issued by banks, 100 percent backed by gold.”

That was the year Paul first proposed a bill to audit America’s central bank. He recruited 44 cosponsors, but the bill never made it out of committee. The congressman introduced another bill to audit the Fed in 1983 and got less than half as many colleagues to sign on.

On another six occasions, Paul introduced bills that would have abolished the Fed entirely. Those acts of legislative defiance accomplished nothing much besides giving the congressman a reputation as an eccentric gold obsessive, hectoring an institution that was seen by almost everyone, critics and supporters alike, as foundational to the functioning of the modern world. Roll Call, a newspaper covering Capitol Hill, chided Paul after he won reelection to Congress in 1996 for his “idee fixe” of “a return to the gold standard,” which it described as a “rallying cry that hasn’t been a real issue since 1971.”

What a difference an economic crisis makes. In 2007 and 2008, as Paul ran for president, the candidate found to his own surprise that his young-skewing crowds reacted to trash talk about the Federal Reserve more than any other element of his small-government, anti-war agenda. So in 2009, with many economists blaming the Federal Reserve at least partly for inflating a housing bubble whose crash continues to inflict the most economic damage seen in the U.S. for a quarter century, Paul started pushing another version of his “audit the Fed” bill, this one numbered H.R. 1207. And as of press time, the bill has attracted a remarkable 282 co-sponsors, more than a majority, giving it a nontrivial shot at passing through the House of Representatives.

H.R. 1207 would lift existing restrictions on what auditors from the Government Accountability Office are allowed to look into when examining the Fed’s books. Specifically, the bill would allow investigators to report on the Fed’s dealings with foreign banks and nations, its “actions on monetary policy matters,” and the operations of its Federal Open Market Committee, the wing whose decisions most directly affect the U.S. money supply. The legislation is cosponsored by every single Republican in the House as well as 105 Democrats.

For the first time in Paul’s long career of tilting at Alan Greenspan’s windmills, popular sentiment against the Federal Reserve has its chairman, currently Ben Bernanke, running scared. Last summer Bernanke launched an unprecedented public relations campaign, explaining himself in venues from 60 Minutes to town-hall-style meetings broadcast on PBS. In July testimony to the House Committee on Financial Services, Bernanke warned that H.R. 1207 would damage global trust in the Fed’s political independence and “could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability.”

Paul, after shepherding his idea from fringe to mainstream, is almost giddy. “Now the Federal Reserve is less popular than the IRS!” the congressman told a July gathering of Young Americans for Liberty in Washington, D.C. “This issue is never going to go away. Who would have thought a politician could talk about Austrian economics and get applause?”

The Austrian Opposition

With its power over interest rates and the supply of U.S. dollars, the Federal Reserve System is the most influential economic institution on the planet. That influence comes surrounded by an impenetrable aura of mystery. Hardly anyone, citizen or congressman, completely understands what the Fed does, how it operates, or what the effects of its actions will be.

Here is a highly simplified outline. The Fed is a set of 12 regional banks under the command of a seven-member board of governors appointed by the president and approved by the Senate. Its 12-member Federal Open Market Committee (FOMC)—the board of governors plus five regional bank chiefs—is responsible for adjusting the federal funds interest rate, which is the rate banks charge each other for loans. The FOMC does this through “open market operations,” buying and selling securities to affect the amount of money in the economy and thus the interest rate paid by banks to get more cash.

This process is hard enough to describe, let alone comprehend, and previous Fed chairmen have found it useful to keep their public pronouncements about the central bank’s operations maximally vague and obscure. A classic from Paul Volcker, chairman from 1979 to 1987: “We did what we did, we didn’t do what we didn’t do, and the result was what happened.” Volcker’s successor, Alan Greenspan, who enjoyed the longest stretch of low-inflation prosperity in Fed history (now widely seen as possibly laying the groundwork for the crash), helped reinforce both the central bank’s reputation for effectiveness and the expectation that its actions would remain inscrutable.

