Of Demagogues and Big Problems

One of the common tricks of demagogues, as cheap as it is common, is to denounce in high dander something for being “Big,”—“bad” because it is “Big.” Some of the recent targets have been Big Banks, Big Pharma (the drug companies), Big Oil, Big Insurance, and Big Business in general.  The target is apparently chosen for its relation to the prescription that the demagogue already has in mind.  Invariably the prescription involves granting more power to the demagogue, sometimes ceded from the freedoms of the targeted Big, but not infrequently taken from the liberty of the people who are somehow harmed by the Big, who are to be somehow made better by being less free.

Obamacare is one example, Big Insurance, Big Pharma, and Big Medicine all denounced to some degree in the effort to generate popular support to pass the legislation.  In the end, as more and more people are recognizing, it is individual choice that has been lost, personal freedoms to choose doctors, medical plans, and available treatments (along with substantial sums of money) that have been taken, passed on to big bureaucracies identified by the demagogues.

Demagogues on left and right and even in the middle resort to this device of denouncing Big Bad, because it resonates with many people who do not consider themselves “Big” anything.  We all can feel intimidated by something in our lives and experiences bigger than ourselves, making us all potentially susceptible to the demagogue’s pandering.  It is also a favorite device of demagogues, because it does not require much thought or creativity to make the anti-Big speech.  It seems almost required that the demagogue at some point refer to the Big Target as “Goliath” and modestly identify himself or herself with “David.”  That tired jape is now getting to be about 3,000 years old, but demagogues think that their audiences just cannot get enough of it.

To be sure, there are some cases where being big is a good thing and some things that can be too big to be good.  It all has to do with why they are big and perhaps how they got that way.  Big savings are usually good.  The Grand Canyon is big and magnificent, and I would say that the Empire State Building is, too, at least as I behold it.  On the other hand, big debts are to be avoided, big pits can be dangerous, and the L Tower in Toronto is an eyesore in my estimation (though I will acknowledge that others could be fond of it). 

Government can be too big or too small, depending on what it does with our rights and freedoms.  There are governments too small to promote and protect freedom, while there are many—most—that are too big, and ever increasing at the expense of individual rights, freedoms, and opportunities.  That includes governments that are big enough to help their cronies become bigger by robbing the competition and the public.  Businesses that are big because of government favor would be better for everyone if they lost the government favor and let competition, efficiency, and customer choices determine how big they should be. 

Some are just big because they grew that way.  Is Microsoft or Apple too big?  I do not know, and neither do you.  Exposed to the full discipline of the free market they will be the right size, and so will their competitors.  What is the right size for banks in the United States?  I do not know, and again neither do you nor does anyone else.  The more that they are exposed to market forces, the sooner we will get the best answer, which I expect will be along the lines of “many sizes and shapes” in order to match the many sizes and shapes and needs of businesses, families, and individuals who rely on banks for financial services.  Free competition in open markets has the power to right size commercial enterprises.    

A word of caution.  Part of the success of the war on Big consists in making the listeners feel small and helpless—unless rescued and led by the fearless demagogue.  Besides belittling most people, the demagogue’s device diverts attention from the fact that just about everyone is part of something Big, a Big that may eventually be the demagogue’s next target.  Maybe your church will one day be considered too “Big.”  Or maybe the industry in which you happen to work will become a “Big” target, the town or region where you live, your race or your ethnic group, your savings and investments, the cars or trucks that you drive, your appetite, your use of water, the size of the lot of your house, the wealth of your nation.  All of these, and many others, have already been used by demagogues in their Big harangues.  The demagogue’s insatiable appetite for power never has enough targets.  He or she is always looking for more.

Sometimes there is a kernel of something genuinely amiss in the demagogue’s Big complaint.  Often, when you boil down the genuine substance of any of the complaints to the hard facts, it is hard to discover what is the Big Deal—at least in the problem.  The Big Deal is to be found in the solution, which is what the demagogue is really after.  Were the Popes in Rome really controlling the lives and governments of England in the time of Henry VIII?  No, but the solution of confiscating Catholic Church properties and awarding them to the King’s cronies was a very Big Deal.  The Nazi demagogues in Germany played the same game with their own people, the German Jews, and with their property and possessions. 

