Archive for February, 2010

Thoughts on Health Care Reform in the United States 2

February 28, 2010

This column continues the discussion that I initiated in my column dated February 27, 2010.  I emphasize that the points that I raise do not reach out to comprehensive reform of the industry, something that is well beyond my competence and, I should add, well beyond the competence of any one else, most especially that of any politician.  I watched quite a bit of the health care summit proceedings, and formed a judgment, based on 48 years in the economics profession, that no one in that room, including the President, is competent to pass an Economics 101 examination. It is extreme arrogance for individuals with such limited education in economics and business  to presume that they can restructure an industry that encompasses one-sixth of the entire economy of the United States.

Here are some further thoughts focused on the cost side of the market (or rather the  non-market) in health care in the United States:

1.  Why are all cost-saving proposals in the legislation to occur after the 2012 or 2016 elections? The answer, Dear Readers, is that both the President and the Democrat majorities in Congress know that the proposed cuts in costs are politically unpopular with key electoral constituencies. The Democrats cannot and will not alienate union support. So the Cadillac policies will remain untaxed until everyone has vacated political office, or, like Senator Robert Byrd, are too brain-dead to know or care what is happening. The Democrats cannot and will not alienate the oldies, who turn out to vote for them in disproportionately large numbers.  But neither the President nor the Congress  intends to impose the medicare cuts outlined in the proposal. After all, they never have done so in the past, especially in election years.  That proposal is simply a fraud perpetrated on voters.  Because the President and the Democrat-majority do not aim to attract small business owners – they fall outside their minimum winning coalition set – those fines will be imposed well before those on the unions, if indeed the latter are ever imposed at all.

2.  Why are medical malpractice litigation costs largely ignored in discussions of cost-containment?  The answer to that question can be found in the follow-the-money theory of understanding political behavior. President Obama’s election coffers, and the coffers of most Democrats running for office in 2008, were saturated with trial lawyers’ dollars.  Those dollars were not forthcoming because the trial lawyers were captivated by the good looks of the recipient candidates.  The money was there to purchase the services of those politicians.  Cheap talk for public consumption nothwithstanding, the very idea that President Obama or the congressional Democrats will seriously consider capping the medical malpractice damages of trial lawyers is absurd.  Yet, that measure alone offers the most significant opportunity to cut health care costs.  Defensive medicine now dominates health care in the United States, exposing patients to significant unnecessary risk while lining the pockets of trial lawyers and medical practitioners for services that essentially are fraudulent.  That is the 800 pound gorilla in the room preparing  to soak up any of the pitifully small cost savings available from health care reform alternatives under consideration.

3.  Why are unwilling participants to be fined for not purchasing a product that they do not desire?  The public relations response to this question is that society is unwilling to deny any individual access to health care, should they become ill, whether they are covered or uncovered by insurance. And that such patients are imposing an intolerable cost upon the system by their easy access to hospital emergency wards. In my judgment, forcing such individuals into the insurance system  is a national socialist way of dealing with a situation that is amenable to market solution. Individuals and families that satisfy specified poverty standards have no problem in accessing the health care industry. Rightly or wrongly, they are the truly privileged group within society from this perspective.  The elderly, whether rich or poor, have no such problem either, at least while medicare funding covers most procedures.  Those who remain uninsured fall into two categories, namely those who cannot locate suitable insurance programs, and those who choose not to participate for good economic reasons. I leave the pooling issue for another time. Here I focus on the issues of moral hazard and adverse selection, issues that clearly fall well beyond the level of comprehension of President Obama and his congressional colleagues.

A significant threat to any insurance program lies in the asymmetry of information within the market place. Potential patients, in this case, know more about their current and likely future medical conditions than the providers of insurance are allowed to access. So insurance providers must price their policies accordingly, charging poor prospects less, and good prospects more, than the risk neutral, fair-market premium. Such a pricing policy deters rational good prospects from joining the scheme. They will self-insure. It attracts the poor prospects in droves. This is the problem of adverse selection.  Unfortunately, it does more than that. With comprehensive insurance now in place, the poor prospects have incentives to adjust their lifestyles to yet more health-reducing levels. The obese become yet more obese, obese to levels that now require hospitals to rebuild their wheel chairs and beds to accommodate  previously unheard of sizes and weights, and to lengthen the incision instruments so that they can penetrate ever increasing layers of fat. They encourage individuals to over-engage in high-risk sports, to eat unhealthy foods, to drink unhealthy drinks, and to avoid exercise whenever possible, reliant on the health care industry to retard the adverse consequences of such self-serving behavior. This is the problem of moral hazard. Health care reform proposals, by not addressing either of these two problems, by forcing insurance companies to ignore pre-conditions when enrolling purchasers, and by denying them the right to impose higher costs and deductibles as a means of controlling moral hazard, invite cost increases of a magnitude yet unheard of in the United States.

How would the market respond to those who choose to self-insure and then  become ill?  Such individuals would be charged regular access prices for the medical services that they seek. They would be billed in the regular way. Debts, if such arise, would be dealt with through collection agencies. In the final analysis, non-paying debtors would be forced into bankrutpcy, with all the adverse consequences of such a state. For the most part, such individuals would pay up, especially if one consequence of such bankruptcy was a denial of all non-upfront, pre- paid-for  future services from the health care industry.

Caveat emptor is the warning that I would suggest might be put in place over the health care proposals currently before Congress. Unfortunately, voters are now all but helpless to avoid the consequences of their careless voting decisions in the 2008 elections. If the proposed  reconciliation procedures are implemented with respect to the two bills currently under conference review, the game is up.  United States citizens will find themselves one more step on a road to national socialism and with it, confronting an associated loss of individual freedom. Such outcomes now look increasingly inevitable.

Thoughts on Healthcare Reform in the United States 1

February 27, 2010

Regular readers are aware that I have devoted little attention to the healthcare reform debate in my daily columns.  My hesitation to engage directly on this topic stems from the enormous complexity of the issues involved and the massive attention that this topic has received since January 2009.  As the debate reaches its critical phase, as Washington’s politicians ready themselves for some definitive closure, and contemplate alternative courses of action, I have decided to share with you some insights that should – but that almost certainly will not – influence the final decisions.

1. All human beings ultimately will die: No one is immortal, whatever the medical care available.  So even if a society decided to allocate its entire resources to death prevention, death would still occur.  More important, because the marginal cost of death protection increases dramatically as an individual draws near to that occurrence – in the United States on average one-third of an individual’s lifetime medical costs are incurred in the final year of life – there are enormously diminishing returns to life-protection. In this sense, death juries are inevitable. Decisions to cut off or to cut back on life protection are made all the time by patients, as well as by doctors, insurance companies, and families.  The United States already expends more of its resources per capita on health care than any other nation on the planet. And the outcome is not spectacular, at least in terms of death prevention, though it is markedly better in terms of the quality of lives that continue to be lived. Almost certainly, it expends more than individuals themselves would outlay in a free market in health care, where they would have to confront directly the cost upon their families of hopelessly trying to extend their lives.