But these days the Federal Reserve faces challenges to both its power and its mystery, thanks to both hot public opinion and cold academic analysis. Politicians are demanding a peek behind the curtain, and holdovers from Paul’s 2008 presidential campaign have kick-started an “End the Fed” movement. Even within the central bank’s natural fanbase of economists and financiers, many are complaining about its appetite for regulatory power and its massive expansion of the money supply. During the last year the Fed has nearly doubled the monetary measure over which it has the most direct control, the “monetary base” (defined as circulating currency plus the reserves that commercial banks keep with Federal Reserve banks).

Signs abound that public sentiment is turning against the bank. Meltdown, an anti-Fed tract by the historian Thomas Woods, sat on the New York Times bestseller list for more than a month. Woods, like Paul, embraces the “Austrian” school of economic thought, which sees central banking as a recipe for endless inflation and constantly growing government. Paul has invited him to Capitol Hill to brief a growing unofficial caucus of Republicans attracted to Paul’s hardcore anti-statism. Fed bashing has been a prominent component of Tea Party gatherings nationwide. The largely Paulite movement Campaign for Liberty has organized “contact your congressman” campaigns to get H.R. 1207 on representatives’ radar screens, and the results are pouring in.

“The bill has received as many cosponsors as it has in part because Dr. Paul’s presidential campaign really brought the Fed into the spotlight, opened people’s eyes,” Paul Martin-Foss, a legislative aide for Paul, writes in an email. “There was also a lot of grassroots support, with numerous offices telling me that they had received a lot of mail about the bill and wanted more information.” Colorado Democrat Betsy Markey specifically credits Tea Party pressure for getting her interested in the bill, which she decided to cosponsor. “There’s a lot of anger from both sides of the aisle towards the Fed, not necessarily coming from the same position or working towards the same goals,” Martin-Ross writes. “But everyone wants to be seen as being in favor of transparency.”

Paul recognizes that the growing support for auditing the Fed does not indicate similar enthusiasm for his more radical goal of abolishing the central bank. He has introduced another bill to do just that, and it has yet to attract a single cosponsor. H.R. 1207 supporters, by contrast, “sign on because it doesn’t do” anything like that, Paul says. “It doesn’t direct policy changes. I did that on purpose.”

Paul’s beef with the central bank is a by-product of his longstanding interest in the works of Austrian school economists, most prominently Ludwig von Mises and Nobel laureate F.A. Hayek. Paul was a fan of Mises and Hayek before he entered politics in the mid-’70s, largely as a result of his reading the publications of the libertarian Foundation for Economic Education.

Paul, like the economists he admires, thought it a mistake to have a giant government-run institution trying to fix prices—in this case, interest rates, or the price of loaned money, which is the Fed’s main mechanism for pursuing its stated goals of economic growth, high employment, and relatively stable prices. As a critic of state power, Paul also worries that once a government has total control over paper money that it can create at will, it becomes too easy and too tempting for the state to spend at will. Cash unbacked by gold will flow to help the government out of its jams, pay for its wars, and appease its most powerful private constituents.

To Austrian-leaning libertarians like Paul, this danger makes the Federal Reserve, central banking, and “fiat” money the key libertarian issue. If the government can manufacture all the money it wants, the fight for limited government is over before it begins.

Central to this critique is the Austrian business cycle theory, which helped win Hayek his Nobel Prize for economics in 1974. Hayek, Mises, and contemporary economists such as Roger Garrison of Auburn University and Steve Horwitz of St. Lawrence University argue that low interest rates set by the Fed fool investors and builders into thinking that consumer demand for future goods is higher than it actually is. Cheap money makes producers more likely to launch long-term projects and take on long-term expenses. When low rates are a product of government intervention, rather than a market expression of people’s desire for long-term goods as reflected in their willingness to save now in order to consume more later, those long-term projects—for example, building and buying homes—will turn out to be unsustainable “malinvestments.” Prices in those areas will plunge. Everyone will start to realize that resources were funneled to unprofitable ends. An exaggerated boom will turn into a catastrophic bust.

