David Ernst chats with the World

Tuesday, 2007-11-13

Filed under: journalism — David @ 12:41 am

I heard Robert Kuttner interviewed on Fresh Air today, promoting his new book The Squandering of America. Just hearing the title already had me incredulous, and now I’m thinking it’s finally time that I follow suit to Kynthia’s outing of herself and myself as being more libertarian than most of our close friends, and perhaps more Libertarian than Democrat.

That’s a huge topic, though, so I’ll focus on just this interview. Um, America has not been squandered. I suppose Mr. Kuttner thinks it is in the process of being squandered, and I certainly welcome the presentation of his case. But, it’s amazing to me that he presents this case as if it were stating the obvious, rather than an extraordinary claim.

Actually, in the remarkably long excerpt from the book that’s on the Fresh Air page, he talks about squandered standing in the world because of the Bush administration’s dreadful foreign policy, and the squandering of our environment. There are strong cases to be made in these areas, and I (and many libertarians (I’m being very intentional about my capitalization here, by the way)) likely agree with many of his points in these areas. But, as he says, that’s not what his book is about:

“To write about all the ways in which the promise of America is being squandered would require more than one book. This book is about one large dimension: the connection between a precarious economy and a diminished politics.”

Just how precarious is the economy? Well, of course, we’ll only know if/when it collapses. Of course, we’d have to agree that it had collapsed (even Kuttner said in the interview that there wasn’t going to be another great depression, but he did have the courage (sarcasm intended) to predict that we would have a recession sometime soon). And even then, we’ll speculate about why it collapsed. So, it’s really hard to say just how precarious it is.

But, of course, the thing all the lefties are citing right now as why free markets are patently bad is the “subprime mortgage crisis.” Perhaps there is a crisis going on, but I really disagree with the way people like Kuttner and Gretchen Morgenson (also recently interviewed on Fresh Air about the “subprime mortgage crisis”) characterize it. Here’s my take:

Interest rates (2002-2005ish) were low
Some financial hotshots started experimenting with new ways to lend people money
They went looking for people to lend money to
Countless middle-to-upper-class people already had mortgages they liked, so they turned to people of lower income and poorer credit ratings (hence “subprime”)
A few years later the adjustable rate mortgages are adjusting way up, and the lower-income borrowers can’t afford their mortgage payments anymore. So, there are record numbers of foreclosures.

I suspect that just about everyone agrees with that characterization of things. So, who are the victims of this crisis? The obvious sympathy would go to the borrowers who are facing foreclosure. While my heart definitely goes out to them, these are people who, almost by definition, had no hope of getting a home loan before this bubble. So, it will be difficult for them, and I do not mean to belittle their situation. But in the end, they will end up renting, just like they were before.

This is a good time to distinguish here a related but different practice, the one commonly called predatory lending. To the degree that borrowers were defrauded by people using criminal or unethically misleading methods, they are extremely worthy of protection under the law. Free markets depend on the rule of law, and any libertarian will tell you that fraud should be considered an extremely serious crime.

But, I don’t think that predatory lending accounts for the majority of this “crisis”. I don’t even think it’s that big a chunk. Most of these borrowers were riding a wave of excitement that they might be able to own a home, and the lenders were doing all of their legal and ethical disclosures trying to find potential sources of revenue.

The victims of this crisis are the lenders. But, unlike so many cases, blaming the victim here is entirely appropriate. These companies knew they were dealing with subprime borrowers… how could they forget? The entire practice was known as “subprime lending”. And they did it. A LOT! They literally bet billions of dollars on people they wouldn’t have lent money to just a few years earlier. And, a substantial number of those bets are failing. And, they’re losing money, executives are getting fired, they’re scrambling to keep things running, banks are pooling funds to prepare themselves to bail each other out if necessary. Definitely sounds like a crisis. But my heart does not go out to them. They are reaping their rotten harvest. The fact that none of them are going to end up hungry or homeless does not, of course, make me feel any more pity.

Now, people like Kuttner and Morgenson look at all this and say “you see? if we had more regulation we could prevent crises like this!” They are probably right. But this is where a free-market type says that the market is correcting itself. The people who made bad bets are the ones in crisis.