2.  Health care is not just a matter of medicine and treatment:  The good health of an individual is a function, to a considerable degree, of genetic makeup and of  personal lifestyle choices.  The genetic quality of individuals in society is influenced by evolutionary factors. In a system where survival of the fittest rules prevail, those who survive tend to be the fittest, and medical interventions tend to be less necessary, at least until the end.  In a system where medical interventions are common-place, the average genetic quality of the survivors will be lower, and medical interventions will appear to be more necessary.  I stress that this is an observation, and not a policy recommendation.  I am not competent to engage in making  medical policy recommendations. Unlike many others, I am well aware of my limitations in this regard.  Personal lifestyle choices, however, are under the direct control of each individual.  Decisions to live well, to avoid obesity, to eat well, to avoid an excessive use of stimulants and depressants, to rest and sleep well, to exercise appropriately, and to avoid high-risk activities in general, are way more important than medicines and treatments in improving the quality and duration of one’s life.  Sadly, the more that medicines and treatments are made available, the less personal care an individual will take of his own health. This is a problem of moral hazard that tends to be downplayed in the health care reform debate.

3.  Individual freedom is worth protecting: As I have explained in these columns, I place the highest value on individual liberty, defined as the absence of coercion by one individual over another.  Whenever I read, in the current health care reform debate, about the desire of some individuals to impose their will on others, I cringe.  Unfortunately, I have grown to cringe a great deal over the past 12 months as suggestions for various kinds of federal oversight over health care provisions have poured out from the mouths and pens of frustrated would-be dictators. The rush to regulate is especially worrying in this debate, not because it is more prevalent than elsewhere, but because it affects one-sixth of the United States economy.  If the liberal progressives have their way on this issue, Americans will find themselves far less free 10-20 years from now, than they have ever been, including colonial times. Worse still, they will find themselves irreversibly enslaved, because they will have rendered themselves dependent on the federal government, a government that will have translated itself from representative of their wishes to dictatorial about their needs. The liberal progressives are well aware of this irreversible shift, as is President Obama, whose primary goal appears to be to shift the United States economy from laissez-faire capitalism to state capitalism and, ultimately to socialism.

4.  The willingness and ability to pay principle is relevant to health care decisions: In most areas of economic activity, Americans prize their free enterprise system. They recognize that individuals will be differentially rewarded in such a system, as a result of genetic advantage, level and quality of education, choice of occupation, hard work, and sheer good luck or misfortune.  They are compassionate towards those who do less well, as long as they are striving to improve their lot.  They are a lot less sympathetic to the undeserving poor, those who have brought poverty upon themselves, and who are disinclined to make the effort to retrieve their fortunes.  Although medicines and treatments are viewed a little differently – few individuals would wish to see those without resources left bereft of interventions – most Americans reject the notion that access to medicine and treatments should be equal across society. Just as in other areas of activity individuals with greater wealth have better access to resources, so it should be with respect to the market in health care. Otherwise, the incentive to do well will be severely diminished, and the society as a whole will be relatively impoverished.  This issue is downplayed in the health care reform debate because of  considerations of political correctness that tend to foreclose on open discussion.

Well, these are thoughts enough for one day. Others will follow in tomorrow’s column. The thoughts that I offer to you may well not change your judgment on the current debate.  Surely they will not change the policy outcomes.  But I hope that they may provide a shade of difference to your reflections on this very important policy issue.

Washington Princes of Darkness Torment the Rising Sun

February 26, 2010

“There is striking evidence that the company was at times more concerned with profit than with customer safety.”  Representative Edolphus Downs (Democrat-New York, Chairman of the House Oversight and Government Reform Committee ) February 24, 2010.

“It is my understanding there are no Americans in the top leadership in Japan.  It might be a good idea to put a couple Americans in the top leadership.”  Representative John J. (Jimmy) Duncan Jr. (Republican-Tennessee and Member of the HOGRC) February 24, 2010 (maybe good idea brush up grammar, Jimmy).

“Toyota North America has some great people there, very professional, good people.  we work with them. They make recommendations to Japan.  The decisions are made in Japan.”  Transportation Secretary Ray LaHood ( in testimony before the HOGRC) February 24, 2010 (a trifle racist, do you not think Mr. Lahood?)

“I said. Lookit: This is serious. Lives are being lost. Right after that, they started taking action.”  Ray Lahood (the same meeting; the grammar problem appears to be catching at HOGRC).

“Toyota may be interested in trading dollars for lives, despite the likelihood of its products causing deaths and injuries, but its customers’ aren’t.”  Joan Claybrook, Administrator of the National Highway Traffic Safety Administration under President Carter.  Her chief claim to fame at NHTSA was forcing automakers to install air bags despite warnings that the technology needed further development to avoid killing infants and children.  At least 65 deaths resulted, including infants and children who were decapitated by the exploding devices. (Source: The Washington Examiner, February 25 , 2010).

“All the Toyota vehicles bear my name.  When the cars are damaged, it is as though I am, as well.” Akio Toyoda ( the grandson of the founder of the world’s largest automaker) Testifying before the HOGRC February 24, 2010.

“I am deeply sorry for any accidents Toyota drivers have experienced.” Akio Toyoda (once again).

“We will listen to customer complaints humbly.” Akio Toyoda (once again).

“We apologize for the embarrassing way some members of Congress treated you these past few days.  If Bill Gates had been treated the way you were in your country, imagine what would happen. We sincerely apologize.” Paul Atkinson, who represents a Toyota council of dealers in the United States.

Well, Mr. Toyoda  (like Mr. Smith before him)  came to Washington. Like Mr. Smith, his welcoming  hosts gripped him warmly by the throat. Like Mr. Smith, Mr. Toyoda brought civility, good manners, and good grammar to a place where those attributes do not appear to flourish; most especially when campaign funding is on the line and can be brazenly pursued before the entire nation’s  television cameras. Oh, would it be impolite to mention that Mr. Toyoda incidentally brings a large number of well-paying  blue-as well as white-collar  jobs to the United States?  I suppose that it would be, since these jobs are (gasp!) Japanese creations!

Readers of this column will know that the United States government is a not entirely disinterested party in this episode of Japanese assault and battery.  The Obama administration currently owns Government Motors, the company that was  driven into Chapter 11 bankruptcy while under Obama  administration ownership and control in spring 2009, in large part, because it was outcompeted by Toyota. The Obama administration is also a significant minority shareholder in Chrysler, another failed automobile manufacturer that was placed into Chapter 11 bankruptcy while under the control of President Obama’s administration in April 2009.