The demagogue’s solutions, resting upon emotion and panic, seldom solve anything and often lead to more problems.  The Climate Wars—one year the coming ice age, the next year global warming, today just climate “change”—is an example we have all seen unfold, inflicting untold billions of dollars of costs while enriching favored cronies, but which in even the most enthusiastic promises of the demagogues will do little to affect the climate in reality in our lifetimes.

The next time you hear a public figure fume about something being Big, carefully inquire into and focus upon what he or she is after.  You may be a target just Big enough.

Of Business Losses and Government Help

In recent days JPMorgan Chase bank announced that it suffered $2 billion in trading losses, and Washington is all a-twitter.  You would think that a government that runs deficits of one and a half trillion dollars would hardly notice any event of $2 billion, but the chattering classes who think that they should have some role in running everything are all chattering about it and how it clearly demonstrates the need for more regulation, i.e. more need for them to be involved in running private businesses.

Mind you, JPMC’s $2 billion loss is a lot of money to you and me, but this does not particularly affect you and me.  JPMC suffered the loss, and given the size of the bank and its earnings (it usually makes somewhere in excess of $4 billion each quarter) it will little affect its bottom line.  JPMC is not asking anyone else to cover its losses, other than its own shareholders, and they will not feel it much if the bank continues to be as well run as it has been.

Ah, but perhaps you are thinking that JPMC got some of that TARP money so involved in the financial panic.  That is true, JPMC was one of the banks whose arms were twisted hard by Treasury Secretary Paulson to take a forced government investment.  Those TARP investments spooked regular, private sector investors, who immediately ran for the sidelines, and the financial crisis was on, propelled (as most are) by bad government efforts to “fix” things.  JPMC did not want the money or need the money and in a few months paid it all back—with substantial interest—as quickly as Congress and the regulators would allow them to.  It reminds me of the elderly gentlemen who finally yielded to family cajoling to take a ride in a stunt plane.  Afterward he thanked the pilot for the two rides, his first and his last.  TARP was such a bad deal for those who received the investments (except for the couple of financial firms that might really have wanted it), that I do not think that any would want a second ride, perhaps not even again at gunpoint.

The recent loss by JPMC, in any event, was one well covered by the bank’s earnings in other of its many lines of business.  Curiously, I do not hear the chattering classes get exercised when each quarter Fannie Mae or Freddie Mac announces several more billions of dollars of losses, losses that they do ask for the Treasury Department to make whole.  Maybe that is because the regulators already run Fannie and Freddie.  Actually, there was a little bit of noise in the past few days when Fannie Mae announced that it had actually turned a profit for the last quarter, the first time in years.

One thing that disturbs me in all of the Washington humbuzzah over JPMC’s trading loss is the implicit notion that there is something wrong about a business losing money on an investment, something wrong enough to call forth a government role.  It seems to me that losses are just as much a sign of a normal market as gains are, that healthy markets have a good share of both.  Nobody seemed to lose money during the housing bubble, no matter what they did, but that was hardly a sign of a healthy market place.

What markets do when they are allowed to is reward good business decisions and punish bad ones, with gains and losses providing some of the most effective means of helping businessmen and their investors understand truly which is which.  JPMC made some bad business decisions and lost money, and the counterparties to those trades made good ones and earned money.  What role can government play in all of that other than to mess it up?

To get government involved in this process rests upon at least two preposterous notions.  First, it suggests that it is somehow the role of government to make sure that businesses do not lose money, otherwise, why all the fuss?  That, of course, was the Soviet business model that did so much to create modern Russia.  Second, and following on the first mistaken notion, it supposes that government officials will know better how to avoid business losses.  Anyone really believe that?  Share with me your examples, and I will pass them on to the Federal budget planners.