Austrians believe increases in the money supply don’t always manifest in economy-wide rises in the consumer price index, the standard definition of inflation. The excess cash might instead flow into specific areas of the economy, depending on real-world factors that vary from case to case. In the housing boom and bust, those factors included mortgage lending standards, the actions of the government-created mortgage holders Fannie Mae and Freddie Mac, and reckless securitization of mortgages. In the Fed skeptics’ story about the last decade’s economic expansions and contractions, the housing bubble was a deliberate effort by the Fed to stave off economic troubles that began when the tech-stock bubble burst in 2000.

Who Else Is Afraid of the Federal Reserve?

A small but enthusiastic audience, largely connected with explicitly libertarian institutions, has kept the Austrian theory of Fed culpability alive in the decades since Mises and Hayek left the scene. (Mises died in 1973, Hayek in 1992.) But the Austrians aren’t the only opponents of the Fed’s practices. Although history tends to craft auras of inevitability around what exists, the Federal Reserve would have seemed an exotic and dangerous change in American monetary practice in the 19th century.

According to a popular Fed creation myth, the bank, established in 1913, brought an end to a chaotic, boom-and-bust environment of unregulated banking, replacing it with managed economic stability. This story is widely believed despite the fact that America’s most severe banking crisis and economic downturn, the Great Depression, occurred two decades after the Fed was created. As the popular historian (and no Austrian ideologue) Jack Weatherford wrote in his 1997 book The History of Money, “the final stripping of local banks of their power to control money came not because of financial failures but as a result of political movements to centralize power in Washington.”

Opposition to central banks and paper money runs strong through American history. Many of the Founding Fathers came to despise paper currency after their experience with the quickly worthless Revolutionary War “continental.” President Andrew Jackson crushed the Second Bank of the United States in 1832 in the name of the people. President James Buchanan noted after an 1857 bank panic that “our existing misfortunes have proceeded solely from our extravagant and vicious system of paper money.” The Civil War “greenback,” our first national government pure paper currency, was initially declared unconstitutional until a later Supreme Court bowed to political reality. And then there was the debate over establishing the Federal Reserve itself, in which opponents such as Sen. Elihu Root (R-N.Y.) noted the dangers of a potentially unlimited money supply.

In the postwar era of normality and economic centrism, noisy mistrust of the Fed was the province of gold fanatics, radical libertarians, and financial newsletter writers and readers who saw the bank as a machine the government used to debase the currency and steal from the thrifty. But the Fed also earned the ire of progressive leftists who saw it as the citadel of moneyed interests helping creditors at the expense of debtors by keeping inflation too low. The critique, which was especially audible from the Volcker era forward, is exemplified by the progressive journalist William Greider’s best-selling 1987 book on the Fed, Secrets of the Temple. It follows the grand tradition of the three-time Democratic presidential candidate William Jennings Bryan, who famously wanted to rescue indebted farmers through using cheaper and more abundant silver as money rather than crucifying them on a “cross of gold.”

During a time when the Fed actually lived up to its much-vaunted, often spurious “independence from political pressure”—when Paul Volcker was using the shock therapy of high interest rates and lower money supply growth to crush inflation in the early 1980s—the Fed came under political pressure from across the ideological spectrum. Its critics included Sen. Robert Byrd (D–W. Va.) and Rep. Jack Kemp (R-N.Y.) as well as many members of the Reagan administration. But for most of the tenure of Alan “Maestro” Greenspan, the Fed was broadly seen as doing little wrong.

Yet Paul discovered during his presidential bid that anti-Fed feeling had somehow morphed into a popular youth phenomenon. At an Iowa campus stop in 2007, the candidate and I expressed mutual wonder at the fact that his biggest applause line was not about ending the war but about reining in the Fed. At other Paul events, I’m told, kids burned Federal Reserve notes (dollar bills to you) to show their hostility toward the unrestricted and damaging flow of fiat currency.

As that flamboyant gesture indicates, anti-Fed feeling has long overlapped with powerful populist passions. Sometimes that attaches itself to misleading history and misaimed anger. Conspiracy theorists often cite the fact that the Fed is officially owned by its 12 private member banks as evidence that the whole system is a means for private bankers to mulct the public. But in its creation, purpose, and function, the Fed is a branch of government. Its board of governors is selected by the president and approved by the Senate, and most of its income ends up in the U.S. Treasury. And contrary to claims that the law creating the bank was pushed through Congress in the dead of night before Christmas 1913 solely as a result of a banker’s conspiracy forged on Jekyll Island, the Fed arose from long public and congressional debate.

