This article is from TOS Vol. 4, No. 1. The full contents of the issue are listed here.
Altruism: The Moral Root of the Financial Crisis
Government intervention is once again wreaking havoc on the U.S. financial system and the economic security of millions of Americans—a tragic replay of previous crises. In 2008–2009, for the second time this decade (the first being 2000–2002), the value of U.S. publicly-traded stocks has plunged by 50 percent—but this time with an additional plunge in the median home price, which has dropped 23 percent from its peak in 2007. Thus American households have suffered declines of $8 trillion and $4 trillion, respectively, in the value of their two key assets—stocks and homes—and a 20 percent drop in their net worth, from its recent peak. Meanwhile Washington policymakers have mired Americans in yet another recession, with declining output, stagnant income, and a rising jobless rate. The current recession is not yet as severe as many prior ones, but it will worsen if interventions intensify.
Relative to past economic downturns, few financial institutions have faltered or failed amid the economic turmoil of 2008–2009, but those that have include some of America’s largest and most famous names, such as Merrill Lynch, Bear Stearns, Lehman Brothers, Citicorp, AIG, Washington Mutual, Wachovia, and Countrywide Financial. Since last fall, Washington has only further fueled a crisis that began modestly in 2007, by bypassing bankruptcy courts and instead bailing out or nationalizing these firms, or forcing healthy firms to absorb them (thereby weakening the healthy ones). Whereas since mid-2007 U.S. stocks generally are down 50 percent, those of large U.S. financial institutions have plunged 80 percent, the worst performance since the Great Depression. With every new government intervention in the sector, there has been only a quickening of capital flight and stock-price declines.
What caused the current financial crisis? If most economists, politicians, and commentators are to be believed, the cause is capitalism and its inherent greed. According to Democrat presidential candidate Barack Obama, “we excused and even embraced an ethic of greed”; “we encouraged a winner-take-all, anything-goes environment”; and “instead of establishing a 21st century regulatory framework, we simply dismantled the old one.”1 As a senator last fall, Obama decried as “an outrage” the need for a bailout plan “to rescue our economy from the greed and irresponsibility of Wall Street” (and then promptly voted for it).2 GOP presidential candidate John McCain said the financial crisis was caused by “greed, corruption, and excess,” as Wall Street “treated the American economy like a casino.”3 With the New York Times in December, President Bush “shared his views of how the nation came to the brink of economic disaster,” citing “corporate greed and market excesses fueled by a flood of foreign cash,” concluding that “Wall Street got drunk.”4 In his New York Times column, Paul Krugman, recipient of the Nobel Prize in economics in 2008, repeatedly blames the crisis on “deregulation” and free-market “dogmas.” Alan Greenspan—who for twenty years headed the Federal Reserve as Washington’s money monopolist and top bank regulator—told Congress last fall that “those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity, myself especially, are in a state of shocked disbelief,” agreed that it was a “flaw” in his ideology, and called for still more government regulation—which led many journalists to declare, with glee, that “Greenspan Admits Free Market Has Foundered.”5 The Washington Post traces the crisis to a U.S.-led “crusade to persuade much of the world to lift the heavy hand of government from finance and industry,” to “spread the gospel of laissez-faire capitalism,” and claims that this “hands-off brand of capitalism” only “sickened the housing market and allowed a freewheeling Wall Street to create a pool of toxic investments that has infected the global financial system.”6
The usual greed-blaming, anticapitalist interpretations cited above have fueled massive interventions in the U.S. financial sector in recent months, including partial nationalizations. America’s largest bank (Citigroup) and largest insurance company (AIG) are now effectively owned and controlled by the U.S. government, through the Federal Reserve and Treasury Department. Since October Washington has sunk nearly $500 billion of taxpayer funds into the shares of America’s four hundred largest banks, failing and healthy alike—often against the will of senior management.7 By March 2009, the money sunk into America’s ten biggest banks constituted 45 percent of their stock market value, twice the proportion of October 2008; in the process, politicians and bureaucrats have increasingly dictated the banks’ policies on lending, dividends, mergers, and executive pay.8 In another intervention, the Federal Reserve has guaranteed more than $2 trillion in shaky short-term business loans and mortgages—and will purchase or guarantee an additional $1 trillion in 2009. Meanwhile the Federal Deposit Insurance Corporation (FDIC), which guarantees bank checking deposits in the event of bank failures, has vastly increased the scope of its coverage, from $100,000 to $250,000 per bank account—and now also insures trillions of dollars in bank bonds and money market mutual funds, a gargantuan liability that it had never assumed before 2008. The FDIC now guarantees about 70 percent of all bank checking deposits, up from 50 percent a decade ago.
Such bailouts and government guarantees (and smaller bailouts targeted at large but insolvent insurance firms and money-losing Detroit automakers) resulted in an $8.7 trillion increase in federal obligations (debts and guarantees) in the second half of 2008 alone.9 To put this figure in perspective, consider that at the end of 2007 the entire national debt was $9.3 trillion, that annual spending in 2007 was $3 trillion, and that the country’s entire annual economic output (GDP) in 2007 was $14 trillion. To compare the magnitude of recent interventions with those of the past, consider that the increase in spending in 2008–2009 is seventeen times the entire cost of FDR’s New Deal (which was $500 billion, inflation-adjusted). And President Obama’s first budget expands Washington’s presence even further, with planned total spending of $4 trillion in 2009 (33 percent greater than in 2008), representing 28 percent of GDP (up from a 21-percent share in 2008).