Well, the situation is a little more sinister even that that, as the breakdown of ownership in Government Motors and Chrysler indicates.  In the case of GM, the US government owns 61 per cent of company stock, the United Auto Workers Union (UAW) owns 17.5 per cent through its retirees’ health-care trust,  the Canadian government owns 11.7 per cent, and the poor bondholders from the old GM, whose priority as preferred creditors was  expropriated by the UAW,  own the remaining 9.8 per cent.

In the case of Chrysler LLC, Fiat SpA owns 35 per cent of company stock, the US government holds 8 per cent of the company’s stock, while the old company’s largely expropriated secured lenders own a derisory residual 2 per cent. The United Auto Workers Union, an unsecured creditor of the old company,  that should have received no stock in its successor, is the majority stockholder, with effective control over the company, owning  55 per cent of the company’s stock.

Well, Dear Readers, the plot against Toyota surely thickens. Not only is Mr. Toyoda berated, with poor grammar, by Ray Lahood, on behalf of  the Obama administration, itself a significant shareholder in two of his company’s three major US rivals.  He also suffers verbal abuse from members of two congressional committees that are largely bought and paid for by the UAW. Follow-the-money is always the safest guideline to understanding  congressional posturing, especially when such posturing takes a threatening tone.  Such is the humbling, but not not the humiliating experience of Mr. Toyoda during his time served on Capitol Hill.  Such is the humbug that permeates the corridors of Capitol Hill.

Toyota has long been a thorn in the flesh of the UAW.  For decades, Toyota  has resisted attempts by the UAW to unionize its workforce.  It has done so by locating its production plants in the ‘right to work’ states of  Alabama, Indiana, Kentucky and Mississippi, by creating excellent working conditions in its plants, and by offering  job security through the satisfaction of consumer demands for safe, high-quality, and relatively inexpensive motor cars. By its example, it has demonstrated to those employed by GM, Chrysler and Ford, that job security does not spring from restrictive, productivity-lowering union practices, and that high wages are not secured by excessively high wage and benefits packages negotiated under the threat of disruptive strike action.

The UAW is a major player in congressional politics, a powerful special interest doling out campaign contributions to those who can deliver the Michigan bacon.  UAW monies have bought out 19 of 36 Democrats on the House Energy and Commerce Committee. UAW  monies have bought out 12 of 25 Democrats on the House Oversight and Government Reform Committee (The Washington Examiner,  February 25, 2010).  It is no wonder – no wonder at all- – that the gracious Mr. Toyoda was received with such an absence of grace by those two committees on Wednesday and Thursday of this week.

Letters of support for Toyota  have been filed by the Governors of the States of Alabama, Indiana, Kentucky and Mississippi.  Those letters do not demonstrate any hostility to the Rising Sun.  But then, those letters were not written by Princes of Darkness. Those letters were written  by far-sighted Governors, speaking out on behalf of the citizens of their States. They were not penned from inkpots stuffed with UAW dollars.

By the way, a recent Zogby poll found that 64 per cent of those surveyed considered Toyotas, on average, to be safer than (18 per cent) or equally safe as (47 per cent) other vehicles. One can only wonder  how that poll data might  change following the two days of congressional hearings. Interestingly, no such hearing has been called to deal with the many vehicle recalls by Ford, GM and Chrysler in recent years. Dear Readers, can you speculate why that dog has not barked in the darkness of the Washington night?

Brain-Dead US Banks Survive on Life Support

February 25, 2010

“Them that die’ll be the lucky ones.”  (Long John Silver, pirate leader, himself responding to the threat of the Black Spot from his own treacherous brigands,  as he storms away from the stockade on Treasure Island behind which Captain Smollett, Squire Trelawney, Dr. Livesey and their few loyal supporters shelter, when they reject his request that they should  surrender)

Robert Louis Stevenson, Treasure Island 

“Troubled banking industry pulls back: Lending down $587 billion.” Binyamin Applebaum, The Washington Post, February 24, 2010.

The FDIC reported on February 23, 2010 that lending by United States banks fell by $587 billion (or 7.5 per cent) in 2009.  This is the largest annual decline since the 1940s. The FDIC also reported that the nation’s 8,012 banks posted an aggregate profit of $12.5 billion in 2009, an increase over 2008, but well below the levels achieved during the mid-2000s.  The largest banks accounted for most of these reported profits. 

 A growing number of smaller banks are struggling to survive losses on commercial real estate loans.  Almost 30 per cent of such smaller banks reported losses in 2009, the largest proportion in the 26 years of available data.  And the FDIC does not mention that a major collapse in the commercial real estate market is the second shoe about to drop on the teetering US economy in 2010. Regulators shuttered 140 banks in 2009.  This number is expected to rise during 2010 with 702 banks considered by the FDIC to be at risk of failure. If the commercial real estate market truly collapses, many more banks assuredly will fail in the absence of bail-out funding.  Predictably, the Obama administration is racing to the rescue, with a proposal to pump $30 million in new federal aid into community banks, yet more hard-earned taxpayers’ wealth to be flushed down the toilet.

According to the FDIC, the vast majority of the decline in lending was the result of cutbacks by the nation’s largest banks.  These banks have tightened qualification standards for borrowers and increased the proportion of money that they hold in reserve against unexpected losses. FDIC Chairman, Sheila C. Bair, was critical of these actions: “Large banks do need to do a better job of stepping up to the plate here” she complained.  The banks cut back most sharply on lending for construction and development, reducing the volume of such loans by 23.6 per cent.  Business lending followed closely behind, down 18.3 per cent.  Lending to individuals also declined, but more modestly.

I am now going to try to interpret these statistics against the backcloth of the discussion that followed my column dated February 16, 2010, wherein Bill Woolsey took me to task for omitting important considerations. His thoughtful  intervention renders my task more complex, but not at all impossible. Among other things, it requires me to make a clear distinction between banks that are illiquid and banks that are insolvent (something that Nathanael Smith and I did in our 2009 book).

A solvent bank enjoys an excess of assets over non-equity liabilities, whereas a non-solvent bank does not.  Solvent banks that are also liquid banks hold sufficient reserves of cash , either in their vaults or in the cash reserve at the central bank, to take care of demands made upon such resources.  Solvent banks that are illiquid do not hold such a sufficiency of cash reserves.  If a financial panic picks up, in the absence of central bank intervention, both insolvent banks and illiquid but solvent  banks will be shuttered.  The traditional good banking doctrine is that the insolvent banks should go under,  but that the illiquid banks should be provided ‘lender of last resort’ cover by the central bank to enable them to mend their over-leveraged ways and to ride out the storm.

The Federal Reserve and the Treasury Department, responding to political pressure from the Bush and the Obama White House, threw good banking practice to the winds in late 2008 and early 2009, and bailed out both insolvent and  illiquid banks via massive injections of TARP monies and quantitative easing of the money supply. Subsequently, the Department of the Treasury imposed stress tests on all the major banks to determine whether they were simply illiquid, or possibly insolvent. In my judgment, either the stress tests were rigged, or the Treasury Secretary was duped.  Every bank came through with flying colors, although at least 4 of the 10 largest banks – Bank of America, Citicorp, Wells Fargo and GMAC – were and still are insolvent.  And several more are teetering on the brink, reliant on the fact that their toxic mortgage-securitized assets are not exposed to market valuations. 

