Squaring the Culture

The big news over the weekend was the onset of one of those crises that most folks just don’t understand; a number of enormous, historic Wall Street firms are about to disappear. The average person in the street hears about it and says “Oh, gee, that sounds bad,” but then immediately wonders how it affects them, and finds he or she has no idea, and none of the newspapers accounts tell them. It’s pretty frustrating.

The reason, of course, is that nobody really knows how it’s going to affect us all. The economy is a very complex thing, far beyond anybody’s ability to model successfully, and also far beyond any government’s ability to predict, control, fine-tune, etc. (This is one of the major reasons socialism never works. I’ll discuss another reason further down.) We’re in fairly uncharted territory, and we don’t know what’s coming next. But there are some clues, and they’re not pretty.

First of all, why’s there a crisis? The timing (Mon, Sept 15) has to do with the required filing of quarterly reports with the SEC. What’s happening is that the big brokerage houses are altering their books to reflect the reality of the falling housing market, and most of them have huge chunks of money in mortgage-backed securities that they used to think were entirely safe. The result is that investors are seeing that they’re not worth nearly as much as they formerly claimed. AIG, for example, lost about $20 billion on paper yesterday as a result of revaluing its mortgage portfolio realistically (out of a net asset value of around $85 billion, I think.) That’s huge. Since these investment companies are not worth as much as before, their credit ratings are being downgraded pretty dramatically. The lower credit rating, in turn, makes it more difficult for them to borrow for operating capital; and if they can’t come up with a source of cash to operate, they have to declare bankruptcy.

This accounts for yesterday’s filing by Lehman Brothers for Chapter 11 protection from its creditors, and for Bank of America offering to buy Merrill Lynch for about half what Merrill was worth just a year ago (an offer which Merrill is happy to accept.) The Times reported on the details Monday, and Joe Nocera put the entire crisis in perspective today by comparing the decisions of the CEOs of major investment houses to the decisions of individual home owners, who simply can’t bring themselves to admit that their house is worth so much less today than it was a year ago. Paul Krugman made history yesterday by writing a column that was actually helpful in explaining why the mechanisms in place to prevent runs on banks didn’t help prevent this crisis. (Krugman is my proof that intelligence and education do not guarantee the ability to get even a single fact right. This is my first link to a Krugman piece, and I expect it will be the last, but who knows?)

The thing to watch for is whether it will be possible to borrow money a couple of months from now. If capital dries up because nobody trusts the banks to stay in business, the economy will grind to a halt. If investors put their money into the remaining investment vehicles, then things will pick up again and go on as usual. We’ll see, very soon.

The one redeeming feature of this week’s crisis is that the government has finally, finally said “No” to a requested bailout. Lehman’s investors are going to eat their bad investments. Today it looks as though Barclay’s, a British financial company, is going to buy some of the more profitable portions of Lehman’s business, which will give the investors a little cash, but pennies on the dollar. This is as it should be. The ongoing game of “heads I win, tails the taxpayer loses” capitalism has to stop; it’s not really capitalism, it’s socialism on the installment plan. Investors know their investment could come to naught, and should be required to face the fact when it happens. The government should have said “No” to Fannie and Freddie, too, and to Bear Stearns back in March.

There will be recriminations for decades, I think. Those who can’t think will blame George Bush, just as they’ve been blaming him for global warming, bad engineering, hangnails, and terminal cancer for the past 7 years. George Bush probably has as much to do with the present crisis as Gerald Ford has to do with it — alright, maybe a little more than that — but the truth is that the blame needs to get spread around pretty widely for this one, including James Johnson (former chairman of Fannie Mae,) Bill Clinton, Alan Greenspan, Ben Bernanke, Henry Paulson, Richard Fuld (chairman of Lehman,) and so on. In fact, I think we’re all on the list.