Opposing something that has long been deemed as essential as air tends to attract eccentric people with eccentric beliefs. When I ask Ron Paul where this unexpected upsurge in youthful disdain for the Fed was coming from, he says the most important source was the website of the Mises Institute, an educational foundation for Austrian economics and libertarian political thought. But beyond the economic arguments against fiat currency, Paul says the biggest feeders of popular fear of the Fed are the conspiracy-minded documentary America: Freedom to Fascism and radio host Alex Jones, staunch opponent of the New World Order. In both cases Fed opposition is part of a general theory of sinister and subterranean forces struggling to keep Americans enslaved.

It certainly was no credit to the anti-Fed movement that Holocaust museum shooter James von Brunn had previously been arrested for attempting a “citizen’s arrest” of the Fed’s governors. And when the U.S. Army Reserve issued a “Force Projection Advisory” in November 2008 specifically targeting that month’s anti-Fed protests for “situational awareness and recommended mitigation measures,” it allowed those on the fringe to feel validation that they were not only right all along but a genuine threat to their enemies.

But the profound effects of the Fed’s avowed purpose—manipulating interest rates and making paper currency—are damaging enough, at least for those who see its fingerprints all over the current crisis, to make more baroque conspiracy theorizing superfluous. And when it comes to mistrusting the Fed, the Alex Jones crowd is not alone.

We’re All Austrians Now

Economists, pundits, and financial analysts are not exactly gathering by the hundreds in front of Federal Reserve buildings and chanting “End the Fed!” But it has become almost impossible to avoid respectable voices in respectable venues laying some of the blame for the economic crisis at the Fed’s discount window.

The Berkeley economist Brad DeLong, a popular blogger and former Clinton Treasury Department official who once dismissed Mises’ general monetary theory as “batshit insane,” still told this story in the October 2008 issue of the liberal American Prospect: “The current financial crisis has its roots in Greenspan’s decision to keep interest rates very low in 2002 and 2003 to head off the danger of a deflation-induced double-dip recession.…Six months ago, I would have said that his judgment was probably correct. Today… I can no longer state that Greenspan made the right calls with respect to the level of interest rates and the housing bubble in the 2000s.”

Fed bashing in a roughly Austrian style has gotten so popular that the theory’s opponents now feel embattled. Scott Sumner, a monetary economist at Bentley University who writes the much-cited blog The Money Illusion, thinks the Federal Reserve was and is too tight with interest rates and money for optimal economic performance. “As everyone knows by now,” Sumner complained in June, “the once kooky and discredited Austrian business cycle model has now become conventional wisdom.”

Blame-the-Fed sentiment now stretches across the spectrum of economic thought, from Keynesians such as DeLong to monetarists (who generally want the bank to maintain a fixed rate of money supply growth). In October 2008, the monetarist Anna Schwartz, co-author with Milton Friedman of one of the most important books of monetary economics, A Monetary History of the United States, told The Wall Street Journal: “If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object.”

In February 2009 the Stanford economist John Taylor, a monetary whiz so influential that there is a rule for setting interest rates named after him, told The Wall Street Journal: “The Fed held its target interest rate, especially in 2003–2005, well below known monetary guidelines that say what good policy should be based on historical experience. Keeping interest rates on the track that worked well in the past two decades, rather than keeping rates so low, would have prevented the boom and the bust.”

Even the Obama administration has gotten into the act. “Monetary policy around the world was too loose too long,” Treasury Secretary Tim Geithner told PBS interviewer Charlie Rose in March. “And that created this just huge boom in asset prices, money chasing risk. People trying to get a higher return. That was just overwhelmingly powerful.”