Claims about the need to contain the supposed “instabilities” inherent in free markets have necessarily brought persistent demands that Washington regulate, bail out, guarantee, and nationalize financial institutions. According to the Economist, “the government of the world’s leading capitalist nation has been sucked into the maelstrom of its most capitalist industry.”10 This account blithely presumes that America today is a capitalist nation and that Washington politicians are victims of a capitalist marketplace, forced to intervene and fix the U.S. economy in the wake of its failures. Capitalism’s modern critics presume that markets left to their own devices are inherently fragile and prone to breakdowns, whereas the U.S. government is a solid, confidence-instilling Rock of Gibraltar.
The above interpretations ignore the plain fact that America today does not enjoy a free-market system—let alone a free-market financial sector—nor has it enjoyed one for most of the past century. Only through a profound misunderstanding of what constitutes a free-market system could anyone honestly blame capitalism for the financial crisis. For decades the American politico-economic system has been a mixed system—a combination of some freedom of choice and action offset by large (and growing) coercive interventions. It was precisely these coercive elements—the regulation, taxation, and subsidization—that caused today’s financial crisis. Washington’s recent and massive interventions did not follow from free-market “failure”; they followed from the market distortions caused by prior government intervention in the economy. Government interventions have both instigated and aggravated the latest financial crisis.
By surveying the government interventions that caused the latest turmoil and wealth destruction in housing and banking, this article will demonstrate that the current financial crisis was caused not by a return to free markets or pro-capitalist policies in the past decade, but by a tragic progression toward socialism. More importantly, it will demonstrate that altruism—the notion that being moral consists in sacrificing oneself for the needs of others—is the basis for this government intervention, and thus the root cause of the crisis.
Of course, in order to recognize that capitalism is innocent of the latest charges against it, we must bear in mind what capitalism is. Capitalism is the social system of individual rights, including property rights, in which all property is privately owned.11 Capitalism upholds the rule of law and equality before the law, forbids government favors to any person or group (including businesses), entails the complete separation of state and economics, and thus leaves each individual free to act on his own judgment for his own sake. With that in mind, let us consider the relevant facts surrounding the financial crisis.
The Troubled Housing Market
Perhaps no single U.S. government intervention has destroyed more capital or wasted more taxpayer funds in recent years than the establishment of “Fannie Mae,” “Freddie Mac,” and “Ginnie Mae”—“government-sponsored enterprises” (GSEs) that for years have been used by politicians to secure campaign funds and votes by promoting artificially cheap home mortgages and “the American dream of home ownership.” The quaint, disarming nicknames for the GSEs actually stand for the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association.
Until their recent insolvencies, the GSEs were neither wholly private firms nor wholly government agencies, but “hybrid” entities, with origins in FDR’s New Deal. The GSEs were established to make home mortgages more available to the “needy,” and for decades had the implicit backing of the U.S. Treasury and immunity from strict accounting standards, so as to reduce interest costs and dilute eligibility rules. Beginning in the mid-1990s, the influence of the GSEs was expanded significantly. The altruistic motive behind the expansion, embraced by Democrats and Republicans alike, was to help the needy and undeserving obtain mortgages they would not be able to secure in an unsubsidized, unregulated market.
Given the broad scope of government intervention in the U.S. home mortgage sector through the GSEs, the maze of other agencies—such as the Department of Housing and Urban Development (HUD), the Federal Housing Finance Board (FHFB), the Federal Housing Administration (FHA), the Federal Home Loan Bank (FHLB), and the Office of Federal Housing Enterprise Oversight (OFHEO)—and the cascade of Congressional acts—such as the Fair Housing Act (1968), the Equal Credit Opportunity Act (1974), the Community Reinvestment Act (1977), the Home Mortgage Disclosure Act (1975), the National Affordable Housing Act (1990), the Community Development and Regulatory Improvement Act (1994), the Home Ownership and Equity Protection Act (1994), and the American Dream Down Payment Act (2003)—it is simply ludicrous for anyone today to speak of the U.S. mortgage sector as having been a fully “free” market before the latest crisis. Only more ludicrous is the claim that the few free elements still remaining, but not the interventions, caused the crisis. Armed with its allegedly “noble” goal of increasing home ownership for the needy, the U.S. government has riddled the mortgage market with perverse incentives and unjust interventions that either compel or induce banks to lend to less-than-creditworthy borrowers, and thus to put themselves at greater risk of insolvency.
Today the concept of “moral hazard”—whereby a public policy necessarily engenders risky and reckless behavior by people and companies that otherwise simply would not arise (or not arise systemically) in a free market—is nearly ubiquitous. Some people now sense what economists (who coined the phrase) have long argued, that Washington’s interventions in home mortgages have created such a “moral hazard” and thus contributed to the crisis. Yet few dare to name the real moral hazard at the root of all the recklessness: the hazard posed by the morality of altruism.