Of Crony Capitalism and Free Enterprise

In 1991, after the fall of the Berlin Wall and as the Soviet Union was disintegrating, the current editor of The Wall Street Journal editorial page, Paul Gigot, warned,

Freedom’s main enemy now is the corporate state, private business harnessed to the coercive power of government.
(Paul A. Gigot, “Trade’s Hamlet: Will Gephardt Do The Right Thing?” The Wall Street Journal, March 8, 1991)

If that was true in1991, it is far more of a danger twenty years later. As a result of recent legislation, including the Dodd-Frank Act, the massive stimulus program, and the huge healthcare overhaul, involvement of government bureaucrats in private enterprise has never been greater in the United States, not even close. Federal officials are being endowed with enormous power in ways large and small to reward favored businesses and punish those that are not so favored, all hidden under the camouflage of acting for the “public good.”

Under Dodd-Frank, for example, federal regulatory czars are given authority to decide what lines of business financial firms can or cannot engage in, what services they can offer to customers, how much they can pay their employees, which firms will be bailed out if they get into trouble, what information private firms must provide to federal operatives, and who gets to foot the bill for all of this federal intrusion. Similarly, under the stimulus plan, hundreds of billions of dollars in federal contracts are up for award under the skimpiest of criteria, while under the new healthcare system myriads of government boards will decide who can receive what medical services at what cost and under which conditions.

It gets worse. Because these government benefits or penalties can be exercised with broad discretion by government officials, staying on the good side of the federal task masters becomes very important. Paying attention to the views and interests of government officials in other matters, even those not directly related to the legislation, can become the key to success or failure for a firm. Certainly complaints about the exercise of government discretion will not be well received. This is not hypothetical. Already it is the rare bank that will publicly complain about a decision by the FDIC, and securities firms are noticeably shy about taking issue with decisions of the Securities and Exchange Commission.

This ability of government authorities to employ the force of government to help friends and penalize perceived enemies, and to use economic levers to do so, is called crony capitalism. Crony capitalism unfairly gives capitalism a bad name. It is Third World-like. It is also old fashioned; it is pretty much the way that kings and czars ran their economies. Free enterprise and free markets will always be at war with crony capitalism.

Under crony capitalism, ownership of business may remain in private hands, but private owners share control with influential public officials. It can pay off big time for a business to get and stay on the good side of these people—whose permission and authority are keys to the success of the business. With government favor, a firm not only can win government business, but rules and regulations can be written in ways that favor the firm and disadvantage competition in the private sector. A new upstart in an industry can find trouble getting licenses, experience delays in regulatory approvals, be subject to heavy paperwork demands, face onerous financial fees and requirements, and through a myriad of techniques find his business handicapped in ways not experienced by firms in favor with federal officials.

Crony capitalism not only corrupts the relationship between businesses and the government; it corrupts the relationship between businesses and their customers. Under free capitalism and free enterprise the marketplace is the arbiter of which products and businesses succeed or fail. The multitude of individual people in the marketplace, through their multitude of individual purchases and other economic decisions, are the ultimate judges of economic success. That is to say, that customers have the ultimate say over which firms are the winners and losers, which in turn makes them, the customers, the winners from a vigorous competition among businesses to please them. It takes protection provided by the government to shield an inefficient business from the discipline of customers and markets, and that is what crony capitalism provides.

Under crony capitalism, judging winning and losing is taken away from the market place. With success derived from the ability of businesses to curry favor with government leaders whose hands are on the economic controls, it is no surprise, then, that the growth of government interference has stimulated a dramatic growth in the need for businesses to have representatives in Washington to plead their cause. Fortunately, that right of representation is enshrined in the Constitution. But it would be a good idea to reduce its necessity by re-enthroning markets and the consumers behind them as the final judges in the economy and return our government to preserving life, liberty, and the pursuit of happiness.