Now, let me try to answer two important questions once  again: why are the banks not lending?  Why has the injection of high-powered money into the system not  triggered the usual money multiplier effect? Let me concede to Bill Woolsey the observation that nominal expenditure is running approximately 10 per cent below its long term trend, and that this reflects (at least in part) an upward shift in the demand for money  function. Where does this leave us?

In my judgment, a large part of the explanation why the banks are not lending, are not expanding the size of their balance sheets to reflect the insertion of high-powered money, lies on the supply side of the money market equation. The insolvent banks are desperate to pull their chestnuts out of the fire by rebuilding their financial reserves while investing in a limited fashion in Treasury notes as a means of boosting earnings without significant exposure to risk, while they wait hopefully for some of their toxic assets to mature under the security blanket of Obama’s mortgage rescue program. Little or no money multiplier can be expected from these basket-cases. 

The illiquid banks are similarly engaged, though with a greater willingness to lend in multiples of their increments in cash reserves.  The community banks are shutting down to weather the coming commercial real estate market storm.  Yes, the demand for money function has also shifted upwards so that evidence of credit rationing is less pronounced than otherwise would be the case.

Now just suppose, Dear Readers, that all the insolvent banks had been allowed to fail during 2008-9, without any bail-out from the federal government. Suppose that the Federal Reserve had protected illiquid banks by lending at penal rates through the lender of last resort facility, while holding interest rates down through open-market operations restricted to the purchasing of Treasury notes. In such circumstances, new banks would have emerged (always assuming that the Fed allowed new entry into the banking industry) and the insured deposits in the insolvent banks would have found their way into banks that were not incumbered by huge volumes of toxic assets.

The money multiplier would have operated, albeit somewhat dampened by the recession, credit rationing would be much weaker, and private investment would be exerting a much more significant positive effect on the macroeconomy.  Surely, banks would not be investing significantly in the construction industry, until the real estate markets have reached full equilibrium.  But credit would be much more forthcoming for small firms and new ventures, both of which are capital starved in the current financial climate. Inevitably, the Fed would then confront the specter of inflation. But, without any toxic assets on its balance sheet, it would be able to reverse open market operations to reduce the supply of high-powered money as the economy rebounded to full employment. As Bill Woolsey suggests, the Fed’s interventions arguably should be targeted  on some appropriate level of nominal income for the economy as a whole.



Is the United States Capital Market Efficient?

February 24, 2010

“So we are again driven back to the position of the EMH (efficient market hypothesis).  Pricing irregularities may well exist and even persist for periods of time, and markets can at times be dominated by fads and fashions.  Eventually, however, any excesses in market valuation will be corrected.  Undoubtedly with the passage of time and with the increasing sophistication of our data bases and empirical techniques, we will document further departures from efficiency and understand their causes more fully.  But I suspect that the end result will not be an abandonment of the profession’s belief that the stock market is remarkably efficient in its utilization of information.” Burton G Malkiel, ‘efficient market hypothesis’ The New Palgrave: A Dictionary of Economics 1987

“Have capital market booms and crashes discredited the efficient market hypothesis?  This column says yes and suggests a new model that explains asset pricing in terms of a battle between fair value and momentum driven by principal-agent issues.  Investment agents’ rational profit seeking gives rise to mispricing and volatility.” Dimetri Vayanos and Paul Woolley, ‘Capital market theory after the efficient market hypothesis’ , October 2009

Nathanael Smith and I suggest in our 2009 book (Economic Contractions in the United States: A Failure of Government) that the efficient market hypothesis (EMH) did not fail in the United States over the period October 2007-June 2009,  as so many critics of the rational choice model from the standpoint of behavioral economics allege.  At least, EMH did not fail in any way that justifies a fundamental revision of its role as a mechanism for the allocation of scarce capital resources within the US economy.

Inevitably, the extreme movements in stock prices over the period under review have raised doubts about this proposition.  The Dow Jones Industrial Average (DJIA) peaked at 14,200 on October 9, 2007, fell to 9,600 on November 4, 2008, declined to an apparent bottom of 6,500 on March 6, 2009 and rose to 8,750 in mid-June 2009, when our book went to press. Since then the DJIA has risen albeit unsteadily to  10,300 where it appears to have stabilized.  These shifts in value are far cries from the marginal changes typically associated with the behavior of the DIJA.  Nevertheless, in our judgment, these facts can be explained without abandoning the EMH paradigm as long as EMH is defined from an Austrian economics perspective in terms of dynamic rather than static criteria.

We use weak-form dynamic efficiency (in the Austrian sense) as the basis for our judgment.  The basic postulates are that all actors maximize expected utility; that on average the expectations of the population of investors are correct in the long run; and that actors update their expectations to account for new economically relevant information when it appears.  EMH allows that some investors may over-react and others-under-react to new information, but that such behavior is random and follows a normal distribution pattern.

Under weak form dynamic efficiency, future prices cannot be predicted by analyzing past price data, and excess returns cannot be secured in the long-run by using investment strategies based on historical share prices or other historical data. Prices follow a random walk.  Because efficiency is not instantaneous (as the Chicago School suggests is the case) sophisticated models may be able to exploit short-term anomalies in the market, and take advantage of market momentum as the market over- or under-shoots its equilibrium. This opportunity explains the apparent successes of some hedge funds, brokers and investment banks during the early years of the 21st century.  However, such returns on the average are wiped out in the long-run, as the market as a whole re-adjusts, as occurred in the United States late in 2008.

Stock market bubbles represent such short run anomalies.  Note, however, that individual actors remain rational throughout the bubble, recognizing that the bubble exists, but unable to identify the peak or the trough, which is  determined through interactive trading.  In this respect, a distinction must be made between risk and uncertainty (in the sense of Frank Knight 1921).  Risk can be calculated (albeit subjectively) on the basis of past experience.  No such probabilities can be attached to uncertainty, because of the absence of a relevant past.

During a stock market bubble, the turning point cannot be calculated in terms of probabilities. The best predictor of the immediate future is the immediate past.  Many actors therefore rationally follow the trend (momentum) and continue to buy during the upturn, even borrowing money to buy on margin. For a number of reasons, including inertia and differing attitudes towards risk, some stockholders sell, thus clearing the market at any point in time.

Those who sell at or near the peak are lucky.  Those who are left holding over-valued stock once the music stops, and the bubble bursts,  are unlucky.  The selloffs that follow are entirely rational, even when the downturn overshoots, under the influence of downward momentum decision-making.