As with any issue in political economy, there’s disagreement. There are a variety of arguments to parry or blunt the Austrian theory. Former Federal Reserve Board economist Arnold Kling, for instance, argues that the modern world of money and credit is so convoluted, with so many avenues for the creation of money-like instruments outside of direct Fed control, that the Fed shouldn’t be seen as the main villain in any credit-driven collapse. At worst, Kling thinks, it’s a hapless bungler pretending to power it can never have. Bryan Caplan, a libertarian economist at George Mason University, thinks people are generally too smart to be fooled enough by false interest rate signals that they precipitate an economic crisis.

And pinning even partial blame for the current economy on the Fed is different from questioning its legitimacy. By limiting his bill to the narrow question of transparency, Paul is making it possible to create a broad political coalition that can agree the Fed needs to be kept in check without necessarily agreeing on why, or on what the Fed ought to be doing.

The Fed Forever?

Despite the palpable momentum behind H.R. 1207, the idea of inconveniencing the Fed with anything more severe than an audit still seems like a far-off fantasy. Meltdown author Woods notes that, although many mainstream analysts are jumping on the Austrian bandwagon to explain the causes of the crisis, none of them are really embracing the Austrian solution of ending the Fed’s power to manipulate interest rates at will. They just call for the power to be used more prudently next boomtime.

The Fed was an ideological and institutional response to a convincingly told story of crisis and solution—basically, that the 19th-century system of mostly private banks issuing their own mostly gold-backed paper was leading to too many small economic crises of the sort that used to be called “bank panics.” Milton Friedman, a critic of central banking practice, at the same time dismissed attempts to return to a commodity standard such as gold. One of his reasons was that it was “not feasible because the mythology and beliefs required to make it effective do not exist.” But with best-selling books, activists in the street, members of Congress, and economists across the ideological spectrum casting aspersions on Fed practice, we may see the crafting of a new set of myths and beliefs.

In this time of political ferment, Stephen Axilrod, a longtime Federal Reserve staff director and monetary policy guru, has issued a memoir from MIT Press titled Inside the Fed. Axilrod admits that Fed interest rate actions precipitated the crisis without letting that fact dent either his admiration for the institution or his belief in its necessity. Still, Axilrod notes something that should encourage Fed skeptics of all varieties: that “a country’s monetary policy is almost necessarily limited by conditions generated from the political, philosophic, and social ethos of the time.”

We are now seeing attempts to move the ethos in an anti-Fed direction. While it’s hard to imagine an America without an institution that has become so central, it’s interesting to contemplate something former Rep. Eldridge Spaulding (R-N.Y.) said in 1868, in the midst of the legal controversy over Civil War greenbacks: “No one would now think of passing a legal tender act making the promises of the Government…a legal tender in payment of ‘all debts public and private.’ Such a law could not be sustained for one moment.”

What anyone would think can change dramatically. Ron Paul, through his Fed audit bill, is trying to get his colleagues, and the American people, to change what and how they think about the central bank. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, told a Massachusetts town hall meeting in August that he believes the House will indeed pass H.R. 1207 in October.

All the anti-Fed agitation we’ve seen in the last couple of years may eventually feel like a footnote if the current binge of monetary expansion creates something Americans haven’t seen for a quarter century: substantial and painful inflation in the consumer price index. For now, Bernanke is trying to assure Congress and the public that the Fed governors are skilled and knowledgeable enough to know when they need to “neutralize” the new money by, for example, selling bonds to the market and essentially swallowing the money back up before prices spike.

But the Fed doesn’t have a stellar track record of timing monetary shifts with scientific precision, and any actions that rein in inflation, thereby cutting off the short-term stimulative effect that governments love, are bound to be politically dangerous both to the Fed and to the president who appoints its overseers. As Bernanke admitted at his televised town hall meeting in July, the Fed can maintain its independence only if it can “show that we are producing good results,” and while he added lip service to independence, the people he must show those results to are Congress and the administration. Though he was appointed to a new four-year term in August, if he flubs inflation, Bernanke will be facing a whole new wave of political attacks.

More generally, the Fed’s independence is threatened by a growing understanding that the Austrian interpretation of central banking’s risks might be correct: Keeping interest rates too low for too long can precipitate severe economic busts. “It’s hard to imagine the little spark that can make big change,” says Austrian business cycle theorist Steve Horwitz, “but it can happen if the drumbeat stays going. The Fed was created by Congress, so we won’t get major change until members of Congress perceive their constituents or people with political, cultural, and social power saying there’s something really seriously wrong here.”