Of What Government Knows and What It Will Do

The biggest cause of the lingering financial trouble and the 2008 financial panic has been bad government policy. The markets did not fail. The markets did just what government policies encouraged them to do, namely over-invest in housing while paying little attention to the risks. That created twin bubbles in house prices and in the ways that building houses and buying houses were financed.

When the bubbles burst, the government leadership panicked, and the markets followed their leadership. Treasury Secretary Hank Paulson predicted imminent disaster, and the Federal Reserve rather than playing an independent steadying and calming hand reinforced those predictions (although without the public “fire in the theater” shouting of the Treasury Secretary).

Perhaps the best that can be said about the federal financial leaders during the financial crisis is that they did the best that they knew how to do. The problem was, that they did not know what to do. Each new memoir or retrospective published by one of these financial leaders reveals that they were acting on insufficient knowledge, insufficient information, and most of all insufficient understanding of what was going on. In other words, none of them knew enough to know what to do, and none of them knows enough now.

No one can ever know enough. The economy is just too big; there is too much for anyone but God to know. In an economy as large and diverse as ours, with billions of economic decisions being made all in the same day, it is impossible for anyone to know enough at any one time—of all that is involved—to be able to make the right decisions to control the economy, even if there were someone wise enough to do it.

That problem is not solved by creating a committee to control the economy. While any one person who serves as decision maker will suffer from lack of knowledge and will wear blinders towards the parts of the economy he either does not understand or is not watching at the moment, a committee of people has its own major shortcomings. Not the least of these is the proclivity of any group to be captured by group think, by the members of the group reinforcing each other to form a consensus and not venturing to upset things by questioning or looking beyond the consensus.

That is usually what happens with economic and financial bubbles. A key idea, usually a wrong idea, captures the group imagination. So many people come to believe this idea—like the odd notion that housing prices rarely if ever decline—that they all act on it, building up artificial values that increasingly depart from reality. When there is no government involvement, these bubbles burst soon enough and are resolved pretty quickly. Government leadership can hasten the formation of group think when an idea is part of official policy, and government policies can help to keep it going. Then, because government officials are slow to admit their own mistakes, government policies slow down the quick and natural adjustments that the market provides when the bubbles burst.

Unfortunately for all of us, the new Dodd-Frank financial regulatory legislation increases the power of new government financial czars to try to control virtually any aspect of the financial system that they choose. That error is not diminished by requiring these financial czars to meet together in committee from time to time, in a new Financial Stability Oversight Council (FSOC).

This last week two of the financial czars testified before a commission created to discover what caused the recent financial trouble and to recommend what to do about it (seems that if people were serious about this commission it would have made sense to pass new legislation only after the commission finished its work). One of the commission’s members, John Thompson, asked this question: “Why should we believe that this Council (the FSOC) is going to be uniquely different and keep us out of trouble?” (Donna Borak, “FCIC Presses Bernanke, Bair: Will Dodd-Frank End Bailouts?”, American Banker, September 3, 2010) Good question, but it got a poor answer, basically the observation that government regulators have more authority now. That is akin to saying that I will improve my aim because now I have more ammunition and a bigger gun.

Federal Reserve Chairman Bernanke admitted that even with all the new power given to the federal financial czars it will take political will to use it. “If there’s a lack of political will, there’s probably no solution that is sustainable.” Even were we to believe beyond all experience that any federal regulators or group of federal regulators could possibly know enough, where is the evidence that there would be the political will to break through the regulatory group think? Where would there have been the political will to bring the housing bonanza to a halt, or even to rein in the politically powerful housing giants Fannie Mae and Freddie Mac (which at least the Federal Reserve was seeking to do, against strong opposition from Congress—the stronger political will opposed needed reform)?

You do not need political will, however, if discipline in the markets is not a political decision. Market solutions do not require any political action or the exercise of political will by some federal financial czar or council of czars. No one needs a federal agency to drive down the stock of a badly managed company. Enron was beaten up by the markets long before Congress got around to it. The financial firms that disregarded risks in the housing bubble were put out of business by the markets—except for the firms that the government decided to prop up.

