Last year Kevin Rudd declared that: “We simply don’t have to choose between Friedrich von Hayek and Leonid Brezhnev”. He was confident that he could stand astride the ideological seesaw placing just the right weight on his left foot then his right to keep both the free enterprise and the government controlled halves of our economy buoyant. It didn’t take long for him to get the wobbles. After his 7744 word wobble titled “The Global Financial Crisis” in this February’s Monthly magazine was all said and done, Rudd kicked Hayek off his seat and slid all the way down the seesaw into the ghostly arms of Brezhnev.
As Rudd’s pedantic slide to the left suggests, we do have to choose between Hayek and Brezhnev, because economic freedom and economic dictatorship are opposites, and a mixture of the two is unstable. A mixed economy such as ours has to move in one direction or the other, because controls breed the need for more controls, and freedoms breed demands for more freedom.
Rudd does not seek the methods Brezhnev used; he doesn’t want the government to own the means of production and trade, but he does want it to control how they are used and who the beneficiaries shall be. Hence his tax-here-handout-there policy, which will not create productive jobs there without taking more productive and sustainable jobs away here. It is easy to “stimulate” X by giving him spending money, but every dollar X gets has to be taken from Y who earned it but no longer has it to spend. Government spending on non essentials, whether from taxes, surpluses or deficits, sooner or later makes matters worse – John Maynard Keynes notwithstanding. All it ends up stimulating is dependence on the government, frustration of individual initiative, and the waste of taxpayers’ money. And contrary to Rudd’s thesis, government intervention is not the way out of the Global Financial Crisis (GFC); it was the way into it.
Rudd blames the GFC on thirty years of “neo-liberalism – that particular brand of free-market fundamentalism, extreme capitalism and excessive greed which became the economic orthodoxy of our time.” It is now up to social democrats “to save capitalism from itself” by intervening and controlling it.
Leaving aside the contradiction involved in trying to save economic freedom by controlling it, his analysis is fatally compromised by his latent ideology.
For a start, Rudd’s insistence that we have had thirty years of “extreme capitalism” is ridiculous.
In 1977/78 the federal government’s tax-take in this country was under $22 billion, which was under 21% of GDP. In 2007/08 it was over $278 billion, which was over 24% of GDP. In real terms (after adjustment for inflation) today’s per-capita tax-take is more than twice what it was thirty years ago. So much for the “wave after wave of tax cuts” that our born-again socialist prime minister laments.
There were some very beneficial privatizations and deregulations during the last thirty years – hence a phenomenal real-per-capita growth (GDP after adjustment for inflation and population) of more than 75%. But this was the product of partial capitalism, not of laissez faire capitalism. A steady stream of new regulations throughout those thirty years hampered production by retying our businesses in knots.
Australia’s economic system is nothing like “extreme capitalism”, and neither is America’s. The tax-take in America (federal, state and local) is over 33% of GDP. Nine federal departments and more than one hundred federal agencies and commissions regulate every segment of the US economy, and the most crisis-ridden segments, such as banking and housing, are the most heavily regulated. Belying the deregulation myth are nearly two million pages of new regulations that were added to the Federal Register during the last thirty years. Spending on banking and financing regulation tripled during that period.
In many ways the economies of Australia and the US are amongst the freest in the world (consequently they are amongst the most prosperous), but that doesn’t make them very free. Our systems are mixed economies, part free enterprise and part government controlled socialism. We have, however, enjoyed enough free enterprise in the mix to demonstrate one economic principle loud and clear: government ownership and control reduces prosperity, whereas private ownership and free enterprise increases it. This was demonstrated most clearly last century where economies were split in two to follow radically different paths, e.g. East and West Germany, North and South Korea, China and Hong Kong. The verdicts of such experiments were unequivocal, as was the verdict of the contest between the USSR and the USA. Other evidence was less clear-cut but just as dramatic when conscientiously analyzed.
No doubt Rudd wants to keep the goods and services and luxuries flowing from “the great strengths of open, competitive markets”; but he also wants to blame the freedom essential to those markets for the GFC, and he wants to be seen as our Franklin Delano Roosevelt, acting “decisively”, saving us from those greedy Gekkos, to be re-elected again and again. But voters would do well to study very carefully what Roosevelt’s economic legacy really was.
Rudd’s Monthly article made it abundantly clear that his “economic conservatism” was election strategy rather than ideological conviction. He may argue, with his resurrected guru John Maynard, that “when the facts change I change my opinion”. But in order to point to laissez faire capitalism as the cause of the GFC he has to ignore or skew facts that point in the opposite direction.
It is fair enough for Rudd to point a finger at Alan Greenspan’s US Federal Reserve and apportion part of the blame to low interest rates. They went so low (1% in 2003/4) that Americans who resisted the temptation to grab a loan for a house rather than wait until they had a larger deposit, looked financially naïve. The loan cost them little, their savings earned them little, and the value of houses kept rising. But why would the (greedy) banks lend so much with so little concern about the borrower’s ability to meet their repayment schedule and about what might happen if the housing bubble burst?