For my thought about the biggest contributor, allow me to point to a piece I wrote back in February, blaming the impulse to extend housing to those who cannot afford it in the name of “racial equality and fairness.” At some level it’s a commendable impulse, but economic facts are economic facts; there’s a reason banks are not willing to lend mortgage money to buyers with marginal credit, and that reason has nothing whatsoever to do with the color of their skin. By forcing them to make the loans anyway, and then providing a trillion-dollar market for them with loosened credit restrictions, the government created an artificial housing boom and guaranteed that a failure of this sort would occur eventually. They get away with it — in fact, call themselves virtuous protectors of the poor, and win elections — because the price tag is hidden in the far future.

This is the second reason socialism always fails: it’s ultimately based on well-meaning wishful thinking, and always runs afoul of reality.

An article at The Beacon yesterday expressed the core of this impulse, and points to a couple of other disasters that are looming in the future somewhere — Social Security, Medicare, the national debt — American experiments in socialism, all. The title, “Ticking Time Bomb Explodes, Public is Shocked,” describes the common reaction when inevitable collapses occur. We build institutions pretending there will never be a price paid for eating our seed corn, and then we wonder what happened when we’re starving a few years later. Liberalism, at its core, is the refusal to discipline the impulse to devour the nation’s productive capacity; and even conservatives like me have given in to it in recent years for political expediency. The alternative, standing for genuine fiscal discipline when everybody around you is saying “You must really hate the poor” for doing so, costs too much personally, but it’s the only realistic course.

From The Beacon:

The failure of Fannie Mae and Freddie Mac, setting in motion the biggest government bailout/takeover in U.S. history, brings a grim sense of fulfillment to competent economists. After all, what did people expect, that water would flow uphill forever?

This financial mega-mess is the same sort of event as the collapse of the USSR’s centrally planned economy, another economically unworkable Rube Goldberg apparatus that was kept going, more or less badly, for decades before it fell apart completely…

In the future, we will see a similar breakdown of the U.S. government’s Social Security system, with its ill-fated pension system and its even more inauspicious Medicare system of financing health care for the elderly. These government schemes are fighting a losing battle against demographic realities, the laws of economics, and the rules of arithmetic. The question is not whether they will fail, but when—and then how the government that can no longer sustain them in their previous Ponzi-scheme form will alter them to salvage what little can be salvaged with minimal damage to the government itself.

Our political economy is rife with such catastrophes in waiting, yet the public always seems startled, and outraged, when the day of reckoning can no longer be deferred, and another apartment collapses in the state’s Hotel of Impossible Promises, loading onto the taxpayers more visibly the burden of sheltering the previous occupants.

Each of these time bombs has at least one element in common: it promises current benefits, often seemingly without cost; but if it must acknowledge a substantial cost, it places that burden somewhere in the distant future, where it will be borne by somebody else. From the standpoint of society in general, every such scheme is a species of eating the seed corn. It satisfies the public’s appetite to consume something for nothing right now, with no thought for the morrow. It represents the height of irresponsibility by permitting people to live higher today than they can truly afford, financing this profligacy by borrowing recklessly and by taxing politically weak and ill-organized people in order to shower benefits on politically strong and well-organized special interests.

I hope you like the house you’re living in. Chances are, you’ll be living in it for a few more years, whether you like it or not. Welcome to the Crash of 2008.

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Update: Ed Morrissey at Hot Air has posted a fascinating retrospective to 2003, when, in the wake of clear indications that Fannie Mae and Freddie Mack were cooking their books, the Bush administration attempted to impose Treasury oversight to make sure assets were valued correctly, and also attempted to impose reserve requirements like banks carry — and were blocked by the Democrats, who benefit from Fannie Mae’s lobbying efforts. Rep. Barney Frank (D, MA) and Sen. Chuck Schumer (D, NY) were, and remain, the leading proponents of Fannie Mae’s credit-worthiness and freedom from scrutiny. Morrissey also points to an article written about 6 months ago by economist John Lott, noting the role that leftist activism attempting to correct “racism” in the banking industry played in producing the federal regulation that led to the current crisis. Again, there’s plenty of blame to go around here, but the primary source has to be government interference in housing, artificially boosting demand which raised the prices of houses above their true economic worth.