Which highlights the danger we are now in: today, as a result of the Dodd-Frank Act we have a financial system dependent on the government. Every important financial decision has now become a political question for one or more regulators to chew on and manage. Ready or not, here they come.

Of Liberty and the Caesars

As we near another annual celebration of our Declaration of Independence and the proclamation of American liberty, it is worthwhile reflecting on what that independence and liberty rest. At its core, the American Revolution revolved around the deep desire to preserve something. That something was the rule of law, an elementary principle of government that the founding fathers had found here and nurtured. The rule of law is the fundamental idea that we should be governed by laws and not by men. It is that principle that throughout our history has set America apart from the rest of the world. Embracing the rule of law the founders built our nation upon a written Constitution.

Our founding fathers frequently used the word “liberty” when referring to the rule of law. When they said “liberty” they did not mean wantonness and libertinism, to be abusive without consequence. Our founding fathers meant by “liberty” the freedom that they had found in America to live beyond the wanton grasp of the arbitrary rule of kings, lords, ladies, and even parliaments. Our founding fathers were comfortable with the idea of government only if what the government did—or more precisely, if what the people in government did—was closely and clearly controlled by laws that everyone understood. To them that meant that they had liberty, and they loved it. The Declaration of Independence is a detailed protest by the Congress of the thirteen new States against the arbitrary violations of the rule of law—of American liberty—by the British crown.

Precisely because the American Revolution was an appeal to the rule of law we succeeded in creating a stable government and society where the French Revolution (and many others since)—appealing to the rule of men, albeit a different crowd of men—fell into chaos and anarchy, merely replacing one despotism with another. The French tore down the monarchy in order to replace it with the Reign of Terror. Americans enshrined liberty in a document that still operates today to resist the arbitrary rule of one group of men over the rest. The Constitution protects the rights of each and all—individuals and minorities—through the rule of law.

The rule of law was not a new idea. Rome’s greatness was built upon it. Its weakness and eventual collapse came as the Romans traded the rule of law for the rule of men under the Caesars. Even then, the Roman tradition of the rule of law was so strong that it took nearly 500 years for the progressive rule of men to lead to the sack of Rome and the ushering in of the Dark Ages, an era dominated by the rule of men.

The idea of the rule of law, however, is much older than Rome. It is found at the heart of Christianity, reaching back to the Garden, from which man was expelled by the breaking of law. Man was redeemed from the broken law by Jesus Christ, whose great sacrifice was made to bind up the broken law and create the path for man to live in harmony with divine law. In modern times Jesus Christ explained the eternal purpose of law in these words: “that which is governed by law is also preserved by law and perfected and sanctified by the same.” (Doctrine and Covenants 88:34)

As our eternal freedom is protected by law, so it is with our civil freedom. Law is our shield against the whim of other men. Without the law, our only defense against someone’s whim is the protection provided to us by the whim of someone stronger. That is the essence of feudalism. That is what our founding fathers were so desperate to leave behind in the Old World, whichever “Old World” they left. That same search for liberty under the law inspires many refugees to America today.

That is perhaps why Americans are made nervous by all of the policy “czars” that have been created by the Obama administration. Czars suggest rule by men rather than by law. “Czars,” the Russian variant of the Latin “Caesar,” are justified by the argument that “they can get things done,” but in the doing they rely upon the arbitrary will of single individuals invested with extraordinary power: rule by men (and women).

Congress is on the verge of enacting—unless the Senate votes “No” when it returns to session in mid July—a major restructuring of the American financial system that would replace rule of law with the rule of men. The new structure rests upon enormous power given to new financial czars. There is a new czar for all federally-chartered banks and thrifts, a new financial consumer czar with power to dictate every aspect of any financial product and service that is offered to the public, and a new systemic risk council with authority to reorganize or even break up any company in America if in their opinion its operations are too risky for the financial economy. The authorities that this new legislation would give are broad, the instructions on how to use those authorities vague, and the ability to find appeal from the mandates of the new czars seriously restricted.

Our founding fathers, who escaped from that kind of rule, would have warned us.