Those who find fault with the EMH, and suggest that profit opportunities are available for exploitation, should be subjected to the empirical test. Are they billionaires or are they not?  Yes, Warren Buffet passes that critical test. Others who put their faith in Buffet typically do not fare quite so well.  Many others lose their shirts on their market gambles.  Talk is cheap, and for the most part should be downplayed for what it is. Actual market success is a better guide; and remember that we define efficiency as a long-term concept, rendering transient short-term market successes less relevant for EMH.

Readers should be alert to the fact that many of those who criticize EMH also criticize free markets more generally. By instinct, they are interventionist, by nature they are paternalistic (albeit with other people’s wealth).  In essence, they tend to be advocates of Lange-Lerner, advocating the substitution of socialist calculation in place of free market values.  They believe that a central planning agency (in the United States read the Federal Reserve Board and/or the Treasury Department, and/or the FDIC) is able to determine stock prices more efficiently than the free market;  that such a central planning agency should oversee the stock market with detailed financial regulations, in order to head off unjustified market movements.  Well, we know what such central planning did to the  economies of the USSR and its Evil Empire, do we not, Dear Readers?  We know, pretty much,  what is happening in Venezuela and Bolivia, to say nothing of Cuba and North Korea;  is that not so?

The error inherent in the ruminations of such market critics is the complete absence of the Austrian economics insight.  Stock market valuations reflect a continuous, decentralized process of information creation, assembly and dissemination that cannot be replicated by a central planning body. A risk-averse bureaucratic central authority could never adequately take into account the wide range of attitudes towards risk and uncertainty; nor could it recognize and evaluate the multiple  opportunities for investment that commingle in a market economy.

Do I believe, and believe fervently, that a deregulated US stock market is more dynamically efficient than would be some  suitably weighted  Bernanke/Geithner/Bair  triple  in allocating capital resources across this great nation?  I suspect that you know the answer to that rhetorical question.

The United States Senate Fulfills its Constitutional Role

February 23, 2010

“It is a misfortune incident to republican government, though in a less degree than to other governments, that those who administer it may forget their obligations to their constituents, and prove unfaithful to their important trust.  In this point of view, a senate, as a second branch of the legislative assembly, distinct from, and dividing the power with, a first, must be in all cases a salutary check on the government.  It doubles the security of the people, by requiring the concurrence of two distinct bodies in schemes of usurpation or perfidy, where the ambition or corruption of one, would otherwise be sufficient.”


“A good government implies two things; first, fidelity to the object of government, which is the happiness of the people; secondly, a knowledge of the means by which that object can be best attained.  Some governments are deficient in both these qualities: Most governments are deficient in the first.  I scruple not to assert that in the American governments, too little attention has been paid to the last.  The federal constitution avoids this error; and what merits particular notice, it provides for the last a mode which increases the security for the first.”

‘Publius,’  The Federalist LXII [James Madison] Independent Journal (New York), February 27, 1788

The  media worldwide resonates increasingly to the tune that the United States has become ungovernable, that the country is so deeply divided that governance is now all but impossible, that the country is committed to the fate of  18th century Poland, doomed to disappear as a nation for the better part of a century (Paul Krugman as reported in The Economist, February 20, 2010).

The media, and Paul Krugman,  are simply wrong in this assessment. The United States currently is being governed precisely in the manner predicted by the Founding Fathers (albeit with one exception).  The Founding Fathers never anticipated the emergence of the Imperial Presidency. The Senate presently is fulfilling its role of ameliorating  damage that might otherwise have occurred as President Obama forgot his obligations and moved forward with a policy agenda rejected by a significant majority of the United States electorate.

The 2008 presidential election was a very unusual event.  With the presidency of George W. Bush widely and correctly discredited for gross incompetence, the election was fought out for the most part in the Democratic Party primaries, pitting a relatively experienced (and therefore controversial)  (female) Senator, Hillary Clinton, against a relatively inexperienced (black) Senator, Barack Obama.  Obama arguably defeated Clinton not on the basis of salience (policy positioning in multi-dimensioned political space) but on the basis of valence (better  looking,  much more eloquent, more energetic).   The general election ran greatly to Obama’s advantage because of the financial crisis that  unexpectedly engulfed the United States in September 2008 and paralyzed the uphill  political campaign of John McCain.

I have little doubt that Barack Obama mis-interpreted the nature of his significant victory, uplifted as he must have been by the tumultuous welcome that his victory received from a population rejoicing that the evil stain of slavery, in part at least, finally had been scrubbed clean.  In reality, a frightened electorate was looking to its new President for a moderate policy agenda that would ease the country out of the financial crisis and economic recession, and return it to the era of The Great Moderation, 1984-2000, when stagflation had been eliminated, and steady economic growth, high rates of employment, and low rates of inflation blessed this exceptional nation.

Such moderation, however, was not to be. Flushed by his victory, and reinforced by significant Democrat majorities in both Houses of Congress, the new president forged ahead with a left-leaning government- expanding policy agenda that put both FDR and LBJ into the shadows. At first, his policies were quickly enacted into law by Democrat majorities that basked in the President’s overwhelming personal popularity. Budgets bursting with pork and overflowing with huge deficits were quickly passed into law, with little attention paid to the opposition of the  disheartened Republican  minority.

By the summer of 2009, however, the electorate began to awaken to the true nature of their President’s political agenda. This was no program of moderation designed to return the United States to its usually well-functioning market system. This was a systematic attempt to redirect the United States to a social market economy.  The examples of  old Europe, of France and Germany do not resonate well in the American psyche.  So Obama’s poll ratings trended downwards. With respect to his three  major initiatives – healthcare reform, cap and trade, card check – clear and growing poll majorities showed strong opposition.

The House of Representatives, under the insensitive, ideologically-driven  leadership of Speaker Nancy Pelosi, completely ignored the warning signs. Ideology trumped politics as the House rushed to pass Obama’s agenda into law. This is exactly what the Founding Fathers anticipated. The House, after all, was designed as the engine of the legislature, fired up by the enthusiasm of transient majority impulses, and operating on a two year treadmill.

Enter the brake, the Senate of the United States, operating through seemingly arcane rules that had evolved through the centuries – most notably through Rule XXII that requires the assent of three-fifths of all senators to bring a debate to cloture – to slow down the pace of legislation, to provide time for the reflection and reconsideration that a sound republic must demand of its representatives. 

And the brake has proved to be effective. Even when the Democrats possessed the requisite three-fifths  majority, the Senate was slow to act, slow to release bills to the floor for debate and vote.  This provided sufficient time, by a hairs-breadth or a whisker, for the people to respond, to take away the two third majority and thereby to freeze bad legislation before it could be rushed irreversibly into law.

‘God bless the United  States Senate’ should be the cry of the world’s media, at least that part of it that bears Americans good will.  ‘Go back to the drawing board, Mr. President, and pay particular respect to the great people whom you are honored to represent.  By paying such respect, and by honoring your oath of office, you may well secure your second term and, with it, ample time to move the United States back to a second episode of The Great Moderation.  And be thankful that brave Republican Senators,and a yet braver few within the Democratic  majority, saved your political bacon by resisting your irrational exuberance at a time when it must have seemed to be political suicide so to do.’