Senior Editor Brian Doherty (bdoherty@reason.com) is the author of This is Burning Man (BenBella), Radicals for Capitalism (PublicAffairs), and Gun Control on Trial (Cato Institute). This column first appeared at Reason.com.

Signs of an American Lost Decade?

anthony.randazzo@reason.org (Anthony Randazzo) — Tue, 27 Oct 2009 14:15:00 EDT

Back in February of this year, I wrote in a policy study (co-authored by Mike Flynn and Adam Summers) that if America did not learn the lessons of the Japanese Lost Decade properly that we would suffer a similar long night of economic malaise. Even earlier this year the signs were starting to show that Washington policymakers didn't really understand what Japan did wrong, as the Fed maintained easy monetary policy and Congress prepared a stimulus package. Over a year after the start of the crisis, it's looking like we haven't deviated from our road towards more economic pain. And others are starting to ask, is the U.S. economy turning Japanese?

That is the question Christopher Wood, author of "The Bubble Economy: Japan's Extraordinary Speculative Boom of the '80s and the Dramatic Bust of the '90s," asks in The Wall Street Journal this morning:

With the U.S. government stepping in to keep markets from clearing, today's U.S. economy in many ways resembles the post-bubble Japanese economy of the 1990s. Ultra-loose monetary policy and low demand for credit, combined with high unemployment and consumer deleveraging, could lead to a prolonged slump. [...]

[In post-bubble Japan] banks took years to be cleaned up as a result of regulatory forbearance. The same kind of forbearance is preventing America's increasingly distressed commercial real-estate market from clearing. Similarly, as was the case with Japan, monetary-base growth has exploded in the U.S. over the past year courtesy of the Fed, while bank lending is declining. This is why there is every reason to fear that America is already in a Japanese-style liquidity trap.

And Wood is correct that we are facing a long period of economic decline and malaise, not a rapid takeoff in the economy. This is not the trough of a V-shaped, or even a U-shaped recession. There are still many things buried in the economic infrastructure of America that need to get sorted out before we have a full recovery. We are facing a W-shaped, double-dip recession... or worse. Consider this:

A recovery of the stock market does not necessarily translate into recovery for the real economy. While the Dow is up 50% from its low in March 2009, other indicators, such as unemployment and consumption numbers, haven't been positive.
The Wall Street recovery doesn't have a stable base. It is being driven by confidence in big firms, but that confidence stems largely from (and is at least dependent on) the government bailout of major financial institutions. And a recovery propped up by too big to fail is a recovery destined to fail.
There are still significant problems in the banking industry. Toxic debt is still hanging around. The securitization markets aren't functioning. And bad business models and pay structures were left intact by the bailout process. These problems are likely to manifest in a big way in 2010 as the reality of the faux-recovery sets in.
There are still significant problems in the housing industry. Foreclosure rates are continuing to rise. Mortgage default rates will like not peak until the end of 2010. And while the sales decline seemed to have bottomed out this year, a housing sales out West appear to be headed back down, signaling a potential nationwide re-decline, beyond the season adjustment we're going to encounter over the next few months. Housing troubles are likely to plague the economy for the next 6 to 12 months at least.
We have still yet to see viable plans for exiting fiscal and monetary policies that are propping up the economy.

We can't have real recovery without the government out of the way. We need to clear the decks and get all the toxicity (of mortgages and otherwise) out of the system. This is what the market tries to do with recessions, but we haven't let it yet.

And thus we are starting to look like Japan. The corporate CEOs who led their companies into financial mess kept their jobs into the lost decade. Stimulus packages only yielded a doubling in unemployment. Oh, and national debt got out of control. Sound familiar?

For more, check out my study on Avoiding an American Lost Decade here.

Reason Around Town: 2:45PM Radio Inverview on How the Economy is Turning Japanese

anthony.randazzo@reason.org (Anthony Randazzo) — Tue, 27 Oct 2009 13:00:00 EDT

I'll be on the "C4" radio show this afternoon to talk about how the U.S. economy is turning Japanese.

