Bailing Out the Sub Prime Lending Market

In his 1994 book Money of the Mind: Borrowing and Lending in America from the Civil War to the Age of Milken (New York Noonday Press) James Grant presents a tour de force of the role finance played in the building of modern America. The author traced two trends in American finance, one good and one bad. American finance has been characterized by the democratization of credit (the good trend) and the socialization of risk (the bad trend).

The Larger Trend

America was the first modern country in which credit instruments of all sorts became available to the common man, whereas in the rest of the world credit had been reserved for the wealthy few. But the democratization of credit merely reflected a larger trend in America. America was the first country in which the common man could build wealth through a system of meritocracy. Unlike the rest of the world, the accident of one’s birth did not determine an American’s place in society. What followed was an unprecedented explosion of entrepreneurship in which the common man benefited as never before. But why did this happen only in America?

Land for All

America became the first modern nation in which the common man could become economically independent, because he could easily own land. In all other societies the common man’s livelihood was a gift from the aristocracy, and the foundation of aristocratic power was ownership of land. Few commoners in Europe owned land freely, called freeholds. Most worked as rural laborers, rented land, or a few held long-term ninety-nine year leases. But even rented or leased land did not make the common man independent. All was different in America. Ownership of the immense North American continent was open to homesteaders–those who, in John Locke’s famous words, mixed their labor with the land resource to produce something of value. From this mixture of labor and land came legal land ownership. When a man owns the tools necessary for his survival he is independent and can become rich. He is no longer a vassal. (That is one of the reasons that I am so opposed to the current “Taxation for Open Space” craze. It taxes the common man to pay large sums of money to current holders of land for their promise not to improve it by building homes or businesses. I cannot conceive of a more anti-capitalistic tax. How can land be placed at the disposal of those who can place it in its most productive form, if government locks it away with our tax money for the dubious benefit of allowing the common people to gaze upon it? This is the old government-enforced aristocratic system painted in new colors. Lipstick on a pig, but a pig nevertheless.)

The widespread ownership of land created a huge customer base for credit that was impossible elsewhere. Hernando De Soto explains this process in The Mystery of Capital. De Soto uses America as an example of the proper way to perfect title in land for the benefit of the commoner. This did not happen in the Spanish colonies, where even today only a small percentage of land is legally protected by perfected title. De Soto calls such land “dead capital”, because it cannot be used for more capital intensive businesses and no one dares build a valuable abode upon it only to see corrupt authorities evict the builder as a trespasser.

The Socialization of Risk

But in Money of the Mind James Grant traced the less advantageous trend in the history of American credit—the socialization of risk. Almost from the beginning, those who were granted unprecedented access to credit clamored for government assistance when their plans went awry and they could not repay their loans. This process repeated itself over and over again. The first lenders to a new class of borrowers, often using new credit instruments, would attract the best credit risks and suffer few credit losses. As pioneers in this new area of lending, they would make extraordinary profits. Copycat financiers were quick to jump into this new market, but the best credit risks were already gone. Nevertheless, it was felt that a new age of finance had dawned (it is always a new age!) Recent experience had shown that previously uncreditworthy borrowers could be lent to profitably using new credit instruments. Grant shows that over and over the last in the new market, whether lender or borrower, were always those who suffered the worst losses when economic reality could no longer be ignored.

The Market Teaches, But Governments Waste

Bankruptcy is a hard but wonderful teacher, and eventually the market learned its lesson, at least for the newly introduced credit instrument. The credit markets settled down to the mundane task of doing good financial analysis of business plans and taking realistic collateral to protect lenders and instill a sense of responsibility in borrowers. But the lesson had to be learned again and again with the introduction of each new credit instrument.

Foolish businessmen and their customers have always lobbied for taxpayer bailouts.

The bailout of Chrysler is the most well-know case, but the bailout of Continental Illinois National Bank of Chicago in the early ‘80s set the tone for the massive bailout of the savings and loan industry later in the decade.

So we have arrived at the year 2007 and what do we read in each day’s headline? Sub prime lenders are going bust. Sub prime borrowers are shocked at the size of their new payments, as variable teaser rates expire and higher ones take effect. And what do these creditors and borrowers demand? That government bail them out with taxpayer funds. You could have read the same headlines in almost any twenty-year period since the Civil War. Our pandering politicians are there with the money. Not their own money, of course, but with our money. These poor bankers and their customers must not be allowed to go bankrupt. Oh, the Humanity! We must show them mercy and charity! Now, I am all for mercy and charity, but I prefer that everyone show such displays with his own money and not mine.

Creating a Moral Hazard

The evils that flow from these government bailouts are seldom discussed. There is the equity problem. By what right does anyone have to my money to keep himself in a home that he cannot afford? I had nothing to do with his transaction, into which he entered voluntarily if foolishly. The same for the lender and the lender’s investors. They lent the money and expected to make a profit. They miscalculated. The market will learn the lesson. But let’s not create what economists call a “moral hazard”, which means that similar transactions will happen again and again because both borrower and lender expect the government to bail them out if things don’t go as planned.

Unfortunately, that IS the lesson from previous bailouts and that is why we have the sub prime lending bailout today. In fact both PA and NJ have institutionalized the creation of moral hazard. In PA we have the Housing Finance Agency. In NJ it is the New Jersey Housing and Mortgage Finance Agency. Neither agency should exist, but spokesmen for both are demanding more “rescue” funds. What else should we expect from bureaucrats whose jobs depend upon rescuing financial disasters with public money? Expect more of the same.

