Who murdered the financial system?

Who murdered the financial system?

by Swaminathan S. Anklesaria Aiyar

http://www.swaminomics.org/articles/20081022.htm

Dated: October 22, 2008

Leftists claim that the global financial crisis was caused by reckless
deregulation and greed. Rightists blame half-baked financial
regulations and perverse incentives. Actually, the financial sector is
deeply regulated, with major roles for both the state and markets. It
was not one or the other that failed but the combination.

The best metaphor for the mess comes from Jack and Suzy Welch, who
recall Agatha Christie's "Murder on the Orient Express." In this
novel, 12 people are suspects in a murder. And 12 turn out to be
guilty. What starts as a whodunit concludes as an everybody-dun-it.

In the same spirit, allow me to present the 12 murderers of the US
financial system.

1. The Federal Reserve Board. Alan Greenspan, Fed Governor in
1987-2006, was once hailed as a genius for keeping the US booming, but
is now called a serial bubble-maker. He presided over bubbles in
housing, credit, and stock markets. He said it was difficult to
identify asset bubbles in advance, so anti-bubble policies might be
anti-growth. It was better to let bubbles build, and sweep up after
they burst. Bernanke, like Greenspan, ignored the US housing bubble
till it burst.

2.US politicians. Envisioning a home for every American, regardless of
income, they provided excess implicit and explicit housing subsidies.
One law forced banks to lend to sub-prime poor borrowers. Legislators
created Fannie Mae and Freddie Mac, government-sponsored entities that
bought or underwrote 80% of all US mortgages, and enjoyed exemption
from normal regulations. Politicians ignored Greenspan's warning that
such a dominant role for two under-regulated giants posed a huge
financial risk.

3.Fannie Mae and Freddie Mac. They resisted regulation, and spent over
$ 2 million lobbying legislators against any tightening of rules. As
mortgagers of last resort they should have been especially prudent.
But they bought stacks of toxic mortgage paper—collateralized debt
obligations (CDOs)—seeking short-term profits that ultimately led to
bankruptcy.

4.Financial innovators. Their ideas provided cheap, easy credit, and
helped stoke the global economic boom of 2003-08. Securitisation of
mortgages provided an avalanche of capital for banks and mortgage
companies to lend afresh. Unfortunately the new instruments were so
complex that not even bankers realized their full risks. CDOs smuggled
BBB mortgages into AAA securities, leaving investors with huge
quantities of down-rated paper when the housing bubble burst.
Financial innovators created Credit Default Swaps (CDSs), which
insured bonds against default. CDS issues swelled to a mind-boggling $
60 trillion. When markets fell and defaults widened, those holding
CDSs faced disaster.

5.Regulators. All major countries had regulators for banking,
insurance and financial/ stock markets. These were asleep at the
wheel. No insurance regulator sought to check the runaway growth of
the CDS market, or impose normal regulatory checks like capital
adequacy. No financial regulator saw or checked the inherent risks in
complex derivatives. Leftists today demand more regulations, but these
will not thwart the next crisis if regulators stay asleep.

6.Banks and mortgage lenders. Instead of keeping mortgages on their
own books, lenders packaged these into securities and sold them. So,
they no longer had incentives to thoroughly check the creditworthiness
of borrowers. Lending norms were constantly eased. Ultimately, banks
were giving loans to people with no verification of income, jobs or
assets. Some banks offered teaser loans—low starting interest rates,
which reset at much higher levels in later years—to lure unsuspecting
borrowers.

7.Investment banks. Once, these institutions provided financial
services such as underwriting, wealth management, and assistance with
IPOs and mergers and acquisition. But more recently they began using
borrowed money—with leverage of up to 30 times—to trade on their own
account. Deservedly, all five top investment banks have disappeared.
Lehman Brothers is bust, Bear Stearns and Merrill Lynch have acquired
by banks, and Morgan Stanley and Goldman Sachs have been converted
into regular banks.

8.Rating agencies. Moody's and Standard and Poor's were not tough or
alert enough to spot the rise in risk as leverage skyrocketed. They
allowed BBB mortgages to be laundered into AAA mortgages through CDOs.

9.The Basle rules for banks. These international negotiated norms
provided harmonized regulatory checks on financial excesses across
countries. The first set of norms, Basle-I, was widely criticized as
too rigid and blunt. So countries agreed on Basle-II, which allowed
banks to use credit ratings and models based on historical record to
lower the risk-ratings of many securities. This dilution of norms led
to excesses everywhere. Iceland's banks went bust holding
loans/securities totaling 10 times its GDP. The dilution of
risk-rating in Basle-II helped inflate the financial bubble.