For those in the greater Baltimore/DC area, check out WBAL AM 1090
Check out The C4 Show's website here.

For our readers across the country, you can listen in live here. Or just check out the WBAL website to listen in.

Also see my writing on this subject:

Financial Market Reform

miron@fas.harvard.edu (Jeffrey Miron) — Tue, 27 Oct 2009 10:57:00 EDT

In the coming weeks and months, Congress will be turning its attention to financial market reform, in hopes of avoiding future financial crises. According to perceived wisdom, the root cause of the 2008 financial crisis was excessive risk-taking, and proper regulation can detect and prevent such excess in the future.

This view is a pipe dream. Most new regulation will do nothing to limit crises because markets will innovate around it. Worse, some regulation being considered by Congress will guarantee bigger and more frequent crises.

Government-Induced Moral Hazard Caused the Crisis

The Financial Crisis of 2008 did not occur because of insufficient or ill-designed regulation. Rather, it resulted from two misguided government policies.

The first was the attempt to promote homeownership. Numerous policies have pursued this goal for decades, and over time they have focused mainly on homeownership for low-income households. These policies encouraged mortgage lending to borrowers with shaky credit characteristics, such as limited income or assets, and on terms that defied common sense, such as zero down payment.

The pressure to expand risky credit was especially problematic because of the second misguided policy, the long-standing practice of bailing out failures from private risk-taking. This practice meant that financial markets expected the government to cushion any losses from a crash in mortgage debt. Thus, the historical tendency to bail out creditors created an enormous moral hazard.

One crucial component of this moral hazard was the now infamous “Greenspan put,” the Fed’s practice under Chairman Alan Greenspan of lowering interest rates in response to financial disruptions that might otherwise cause a crash in asset prices. In the early to mid-2000s, in particular, the Fed made a conscious decision not to burst the housing bubble and instead to “fix things” if a crash occurred.

It was inevitable, however, that a crash would ensue; the expansion of mortgage credit made sense only so long as housing prices kept increasing, and at some point this had to stop. Once it did, the market had no option but to unwind the positions built on untenable assumptions about housing prices. Thus government pressure to take risk, combined with implicit insurance for this risk, were the crucial causes of the bubble and the crash. Inadequate financial regulation played no significant role.

New Regulation Must Avoid Moral Hazard

If government-induced moral hazard caused the crisis, then new regulation should avoid creating or exacerbating this perverse incentive. Yet two components of proposed regulation will increase, rather than decrease, the chances for moral hazard.

One proposed change in regulation would give the Federal Reserve increased power to supervise financial institutions, especially bank holding companies such as Citigroup or Bank of America. This approach is a triumph of hope over experience. Why should an expanded Fed role be beneficial when the Fed erred so badly in the previous instance?

Defenders of an expanded Fed role will claim that, in the lead up to the crisis, the Fed did not have explicit powers to supervise and monitor non-bank financial institutions, and that such powers could have avoided the crisis.

Yet during the years before the crisis, the Fed had more than ample power to recognize the unprecedented level of risk that was building in the economy and to issue stern warnings, whether or not it had explicit regulatory authority. In fact, far from cautioning the market to behave, the Fed promoted the notion that it could solve any problems that might result from a bursting of the housing bubble.

Regulators are fallible. Alan Greenspan, once thought to be the Maestro, got it fabulously wrong. Ben Bernanke, regardless of the merit’s of his stewardship, will not be Fed chairman forever. Centralized and expanded power to make things better is also centralized and expanded power to make things worse. In particular, any mistakes made by a powerful, centralized authority have a magnified impact because they distort the behavior of the entire market.

Just as problematic as granting the Fed additional powers is the proposal to allow the FDIC to resolve bank holding companies using taxpayer funds. Under the proposed arrangement, the FDIC rather than bankruptcy courts would be responsible for bank holding companies, and the FDIC would be authorized to make loans to failed institutions, to purchase their debts and other assets, to assume or guarantee their obligations, and to acquire equity interests. The funds would be borrowed from Treasury.