The United States: Government by Red Ink

February 22, 2010

“Perhaps the most important economic problem facing Western democracies over the remaining years of the twentieth century is the propensity of governments to operate in the red, to generate budget deficits in response to demand pressures from voters and special interest groups.  The problem posed by this ‘red ink’ syndrome is multidimensioned, reflected as it is in oversized government, in the ever-present spectre of debt monetization via inflation and/or in the rising burden of real debt imposed on the future generations.”

James M. Buchanan, Charles K. Rowley and Robert D. Tollison (eds.) Deficits 1986

“As the White House tried one more time Thursday to galvanize support from a recalcitrant Congress for a deficit commission to tackle the nation’s dangerously bloated debt, fears are growing that the United States will once again resort to printing money and ginning up inflation to resolve its debt problem.” Patrice Hill, The Washington Times, February 19, 2010

Since 2001, government expenditures in the United States have rapidly increased as a per cent of gross domestic product. As the Index of Economic Freedom for 2010 indicates, total government expenditures, including consumption and transfer payments, equaled 37.4 per cent  of GDP in 2009, and have increased more than 20 per cent over 2008.  Stimulus spending alone over the three years, 2010-2012 is estimated to equal 5 per cent of 2009 GDP.

The burden of taxation itself is relatively high, running at 28.3 per cent of GDP in 2009, but yet is 9 percentage points shy of covering the total cost of government spending, even as conventionally measured, without its major off-budget items.  There is no policy proposal before Congress at this time to increase tax revenues, except through increasing the burden on already heavily-taxed  top earners who represent, for the most part, the most productive members of society. In the absence of significant policy interventions, the debt burden, as conventionally measured,  is expected to increase from its current level of 60 per cent of GDP to 76.5  per cent of GDP by 2019, a level last experienced in the years immediately following the end of World War II.

There are only three ways for a government to cover the cost of its spending: debt, regular taxes, and inflation.  Because regular tax increases cannot be hidden, at least easily, they tend to be vote losers, to be resorted to only as a last resort, and even then, only in a discriminatory manner designed to impact adversely on a small minority of voters. Because increased debt is less transparent to the voters, and therefore, politically feasible, deficit-financing tends to be the preferred instrument, up to the point where  its burden becomes apparent to the international community. At that point, inflation tends to comes into play, as governments scramble to reduce the real burden of the debt by debauching its currency.

Of course, the real problem is located on the expenditure side of the budget. In the United States, this side of the budget is currently out of control, with spending on the major entitlements – medicaid, medicare and social security – seemingly untouchable, at least in the absence of any statesman-like leadership.  A determined program of spending reductions, that would tighten the means-testing of medicaid, that would raise the age-eligibility for accessing medicare and social security benefits,  that would means-test the latter eligibilities, and that would eliminate all federal subsidies to agriculture, education and the corporate sector, would surely lower government spending by the 9 percentage points required to balance the federal budget.  However, if such targets eluded the grasp of Ronald Reagan, the probability of their being seized by Barack Obama is lower than a snowflake’s chance in Hell.

So, we are left with the inflation tax.  As Patrice Hall notes in his above-mentioned column, signs are appearing that this prospect is drawing the attention of internal Federal Reserve Board deliberations. According to Hill,  Thomas Hoenig, President of the Kansas City Reserve Bank, and the most committed anti-inflation hawk within the Fed, now  ‘expects political leaders to be “knocking at the Fed’s door” to demand that it print money to pay for the debt.’  What Hill does not mention is that the Fed has no need to print additional money. The money has already been printed in trillions of dollars and passively awaits an inevitable uptick in the rate of price inflation.

The historical experience that drives this inflationary line of thinking, as Hill notes,  is the first 15 years after World War II, when inflation rates ranging between 4 to 6 per cent per annum, coupled with moderate rates of economic growth, drove the real burden of the debt down from some 100 to some 30 per cent of GDP,  all without raising undue concerns within the international community. 

The problem with this line of thinking is that 1945 is not 2010.  The United States  no longer towers hegemonic over a war-shattered world economy.  It is a relatively declining participant in a growing global world economy that is no longer driven by the United States and Western Europe.  Furthermore, in an information-conscious environment, the US government can no longer fool the electorate into accepting real income reductions through creeping inflation.  Inflationary expectations are poised to pounce on any sign of an inflation uptick.  It is simply impossible to hold inflation within a 4-6 percentage range in the absence of imposing the kind of fiscal and monetary discipline that the President and the Congress will not tolerate. The problem with this line of thinking, in a nutshell, is that it is a harbinger of stagflation, that nasty phenomenon that brought the progressive movement to its knees for some 20 years following the debacle of the Carter administration. As President George W. Bush might have said, before his voice was stilled:  “Bring it on!”

The United Kingdom’s Social Market Economy is on the Ropes

February 21, 2010

The United Kingdom is the world’s fifth largest economy.  During the 1980s, Margaret Thatcher instituted pro-market reforms that cured the economy of its British Disease of stagflation and enabled it to become the economic powerhouse of the European Union.  Her immense achievement has been dissipated since 1997 by successively worse Labour Governments, whose policies have eroded laissez-faire capitalism, and moved the nation seemingly irreversibly to the economic stagnation of the continental European social market economies.

As a consequence, the United Kingdom is sliding down the Index of Economic Freedom.  In 2010, it lost its place among the 10 most free nations, slipping to 11th place, and losing a significant 2.5 points.  This points reduction reflected reduced scores in freedom from corruption, financial freedoms and monetary freedoms. Most significantly, the score for fiscal freedom came in at a low 61.8 and for government spending at a disgraceful 41.9. 

In terms of fiscal policy and government spending, the United Kingdom ranks with Greece as one of the two basket-cases of the European Union. This shows up dramatically in a recent listing of advanced nations in terms of budget deficits as a per cent of gross domestic product, where Iceland ranks worst at 15.7 per cent, followed by Greece at 12.7 per cent, followed by the UK at 12.6 per cent.

The explanation for this depressing economic performance lies in 13 years of socialist policies, deployed with increasing intensity by successive Labour governments, especially since September 2008.  A dramatic expansion of state ownership took place as the British government nationalized or seized ownership in some of its largest banks.  Deterioration in its public finances is worse than in all other leading economies, with public debt now measured at 60 per cent of gross domestic product. The government deficit is high and rising under unsustainable levels of expenditure on a poorly functioning National Health Service, on a poorly functioning state education system, on unproductive contributions to the EU agricultural dole system, on misguided so-called ‘green’ energy programs, and on exploding levels of welfare benefits. The economy is also reeling under the impact of inward migration from poorly educated individuals and households from central Europe, fueled by excessively easy access to welfare benefits and housing subsidies.