Altruism has motivated the utter debasement of lending standards in the past decade. Mortgage lenders joked that the Bush administration’s crazed push to increase home ownership among blacks and Hispanics led to a proliferation of so-called “NINJA” loans—those granted to borrowers with “No Income, No Job, or Assets.” Altruism commands service to the needy—and NINJA “borrowers” fit the bill perfectly. Highlighting the legal-coercive backing of Washington’s altruistic credit policies, the Federal Reserve Bank has for years distributed a booklet to mortgage lenders—Closing the Gap: A Guide to Equal Opportunity Lending—which includes sidebar reminders that fines and jail terms await those found to be deficient in fighting “discrimination” by lending to the less-than-creditworthy. The booklet, still distributed today, derides as “arbitrary and unreasonable” such traditional credit standards as a 20 percent down payment (or loan-to-value ratio of 80 percent), an above-par credit score, a history of paying one’s bills on time, and a steady job yielding an income sufficient to make monthly mortgage payments.12
In order to “close the gap” and “achieve the American dream,” “subprime” mortgages were extended to those with poor credit histories and those who put down little or no equity, leaving neither a collateral cushion for lenders nor an incentive for borrowers to repay their loans if house prices declined below the loan value. “Fannie Mae” and “Freddie Mac” further encouraged the expansion of subprime mortgage loans by encouraging loan originators to package them into instruments called “mortgage-backed securities” for sale either directly to the taxpayer-backed GSEs or to private investors with a GSE guarantee—a process known as “securitization.” The GSEs then pressured rating agencies such as Moody’s and Standard & Poor’s to assign top grades to these low-grade securities in order to entice financial institutions throughout the world to purchase them. Because banks and mortgage firms were encouraged by the GSEs to sell their home mortgages shortly after originating them—in the process collecting rich fees and then jettisoning the consequences of borrowers defaulting on their loans—they became far less concerned about the quality of their borrowers or their loans.
The incentive to lend (or borrow) with care in the mortgage sector was radically diminished when, in 2002, Washington set a goal of artificially boosting the home ownership rate from 65 percent of households (the rate for the prior two decades) to 70 percent. Washington’s array of mortgage agencies and laws were deployed to meet the altruistic goal, which necessitated the lowering of credit standards. Banks subject to the Community Reinvestment Act were aggressively penalized if they were not found boosting their subprime loan volumes; and to deprive them of any excuse, the GSEs began significantly increasing their purchases and guarantees of such loans.
Washington’s overt sponsorship of debased lending standards in home loans was the primary economic cause of America’s 2007–2009 mortgage-housing crisis. Washington provided massive political-financial incentives to make bad loans. Such loans were made, and soon exhibited sky-high default rates. High default rates caused bank losses, so bankers restricted their lending, resulting in a peak (and decline) in house prices that wiped out home equity and caused further defaults. The highest default rates on subprime mortgages have occurred in such immigrant-heavy states as Arizona, California, and Florida, where, through altruistic schemes, politicians expected to generate a wave of new voters.
The Federal Reserve also contributed significantly to the mortgage-housing crisis by encouraging the vast expansion of riskier “adjustable-rate mortgages” (ARMs). As compared to traditional thirty-year, fixed-rate mortgages, short-term ARMs entailed lower monthly payments when short-term interest rates were lower and higher monthly payments when rates were higher. In 2004, Fed chairman Alan Greenspan chastised lenders for extending too many traditional, fixed-rate mortgages and not enough ARMs. Citing Fed research, he declared that “many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages,” and that “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.”13 The Greenspan Fed had lowered short-term interest rates to a mere 1 percent in 2004 (from 6 percent in 2001), and kept rates low in 2005. By the middle of 2006 ARMs had grown to 12 percent of the $8 trillion residential mortgage market, but the Fed soon rendered the newly extended ARMs unaffordable, by reversing course and quintupling short-term interest rates from 1 percent to 5 percent in late 2006. Not surprisingly, defaults on ARMs and subprime mortgage loans began skyrocketing soon thereafter, dramatically undermining the value of mortgage-backed securities and causing systemwide losses.
Even absent the Fed’s encouragement and destruction of ARMs through its interest-rate gyrations of 2001–2006, the much-expanded role of the GSEs would have caused massive trouble. The period from 1970 to 2000 saw a fivefold increase in the GSE’s share of U.S. residential mortgages, from 8 percent to 42 percent, while the market share of private savings institutions in this same period plunged from 44 percent to 11 percent. In just three decades, Fannie Mae and Freddie Mac effectively displaced the private savings institutions in mortgages, reversing their respective market shares.
But this was not enough for Washington politicians set on promoting home ownership among the “disadvantaged.” In 1999, under pressure from the Clinton administration, the GSEs actively debased their mortgage underwriting standards. “The action will encourage banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans,” noted a New York Times article before cautiously pointing out, “Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn.”14 That trouble would begin roughly eight years later, during the Bush administration.
