Free market capitalism: A 'peek behind the curtain'
"It is a popular myth that financial markets are based on principles of capitalism," observes Ron Rowland in his All Star Investor newsletter, adding, "but the opposite is closer to the truth."
Assessing what he calls the Federal Reserve's moves to "buy Wall Street," he offers a straight-forward overview of the current situation and a "peek behind the curtain" of free markets and Wall Street.
"Banks, brokers and insurance companies are assisted and protected by a wide variety of governmental mechanisms.
"Wall Street propagates the myth of 'free markets' because it serves to obscure the truth, which is that their profits are earned at the expense of those with less sophisticated and well-funded Washington lobbying operations. You are now getting a peek behind the curtain.
"Yes, it is true that Lehman Brothers (NYSE: LEH) was denied government assistance and is being allowed to fail. In fact, Lehman is now serving as a kind of scapegoat that allows those in power to appear firm in their resolve not to put taxpayers at risk.
"If it were more than mere appearance this would be good news, given that taxpayers have already taken on plenty of risk with Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE). The reality, however, is that the bailouts are continuing through other, less obvious means.
"On Sunday the Federal Reserve announced a number of modifications to its lending policies. Two changes are particularly disturbing.
"First, the Fed will now allow investment banks to post equities as collateral in the Primary Dealer Credit Facility.
"Now the purpose of collateral is to give the lender something to hold which is of known and reasonably stable value. Equities do not fit that definition. Ben Bernanke knows this full well but obviously doesn't care.
"The second Fed action is more alarming: banks are now allowed to use depositor's money to fund the operations of their non-bank affiliates.
"Your savings account is being used to prop up the trading operations of your bank's parent company, which not coincidentally is the source of the huge losses the industry has racked up this year.
"And what happens when that deposit money goes up in smoke? Ah, yes, FDIC steps in and protects depositors. And who protects FDIC? Good question. Look in the mirror and you'll see the answer.
"Yet we are told that taxpayers aren't bailing out anyone. This action is arguably illegal, but at this point the Fed clearly is not concerned with what is legal or not. It is now a law unto itself.
"In a related development, Merrill Lynch (NYSE: MER) is being taken out by Bank of America (NYSE: BAC) at what appears to be a bargain price. Had BAC waited a day or two they might have got a much better deal, but we suspect this merger was forced on both firms by the powers-that-be.
"Merrill Lynch exemplifies the small investor, and its failure - more than most firms - could have sparked widespread panic. Hence the hastily-arranged shotgun wedding.
"More ominously, insurance giant American International Group (NYSE: AIG) is in dire need of capital and the traditional sources have slammed the door shut. There are rumors this morning that Warren Buffett might come to the rescue; if true, we suspect Buffett will drive a hard bargain.
"A collapse of AIG presents a systemic threat in a way that Lehman, Merrill and even Bear Stearns did not. It is a very dangerous situation. Given turbulent market conditions, we will avoid making any new investments for now and hold on to our cash allocation, which is roughly 54%."
America's economy
Wait and see
The Fed reckons the financial crisis has not yet seriously undermined the economic outlook
DEFYING market expectations for a cut, America’s Federal Reserve kept its short-term interest rate target steady at 2% on Tuesday September 16th. The statement accompanying the decision was, at first glance, hard nosed. Ben Bernanke and his fellow central bankers reckon that “The downside risks to growth and the upside risks to inflation are both of significant concern”, implying an equal propensity to raise rates as to lower them.
But a closer read suggests the risks have tilted in the direction of weaker growth and away from higher inflation, though not by enough to put a rate cut on the table yet. “Strains in financial markets have increased significantly and labour markets have weakened further”, it said. “Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters.” These all reflect more concern than the statement that followed its meeting on August 5th. Gone was last month’s reference to elevated inflation expectations.
Still, given the convulsions that have just swept the markets—the bankruptcy of Lehman Brothers’ holding company, the bail-out of AIG and Monday’s 4% plunge in stock prices—why not cut rates?