Nor is the budget deficit a result of low taxes. In 2009, the top rate of income tax was 40 per cent (since jacked up to 50 percent), the top rate of corporate tax was 28 per cent, and value-added tax rates are back up at 17.5 per cent. Overall tax revenues as a per cent of gross domestic product are a whopping, wealth-destroying  39.7 per cent. A loose monetary policy threatens to return significant inflation to the United Kingdom.

The Labour Government has rejected out of hand all immediate measures to implement cuts in government spending, largely one suspects for political reasons, given the general election that must take place within the next four months. In consequence, the country confronts a very real prospect that its credit rating will be lowered, with all the consequences that would follow for a run on sterling and for interest rate hikes on its national debt. In a nutshell, the United Kingdom’s economy has taken a well-deserved pounding in the ring over a wearing 13 rounds (years), has been down for counts of 9 on at least two occasions, and is now hanging onto the ropes for dear life as global market forces pound it into a bloodied pulp, and as it waits agonizingly for the relief of  the final bell.

As might be expected, all the old, tired, hydraulic Keynesians have exited their retirement homes and joined the ringside in their wheel chairs and on their crutches to cheer on the failing Keynesian experiment  in which Prime Minister Brown is so thoroughly engaged.  In a list of some 67 Keynesian economists begging the Labour Government to maintain its loose fiscal stance, we find such Emeriti as Victoria Chick (Emeritus Professor), Sheila  Dow (Emeritus Professor) Geoffrey Harcourt (Emeritus Professor), Grazia Ietto-Gillies (Emeritus Professor), Alan Kirman (Emeritus Professor), Lord Peston (Emeritus Professor), Robert Rowthorn (Emeritus Professor), and John Weeks (Emeritus Professor) as well as the usual list of  somewhat younger hydraulic Keynesian suspects from the United States. Interestingly enough, on the other side of the ring, begging the sagging candidate to go down for the final count, we find just 20 non-Keynesian economists, none of whom appear to be Emeriti.

The $64,000 question, of course, is to which of these  two voices will a majority of the UK electorate respond, the tired past or the vibrant future.  The answer, one might think must be simple. Seldom can a government have come to the polls so battered and with such a string of failures to its discredit. Unfortunately, the situation is more complex. Since I emigrated to the United States in December 1983, I have watched with increasing dismay and sadness as my countrymen have succumbed to the Sirens of fairness and equity and have turned increasingly away from the wealth-enhancing goals of economic efficiency. So vulnerable has that electorate become to the specious demands of politicians for rational sacrifice, that many, perhaps most of them, now despise the selfish gene on which their survival as a small-island race  ultimately has always depended.  When the selfish gene abandons its innate selfishness, its viability is directly jeopardized.  At best, the selfish gene ends up on the life-support sparingly provided by the hostile social market economy upon which it has allowed itself to depend.

The United Kingdom hovers on a margin of economic self-destruction as its electorate takes to the polls, most probably in late  May 2010. My fingers are crossed that the selfish gene will pull itself together and do what it must.  The unfocused and  lost voices that I hear from across the Atlantic Ocean, guided by the constant drumming of the Keynesian impulse through the left-leaning British media,  do not greatly reassure me that this most fervent wish will come to pass. 

Hat Tips: Diana and Maggie

The Specter of Inflation Stalks the United States

February 20, 2010

inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

“Government spending may or may not be inflationary.  It clearly will be inflationary if it is financed by creating money, that is, by printing currency or creating bank deposits.”

“There is a great deal of evidence from the past attempts by monetary authorities to do better.  The verdict is very clear.  The attempts by monetary authorities to do better have done far more harm than good.  The actions by the monetary authorities have been an important source of instability.”

“A steady rate of monetary growth at a moderate level can provide a framework under which a country can have little inflation and much growth.  It will not produce perfect stability; it will not produce heaven on earth; but it can make an important contribution to a stable economic society.”

Milton Friedman, The Counter-Revolution in Monetary Theory, Institute of Economic Affairs 1970.

I was blessed to attend this First Wincott Memorial Lecture delivered at the Senate House, University of London, 16 September 1970.  It was the very first time that I saw Milton Friedman weave his spell of monetary magic over an audience.  It was the moment when I first truly understood the significance of the monetarist counter-revolution against the Keynesian hegemony that still held sway over the backward,  xenophobic British economics profession, of which I was an increasingly disenchanted member.

Ideas, for the most part, like changes in the quantity of money, make their way slowly through a system, with long and variable lags.  Monetarism was such an idea. It took 9 years for the idea that inflation is a monetary phenomenon to percolate through British politics into the thinking of the Thatcher administration. It took 10 years, with the election of Ronald Reagan, for it to percolate into the thinking of Paul Volcker, Chairman of the Federal Reserve, who reversed the Fed’s policy of easy money and  placed the United States economy into a monetary refrigerator. It would be several more years before monetarism finally squeezed out inflationary expectations and set the British and the US economies on course for 16 years of  the splendid  Great Moderation.

Certainly, monetarism did not take us to Paradise; but it eased one big worry from our minds. Ordinary people could go about their business and live their lives without concerning themselves about the uncertainties created by high and volatile rates of price inflation. Economic decisions could be registered on the basis of real factors, without undue concern for nominal white noise. The brilliant son of poor Jewish immigrants, who had started out their lives in the United States gladly working in sweatshops, had delivered an enormous benefit to mankind.

Only to be reversed by the inexcusable ignorance of two younger members of his own ethnic group, Alan Greenspan and Ben Bernanke.  Now, it is true that neither of these two future Fed Chairmen learned their economics at the feet of the Maestro. Certainly, however, they had more personal exposure to his nonstrums than had I, living through the critical years of the counter-revolution some 4,000 miles away from the capital of Freshwater Economics. In each case, before they assumed high office, they had the spectacular success of Maestro Volcker to guide them in their ministrations.

As a historical fact, both Greenspan and Bernanke failed to understand the message, failed to honor their oaths of office.  Jointly and severally, they have returned the United States to its former inflationary path. Jointly and severally, they have abandoned the great monetary counter-revolution and returned the US economy to the dominance of the Keynesian episode. They should be thoroughly ashamed, not just for themselves, and their own monetary ignorance,  but more importantly,  for all our children and our grandchildren, who now seem to be doomed to the returning misery of stagflation.

For make no mistake about it, Dear Readers, the specter of inflation once again stalks the United States as a consequence of the monetary furnace fired up by Ben Bernanke since September 2008.  Because Bernanke misread his own scholarship, and wrongly identified a limited economic contraction in 2008 as a return to the Great Depression, he has debauched the currency of the United States. Because he falsely believed that the United States was teetering on the edge of a deflationary cliff, he  poured high-powered money into the financial system, tripling the size of the Fed’s balance sheet, and setting the scene for a potential 96 per cent increase in M2 money, once the income velocity of circulation of money returns to its historical norm. 