The trouble was that market restraints against making risky loans that operate in a free market had been removed by government interventions.
The US government’s intervention into the housing market goes back as far as Roosevelt’s New Deal. The following are a few of the highlights. In 1937 the Housing Act established the US Housing Administration Authority. In 1938 the National Mortgage Association was chartered. In 1965 the Department of Housing and Urban Development (HUD) was created and in 1968 it was empowered with a carrot and a stick: insurance on mortgages to moderate income families, and discrimination laws which could be used to sue banks for refusing to make loans. In 1970 the Community Development Corporation and the Federal Home Loan Mortgage Corporation were established. In 1977 Urban Development Action Grants were introduced. In 1988 the Fair Housing Amendments Act made it easier to sue banks and other lending institutions for discrimination if they refused loans. In 1990 the National Affordable Housing Act and Housing Preservation and Residential Homeownership Act fortified the government’s “commitment to preservation of assisted low-income, multifamily housing.” In 1992 the US Congress mandated that the Federal National Mortgage Association (now known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (now known as Freddie Mac) increase their purchases of house mortgages made to low and medium income borrowers – which meant subprime loans.
During the 90s HUD pressed banks to increase the flow of cash to medium and low income earners, eased its requirements for guarantees on mortgages to first home buyers, reduced the stable income provision from five to three years, and let the requirement that the borrower be interviewed lapse. When the flow of cash from the banks didn’t satisfy the government’s “affordable housing” agenda new brokers and lending institutions were encouraged into the market; such as Countrywide Financial, who signed a pledge to use “proactive creative efforts” such as interest-only loans to low-income earners. The Clinton administration used fair housing and fair lending laws, such as the Community Reinvestment Act, to press institutions to lend to disadvantaged minorities, as did community groups such as ACORN. Lending institutions came to fear allegations of discrimination and the prosecutions and bad publicity that might result more than they feared defaults. And besides, many of their mortgages could be insured or passed on to Fannie Mae or Freddie Mac.
Fannie and Freddie are government-sponsored entities, companies controlled by boards of directors, some of whom are appointed by the President, which pursue profits for their shareholders by carrying out their chartered purpose for the government, in exchange for its backing. Fannie and Freddie’s primary means of implementing the government’s “affordable housing” policy was the purchase of qualifying mortgages from lending institutions, thus freeing the institutions’ funds so they could make more loans.
During the 90s Fannie and Freddie opened local offices and conducted advertising campaigns to encourage disadvantaged minorities to apply for housing loans. The lending institutions didn’t have to worry too much about the borrowers’ ability to meet repayment schedules, as they could pass the liability on to Fannie or Freddie, who bundled the mortgages and sold them on as mortgage-backed securities, or held them as collateral for short term loans. Money was easy to come by, it flowed in from all around the world, from funds and institutions and banks who presumed that since Fannie and Freddie were government sponsored the US Government would never let them default. A loan to Fannie or Freddie was considered nearly as safe as US treasury bonds.
The social engineers were proud of the results. The percentage of American families living in their own home rose to an all time high and loans to Blacks and Latinos increased by 72% and at least 45% respectively, between 1993 and 1997. But the government was not yet satisfied. President Clinton and congressmen pressed on. In 1997 Fannie Mae made a commitment to provide US$1 trillion for 10 million homes for “low- and moderate-income families, minorities, new immigrants, residents of central cities and other underserved areas” by the end of the decade. In 1999 HUD stipulated that the percentage of such (subprime) loans in Fannie and Freddie’s portfolios be raised from 44% to 50% by 2001.
The change of government in 2000 made little difference to the flow of cash for subprime loans. After all, who would want to be branded the politician who stopped poor people getting their own roof over their head? Fannie and Freddie enjoyed a good press. They were the good guys helping the disadvantaged to realize the American dream.
Then in 2003 an investigation exposed fraudulent accounting practices at Freddie Mac and in 2004 an even larger fraud was uncovered at Fannie Mae. On October 4th 2004 the Wall Street Journal reported that Fannie Mae had been:
cooking the books. Big time. Analysts are predicting that Fannie Mae will have to compensate for $11 billion in accounting errors. To put this in perspective, Enron overstated its earnings by $567 million: 5% of Fannie Mae’s fiasco….
Despite these incredible losses and errors, as well as three separate investigations, the broadcast media have ignored Fannie’s decline.
Fannie’s deception was more than nineteen times as large as Enron’s, but whereas Enron was dragged through congressional hearings and the media mud to its ignominious execution, Fannie Mae replaced some executives and went about its lauded business.
In his Monthly article Rudd exemplifies Wall Street’s “greed of epic proportions” by noting that in 2007, “S&P 500 CEOs averaged $10.5 million.” The CEO of Fannie Mae, in the year his company tanked, earned a package worth $39.6 million. The only mention Rudd makes of Fannie and Freddie is when he presents their bailout as an example of “the social-democratic state, not the unfettered forces of the market [being] called to the rescue.”