To be sure, doing so might have been hard for the Fed’s hawks to swallow. Only a month ago officials thought their next move would be to raise rates, not lower them. On the other hand, inflation risks have clearly receded. The price of oil, which topped $140 a barrel in July, fell below $93 on Tuesday.
Consumer prices actually declined by 0.1% in August compared with the month before, the Labour Department said on Tuesday. That brought the annual inflation rate down to 5.4% from 5.6%. It will almost certainly fall sharply in the coming year. Core prices, which exclude food and energy, rose by 0.2%, keeping the core inflation rate at 2.5%. The Fed had thought core inflation might creep higher this year as prior energy price increases were passed through to other products, so the tame core reading might have been a pleasant surprise. Finally, with the unemployment rate now up to 6.1%, disinflationary slack is rapidly accumulating in the economy.
The likeliest explanation for the Fed’s decision to stand pat is that it is too soon to know whether the recent developments have affected growth. The Fed may reckon that a 2% funds rate should be sufficient to get the economy through its current slump. There are also other tools to contain the risk: the Fed expanded the size of one of its lending programmes and broadened the type of collateral it accepts in another, and the Treasury has the ability to purchase mortgage-backed securities.
The risks that surrounded a potential collapse of AIG, of course, pose another problem altogether since its life-threatening crisis crystallised quite suddenly, and it is larger and more complex than Lehman. And unlike Lehman, the Fed does not know the firm well (it’s regulated by the state of New York). Christine Cumming, first vice-president of the Federal Reserve Bank of New York, voted in the place of the president, Timothy Geithner, who stayed in New York to oversee the rescue of the big insurer.
A rate cut now might not even have been felt: the collapse of Lehman has triggered a mad scramble for cash by banks, driving the interbank-lending rate as high as 6% in recent days. The Fed has responded with massive injections of cash into the money market to get the rate down. In that environment, a rate cut would have signalling value but would not rapidly translate into actual borrowing costs.
by Michael S. RozeffThe Fed’s Failure
The first and most important rule of speculation is to cut your losses quickly, while they are still small. In poker, this means folding when you don’t have good cards. In research and development, it means halting investment when the initial results are unpromising. In stock speculation, it means selling a purchase when it falls by 7–8 percent below a well-chosen entry level.
The first loss is the smallest, the saying goes. The Fed is violating that rule, and it is encouraging banks to violate that rule. It is doubling down on a bad hand. It is buying more stock as it falls, instead of selling out. How is it doing this? The Fed is lending more and more of its liquid government securities to client banks. In return, it is accepting their questionable and risky collateral.
The Fed is making three kinds of bad loans. First, the Fed is lending to banks that are in bad shape and need the funds badly. They are simply bad risks. If the Fed were a profit-maximizing banker, it would not make such loans, throwing good money after bad. The Fed is simply gambling (not wisely speculating) that in time these banks will recover. The gamble is huge; the amounts it is lending are a huge portion of its assets.
Second, the Fed is lending to banks that have agreed to take over some other failing financial institution, like JP Morgan Chase taking over Bear Stearns and Bank of America taking over Merrill Lynch. These buyouts and these loans are hastily arranged affairs. The buying bank doesn’t really know what liabilities it is absorbing, and neither does the Fed. More often than not, mergers do not work out at all well. The costs of bringing two organizations together often are far greater than the buyers imagined.
These mergers will end up weakening the stronger bank as it absorbs the corpse of the weaker bank. No prudent banker would make such large loans on such short notice. The Fed is not a prudent banker.
Third, the Fed is lending to banks that have themselves agreed (under Fed pressure) to make loans to such failing giants as AIG. The Fed then has an indirect stake in making loans to a very risky enterprise like AIG. Again, both the lending banks and the Fed weaken themselves by making these loans that are supposed to shore up and save a failing institution.
We have a series of Titanics in these failing financial businesses, and their rescuers are not in much better off condition. They all employed too much leverage. They all made unsound investments. They are all sinking. Now, the Fed attempts to keep them going and/or prevent their outright bankruptcy by lending out its own high-grade securities. And the banks it is lending to have problems all their own to boot!
The losses do not disappear by these maneuvers. Perhaps they are submerged for a time within watered down balance sheets, but they will bob up and surface later.