Washington’s efforts to provide the needy with homes through the GSEs only intensified during the Bush years. By 2001, roughly two-thirds of all U.S. households owned homes, while the remaining one-third rented affordable apartments. Yet in 2002, Mr. Bush decried the “gap” between home ownership rates for white households (more than 75 percent, on average) and those for blacks and Hispanics households (50 percent or less, on average), even though home ownership rates among “minorities” had increased steadily in the prior decade. Altruism-driven Washington dictated that bankers lend on the basis of nonobjective criteria (ethnicity and skin color) rather than by a rational standard (creditworthiness). In a “White House Conference on Increasing Minority Homeownership” in 2002, Bush declared, “we can put light where there’s darkness, and hope where there’s despondency in this country. And part of it is working together as a nation to encourage folks to own their own home.”15 He continued:
An ownership society is a compassionate society. Two-thirds of all Americans own their homes, yet we have a problem here in America because fewer than half of the Hispanics and half the African Americans own the home. That’s a homeownership gap. It’s a gap that we’ve got to work together to close for the good of our country, for the sake of a more hopeful future. We’ve got to work to knock down the barriers that have created a homeownership gap. I set an ambitious goal. It’s one that I believe we can achieve. It’s a clear goal, that by the end of this decade we’ll increase the number of minority homeowners by at least 5.5 million families.16
Bush pledged to “use the mighty muscle of the federal government” (his words) to meet his goal of extending home ownership to “underserved” minorities, by pressuring or subsidizing lenders to lower credit standards, on the premise that “corporate America has a responsibility to work to make America a compassionate place.”17 In subsequent years Bush brazenly pushed schemes like the “Zero Down Payment Initiative” (praised by Democrats at the time)—despite the Congressional Budget Office’s warning that the scheme would boost default rates.18 In addition, Bush signed legislation and approved budgets that added trillions of dollars and thousands of regulations to Washington’s already huge presence in mortgages and housing.
Acceptance of altruism as a legitimate guide to financial decision-making was rampant at the GSEs. In 2004, Fannie Mae chairman Franklin Raines followed the president’s lead by promising a continuation and intensification of the agency’s multiyear mission—to close “America’s homeownership gaps” via “underwriting experiments that redefine creditworthiness”:
In almost every respect, 2003 was the greatest year for housing in America’s history. . . . Much more needs to be done, however, to deliver the American Dream . . . . Fannie Mae must expand its “American Dream Commitment” to underserved families, especially minority Americans. We are committed to creating six million new homeowners (including 1.8 million minority families) over the next ten years . . . . We’ve launched a groundbreaking consumer outreach effort . . . developed new mortgage products and devised underwriting experiments that redefined creditworthiness. . . . Fannie Mae and its many housing partners around the nation are determined to close America’s homeownership gaps.19
Altruism-driven politicians and bureaucrats demanded that long-recognized credit standards be ignored or jettisoned in order to adhere to a standard of need over greed. Armed with an ethic that was unquestioned by almost everyone, and with access to taxpayer wallets, the GSEs went on a spending spree. Whereas in 1995 the sum of all home mortgages, guarantees, and mortgaged-backed securities held by GSEs represented 39 percent of all residential mortgages in the United States, by 2007, just prior to the crisis, the GSE’s share had risen to 52 percent. By then (and even today, as insolvents) the GSEs participated in 80–90 percent of all new home mortgages, or twice the rate of 1995. The GSEs by now have almost completely overwhelmed and contaminated America’s residential mortgage market and, with defaults rising, are fast becoming the largest national landlord to the needy. And, of course, the “compassionate” GSEs now demand a moratorium on home foreclosures, so as to convert credit deadbeats into squatters. This indicates the evil and poverty to which altruistic lending invariably leads—and the injustice to all those who must finance the fiascos that it necessarily condones.
This moral bankruptcy finally pushed the GSEs into financial bankruptcy. By the end of 2007, they held mortgage assets of nearly $6 trillion, but a net worth (capital) equivalent to less than 2 percent of that sum. After short-term interest rates increased in 2006 and house prices began to level off or decline, the value of GSE assets—as well as publicly traded GSE bonds and stock—also began to decline. In 2007–2008, these values plunged further and, in September 2008, the GSEs became insolvent. At this point, the Bush Treasury injected $200 billion into the failed enterprises and completely took them over—adding another $5.5 trillion to the national debt and sapping the strength of hundreds of banks that held GSE securities on the expectation that, backed by the “full faith and credit of the United States” they would keep their value.20 As GSE losses mounted in early 2009, the Obama administration gave them an additional $200 billion, while pressuring them to lend still further and to resist foreclosing on defaulters.