When a Reporter Is Just a Reporter

Mark Bowden, author of the popular book and movie Blackhawk Down and the highly acclaimed Killing Pablo, spoke to members and guests of The Middle East Forum yesterday about his new book Guests of the Ayatollah. Speaking at the law offices of Pepper Hamilton in Center City, Mr. Bowden gave a highly interesting and entertaining talk about the cultural differences that led up to America’s first clash with radical Islam—the Iranian seizure of our embassy in Tehran in 1979—and the experiences of the hostages and their captors. Mr. Bowden has interviewed personally many of the hostages and some of the Iranian hostage takers, plus many American officials from that time. I enjoyed his talk immensely, but I was struck how easy it was to spot when he moved from reporting, where he is a master craftsman, and into analysis and opinion, where he is less adept.

I have not read either of these books, but I am certain that the reader would find Guests to be a fairly factual account of what happened. This is the mark of a good journalist. Mr. Bowden told us amazing stories from his many interviews, such as a thumbnail sketch of the failed American rescue mission. He also explained the political forces that acted upon the Carter administration and caused it to feel that there really was nothing that could be done. Most important of these were the fear that escalating the crisis might bring in the Soviets and start World War III and the fact that our military really had no capability to rescue the hostages, who were being held in the middle of a huge city hundreds of miles from our nearest bases and fleet.

But during his talk one could easily discern when Mr. Bowden veered from reporting to inserting his own judgement and analysis. He was excellent at telling us what DID happen and less astute when he told us WHY it happened and even less so when told us what SHOULD have happened. For instance, Mr. Bowden told us that the Carter administration handled the situation rather well by refusing to escalate the crisis militarily. Well, that is a value judgement that others may debate. As one attendee stated in the Q&A period, the U.S could have punished the Iranians militarily rather easily and that we played into the Iranians’ hands by placing the welfare of the hostages above all other national interests. This is a lesson that we should have learned from the many Israeli experiences. In the ensuing decades Iran has been responsible for mayhem world wide, from funding and arming Hezbollah in Lebanon to the recent capture of the British sailors and marines. It is certainly arguable that an overwhelming military response in 1979 to an attack upon our embassy, which was an attack upon American territory under international law, might have prevented these warlike actions and even caused the Iranian people to discard the reign of the radical mullahs.

This is all speculation, of course, but the point is that Mr. Bowden was merely speculating, too. He is not an expert in international affairs and admits to being completely ignorant of America’s military capability, telling a humorous anecdote that he had to admit in a talk to Army officers that he didn’t know what a Bradley Fighting Vehicle was. This admission early in his talk indicated to me that Mr. Bowden was just a reporter, a good reporter, but just a reporter nevertheless.

U.S. Senate to Sick People: Drop Dead!

Early last week the U.S. Senate made it illegal for Americans to buy medication from foreign sources, by requiring that the FDA certify that such all medications are safe and effective. Since the FDA has stated that it cannot meet this requirement, our government has condemned millions of Americans to misery, poverty, and even death.

Reputable sources claim that foreign medications, which are often the very same medications sold in the U.S. and produced by the same manufacturer, can cost as little as one-third the price as the identical medication sold here. Of course, the drug companies mounted a massive disinformation campaign to switch the topic from drug cost to drug safety. We are only thinking of the best interest of the consuming public, they pontificate, who cannot be trusted and, therefore, cannot be allowed to make these decisions themselves. Pardon my French, but what a crock!

A New Kind of Protectionism

There are many fine sources that will explain the marketing strategies of the drug companies that result in price gouging of American consumers. Now, I am all in favor of the drug companies selling their product for whatever price they think they can get anywhere in the world. But what I adamantly oppose is the drug companies lobbying our government to insure a captive market here at home. This is protectionism of a new kind—preventing the re-importation into America of one’s own product after one has sold that product oversees to third parties. There is no rationale for such abusive and coercive measures, regardless of the drug companies’ crocodile tears. Our drug makers and our politicians who pander to them surely deserve a few extra million years in purgatory to atone for the unnecessary and senseless suffering they are inflicting on their fellow Americans—suffering from pain, suffering from immobility, and suffering from a diminished standard of living, to say nothing of the suffering from premature death.

But what of the drug companies’ and the politicians’ claims that they have only our best interest in mind? Surely not all of those who labored to pass this disreputable bill truly desired to harm their fellow Americans. Probably not. But they do labor under a false understanding of man’s natural rights, from which all law flows. The very foundation of our nature rights is the right of ownership of our own bodies and all that that entails.

Who Owns Our Bodies?

Who owns one’s body if not oneself? Does some other person own it? By what right does he claim ownership? And if he owns my body, why do I not own his? Let us hope that this theory was vanquished from America at the end of the Civil War. How about the claim of the socialists that we all are responsible to one another and, therefore, all have a right to decide what one may do with one’s body. That founders on the shoals of impracticality. Shall I canvass everyone in America or even everyone in the world before I consume some substance? That means that everyone must canvass everyone else continuously.

Well, then, how about the idea that we ELECT certain people to make these decisions for the rest of us? That is the nature of this ban on foreign drugs. But by what natural right do these representatives make such a claim except that a majority has voted them into office? That is no explanation. What if a majority wants to re-enslave all persons of color or some other despicable act? The fact that a majority desires it is no justification. I doubt that my neighbor would acquiesce if I told him that my son and I held a vote and decided to take ownership of his new car. Plus we already said that one person cannot own another, the definition of slavery, so by what twisted logic do we say that a group may own a person or, in this case, all persons in America and make such life and death decisions as prohibiting the purchase of medications from foreign sources? For this is the issue. If the U.S. government can deny Americans this right, then it has made us slaves.

If ever there was a law that called for civil disobedience, this is it. No court in the land should accept a case from a government prosecutor attempting to enforce this law. No jury should convict a defendant should a court accept such a case, regardless of the facts and the letter of the law. No law can stand if citizens refuse to obey it. This is such a law.