The Fed is prolonging the credit bust. It is also weakening itself by making such questionable loans to risky deals upon collateral whose value is probably only a fraction of par.
What is going through the minds of the Fed’s governors? Fed Chairman Bernanke says of recent steps that they "are intended to mitigate the potential risks and disruptions to markets."
In other words, the Fed is trying to lessen the price declines in asset markets. And its preferred method is itself to make loans and have its client banks make loans to failing banks and other financial institutions.
There are a number of cogent reasons why the Fed will fail in this attempt to stem price declines in such markets as stock markets, preferred stock markets, and corporate bond markets.
First off, the Fed is speculating against the market. If Merrill Lynch stock is worth $10 a share and not $60, it is because the cash flows of Merrill that come from its assets can only produce a cash return that justifies a $10 price. The assets are able to produce a cash flow such that, after paying a return to the bondholders, the stock’s price is only worth $10 in view of that net cash flow.
Lending Merrill more money will not create value for the stockholders unless that money can be put to use by buying assets that earn returns in excess of the required return on Merrill’s capital. But if Merrill actually possessed such good investment projects, it would be able to borrow money or issue stock and get capital based on the merits of those investments. The fact that the stock has sold off drastically is because it does not have such projects. It is a sign that investors do not want to provide Merrill with more capital.
In making its loans, the Fed is basically pitting its judgments of value against the market’s. The evidence of such past attempts, such as in currency markets, is one-sided. Central bankers do not know more about valuation than markets know. If that is so, then no matter how much the Fed lends to a Merrill or a bank whose stock has declined greatly, the loans cannot shore up the stock price. They can only keep the patient alive and substitute the Fed’s ownership for the ownership of investors in the market.
Secondly, the Fed is only one player in the market. The markets are in the aggregate much larger than any single player, including a large one like the Fed.
There was a time when J.P. Morgan could place a bid under U.S. Steel and stem a stock market decline. At that time, people knew that Morgan was risking his own capital, and so they interpreted his buying as a positive signal. But even then, speculators understood that perhaps Mr. Morgan was liquidating other issues under cover of strength in Steel.
The Fed has no such credibility when it makes loans. The Fed governors are not risking their own money, and they have a backup which is an open checkbook to create high-powered money.
When the Fed steps up to bail out a failing bank, it is taken, not as a sign that the bank is worth more than what the market thinks, but as a sign that the Fed is afraid that prices will fall further; for that is exactly what Bernanke has himself said. Indeed, one institutional investor said of the Fed’s moves: "There is little doubt that the Fed believes systemic risk is coming closer to really landing on shore."
Each time that the Fed makes a move to shore up the system or keep it "orderly," it has the opposite effect of what a Morgan could do. It is interpreted as a sign of the Fed’s negative expectations.
Each time that the Fed raises the ante, it communicates more and more desperation. In this latest Lehman episode, the Fed will for the first time in its history accept stocks as collateral. The Fed in all likelihood has already accepted a good deal of very low-grade mortgage collateral. From that viewpoint, accepting stock collateral is not a big stretch. But there is an important difference. The stock collateral has quoted markets. Will the Fed now follow the rules and require maintenance margins and issue margin calls if the stocks decline in price?
In past bear markets, institutions that are pressed often sell stocks to raise liquid capital. If stocks are held off the market, will this stem their price declines? They will not, because the stock prices are determined by the cash returns that the assets can produce. If the stocks are locked up in the Fed vaults rather than traded, the main effect may be to make markets less liquid.
The day is coming closer when the Fed is out of securities to lend. At that point, its only tool will be to print money if it wants to bet against the financial markets. Helicopter Ben will have to gas up and learn how to fly. But since the Fed’s paper is not real capital, this will do nothing to augment value in the capital markets.
Value creation induces the creation of credit when lenders believe that a value-creator has or can create assets that have returns that warrant loans, but credit creation itself does not create value. The Fed cannot create value. Causation runs from sound assets to sound credit. Causation does not run from credit creation to sound assets.