In order to meet quotas for loans to the needy, GSE officials deliberately ignored warnings about their excessive risk-taking.21 Fannie Mae’s ex-CEO Daniel Mudd pretended to believe “almost no one expected what was coming” and insisted it was “not fair to blame us for not predicting the unthinkable” (even though his organization was found to have engaged in a massive accounting fraud in order to hide growing losses and razor-thin capital ratios). But the resulting disaster was predicted by basic economic principles, by numerous independent studies, and by many of Mudd’s own managers, who warned that “lenders were making too many loans that would never be repaid.” Mudd—who, before he settled on Fannie Mae, “told a friend he wanted to work for an altruistic business”—readily complied with Congressional pressure to “help steer more loans to low-income borrowers” and, in 2004, began to drive his enterprise “into more treacherous corners of the mortgage market.”22
Importantly, Mudd and the politicians and bureaucrats involved were not the only players with overtly altruistic motives; they had hundreds of “compassionate” accomplices within “private” mortgage firms. But perhaps none was more consequential than Angelo Mozilo, CEO of Countrywide Financial. Working closely with Fannie Mae, Countrywide had, by 2006, become America’s largest originator of residential mortgages, especially the risky subprime variety. Mozilo acted as though he were an ambassador for the White House, publicly touting the GSEs, HUD, the FHA, and spouting all the altruistic arguments of liberals and conservatives alike in favor of substandard mortgages. To ask the “underserved” for a mortgage down payment was “nonsense,” he said in 2003, addressing fellow bankers, adding, “we’ll never solve any of our societal problems” until we satisfy the housing needs of those who lack credit.23 “Our goal is to demonstrate that there is a unique role for the private sector in public service,” he told a Harvard conference, complaining that “the gap between low income and minority homeownership, and what is classified as white homeownership, remains intolerably too wide.” What we need are “new, creative and flexible underwriting techniques” such that lenders will “say ‘no’ only to those deemed unwilling to make their mortgage payments.” Those willing but unable to pay their mortgage deserved one anyway, he implied, and in this way, America could narrow what he called the “Money Gap . . . the obvious barrier created by the fact that there are those who have capital and access to credit, and those who don’t.”24
For years Mozilo won praise (and awards from the Fannie Mae Foundation) for being socially conscious—until, at the end of 2007, the weight of bad loans dissipated his firm’s net worth, bringing other firms down with it. Even so, a CNBC reporter praised Mozilo for his “good intentions” and “noble initiatives.” “Democrats and Republicans alike wanted to extend home ownership to people who did not have credit,” he added, and “although it ended disastrously, it was a noble aspiration.”25
How did Washington respond to this? Instead of ushering Countrywide into bankruptcy court, it intervened and strong-armed a then-healthy Bank of America into absorbing the firm’s toxic portfolio (as it did with Merrill Lynch), thereby weakening the acquirer. But (practically) no one—not even Bank of America’s executives—protested, because (practically) everyone accepts the altruistic notion that the successful must sacrifice for the needy.
Altruism-driven politicians and businessmen inexorably demand such strong-arm tactics, even while acknowledging that they render rational, self-interested banking impossible. According to billionaire George Soros, “the public interest would dictate that the banks should resume lending on attractive terms,” but “this lending would have to be enforced by government diktat, because the self-interest of the banks would lead them to focus on preserving and rebuilding their own equity.”26 On the principle of altruism, today’s troubled bankers must sacrifice their selfish goal of “preserving and rebuilding their own equity” and be forced to further damage their health by resuming lending on whatever terms the government deems “attractive” to “the public interest.”
Bank executives who accept the premise of altruism are morally defenseless against such coercion. In hearings held in February 2009, Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee and one of the biggest enablers of the GSEs in recent decades, warned top bank executives against putting “their own economic self-interest ahead of a necessary government program,” and “urged” them to become more “willing to make some sacrifices,” by acceding to still further controls.27 One of the eight bank executives testifying before Frank’s committee was J.P. Morgan CEO Jamie Dimon, a highly competent and accomplished banker, who nevertheless concurred with Frank’s altruistic premises. Only two months earlier, when asked why he accepted Washington’s “capital” injection, Dimon answered, “We didn’t think J.P. Morgan should be selfish and stand in the way of what the government was trying to do. We did get the money, and we’re going to try to do exactly what they want us to do, to make more loans. . . .28
It should surprise no one that the altruism-infested “credit market” has been impractical—and impractical even as regards the altruistic goal of helping the needy to own homes. Washington pushed to raise the national home ownership rate from 65 percent to 70 percent and to narrow the “gap” in ownership rates between white and nonwhite households, but in the wake of that push—as mortgage defaults and home foreclosures skyrocketed—the home ownership rate, after rising a bit, is now slipping below 65 percent, while the “gap,” having narrowed in years before 2002, has been widening since 2007. Home ownership rates among blacks and Hispanics, those who were targeted by the Bush administration, have dropped precipitously, in many cases to below the prior peaks that were deemed unsatisfactory by the social planners.
Who is to foot the gargantuan bill for this altruism-induced mess? Just as altruism would have it: the innocent—the innocent taxpayers and the 93 percent of all American home owners who pay their mortgages on time but now will be forced to pay other people’s mortgages and to bail out businesses they did not botch and do not own.
The Century-Long Erosion of American Banking
The mortgage-housing turmoil responsible for much of America’s current financial crisis is the result of decades of compounded government intervention. But altruistically motivated mortgages are not the only problem. America is also suffering the consequences of altruistically motivated government interventions in its other financial institutions, dating back almost a century, interventions (whether in the form of regulations or subsidies) that have led to financial crises time and again and will continue to do so as long as they remain in place.
In 1913—after about a century of the stable free banking system that financed America’s stupendous Industrial Revolution—Washington took a large step toward wresting control of America’s financial system when it established its central bank, the Federal Reserve. Previously, banks with conservative reputations (e.g., J.P. Morgan & Co.) had issued reliable currency convertible into fixed weights of gold (the essence of the gold standard). But critics insisted that there was “too little” money, that overextended borrowers should enjoy an occasional inflation to reduce the burden of their debts, that the needy should have easier access to money and credit, and thus that government should control the supply of each.
The Fed was granted a monopoly on the issuance of currency; all other bank currencies were deemed illegal. Within twenty years (in 1933), the Fed reneged on the gold standard and began issuing fiat paper money—money unmoored to any objective standard of value—as it does to this day. With this privileged, pet bank at their side in the decades since, Washington’s politicians were better able to finance the burgeoning American welfare state. Had Americans objected to this monopoly and its nonobjective money at the outset, we would be thriving in a very different America today. But Americans did not object. Why?