10.US consumers. Their savings used to be 6% of disposable income some
time ago, but more recently has been zero or even negative. They have
gone on a huge borrowing spree to spend far more than they earn. This
excess is reflected in huge, unsustainable US trade deficits.

11.Asian and OPEC countries. They undervalued their currencies to
stimulate exports and create large trade surpluses with the US. They
accumulated trillions in forex reserves, and put these mostly into
dollar securities. This depressed US interest rates, and further
fuelled borrowing there.

12.Everybody. Consumers, corporations, banks, politicians, the
media--indeed everybody-- was happy when housing prices boomed, stock
markets boomed, and credit became cheap and easily available. Bubbles
in all these areas grew in full public view. They were highlighted by
analysts, but nobody wanted to stop the lovely party. Everybody liked
easy money and rising asset prices. This trumped prudence across
countries.

So, forget the left-versus-right or regulations-versus-markets debate
on the financial crisis. States, institutions, markets and everybody
else was guilty. These actors will for some years don sackcloth and
ashes, adopt stiffer regulations, and listen to lectures on the
virtues of prudence and restraint. But after seven to ten years of the
next business upswing, I predict that we will once again have a new
generation of bubbles, evading whatever new checks have been put in
place. When everybody loves bubbles, they are both irresistible and
inevitable.

http://www.swaminomics.org/

Where did all this money come from ?

Dear Sir,

The current ciris is in finanacial markets and tooted in sub-prime
mortages, as we all know. First of all, the money market has severe
govt intervention for several decades when fiat money was invented and
gold
standard was abandoned.

Some centuries ago the currecy were issued by banks backed by their
gold or other assets. Hence the original name : bank notes. Govts all
over the world 'nationalised' the currecy issuing system and established
Central Banks with sole monopoly over issue of legal tender. This is first
of all certainly not free market in the real sense.

Secondly, the chronic defict financing of all nations over decades
pumped in more money into the sytem than the sytem could absorve
thru growth in real GDP. This is true of most economies.

And US is in a unique position : its currency USD is the reserve
currency and most of world trade occurs in USD. And hence the
entire world funds the US deficts which is in trillions and trillions
over the decades. US govt prints and pumps in trillions and
trillions of USD into the world economy over the decades. The
cumulative effect of all this should be taken into account while
blaming 'free markets' alone for all this mess.

I vividly remember our discussion about value and money ; and
about the functions of money : as a medium of exchange, measure of
value, etc ; Especially the function : 'store of value' ; The accumulated
'surplus values' or capital or whatever the term flows all around the sytem
in search of investemtn avenues and good return on investemnts.
As the term value is tricky to define and contantly fluctuates in
currency and debt markets, the cumulative effect of too much money
chasing too few goods or avenues for investment seems the crux of
all issues.

The old deficniton for inflation : "Too much money chasing too few
goods" : This seems to aptly apply for this financial market mess.
Combined with the govt gurantess of the twin giants for many trillions
(Freddie and Fannie), etc.

The word cheap money, easy credit, easy money, etc are all result of
this too much fiat money ? And as the govt is the both the issuer of
money and lender of last resot, it also controls the effective interest
rates by tinkering with Fed rates. All these are certainly govt intervention
and not free markets. Last year i read in major papers that the world
boom in equity and real estate is a function of global liquidity. Means ?

Excess liquidity ? And cyclic asset bubbles are always regular
happenings. What about the net amount of M4 or legal tender that
exists in the world economy at any given moment ?

The crisis is not in manufacturing or other services. Hence to term
all this as the failure of free enterprise capitalism is pre mature.

Anyway, I guess no one wants to get back to socialism. In US no one
seems to re-establism the, say : ICC (Interstate Commerce Commission)
which throttled many sectors like trucking (like our license raaj in India
as on date).

More later..

Anbudan
Athiyaman

Holiest of all holies

Dear Freind,

I could not make myself very clear to you while arguing about free
market capitalism. The UN decleration of fundamental rights covers all
aspects of life.

http://www.unhchr.ch/udhr/lang/eng.htm

and free enterprise is but a part of this declration : right to
property, right to do business and employ anybody thru volountary
free contracts ; and above all rule of the law and non-violation of
anyone's basic rights thru any means for any objectives.

All the rights of every human should not be violated by any other
individual or group or company or army or a nation or parliament or
statute or religious body, etc. that is the crux of it all. Violation of these
rights by any isim is wrong and
unjustifiable.

I consider these basic rights as the holiest of all holies in life.