Judging from price declines that have already occurred, many more bank failures lie ahead. More large banks and important regional banks will fail. The Federal Deposit Insurance Fund will quickly be depleted. The Fed will be helpless to address the problems. Its moves to date already show how ineffectual it is.
As with Fannie Mae and Freddie Mac, so with the rising tide of failures to come. The Congress and the Treasury will be directly involved in their resolution. This prospect is a fearful one. There is no telling what schemes legislators will propose and pass in the face of widespread bank and financial institution failures.
September 17, 2008
Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York.
Are Fannie and Freddie Too Big to Fail?
On Sunday, September 7, 2008, the US government seized control of mortgage finance companies Fannie Mae and Freddie Mac. According to the government's statement, the financial health of both Fannie and Freddie (FF) had deteriorated to such an extent that it could have posed a serious threat to the US economy.
Congress established the FF in order to provide support for the housing market by keeping money flowing in the mortgage market. (Fannie Mae was established in 1938 as part of Franklin Delano Roosevelt's New Deal; Freddie Mac was established in 1970.)
The FF market share of all new mortgages reached over 80% early this year. From this one can infer that a deterioration in FF financial health, which undermines their ability to keep the flow of money going to the mortgage market, is likely to hurt the housing market and the economy. Hence most experts have concluded that the seizure of the FF by the government was a responsible act, one which could restart the flow of money to the mortgage market, reviving the housing market and in turn the rest of the economy.
How Fannie and Freddie Keep the Mortgage Market Going
The key to FF operations is the buying of home loans from mortgage originators such as banks. The FF then bundle the loans they purchase into mortgage-backed securities (MBS), which are sold, with a guarantee of payment to investors. (The FF guarantee that the principal and interest on the underlying loan will be paid back regardless of whether the borrower actually repays.) The FF makes money by charging a guarantee fee on loans that it has purchased and securitized into MBS. By buying mortgages and repackaging the loans for resale via MBS, or by owning mortgages outright, the FF have provided banks and other financial institutions with fresh money to make new home loans.
Due to an implied government guarantee, the FF were able to raise funds relatively cheaply by selling their debt to investors. This in turn enabled them to pay higher prices to the originators of mortgages than potential competitors could pay. On average, between January 2000 and August 2008, the yield on the 10-year Fannie Mae debt was 0.589% above the yield on the 10-year Treasury debt. In contrast, the yield spread between AAA corporate debt and the 10-year Treasury debt stood at 1.446%. This means that on average, from January 2000 to August 2008, the Fannie cost of funding was below the AAA corporate by 0.857%.
Given the fact that the debt issued by FF was considered almost as good as Treasury debt, they could attract money from around the world. In 2007, foreign holdings of US Government Sponsored Enterprise debt (the FF are part of the GSE) stood at $1.304 trillion — an increase of 33% from the previous year and an increase of 165% from 2002. (Note that in 2007, China's investment in the GSE debt comprised 29%, Japan's 17.5% and Russia's 5.8%.)
As a result, the FF have become the dominant force in the housing market. The combined assets of the FF jumped from $160.2 billion in Q1 1990 to $1.77 trillion by Q2 2008. The two companies own or guarantee $5.4 trillion in outstanding home-mortgage debt.
The Real-Estate-Market Crisis and the Demise of Fannie and Freddie
In response to a fall in home prices, coupled with a growing number of home foreclosures, the FF have been required to write off some of the MBS held on their balance sheets. They also had to pay out on guaranteed mortgages that defaulted. As a result the FF have reported nearly $14 billion in losses in the last four quarters. The yearly rate of growth of the FF net worth fell to negative 17.3% in Q2 from negative 23.2% in the previous quarter. Net worth as percentage of assets fell to 3.1% in Q2 from 3.4% in Q1.
As the housing market continued to deteriorate, it started to put pressure on FF stock prices. After increasing to 35.8% in June 2007, the yearly rate of growth of the Fannie stock price fell to negative 89.6% by the end of August this year. Year on year, the price of Freddie's stock fell by 92.7% in August after falling by 85.7% in July. (Note that in May last year, the yearly rate of growth stood at 11.2%.) This made it difficult for the FF to raise capital. The deterioration in their solvency raised the risk that the FF would not be able to secure funding through selling their debt to large buyers such as various central banks. As a result, the prospects for the FF to buy mortgages from lenders and supply fresh funds to the mortgage market were severely hampered.