Few people have ever objected to the Fed’s role as financier of the welfare state because so few object to the welfare state itself. The welfare state is the political ideal of altruism; it facilitates the sacrifice of the successful to the needy. Indeed, defenders of the welfare state defend the Fed no matter how irresponsible its policies or actions, precisely because it is so integral to the welfare state. And Fed officials excuse their own irrational behavior in the ether of moral superiority, seeing themselves as duty-bound to help the needy, even if indirectly, through the funding of mathematically and economically ridiculous Congressional schemes. They willingly finance (by printing fiat money) the welfare schemes that Congress cannot finance via direct taxation. Paul Volcker, head of the Fed from 1979 to 1986 and now an economic advisor to Mr. Obama, admitted that “central banks are not exactly harbingers of free market economies,” primarily because they have always been “looked upon and created as a means of financing government [projects].”29
(As America has moved toward a more socialistic money and credit system in the past century, few people have acknowledged how closely it has reflected and codified avowedly altruistic premises. Karl Marx, the preeminent altruist and socialist of the 19th century—who enjoyed renewed acclaim during the alleged “breakdown” of capitalism and the gold standard in the 1930s—argued that in a truly socialist world, wealth would be perpetually transferred “from each according to his ability, to each according to his need.” Toward this altruistic ideal, plank five of his Communist Manifesto  demanded a “centralization of credit in the hands of the state, by means of a national bank with state capital and an exclusive monopoly.” This is exactly the role of the U.S. Federal Reserve.)
Motivated as they are by altruism, the Fed’s monetary policies have inflicted significant damage over the years. In sabotaging America’s banking system in the early 1930s, the Fed (together with punitive tax policies) caused the Great Depression. Today’s Fed chairman, Ben Bernanke, who specialized in the Great Depression when he taught at Princeton, admitted as much in 2002, after summarizing a 1963 book by Milton Friedman and Anna Schwartz that showed definitively that Fed officials (not free markets) were to blame: “As an official representative of the Federal Reserve, I would like to say to Milton and Anna, regarding the Great Depression: You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”30
But neither Friedman and Schwartz’s book nor Bernanke’s admission have reined in the Fed’s monetary policies, which continue to wreak havoc on American finance and contributed greatly to the current financial crisis. In addition to instigating the recent wave of loan defaults by encouraging borrowers into ARMs and then skewering takers by dramatically raising short-term interests rates in 2006, the Fed also sabotaged bank profit margins, caused bank insolvencies, and killed the remaining banks’ incentive to lend—by raising short-term interest rates well above long-term interest rates, a policy known as “inverting” the Treasury yield curve.
The significance of this Fed policy cannot be overstated. As intermediaries, banks collect demand deposits and funds that are payable in the short term, then lend the proceeds over the longer term. Consequently, when short-term interest rates (say, 1 percent) are below long-term rates (say, 5 percent), banks are profitable (at a margin of +4 percentage points) and thus motivated to expand their extension of loans; in the rarer cases where short-term interest rates (say, 5 percent) are above long-term rates (say, 3 percent), banks suffer losses (at a margin of -2 percentage points) and are thus motivated to contract their extension of loans. This latter phenomenon—an inverted yield curve—has preceded all six U.S. recessions (and all “credit crunches”) since 1968, including the latest one. And though this causal link is well known to Fed officials, they persist in using this interest-rate weapon to fight what they deem to be “excessive” economic growth. The Fed, established to help Washington finance its various altruistically motivated programs, is an economically devastating institution, but its destructiveness is largely ignored or excused as the unavoidable but acceptable side effect of the “moral” goal of helping the needy.
Washington has a long tradition of attempting to solve financial system problems caused by its previous interventions with still further interventions. For example, rather than abolish the Fed or even restrain its powers in the wake of its well-known role in causing the Great Depression, Washington expanded the Fed’s power to control American banking, by abandoning the gold standard and establishing the Federal Deposit Insurance Corporation (FDIC), the purpose of which was to guarantee bank account holder deposits in the event of a bank failure. In so doing, Washington institutionalized a system of undisciplined money-credit expansion. Freed from the gold standard, the Fed could print money without limit; buy an unlimited supply of government debt; and inject currency as reserves into banks, thus manipulating them for Washington’s altruistic ends. The welfare state now had a dark angel who, through inflation—which dilutes the value of everyone’s money—could steal wealth by stealth.
By expanding the scope of its money monopoly and providing deposit guarantees, Washington increasingly encouraged private commercial banks to lend recklessly and operate, over time, with successively thinner capital cushions. With FDIC coverage, banks feel no need to prove their safety or soundness to depositors, and depositors become careless, too, frequenting reckless banks; the result is an increase in reckless banks that rely increasingly on government-backed funding sources. Whereas in the few decades before the Fed was established (in 1913) most U.S. banks had capital equivalent to 20–25 percent of their assets, in the years immediately following the formation of the FDIC (in 1934) this cushion dropped to 15–20 percent, and it has fallen steadily ever since. Today the capital cushion for most banks is a mere 3–5 percent. Consequently, a small decline in the value of a bank’s assets (which are mostly loans) can render such a bank insolvent; and when, in addition, that bank holds a high percentage of loans from mortgagees who put down little equity, its already thin capital cushion becomes even more precarious, and something has to give. In no case would such fragility develop in a fully free banking system (i.e., one without government banks, subsidies, or controls).31
While encouraging risky lending on the part of banks, America’s altruistically motivated interventionist policies have discouraged depositors from scrutinizing the safety and soundness of their financial institutions. Consequently, sound banks have a greater difficulty outcompeting reckless ones—especially when, in addition, they are taxed to replenish the FDIC deposit fund after it is depleted by the depositors of the reckless, failed banks. Financial regulations have instilled a false sense of security in depositors and investors alike, encouraging risky behavior and thereby increasing the likelihood of financial crises.