Of Wall Street and Pennsylvania Avenue

Who wants another financial crisis? To hear the advocates of the Administration’s financial regulation bill, anyone who disagrees with them does.

Let us walk past the discussion of others’ motives, important as they might be. Let us, you and I, agree that we do no want another financial crisis. Or, phrased better, let us agree that we would like to reduce the likelihood of another financial crisis and minimize the extent of crisis when it comes. Anyone believe that there will never be another one? Recognizing that crises will occur and that we will be better prepared to face them by acknowledging and preparing for their possibility, let us consider which approach is likely to work to reduce their frequency and their severity.

Which is more likely to be more effective at reducing the risk of financial crises: government regulators or market discipline? Relying upon experience as a reliable guide, the question is soon answered. Government was all over the most recent crisis. In fact, the most recent financial crisis was fomented by government regulations and stimulated into panic by unwise government actions, all of which worked to shield key players from market discipline. Government housing programs and guaranties led people to ignore the risks of mortgage lending—ignored by borrowers and lenders. Credit rating agencies (CRAs) were able to classify risky mortgage securities as nearly risk-free, shielded by the Securities and Exchange Commission from market pressures to identify risks that the CRAs were paid to find.

The crisis was fanned into a panic after the Paulson Treasury Department (1) orchestrated the bailout of the securities firm Bear Stearns, then (2) subjected investors to a big tease with Lehman Brothers which they at last decided not to bail out, (3) bailed out AIG, (4) bailed out bond investors in Fannie Mae and Freddie Mac, and then (5) demanded from Congress $700 billion for the catastrophic Troubled Asset Relief Program (TARP). None of the TARP money was used to buy any troubled assets. A third of it went to bail out banks that were not in trouble (until they took the Treasury’s shilling) while other billions went to auto companies that were.

So why are the Administration and leaders in Congress on the verge of enacting legislation that will give Washington bureaucrats virtual control of any and all of the financial system at their whim? Could it be that these friends of regulation, who control the lawmaking powers this year, are unwilling to admit their mistakes? Or is it that the friends of regulation see the financial crisis—whatever its cause—as a wonderful opportunity to expand regulatory controls? Or maybe it is just that once you tell a story—that Wall Street caused the financial crisis—you have to carry the story on to its conclusion, however wrong that might be. In either case, the friends of regulation control the megaphones and the levers of power. If they have their way, though, Time will surely tell whether it was a good idea for Pennsylvania Avenue to replace Wall Street as the financial center of America.

Of Financial Reform Promises and Too-Big-to-Fail Firms

One of the many astonishing things about the Obama Administration’s financial regulatory legislation is that it promises so much and delivers so little of what it promises. In fact, in most cases it delivers the opposite of what it promises. Seemingly, the Administration knows what the American people want, so it uses promises of delivering what the people want and what the nation needs in order to enact changes that most Americans will neither want nor like.

As Senators and congressmen prepared to return to their states and districts the Administration published a list of “Top Ten Things You Should Know About Financial Reform.” Presumably this would serve as a guide to politicians giving their Memorial Day stump speeches. I heard one Democrat congressman at the Memorial Day ceremonies in Waterloo, New York. Neither the list nor the legislation found its way into his remarks. Good thing for the congressman, because the legislation as currently written fails on all ten of the “Things” that the Administration paperwork boasts that it delivers.

Let us examine Thing 1:

1) End of Too-Big-To-Fail: If a big financial firm is failing, it will have only one fate: liquidation. There will be no taxpayer funded bailout. Instead, regulators will have the ability to shut down and break apart failing financial firms in a safe, orderly way—without putting the rest of the financial system at risk, and without asking the taxpayers to pay a dime.

Part of that Administration statement is true, but only part of it, and not the most important part. The legislation would provide regulators with the ability to shut down and break apart failing financial firms. Regulators already have that authority today and have been exercising it weekly for the past two years to close down failed banks “without putting the rest of the financial system at risk, and without asking the taxpayers to pay a dime.” Failed non-bank firms have been closed down through bankruptcy proceedings—again, “without putting the rest of the financial system at risk, and without asking the taxpayers to pay a dime.”