Will the US Treasury Plan Cause Banks to Lift Mortgage Lending?
So how then can the government seizure of FF fix the problem? According to the plan, the government will inject up to $200 billion over time into the FF and it will also engage in the active buying of MBS from various financial institutions that are currently trying to get rid of these assets. By buying MBS, the Treasury aims at pushing their prices higher and arresting the asset-price deflation.
Also, by injecting money into the FF, government officials hope to restart the flow of money to the mortgage market and bring things to normality. By "normality," they mean that the FF can start buying mortgages from the banks and, after bundling them into the MBS, sell them to the market as before. Treasury officials and various experts are hoping that this will lift home prices and, in turn, lay the foundation for the improvement in consumers' wealth. Subsequently, this will revive the pace of economic activity, so it is held. (Remember that the increase in mortgage lending results in more money being directed to the housing market. This means more money per house, i.e., higher house prices.)
But why should banks consider lifting the pace of mortgage lending? According to a Federal Reserve July survey of loan officers, in excess of 80% of banks have reported that they have tightened their lending standards on residential mortgages. In the previous survey, this figure stood at 72%. Observe that in the July survey last year, the figure stood at 37%. In August, the yearly rate of growth of commercial bank home loans stood at negative 2.2% after being negative at 1.6% in July. This was the third consecutive monthly decline in home loans by commercial banks.
At present, the major concern of most US banks is to improve their net worth, i.e., to strengthen their solvency. This means that the volume of lending is not going to increase if the quality of borrowers does not meet the more stringent standards. According to the Federal Deposit Insurance Corporation (FDIC), commercial banks' and savings institutions' net worth fell by $10 billion from Q1 to Q2. This was the first decline since the data were made available in Q2 2000.
Also, it is questionable that various investors who are at present trying to dispose of MBS would all of a sudden welcome them back into their investment portfolios. We suggest that the FF will have difficulty finding willing buyers of MBS. However, one could argue here that, since the US government guarantees MBS, investors might find them attractive — after all, it is held, the US government cannot default on their debts. From this perspective, one may conclude that the US government plan to take over Fannie and Freddie is a great idea and might work. (Most experts, including the Fed Chairman, are of the view that this is a great plan.)
Confusing Capital with Money
It seems that most experts are confusing capital with money. Treasury officials and Fed policy makers give the impression that they have a hidden pool of resources that can be employed in emergency cases. This is not the case. Neither the Treasury nor the Fed has any real resources as such. All that they can do is redistribute the existent wealth by means of taxes or by means of printing money. (Remember that it is real savings that makes real economic growth possible and not money.)
The act of real wealth redistribution can only weaken wealth generators and make things much worse. Pushing more money into the FF cannot set in motion an increase in lending if the pool of real savings is under pressure. After all, the essence of credit is not lending money as such but lending real stuff. Lending amounts to a transfer of real savings from a lender to a borrower by means of the medium of exchange, i.e., money.
The existence of banks enhances the use of real savings. By fulfilling the role of middleman, banks make it easier for a lender to find a borrower. When a bank lends money, it in fact provides the borrower with the medium of exchange that can be employed to secure real stuff that is required to maintain people's lives and well-being. It is therefore futile to urge banks to lend more if real savings are not there. Likewise, it doesn't make much sense to suggest that the Treasury or the Fed could somehow replace nonexistent real savings. Again all that such actions will produce is the depletion of the existent pool of real savings.
The guarantee that the Treasury is going to assume for the mortgages could be very costly to the taxpayer if the housing-market slump continues. We suggest that if the pool of real savings is declining, then the real economy will follow suit irrespective of various plans by the Treasury and the Fed. In these conditions, even if banks follow the Treasury plan and renew lending, this would be an exercise in futility. A falling economy and decreasing real incomes will reduce individuals' ability to service their debt. Consequently, the government (i.e., the taxpayer) will have to foot the bill.