Given the array of perverse incentives infecting and undermining the U.S. financial system, today’s bank nationalizations were wholly predictable. As I wrote in 1993:
Consider the options available to a government that says it will guarantee the deposits of the banking system, a government that considers the majority of banks too big or too important to a community to fail, a government that, in making these assurances, and otherwise intervening in the money and credit system, ends up undermining the financial condition of the banking system. There is only one option available to such a government and that is to take over failed banks and run them as part of the government.32
This is precisely what has been happening since late 2008, when Washington began to purchase shares in hundreds of America’s top banks for the first time in American history. And this lunge toward socialist money and banking will have further dire consequences. When the Fed, Treasury, or FDIC take bad bank assets onto their own balance sheets—as they have done in spades over the past year—they further corrupt the credit system, prevent lenders and investors from accurately identifying and pricing loans and securities, and ensure future financial catastrophes.
The Moral Cause and the Moral Cure
From a state monopoly on money, to state guarantees of bank liabilities, to state sponsorship of mortgages, to state ownership of banks—the progression in the past century has been to move away from free markets toward socialist banking. Why? The fundamental answer is: altruism. The fitful, halting lurches toward ever greater government intervention in American finance follow logically from the altruistic premise that permeates our culture and resounds throughout the halls of power—the premise that being moral consists in self-sacrificially serving those in need. The welfare state and its main financier, the Federal Reserve, are ultimately “justified” on the grounds that the government has a moral duty to provide the needy with goods and services—from education to health insurance to mortgages.
On the premise that a free banking system inadequately served the poor, the Federal Reserve was formed. On the premise that welfare spending is too important to be tied down to an objective system of money, the gold standard was abolished. On the premise that taxpayers have a moral duty to bail out needy banks and careless depositors, the FDIC was established. On the premise that we all have a moral duty to help needy, low-income families “achieve the American dream,” the GSEs were established. On the premise that Americans have a moral duty to preserve America’s financial institutions, Washington is now nationalizing them—ensuring the full politicization of lending, a perpetual flight of private capital, and an endless drain on taxpayers’ wallets.
The fact that each of these interventions has caused (and continues to cause) financial-economic turmoil and wealth destruction is, to those who believe the interventions were moral, simply beside the point. By demanding that one consider the needs of others above all else, altruism morally forbids one to consider the facts of reality that conflict with that mandate. Thus, in the case of a banker who embraces altruism, the fact that a loan applicant is not creditworthy matters not; the fact that default rates are rising matters not; the fact that his bank is nearing insolvency matters not. These are mere economic facts, whereas altruism speaks of moral truth—and in any contest between economics (or common sense) and morality, morality always wins.
Acceptance of altruism leads people to abandon their self-interest, the profit motive, the basic principles of economics, and the basic principle of America: the principle of individual rights. But these values are essential to good living, to wealth creation, to a healthy economy, and to a just society. America’s financial market is suffering not because of greed or freedom, but because of the widespread acceptance of altruism and the consequent government intervention in banking.
The financial crisis is, fundamentally, a moral crisis. The extent to which Americans accept that they have a moral duty to sacrifice for the sake of others is the extent to which they will allow our government to compel us all to do so—by means of further interventions, further subsidies, further controls. To end the crisis, we must acknowledge that government intervention caused it, and we must demand that the government begin removing its coercive hands from the economy. With an eye to the short term, we must demand that it scale back the powers of the GSEs, the Federal Reserve, and the FDIC; and with an eye to the long term, we must demand that the government abolish these agencies entirely and restore a gold standard run by private, currency-issuing banks subject solely to the objective commercial and bankruptcy codes.33 But in order to advocate these reforms, Americans must reject the moral code that stands in the way. We must reject altruism. We must defend each individual’s right to exist, not as a slave to the needs of others, but for his own sake—bankers included.
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1 Barack Obama, “Renewing the American Economy,” transcript of speech at Cooper Union, New York Times, March 27, 2008.
2 Obama, floor remarks prior to voting for the Emergency Economic Stabilization Act, October 2, 2008.
3 Rick Klein, “McCain Blames Greed for Wall Street Mess,” ABC News, September 16, 2008.
4 Jo Becker, Sheryl Gay Stolberg, and Stephen Labaton, “White House Philosophy Stoked Mortgage Bonfire,” New York Times, December 20, 2008, p. A1.
5 Jay Bookman, “Greenspan Admits Free Market Has Foundered,” Atlanta Journal-Constitution, October 27, 2008; Scott Lanman and Steve Matthews, “Greenspan Urges Tighter Regulation After ‘Breakdown,’” Bloomberg News, October 23, 2008.