The risk to the rest of the financial system and the demand for taxpayer bailouts have all come in the past few years as the federal government has gotten involved to prop up firms that the federal government did not want to fail. Prior to the recent financial crisis, too-big-to-fail was a theory. Treasury Secretary Paulson made it official policy and practice, which policies and practices have been officially approved and adopted by the new Administration.

The new financial regulatory legislation—even while making it easier for financial regulators to break up and unwind failing financial firms—would also give to regulators legal authority to bail them out, prop them up, and have them born again as clean firms, free of the financial encumbrances of all of their sins of the past. In very real and important ways the legislation would take the theory of too-big-to-fail, turned into official practice by the Paulson Treasury Department, and make it the law of the land.

There are several ways that the legislation would provide this service. One important tool is the new explicit ability of the FDIC (which would become the agency for handling not just failing banks but any failing firm that government leaders considered important enough for the FDIC’s care) to treat the investors in a failing firm differently. The FDIC would be explicitly authorized to protect some investors and not protect others, giving special attention to the customers of a firm and those who have lent money to the firm. Shareholders are supposed to be wiped out and the leaders of the firm fired, but the bondholders and counterparties doing business could be protected.

If this sounds familiar, this is exactly how the federal government has been treating housing giants Fannie Mae and Freddie Mac. When the government took them over in late 2008, shareholders were nearly but not entirely wiped out, leaders were let go, but all of the bondholders, counterparties, and investors in debt securities of Fannie and Freddie became 100% protected by the federal government and remain so today. Several other participants in the financial system were “put at risk,” the government’s exercise of discretion to pick winners and losers precipitating the failure of several banks that were holding preferred shares of Fannie and Freddie that the government chose not to protect. The taxpayer has not been protected either, the Treasury deciding last Christmas Eve to allow Fannie and Freddie to receive unlimited federal support, already totaling hundreds of billions of dollars.

Fannie and Freddie are government sponsored enterprises (GSEs). The government subsidy programs for these GSEs would be the new model available for any firm designated as systemically significant by the federal government under this legislation. That is to say, that under this legislation, in place of two GSEs we would have potentially dozens.

There is a price for this attention. Whether a firm wants it or not, under this new legislation, if enacted, any firm could be given the GSE treatment. Once the government considered a firm to be “systemically” important it could be told in as much detail as the government leaders considered necessary exactly how to run its business. No part of the business of the firm would be exempt from the government’s reach. The federal government would become the effective partner of that firm. And as former Congressman Dick Armey once said, when you partner with government, the government is never the junior partner.

Now, ask yourself this real-world question: as senior partner, would the government ever let any of its partner financial firms fail? If, as is the case with Fannie and Freddie, by following government mandates the firm got so deep in the red that action became unavoidable, the federal government would be able to use another powerful tool in the proposed new law: the authority to create a “bridge bank." As the government has been doing with Fannie and Freddie—and as many suspect the government will do to “fix” Fannie and Freddie—government officials could take over the operations of the firm and use this bridge bank authority to protect whichever investors they wished and make others (not leaving out the taxpayer) suffer loss. Through a legal and financial “baptism” administered by the federal high priests of finance all of the sins of the failing firm could be gathered together into one “bad bank” and all of the remaining operations of the firm could emerge as a new firm washed completely clean of bad debts and uncollectible assets. The new firm could then be offered up again—either with the same name or a new one—to investors. Of course, the federal government would likely remain as senior partner, but this would give comfort to investors who, like investors in Fannie and Freddie, were looking for a place to put their money where the government would be expected to protect those investments.

Ending too-big-to-fail? In the Administration proposal too-big-to-fail becomes the law of the land. The Administration’s number one selling point for financial legislation is a very good reason to oppose its bill.

