Planned Economies Do Not Work - Part II

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The Federal Reserve Bank is no less an institution of central economic planning than the politburo was in the now defunct Soviet Union. The governing board of the Fed is an unelected bureaucracy with accountability to no one that single-handedly controls the lifeblood (e.g. money) of the U.S. economy. Worst, when economic crisis does happen, it always seems the Fed is immune from any blame in the matter. Examples of where Fed policies have caused or at least not prevented crisis include the Great Depression of the 1930s, the high inflation period of the 1970s and the current subprime mortgage crisis and housing bubble of 2007-2008. You would think that with a track record such as the Fed has that both major presidential candidates would be calling for changes in the way our currency is managed. Think again.

The current subprime mortgage crisis and housing bubble are indicative of the fact that Barack Obama and John McCain are either ignorant of its causes or the Fed, J Edgar Hoover style, has a dossier of incriminating material against both men. My guess is that there is a third option and that is that both men dare not rail against the sacred economic oligarchs at the Fed. because that would make them sound like kooks to the rest of the Washington Establishment. After all, how can the Fed ever be at fault since it is our great protector against everything that is wrong with capitalism?

The fact of the matter is that the Fed is the primary culprit for the current subprime crisis and housing bubble. Through artificially low interest rates and expansion of the money supply, the Fed caused many debt-ridden Americans to go deeper into hock by committing to loans they had no chance of repaying. For instance, in 2000, the federal funds rate, the rate set by the Fed that is related to mortgage rates, was at 6.24% (see table below). To head off a recession caused by the dot com bubble (another crisis caused or at least not prevented by the Fed) and 911 attacks, Fed chairman Alan Greenspan took the rate down to 3.88 in 2001 and into the 1% range for the next three years.

2000, 6.24
2001, 3.88
2002, 1.67
2003, 1.13
2004, 1.35
2005, 3.22
2006, 4.97
2007, 5.02
source: www.federalreserve.gov/releases/H15/data.htm

These artificially low rates attracted borrowers into the housing market who were one rate adjustment or one pink slip away from foreclosure. That is exactly what has happened to many of them. May marked the 29th straight month where there has been a year over year increase in foreclosures.

So, what do Obama and McCain think caused the credit crunch. Best guess says they each think there was fraud on the part of mortgage lenders and just plain bad financial decisions by consumers. They are correct on both accounts, but still have not mentioned the Fed as being even partly to blame. Besides being in denial about the main cause of the crisis, their solution to fix the problem is even more regrettable.

With some minor differences, both men essentially favor the plan just passed by the House which would allow lenders to voluntarily write down mortgages to the current market values of the homes involved. The federal government would then insure eighty percent of the new loan amounts in exchange for a portion of the proceeds if the borrower eventually sells the home for more than the refinanced loan. Everybody seems to win with the plan. Mortgage lenders win because they can recoup a good percentage of the original loan amounts. Borrowers win because they get a second chance to keep their homes. American taxpayers win because they could reap a windfall profit from future home sales.

What McCain and Obama’s solution for the credit crisis amounts to is simply more government central planning of the economy to combat a failed previous attempt at government central planning of the economy. Their plan could cost up to $300 billion, help only about ten percent of homeowners, and be yet another example of the nanny state rewarding bad economic decisions by consumers and lenders.

It is way past the time to end government central planning of our economy in the U.S. In the current subprime crisis, government intervention is crucial. But, it should be in the form of tax and spending cuts to provide real relief for all Americans. It should allow the cost of money to be determined by the market and not a cabal of central planners. Finally, it should provide a commodity backed currency which would place restraints on the government and not allow it to spend billions on programs meant to rectify the consequences of previous government policies. If put into place, these policies would greatly curtail the ability of Washington to centrally plan our economy, thereby reducing the risks of stifling fiscal policy, financial bubbles, and inflation. National prosperity would be the result. At that point, the Fed can be laid to rest along side the politburo in the graveyard of defunct economic planning juntas.

Sources
CNN: http://money.cnn.com/2008/06/13/real_estate/foreclosures_may/
CNN: http://money.cnn.com/2008/04/10/news/economy/mccain_econ_plan/index.htm?...

Kenn Jacobine teaches History and English for the American International School of Lusaka, Zambia. Send him email at lovesliberty@gmail.com.