However, we suggest that, if the pool of real savings is falling, the banks are likely to curtail their lending as a result of a diminished number of viable borrowers. Now, if the pool of real savings is still OK then there is no need for the Treasury plan. The growing pool of real savings will fix the problem.
The Fallacy of "Too Big to Fail"
Most experts are in total agreement that the government seizure of the FF was a necessary act since it has most likely averted a massive economic disaster not only in the United States but worldwide. It is held that, if the FF were allowed to go belly up, this could have inflicted heavy losses on foreign investors in FF debt, which, it is held, could also have eroded foreigners' willingness to invest in US government debt.
The view that some institutions are far too big to be allowed to go under is another fallacy. According to the popular way of thinking, if a large institution is allowed to go under, this could cause severe damage to the economy, since the failure of a large institution would generate large disruptive shocks. Since everything in an economy is interrelated, this means that a major shock could end up in a massive disaster.
In a market economy, a business that reaches the state of bankruptcy is most likely pursuing activities that do not contribute to real wealth but rather squander wealth, i.e., activities that make losses. Since such activities cannot support themselves, it means that real savings must be taken away from activities that do generate real wealth.
The longer a losing activity is allowed to stay alive, the more damage is being inflicted on real wealth generators. So, on the contrary, the liquidation of a losing activity cannot cause more damage; rather, it is going to arrest the damage inflicted on wealth generators. Once the losing activity is gone, the wealth generators with more real savings at their disposal can start expanding wealth-generating activities and lay the foundation for healthy economic growth.
The proponents of the "too large to fail" argument maintain that allowing a large institution to fail will lead to a sharp increase in unemployment and unacceptable human suffering. This is true. However, the reason for the hardship is not a loss of jobs as such but the erosion of the pool of real savings. The erosion of the pool means that there is not enough funding to support various economically nonviable activities. Allowing such activities to stay alive only weakens the pool of real savings further and leads to the further erosion of people's real incomes and makes things much worse. Furthermore, activities of a large entity absorb in absolute terms more scarce savings than a smaller entity, both directly and indirectly. We can infer from this that a large misallocated business is too big to be kept alive rather than too big to be allowed to fail, as the popular thinking has it.
The argument that the government seizure of the FF prevented the downgrading of US Treasury debt by foreigners is suspect. The key factor that has been providing the high rating to US government debt is the perception that the US economy is still very wealthy. Every investor implicitly or explicitly holds that, without support from private-sector wealth, US Treasury debt would have been worthless.
As long as the economy still generates wealth, the government debt will be considered safe. Once the pool of wealth starts to shrink, foreign buyers of US government debt are likely to abandon the sinking ship, irrespective of government "rescue" plans. If the US pool of real savings is falling and the housing market remains depressed, then this will result in the US Treasury incurring large losses in order to maintain so-called credibility, i.e., by not allowing the FF to go under. Needless to say, this is likely to further undermine the pool of real savings and the process of wealth formation. We suggest that a less wealthy US economy is going to hurt all other economies through the channel of international trade.
Allow the Market to Fix the Current Credit-Market Crisis
An alternative solution is to allow the FF to go belly up and allow the market to allocate in the best way scarce real savings. The free market will eliminate nonproductive, wealth-consuming activities and promote wealth-generating activities. The fact that Fannie and Freddie have reached the stage of bankruptcy is the manifestation of a severe misallocation of scarce savings. (In addition to being able to secure cheap money, the FF was given a boost by the extreme loose-interest-rate stance of the Fed between January 2001 and June 2004.)
Allowing the FF access to cheap money has resulted in far too many houses being built, relative to peoples' ability to fund them. This misallocation has robbed the wealth producers of real savings and has impaired their ability to generate real wealth and promote true real economic growth (please don't confuse it with the GDP rate of growth).
Again, allowing various misallocated structures to go under will stop the bleeding of wealth generators. (Note again that the misallocated structures must be funded all the time. This means that wealth generators will have less real funding than they could have had at their disposal as long as these structures are allowed to exist.)