Of Government Collusion and Market Discipline

There is a lot of noise and confusion about what caused the recent financial panic. The Obama Administration believes that the basic problem is that markets do not work right, people are too dumb to choose for themselves, and that regulatory agencies were not able or were unwilling to keep up with bank shenanigans. Their solution: more of the same, that is, create a variety of new government agencies and bureaus that have the authority to dictate and control any part of or player in the financial system, including control of financial customers large and small (look in the mirror for the definition of financial customer). This neglects the fact that government agencies were the most blameworthy in the recent financial panic. In fact, it is impossible to have a long, sustained economic recession or depression without government policies causing it. (I will save for another day how the policies of the Federal Reserve and the Franklin Roosevelt administration made sure that an economic downturn became a depression lasting for a decade.)

Let me address the first of these points in the Obama administration’s justification for taking over the financial system. First of all let us consider the markets. It is true that the markets did not perform right. That was because government rules, structures, and programs did not allow the markets to perform right. The government guarantees bank deposits, so depositors do not care very much how safe or sound a bank is. Government-sponsored enterprises (GSEs), like Fannie Mae and Freddie Mac, bundle up mortgages into securities that investors assume have little or no risk. The Securities and Exchange Commission (SEC) approves and controls the small number of credit rating agencies, and investors believe that these agencies are right when they give to a particular company or investment their highest credit rating (such as AAA), a rating that is thought to present little or no risk. The SEC has protected these agencies from competition and from market discipline for their errors while providing little in the way of regulatory discipline.

With those and other government protections in place the appearance of risk just about disappeared from the mortgage markets. Different investors have different appetites for risk. It was not the people hungry for high risk returns that fueled the housing bubble. Many of those with the weakest appetite for risk, seeking the safest investments, were drawn to the mortgage markets. In this government-manufactured atmosphere of little or no risk, many mortgage firms, increasingly non-bank mortgage firms, made it more and more possible for people to buy houses that they could not afford. Once the mortgage firm made the mortgage, regardless of the ability of the borrower to repay, the firm sold the mortgage to the GSEs, who sold it on to investors who poured trillions of dollars into what they thought was a safe haven. Then the mortgage firm went on to make more mortgages. Investors were shielded from asking whether the mortgages were any good, that is, whether the person buying the house could actually afford it.

That mispricing of the risk pulled more and more money into mortgages and real estate, driving prices up and up, pulling in more and more investors as the prices rose, until it was impossible to put one more Jack on the house of cards without it tumbling down. People panicked when “safe” investments turned out to be risky. Then the government started panicking, bailing out some firms and not others, changing the rules almost weekly, demanding hundreds of billions of dollars from taxpayers in order to pick financial winners and losers. Investors, not knowing where the government would turn next, panicked some more.

It was government interference in the market that failed, not the markets. Without all of the government camouflage, investors would have insisted on knowing that the mortgage borrowers could afford their houses before funding loans to buy them. Ask yourself this: would we have had the whole housing blow up if people who could not afford to buy houses were not given mortgages? Yet the Obama Administration, even today, is tripping over itself to find new ways to guarantee new mortgages, in many cases especially for people who cannot afford their houses. Where have all the subprime mortgages gone? They have gone to the Federal Housing Administration (FHA), where they have a government guaranty. (Watch what happens to the FHA house of cards in the coming months.) When will they every learn? Oh, when will they ever learn?

Giving more power to the kind of government agencies that helped create these problems hardly seems like the sensible answer. That is what the Obama Administration proposes, though. Instead of controlling the markets with more government interference and masking of risk, more bailouts for firms that should be allowed to fail, more power for some new government bureau to pick winners and losers and to tell people which financial products they can and cannot have, we should be exposing financial players more to market discipline. We should make it harder to hide risk and easier for investors to recognize the risks and allow the markets to charge higher prices for higher risks and lower prices for lower risks.

Market discipline has always been the quickest and surest regulator. It rewards the efficient provider of what the buyers in the market want, and it punishes the incompetent. Very importantly today, the market is stingy about bailouts.