For the time being the world sleeps, as money exerts its slow influence in the manner identified by Milton Friedman.  First, monetary expansion will impact on real output, as already is the case.  Then it will impact on the price level, slowly at first, but then with increasing venom.  The first signs are already evident: the CPI rose 2.7 per cent in 2009, according to the recent update by the Bureau of Labor Statistics, and it did so against a backcloth of 9.3 per cent unemployment.  This is a first green shoot of stagflation. A 2.7 per cent rate of price inflation is above the rate achieved in 5 out of the past 10 years in the United States. It does not signify a nation teetering on the edge of deflation.*

Do you still remember the Misery Index that became such a central feature of economic  evaluations during the stagflation era?  This Index is the sum of the unemployment and the inflation rates at any point in time.  In 2009, the Misery Index is measured at 12.0.  This is the highest level of the index over the past 26 years, going right back to 1983, when it was 13.4, immediately before Paul Volcker’s monetary refrigerator conquered inflationary expectations.

Brace yourselves, Dear Readers, for worse that is yet to come.  Ben Bernanke is no Paul Volcker; and Barack Obama is no Ronald Reagan. The Fed is still firing up the monetary furnace, would not dare to tighten the economy by reversing course. Barack Obama is still spending the nation’s wealth as though there is no tomorrow.   The promise of a new era of Great Moderation lies as far ahead at this moment in time as it did in September 1970, when I attended that eye-opening presentation by Milton Friedman.

Milton Friedman sadly is no longer with us to sound the warning yet again.  And almost everyone else is asleep, as the Captain of the Titanic  steers his ship full speed ahead onto the silently floating iceberg that will surely destroy his vessel, and all our lives.

* These statistics were reported by Robert Murphy in The Washington Times (February 19, 2010). The monetarist interpetation of these developments is my responsibility. I am usually careful to cite sources.  In my initial posting of the column,  I regretfully overlooked the source of these statistics, believing that they had been published in an unnamed Editorial.  I am now rectifying that omission.

Housing Boom and Bust in the United States: 1932 versus 2009

February 19, 2010

In my column dated February 18, 2010, I explained that the housing crisis in the United States that confronted FDR in 1932 primarily was a consequence of deflation, of a massive decline in the general price level and nominal incomes over the period 1929-1932, and not a manifestation of a relative decline in the housing market. Those who entered the housing market during the period 1921 to 1927, unlike those who entered the stock market,  had not, for the most part, ignored the underlying real value of the housing stock and gambled on making quick gains by entering and exiting a housing market fueled by bubble mentalities. The real price of housing held up extremely well throughout the Great Depression. The investments were basically prudent and sound.

The problem was maintaining mortgage commitments fixed in 1929 prices at incomes that had collapsed to reflect the 1932 CPI.  The problem was that some 25 per cent of mortgage-holders had lost their jobs in an environment where, for the most part, women were excluded from the labor market. The problem was that when mortgages came up for refinancing (and in the 1930s most mortgages were of  5 year duration) existing lenders had been bankrupted and the cost of credit intermediation was extremely high if available on any terms. 

In such circumstances, the foreclosure rate soared, because of deflation, not because of  house buyer error and/or greed. In January 1934, some 43.8 per cent of all urban, owner-occupied homes on which there was a first mortgage were in default.  Among the delinquent loans, the average duration of that delinquency was 15 months.  Among homes with a second or third mortgage, 54.4 per cent were in default, and the average duration of that delinquency was 18 months. Thus, at the beginning of 1934, approximately one-half of all urban houses with an outstanding mortgage were in default.  For comparison, in the fourth quarter of 2007, 3.6 per cent of all US residential mortgages and some 20 per cent of all adjustable-rate subprime mortgages (unheard of in 1934) had been delinquent for at least 90 days.  The difference is major and unmistakable.

When FDR intervened to limit the magnitude of the home-ownership crisis, there was no prior experience of the corruption and political manipulation that is endemic in such large-scale institutional interventions. FDR for the most part believed in the myth of omniscient and impartial government that dominated economics and political science until the public choice revolution in the late 1950s. He had no real perception of the depths of depravity and chicanery that would manifest themselves in the activities of the monsters that he created: the Federal Home Loan Bank System (FHLB), the Home Owners’ Loan Corporation (HOLC), the Federal Housing Administration (FHA), the Federal Savings and Loan Insurance Corporation (FSLIC), and the Federal National Mortgage Corporation (FNMA).

As taxpayers were to discover over succeeding decades, the long-term cost of the house-market support mechanisms put in place by FDR would be extremely high.  The policy of house-market intervention would prove utterly irresistible to politicians and presidents of all stripes, would indeed bring about the financial crisis of 2008 and the ensuing economic contraction (Rowley and Smith, Economic Contractions in the United States: A Failure of Government, September 2009,

As Nathanael Smith and I outline in our book, the United States house market problem that manifested itself in late 2006 and ultimately brought the world economy to its knees, was a problem of a very different nature. The problem in this instance was the product of contemptible greed and selfishness, on the part of politicians and presidents who craved every last vote and campaign contribution from housing market participants, on the part of the banks, financial institutions and government agencies that knowingly promoted a house price bubble of immense proportions, and on the part of all those households that played musical chairs through the bubble, expecting to enter and to exit the housing market, to move upwards from apartments to mini-mansions on janitorial salaries and unemployment benefits, and to take their high-risk gains before the music stopped.

By 2009, Obama and his administration knew full well the level of depravity and corruption that accompanies large-scale interventions in the housing market. The evidence from the savings and loans fiasco of the 1980s and the promotion of subprime lending to indigent households during the noughty years, was staring his administration in the face. In 2009, deflation was not the problem, but rather a significant relative over-pricing of the housing stock in the United States.

The solution was obvious:  allow the market to adjust through private intermediation within the mortgage market, through orderly foreclosures,  and through bankruptcy, the  mechanisms of market adjustment that had evolved over many decades. The four million additional households that had moved, in many instances unjustifiably,  from renting to home-ownership, or from modest to spectacular home-ownership, between 2004 and 2008,  for the most part, would have to return to their previous, affordable stations in life;  and would do so quickly in the absence of government intervention.

 Instead, Obama has followed the flawed FDR trail, as is his instinct in all matters political.  In consequence,  housing market adjustments have been blunted and delayed,  and a massive burden of toxic assets weighs down not just the private financial markets, but the Federal Reserve itself, putting at serious risk the international reserve status of the US dollar. Of course, by this ill-judged emulation of FDR’s policies, Obama has placed his own administration into serious jeopardy, jeopardy of policy paralysis until 2012, and of political oblivion thereafter. He has imposed intolerable long-term burdens on US taxpayers, as the Tea Party revolution is already demonstrating.  Inevitably, and justifiably, he will pay a very high political price for this extremely serious error of political  judgment.