6 Anthony Faiola, “The End Of American Capitalism?” Washington Post, October 10, 2008, p. A1.
7 Martin Crutsinger, “U.S. Summons Banks to Meeting on Rescue Plan,” Associated Press, October 13, 2008; Mark Landler and Eric Dash, “Drama Behind a $250 Billion Banking Deal,” New York Times, October 15, 2008, p. A1.
8 Jim Kuhnhenn, “Obama Caps Executive Pay at $500,000, Tied to Bank Bailout Money,” Associated Press, February 4, 2009.
9 Jeanne Cummings, “Bailout Tops $8 Trillion,” Politico, December 16, 2008, http://www.politico.com/news/stories/1208/16620.html.
10 “What’s Next?” Economist, September 20, 2008, p. 19.
11 Cf. Ayn Rand, Capitalism: The Unknown Ideal (New York: The New American Library, 1966), pp. 19–20.
12 Closing the Gap: A Guide to Equal Opportunity Lending, Federal Reserve Bank of Boston, http://www.bos.frb.org/commdev/commaff/closingt.pdf. Excerpt: “Did You Know? Failure to comply with the Equal Credit Opportunity Act can subject a financial institution to civil liability for actual and punitive damages in individual or class actions. Liability for punitive damages can be as much as $10,000 in individual actions and the lesser of $500,000 or 1 percent of the creditor’s net worth in class actions” (p. 10).
13 Alan Greenspan, “Understanding Household Debt Obligations,” the Credit Union National Association, Governmental Affairs Conference, Washington, D.C., February 23, 2004, http://www.federalreserve.gov/boarddocs/speeches/2004/20040223/default.htm.
14 Steven A. Holmes, “Fannie Mae Eases Credit to Aid Mortgage Lending,” New York Times, September 30, 1999.
15 Cited in Becker, Stolberg, and Labaton, “White House Philosophy Stoked Mortgage Bonfire.”
16 “White House Conference on Increasing Minority Homeownership,” October 15, 2002 (see full speech at http://isteve.blogspot.com/2008/09/2002-bushs-speech-to-white-house.html).
17 Cited in Becker, Stolberg, and Labaton, “White House Philosophy Stoked Mortgage Bonfire.”
18 Chris Reid, “Zero-Down Mortgage Initiative by Bush is a Hit; Congressional Budget Office Says Plan Likely to Spur More Loan Defaults,” Boston Globe, October 5, 2004.
19 Franklin Raines, “Chairman’s Message,” National Housing Survey 2003: Understanding America’s Homeownership Gaps, Fannie Mae, Washington, D.C., http://www.fanniemae.com/global/pdf/media/survey/survey2003.pdf.
20 James R. Healey, “Taxpayers Take on Trillions in Risk in Fannie, Freddie Takeover,” USA TODAY, September 7, 2008.
21 Alan Zibel, “Documents Released by House Committee Show Fannie, Freddie Ignored Warnings on Risky Mortgages,” Associated Press, December 9, 2008.
22 Charles Duhigg, “Pressured to Take More Risk, Fannie Reached Tipping Point,” New York Times, October 5, 2008, p. A1.
23 Lew Sichelman, “Mozilo: End Downpayment Requirement,” National Mortgage News, February 17, 2003.
24 Angelo Mozilo, “The American Dream of Homeownership: From Cliché to Mission,” a lecture sponsored by the Joint Center for Housing at Harvard and the National Housing Endowment, Washington, D.C., February 4, 2003, http://www.jchs.harvard.edu/publications/homeownership/M03-1_mozilo.pdf.
25 Charles Gasparino, on-air financial reporter, CNBC, January 10, 2008.
26 George Soros, “The Right and Wrong Way to Bail Out the Banking Sector,” Financial Times (London), January 22, 2009.
27 Barney Frank, opening remarks, hearings of the House Financial Services Committee, February 11, 2009.
28 Jamie Dimon, interviewed on CNBC, December 11, 2008.
29 Paul Volcker, “The Role of Central Banks,” in Central Banking Issues in Emerging Market Economies, symposium sponsored by the Federal Reserve Bank of Kansas City, 1990, pp. 2–3, http://www.kansascityfed.org/publicat/sympos/1990/S90.pdf.
30 Remarks by Fed Governor Ben S. Bernanke, “On Milton Friedman’s 90th Birthday,” November 8, 2002, http://www.federalreserve.gov/boarddocs/speeches/2002/20021108/default.htm.
31 See Richard M. Salsman, Breaking the Banks: Central Banking Problems and Free Banking Solutions (Great Barrington, MA: American Institute for Economic Research, 1990); and “Breaking the Banks,” The Intellectual Activist, vol. 5, no. 5, October 17, 1990.
32 Richard M. Salsman, The Collapse of Deposit Insurance–and the Case for Abolition (Great Barrington, MA: American Institute for Economic Research, 1993), p. 21.
33 See Richard M. Salsman, “Why We Need Free Banking,” Research Report, vol. 57, no. 11, American Institute for Economic Research, June 4, 1990; “Banking Without the ‘Too-Big-To-Fail’ Doctrine,” The Freeman, vol. 42, no. 11, November 1992; and Gold and Liberty (Great Barrington, MA: American Institute for Economic Research, 1995).