The Future of the Financial System, Part II

Interview with FEE Chairman Wayne Olson

In June, I sat down with Wayne Olson, chairman of the board of Foundation for Economic Education (FEE), one of the oldest free-market organizations in the United States to talk about the future of the financial system. Mr. Olson spent most of his career as a banker focused on fixed-income products with the international financial services institution Credit Suisse. Drawing from his extensive experience, we discussed the financial crisis, Wall Street’s culture of risk taking, financial services regulation, the housing market, and inflation concerns.

In Part I of this interview we talked about causes of the financial crisis, monetary policy, risk management on Wall Street, the value of the FDIC, consumer confidence, and the importance of a strong dollar. Part II continues here.

Randazzo: Shifting gears a little bit, how do you think the end of the Bush tax cuts will affect Wall Street or businesses around America?

Olson: Yeah, why is it that tax reduction bills are always called Job Creation Acts, or Economic Stimulus Acts? But if you increase marginal tax rates, it’s never called the Job Destruction Act of 2009? Raising the capital gains rate is going to be bearish for stocks. This isn’t rocket science! It’s bearish for equities, thereby encouraging more leverage in the economy, and raising marginal income tax rates increases the incentive for people to invest in facilities that employ labor in other places, like Brazil, Russia, India, and China.

Randazzo: Do you have a sense for how much of economic recovery depends on the recovery of the housing market?

Olson: You spoke about confidence a minute ago. What the housing market needs most is for people to have confidence in the pricing. There is a natural course of adjustment that goes on in the wake of a bubble. People realize that the asset prices are too high and there’s a price discovery process where people are trying to find the right price for these assets. Once people restore confidence in the prices of houses and office buildings and shopping centers and so on, then that’s a key step along the road to recovery. The government, when they talk about recovery in the real estate market, they always mean keeping prices higher than they should be.

Randazzo: You’re talking about the government tendency to push more people into home ownership than we can sustain? The rate of home ownership growing from 62 percent to 70 percent of Americans during the course of the bubble?

Olson: Well, people buying homes when they should be renting apartments. The government push is an example of the fatal conceit. Folks in Washington think they know what the optimal percentage of home ownership is in the economy at any given time. I don’t know for any individual whether he should buy or rent. I, myself, am on both sides of that fence. Sometimes I buy, sometimes I rent. How do I know what the whole economy should do?

Randazzo: What kind of problems, moral hazard or otherwise, does the quasi-nationalization of General Motors create?

Olson: There’s a bunch of problems with it. Moral hazard is just one of them. The assets that are owned by General Motors, if the natural course of events had gone forward in accordance with the way the law used to be, would have gone into reorganization under Chapter 11 in the federal courts without government money or interference. And these assets would have been sold and redeployed, put in the hands of somebody that could have used them more productively. A bunch of the folks that are on the payroll at GM would have been taken off the payroll at General Motors and redeployed to more productive use. There would be a labor pool available for other employers at reduced labor costs. We’re obviously not trying to let prices find their proper level, we’re trying to continue to inflate the price of labor and the price of physical assets. You’ve got to find the right use for that labor and the right use for those capital goods. The bailout of General Motors is doing exactly the opposite.

Randazzo: What about problems with the way the Obama administration restructured ownership with the unions and creditors?

Olson: I spoke about confidence in the rule of law. There’s no law more important to creditors than bankruptcy. To the extent that you impair the operation of bankruptcy law, you introduce massive uncertainty. I used to structure bonds, and there are lots of assurances given by borrowers to lenders in bonds. Now what assurances do I put in my next bond issue that’s going to make it attractive for people to buy?

Randazzo: Because people just aren’t going to trust that the government’s going to honor them?

Olson: Well, it used to mean something when you created secured notes. It meant something to be a secured creditor. It still means something, but it’s a lot less clear what it means. Your rights might be enforced, and they might not.

Randazzo: You’re the chairman of FEE and are focused on economic education. If we had better education for how economies functioned, would that have mitigated some of the problems we’ve seen with the government’s response to the crisis? Would this have prevented some of the disrespect for rule of law?

Olson: I do think that economic education would improve matters, but I don’t think that it’s necessary to win over the vast majority of people. There is such a thing as an intellectual elite, people who are involved in the knowledge professions, and it is of particular importance that people who manage words and ideas for a living should be well educated on such questions as, where do jobs come from? There are people in the knowledge professions who pretend to have a well-informed opinion about managing the economy and creating jobs who have no idea where jobs come from, and that makes just as much sense as managing the population without knowing where babies come from. Yes, I think people should know where babies come from, and I think people should know where jobs come from.

Randazzo: Do you think that FEE, along with think tanks and education groups similar to your own, has failed in the past few decades in bringing economic education to America?

Olson: The intellectual environment in which we find ourselves is a lot better than it was when FEE was founded in 1946. In 1946, there was a sense that we were this tiny band, like monks on the west coast of Ireland preserving Christianity in the Dark Ages. We were writing our manuscripts, keeping the sacred texts in print and talking about ourselves as the remnant. Now you have free market think tanks in just about every state in the union. The State Policy Network didn’t exist twenty years ago. Now it does, its members are very active, they’re everywhere, and they do great stuff. To talk about a failure is really overstating the case. The fact that we haven’t changed the world doesn’t mean that we haven’t created a much better environment for the respectability of free market principles.

Randazzo: So with all the turmoil in the economy, but couched in a perspective that we are better off than sixty years ago, are you optimistic or pessimistic about the future of America and the future of the American economy?

Olson: I’m bearish on the relatively near term. I don’t know if I’m bearish on equities, but I do believe that there will be inflation commensurate with the seventies. Stagflation had the unemployment rate and inflation rate approaching double digits for a number of years. Bond yields went crazy. People made more money in commodities and real estate than they did in productive assets. Equities sort of drifted most years. They didn’t really keep up with inflation, but to the extent that equities are based in hard assets, the inflation we will have soon can inflate the price of equities to some extent as well. In terms of productivity of the economy and value of the dollar and leadership of the world and that sort of thing, I don’t think the prospect for the next few years is very good.

Randazzo: What about the long term?

Olson: If you think back to the seventies, we had Nixon, who ended the gold standard. We had Ford, from whom we got “Whip Inflation Now” buttons, you know, we would all “whip inflation” by wearing WIN buttons. We had Jimmy Carter in his cardigan sweaters who was the audacity of hope type, the inspirational sort that Obama is. I was in business school at the time, and I thought there was no hope. It wasn’t just that the government was evil and overreaching, but it was incredibly stupid, and Washington was taking over everything. All of a sudden you got Reagan. Where did that come from? You had Maggie Thatcher. Where did that come from? And now, you know what gives me hope? We’ve got Angela Merkel and Nicolas Sarkozy giving lectures to America on fiscal responsibility and monetary discipline. That gives me hope. There’s such a thing as competition in the world. If I may use the metaphor of a parasite, I recently had the job of cutting back a bunch of wisteria from overrunning the trees in my garden, and I observed that there’s a limit to how much wisteria can take over a garden, because sooner or later it kills the host. Competition ensures that there’s a limit to the extent of which government can impose its will on the economy, because capital just goes someplace else, and freedom arises someplace else.

Randazzo: Well, thank you very much for this conversation. I have found it educational and interesting. I believe our readers will as well.