But Fannie Mae and Freddie Mac weren’t creatures of the unfettered market; they were creatures of the social-democratic state.
Due to their special government sponsored status Fannie and Freddie were able to accumulate much more debt than private institutions. Whereas commercial banks are usually leveraged at 10 to 1, and investment banks are usually leveraged at 30 to 1, Fannie and Freddie were leverage at 1000 to 1.
It was only a year ago that it was still considered politically incorrect to disparage Fannie and Freddie’s operation. Congressmen and advocacy groups continued to lobby fiercely against any curtailment of their subprime business. But the market was over supplied to the tune of at least 600 billion dollars worth of houses. Consequently house prices began to plummet and defaults began to escalate. By the middle of last year the numbers were telling anyone who dared to look that Fannie and Freddie were going down. Big time.
On the 8th of September 2008 Fannie and Freddie were placed into conservatorship. They owned or were guarantors for about half of America’s house mortgages, which added up to liabilities of about five trillion dollars. That’s US$5,000,000,000,000. If they had started lending a million dollars a day when Jesus walked in Galilee, and had kept lending at that rate until today, without receiving any repayments, they would have accumulated liabilities of a mere US$730 billion by today. To accumulate five trillion dollars of liabilities they would have had to lend US$6,850,000 per day from the time of Jesus until now. This amount is worth keeping in mind when someone like Rudd implies that the GFC had something to do with greedy CEO’s taking multi million dollar bonuses and fund managers taking hundreds of millions.
By mid February 2009 the government had pumped US$ 400 billion into Fannie and Freddie and another US $75 billion had been allocated for assistance to home owners, in the hope that this would stem the tide of foreclosures. But no one was confident that this would be all that would be required to prevent Fannie and Freddie from defaulting.
The “proximate cause” of the GFC argues John Allison, chairman of BB&T, is the “mathematical disasters” of Fannie and Freddie. “A free market could have prevented this,…a lot of financial institutions did dumb stuff, but they did it in the context of a government system that was misleading…. Once you had this government — through the Federal Reserve, through the FDIC, through Freddie Mac and Fannie Mae — supporting this expansion of housing, it’s easy to believe that housing prices won’t ever fall…. That was the context in [which] very poor decisions were made."
Fannie and Freddie are not products of “extreme capitalism”, and neither was the blockbusting subprime house bubble that precipitated the GFC. Fannie and Freddie represent exactly the sort of “third way” enterprise that Rudd advocates as a means of providing “public goods” by combining “private incentive with public responsibility.” They were designed to harness “the private and the public,…the market and the state” in order to offset “the inevitable inequalities of the market with a commitment to fairness for all.” These quotes are taken from Rudd’s Monthly article, but they describe Fannie and Freddie’s mission exactly.
The full GFC story, of course, is enormously complex, involving government deposit insurance (FDIC), government sponsored rating agencies, government mandated fair value accounting, hedge funds, credit default swaps, mortgage bonds, mathematical modeling, too-big-to-fail anomalies, HOPE and TARP programs and many other complications; its telling will no doubt keep economists gainfully employed for decades. But before we allow “extreme capitalism” to become the scapegoat, we should tease out the free from the fettered aspects of our economy and apportion the blame judiciously.
And we should ask where and when has any government as controller and stimulator of economic activity ever worked better than government as protector and liberator of economic activity?
The government does have a vital role, it holds a monopoly on the use of force, which it must use to prevent theft and fraud and breach of contract, with all that that entails. And as long as our money is supplied by central banks the government is directly or indirectly responsible for that – although this would not be the case under laissez faire capitalism. But the solution to the GFC is not a slide into the arms of Brezhnev, or John Maynard Keynes. We have come a long way since their iniquity and folly were exposed.
What Rudd characterizes as a failed thirty year experiment in “free market fundamentalism” is what gave us phenomenal economic growth – enough to support a 50% rise in the world’s and Australia’s populations, without the Malthusian correction by mass starvation that characterized population explosions during all of the pre-capitalist centuries. In fact, those thirty years saw ever increasing levels of health, wealth and well being wherever capitalism gained a foothold.
Now is not the time to lose our nerve and put our faith in big daddy state to look after us in exchange for our property rights and liberty. Governments can’t Fannie-and-Freddie us back to economic health. But the good news is that there is a lot that governments can do, or undo, to liberate our productive power. They can reduce taxes – John Howard’s suggestion of a suspension of the payroll tax sounds like a good place to start. They can reduce handouts – including those made to me. They can refrain from making sacrificial offerings – such as anti carbon “pollution” legislation. They can privatize and allow competition between utility providers – most urgently for the water supply. They can abandon social engineering interventions – from baby bonuses to export development grants. They can reduce constraints on trade – including the trade between employers and employees. And they can stop blaming “extreme capitalism”, until they’ve given it a try.
John Dawson is the author of Washout: on the academic response to The Fabrication of Aboriginal History (Macleay Press)