It’s interesting to compare this all with the other recent “bubble”, which was of course the “dot com bubble”. Morgenson referenced this while she was criticizing Alan Greenspan saying that he “never met a bubble he didn’t like”. Brother. Obviously he didn’t LIKE them (does “irrational exuberance” sound like praise to you?), he just believed that the proper solution was to let the people making bad bets lose. Kuttner and Morgenson would clearly prefer that the bad bets not be placed in the first place. The question in my mind is, which is better: a society where you can make whatever bet you want, but you have to pay for your bad bets; or a society where the government limits the bets you can make?

Who were the “victims” of the Dot Com crash? Mostly people who had invested heavily in dot coms. And actually, it was mostly people who invested heavily late in the game. A friend once joked that if he had a time machine he might tell people not to buy tech stocks during the craze. I said “Are you crazy? The correct message is “sell your tech stocks before March of 2000!” If you bought a NASDAQ index fund on January 1 1999 and sold a year later, you would have made very roughly 100% annual return. But if you bought on January 1 2000 and sold a year later, you’d be very disappointed. By the beginning of 2000, everyone knew this was a bubble. That was a high risk, and people who made it might have lost a lot. Meanwhile, after countless companies folded and a terrorist attack that destroyed one of the most important financial centers in the world, the US experienced a mild recession. Sure, a lot of dot com millionaires were no longer millionaires, but this was not a broad crisis. Indeed, service industries boomed during this period, I suspect many of the lowest-wage workers felt the boom but the bust not nearly so much.

So, coming back to the present, the housing bubble is bursting. Yes, some low-income people are losing their homes, and this is definitely sad. But, they didn’t die, they have some major cleaning up to do, and hopefully they’ll be back to try again someday soon. Meanwhile — and I can’t believe no one talks about this — a substantial number of these subprime loans are not going to fail. That means that a huge number of people who in the 1990s would have been entirely unable to get a home loan will be home owners for the rest of their lives. They should be careful about their mortgage, they should work on negotiating with their lender if they are in trouble (banks hate foreclosing, I believe the financial advisors I’m hearing that are encouraging people to call their lenders and work on restructuring their loans if they are in trouble). Those who succeed should proudly enjoy the home that they have earned the right to call their own. Meanwhile, many of us in the middle class are paying unbelievably low interest rates on our mortgages, locked in when rates were so low. And of course, most of our houses are worth much much more today than when we bought, even in cases where the price has dropped a bit recently.

According to the census bureau, (and this graph in wikipedia) in 1970 the home-ownership rate in the US was just over 64%. From 1985-1994, it was never more than half a percentage point away from 64%. The most recent reported number is 68.2%. That’s down from a year ago, and I bet it will fall more from here. But, I bet it will not be down below 64% again for a long long time. So, amazingly (sarcasm again intended) home ownership will have increased substantially during this “crisis”.

In short, the people who made good bets are doing well. The people who made bad bets are suffering. The left in America reads this as a reason to regulate this process. The free-marketeers are saying “well, the moral of the story is: make good bets, stay away from bad ones.” As to which way things work better, we’ll never know for sure. But I’m with the free-marketeers.

2 Comments »

Interesting points, David - can’t say that I disagree with much of what you wrote. But, I feel perhaps you’re leaving something out - that the lenders in this case, those who deal in sub-prime (or even predatory) loans, will not actually be held responsible for their bad judgment. The government (i.e. us taxpayers) will end up bailing out these lenders in order for our economic boat to remain somewhat stable…and, of course, the average person who can’t make their house payment won’t get any sort of comparable handout. The thing that’s so troubling about this bursting housing bubble is how many characteristics it shares with the Savings and Load crisis of the 80’s.

The S&L crisis was described as:
“Estimates of a clean-up bill of around $30 to $50 billion shocked US taxpayers at the time, but turned out to be optimistic. Today we know that between 1986 and 1995, when the storm abated, the underwriting of US thrifts by the financial industry and the US taxpayer cost an extraordinary $153 billion. The extent of the disaster turned it into a major threat to the US financial system, and one of the most expensive financial sector crises the world has seen.

The losses were the result of unmanaged asset/liability gaps that led to interest rate exposures, speculative investments in junk bonds and service industries, fraud, and - most especially - massive losses from lending to and investing in the US commercial real estate sector. ”
(from: http://www.erisk.com/Learning/CaseStudies/USSavingsLoanCrisis.asp).

Comment by nerdmeyr — Wednesday, 2007-11-14 @ 10:47 am
Be careful, David, you are thinking more and more like your Dad.

Comment by Donna — Wednesday, 2007-11-14 @ 10:53 pm

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