This means that FDIC resolution of bank holding companies would put taxpayer skin in the game, a radical departure from standard bankruptcy and an approach that mimics the actions of the U.S. Treasury under TARP. Thus, the new approach would institutionalize TARP.

The result will be that under the proposed system, bank holding companies would forever more regard themselves as explicitly, not just implicitly, backstopped by the full faith and credit of the U.S. Treasury. That is moral hazard in the extreme, and it will create an unprecedented incentive for excessive risk-taking by these institutions.

The Bankruptcy Approach

The only way to limit financial panics is to eliminate government-induced moral hazard, and that means letting failed institutions fail. Whether resolution is carried out by the FDIC or a bankruptcy court is not the crucial question; rather, it is whether that resolution process forces all the losses on the institution’s stakeholders rather than bailing them out with taxpayer funds.

The standard objection to allowing failures is that some financial institutions are allegedly so large or interconnected that their failure causes a breakdown of the credit mechanism, thereby harming the whole economy rather than just transmitting losses that have already occurred. According to this view, letting Lehman Brothers fail was a crucial mistake that initiated the meltdown, and bailing out other financial institutions was a necessary evil to prevent even further chaos. Nothing could be further from the truth.

Rather than being a cause, Lehman’s failure was merely the signal that time had come for the U.S. economy to pay the price for all the distortions caused by the misguided policies toward housing and risk. Given those distortions, a massive unwinding and restructuring was necessary to make the economy healthy again.

This restructuring required lower residential investment, declines in stock and housing prices, and shrinkage of the financial sector. All of this implied a recession, even without any impact of financial institution failures on the credit mechanism, and the recession meant that lending would contract, even without a credit crunch.

The bailout itself, moreover, caused much of the financial market turmoil. The announcement that the Treasury was considering a bailout scared markets and froze credit because bankers did not want to realize their losses if government was going to bail them out. The bailout introduced uncertainty because no one knew what the bailout meant. The bailout did little to make balance sheets transparent, yet the market’s inability to determine who was solvent was a key reason for the credit freeze.

Thus letting Lehman fail was the right decision; bailing out Bear Stearns, Fannie, and Freddie in advance of Lehman, and the rest of Wall Street afterwards, were the mistakes. For all its warts, bankruptcy rather than bailout is the right way to resolve non-bank financial institutions. Any regulation that formalizes bailouts creates an enormous moral hazard and a black hole for taxpayer funds.

The Future

To limit future financial crises, policy must first avoid the distortions inherent in the attempt to expand homeownership. This means eliminating the Federal Housing Administration, the Federal Home Loan Banks, Fannie Mae, Freddie Mac, the Community Reinvestment Act, the deductibility of mortgage interest, the homestead exclusion in the personal bankruptcy code, the tax-favored treatment of capital gains on housing, the HOPE for Homeowners Act, the Emergency Economic Stabilization Act (the bailout bill), and the Homeowners Affordability and Stability Plan. None of this is sensible policy.

In addition, policy must end its proclivity to bail out private risk-taking. This second task is difficult, since it requires policymakers to “tie their own hands.” Specific changes in policies and institutions can nevertheless support this goal. The first is avoiding new regulation that makes bailouts more likely. A second is repealing all existing financial regulation, since this would signal markets that they, and only they, can truly protect themselves from risk.

The third and perhaps most important way to reduce moral hazard is to eliminate the Federal Reserve. As long as the Fed exists, it will regard itself as, and be regarded as, the economic insurer of last resort. In a world with perfect information, appropriately humble central bankers, and an absence of political influence on monetary policy, such a protector might enhance the economy’s performance on average.

In the world we live in, none of these conditions will hold consistently, so the potential for policy-induced disasters is large. The U.S. economy prospered for its first 125 years without a central bank. It’s time to try that approach again.

Jeffrey A. Miron is Senior Lecturer and Director of Undergraduate Studies in the Department of Economics at Harvard University and a Senior Fellow at The Cato Institute. He blogs at http://jeffreymiron.blogspot.com. This column first appeared at Reason.com.