The US government and the Fed could learn from the Japanese experience: schemes to fix the economy don't work if the pool of real savings is not there. In order to lift banks' lending between 2001 and 2003, the Bank of Japan (BOJ) had been aggressively pumping money into the financial system. The average rate of growth of monetary pumping, as depicted by the bank holdings of balances at the BOJ, had increased by 93% during that period. In April 2002, the yearly rate of growth stood at 293%. Yet bank loans had continued to fall. The average yearly rate of growth of loans from 2001 to 2003 stood at negative 4.5%.
Conclusion
We suggest that the seizure of Fannie Mae and Freddie Mac (FF) by the government cannot help the housing market or the economy. Most people hold the mistaken view that the government has extra real resources that can be used in emergencies. This is erroneous. The government is not a wealth generator; it can only consume and redistribute real wealth. What is needed to revive the economy is a growing pool of real savings.
Neither the US Treasury nor the US central bank can create real savings. In order to keep the failing FF going, the taxpayers will be forced to foot the bill. This means a further squandering of the already depleted pool of real savings. Only wealth generators can revive the economy by accumulating enough real capital. In this regard, no government or central-bank policies can replace wealth generators.
The only way wealth generators can act effectively is when they are not disturbed, i.e., in a free-market environment. The sooner the government allows them to move ahead, the sooner we will have economic improvement. Any government or central-bank policies that are intended to improve on the free market — in particular during difficult economic times — are likely to make things much worse and prolong the economic crisis.
Do You Really Want Small Government?
If so, says Libertarian candidate Bob Barr, you should be supporting him for president.
Third party presidential candidates are often overlooked in the horserace discussions leading up to an election, but -- as George H.W. Bush and Al Gore learned the hard way -- they can have an impact. This year, even though he's not getting a lot of attention, the third-party candidate who has the best chance to upset the political applecart is Libertarian Bob Barr.
A former Republican Congressman from Georgia, Barr came to Washington in 1995 as part of the "Republican Revolution." He gained a reputation as one of the most conservative members of Congress, authoring the Defense of Marriage Act and serving as one of the major forces behind the Bill Clinton impeachment proceedings. Barr, however, began questioning the Bush administration over post-9/11 privacy and civil liberties issues. After leaving Congress in 2003, he became a more outspoken critic, formally leaving the Republican Party in 2006. He became the Libertarian candidate for president in May and has made the reduction of the federal government, the end of the Iraq War, and the expansion of personal liberties the centerpieces of his platform.
Polls currently have Barr at between 3 and 6 percent nationally, but Zogby has him performing stronger in some key states. He's polling 5 percent in Florida, 7 percent in Arizona, 8 percent in Colorado, 10 percent in Nevada and 11 percent in New Hampshire, numbers that should be giving both the McCain and Obama camps pause. Barr, however, says he's in it to win it.
Entrepreneurs tend to have a strong Libertarian streak. What would they like best about a Barr administration?
No longer would there be thousands of new regulations each year by faceless bureaucrats. The federal government would finally start to shrink instead of growing ever larger under Democrats and Republicans. We'd see a tremendous burst of enthusiasm and support represented in a dramatic increase in investment activity that would be reflected on Wall Street.
What would you do right away?
To set the example, immediately upon taking office, I would reduce the size, expenditure, and personnel of the Executive Office. We would start conducting cost/benefit analyses of federal programs and agencies, prioritizing those agencies performing legitimate functions and the much larger number that aren't. I would send a message to Congress that there will be no legislation raising the ceiling on the national debt. We'd begin dramatically cutting from that point to reduce the size, scope, and power of the federal government.
What effect do you think the "war on terror" has had on small business and scientific research and development?
A main one is the decrease in the number of foreign students able to enter the United States for educational purposes, which will have dramatic and long-term negative effects. We lose participation from those individuals as potential entrepreneurs in this country, and we lose this generation and future generations as pro-American entrepreneurs in other countries. In decades past, the magnet was the United States. The goal of students with an entrepreneurial bent was to come here to study and conduct research with American companies. Those students have been diverted to Europe.
Are there any business regulations you favor?
I think regulations should do two things: protect against piracy and fraud of one's intellectual or tangible assets, and those related to the broad general welfare. Other than those two things, businesses ought to be left to operate subject only to legal actions if they harm other individuals or businesses.
In a recent Newsweek cover story, Fareed Zakaria wrote, "Bush 43 has surely been the most fiscally irresponsible President in American history." Do you agree?
There have certainly been other presidents that were fiscally irresponsible. LBJ and FDR come to mind, and I’m not sure one can say in absolute terms that Bush has been worse than them, but his problem is more acute because he continues to tout himself as a conservative. Clearly, he is not.
You served in Congress and worked with President Clinton to balance the federal budget. How important is a balanced budget?
It's extremely important. Not as an end unto itself, but as a step toward permanent fiscal responsibility. You can't begin to tackle the national debt until you balance the budget. It also sends an important psychological message to investors and business owners.
Let's go through a few issues. From 2000 to 2006, the U.S. economy grew by 15 percent, but real median family income decreased. Any thoughts on how to ensure economic growth isn't just for the top percentage of Americans?
As the private sector is losing jobs, the government sector is gaining them. The fact of the matter is there is way too high of a percentage of economic activity directly related to government spending and regulation. That's what's holding the entire equation back.
How do you feel about the defense industry, which grows by leaps and bounds every year?
It's gotten much worse since we've been spending such huge sums of money in Iraq. There's even less oversight than normal, and there's normally very little. That's not only a result of the geographical distance that breeds a lack of transparency, but also because the Bush administration has through Executive Orders shielded companies in Iraq from public or regulatory scrutiny. There is a complete lack of accountability in defense spending. Everybody knows the constant increases are going to occur, so there's no discipline. From time to time, Congress will hold hearings to look into these problems and bluster about it. But as long as the same two parties are in control, it won't change because neither wants to limit the other one because that will eventually become a limitation on their own party.
Can the free market wean us from our oil dependency?
The recent experience with ethanol is a perfect example of special interests pushing governmental leaders to favor one approach, and one product, over another. Ethanol has been no gain to the general economy, but it's been a boon for certain agricultural producers. It hasn't done anything to clean up our air so to speak, or to wean us from the ever-increasing need for petroleum. The market needs to determine what's going to work and what isn't. The high price at the pump proves that point. People have changed their driving habits and their car purchasing patterns.
Where wouldn't you drill for oil?
I wouldn't drill where there's no oil. Where there's oil, I'd drill.
How has your stance on the Iraq War changed?
The Bush administration used what is best described as bait-and-switch. In 2002, they came to the Congress and the American people and laid out a scenario based on a false sales pitch. They secured a resolution and the support of the country to go in and take care of a specific problem. Again, based on false information. But it was still a very short-term objective: Go in and take out Saddam Hussein and his regime, which in the view of the administration, was a serious and imminent threat to the United States.
Did you believe that?
I voted for the resolution in 2002 based on clear arguments. We were told that intelligence showed there were weapons of mass destruction maintained by the Saddam Hussein regime and that they were poised to use them against America and its interests. We need to stop the Iraq War immediately. It will only be when we remove the economic and military security blanket that's propping up the Iraqi regime, that they'll take responsibility for their own affairs. I'm glad to see there's some movement in that direction, but it's still several years away. That's too long to have the hemorrhaging of American taxpayer dollars going over to Iraq.
Most people hold some Libertarian views. We all want less government somewhere. But gun owners don't have the same concerns as people advocating for gay marriage, or the elimination of the IRS, or the legalization of drugs. How do you bring the different groups and agendas together?
You look for the common ground. That’s what I've done since leaving Congress. I worked with both the ACLU and the ACU, the American Conservative Union, for about four years on the same issues. It's the respect for smaller government in the arena of personal privacy where there’s overlap between the left and the right. My job is to remind people that they have to put aside their differences on other issues to work on their fundamental liberties. Otherwise, they’re all going to lose.
Do you fear being labeled the Ralph Nader of 2008?
I am not in the presidential race to be a spoiler. I have much better things to do with my time.
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