Violation of property rights took place in Nandigram and elsewhere. Pls
compare how lands for mines and industires were / are acquired in the
West (say in Germany or Canda). but Gujarat SEZ land aquisition was
voluntary, free and fair.

http://www.expressindia.com/latest-news/SEZheavy-Gujarat-Thanks-to-the-states-landacquisition-policy-for-no-Nandigrams-here/273221/

Pls see my latest post :

http://nellikkani.blogspot.com/2008/06/museum-of-communism.html

anbudan
Athiyaman

Pains of a slowing miracle economy

http://swaminomics.org/articles/20081005.htm

by : Swaminathan S. Anklesaria Aiyar

Pains of a slowing miracle economy

Dated: October 5, 2008

I am not usually a pessimist. But I predict that India will suffer a
lot of pain in the next 18 months, as the economy slows down along
with the current global slowdown.

The US, Europe and Japan are sinking into recession together. Forget
claims that India has decoupled from the US and can keep growing fast
regardless. India and most developing countries are indeed much less
dependent on the US economy than in the past. So, Indian growth will
be dented rather than smashed. GDP growth will slide from 9 % last
year to 7% this financial year, and to maybe 6% next year.

Now, 7% is a miracle growth rate by historical standards. You might
think that declining from super-miraculous to merely miraculous growth
cannot be particularly painful. You would be dead wrong. The direction
of change matters more than the absolute level. Rising from 5% to 7%
is blissful, but falling from 9% to 7% is painful. And a subsequent
tumble to 6% will be more painful still.

To appreciate why the direction of change matters so much, recall the
1990s. India went bust in 1991, reformed by globalising, and reaped
the reward of fast growth. GDP growth averaged 7.5% in the three-year
period 1994-97. India's growing integration with the world economy
enabled it to share in the global economic boom of those years.
Foreign institutional investors flooded into all emerging markets,
including India, sending stock market prices spiraling.

Indian optimists thought that miraculous growth was here to stay. But
along came the Asian financial crisis in 1997, and the Indian economy
slumped along with the global economy. Indian GDP growth averaged just
5.5% in the next five years.

Now, 5.5 % may not sound too bad, just a modest deceleration from the
7.5% of the preceding boom. Indeed, India's 5.5% at the time was one
of the fastest growth rates in the world. Yet the change in direction,
from acceleration to deceleration, caused enormous pain.

Industrial growth crashed in 1997-98, and barely limped forward for
years. Many industries had borrowed massively during the mid-1990s
boom to invest in world-class new plants, for which there was suddenly
no demand. Huge projects were abandoned unfinished, with companies
defaulting on mega-loans. These financial defaults brought the lending
institutions also to the verge of bankruptcy, from which they were
saved mainly by creative accounting and a friendly RBI. Medium and
small companies crashed along with their larger brethren. Employment
went into a tailspin. Stock markets crashed and companies stopped
repaying fixed deposits, so household investors suffered trauma.

The budgets of the central and state governments assumed steady growth
of revenue year after year. But the 1997 slowdown hit tax collections.
Meanwhile, a bumper Pay Commission award hugely inflated the wage
bills of central and state governments. So, governments, corporations,
employees and households investors were all sucked downward into a
whirlpool of distress. The only saving grace was the IT boom, sparked
by the global YK2 scare. But that turned out to be a bubble, and it
burst in 2001.

Difficult though these years were, they did not witness economic
collapse. India did not revert to the old Hindu rate of growth of 3.5%
witnessed in the three decades after independence. GDP growth in
1997-02 averaged a solid 5.5%. But the direction of change was
downward, not upward, and that was enough to cause widespread
distress.

I fear we are about to see a repetition of that process. As in the
1990s, a booming world economy first lifted Indian growth (and stock
markets) to new heights for several years, giving rise to the illusion
of permanency. As in the 1990s, the subsequent global slump is going
to cause an Indian slump too. As in the 1990s, the fiscal problems of
the government are going to be exacerbated by a Pay Commission award.

However, we are much better prepared for this downturn than in the
1990s. Our foreign exchange reserves are almost $ 300 billion,
cushioning our balance of payments. Corporations have not gone on a
borrowing spree paying 20% interest, as they did in the 1990s—they
have large cash reserves, modest debt-equity ratios, and interest
rates are much lower today. The banking system is in relatively good
shape today. The latest Pay Commission award this time is less onerous
than the 1997 one. Our savings rate has crossed 30%, and can keep
financing a healthy rate of investment. Infrastructural sectors like
telecom, power, roads, and ports will be only minimally affected by a
recession.

Nevertheless, pain will be widespread and sometimes deep. Income and
job opportunities will slacken, sometimes dramatically. Many companies
will suffer shrinkage or bankruptcy, especially small ones. Boom
sectors like transport, restaurants, trade, real estate and exports
will go into reverse gear. Credit will tighten, for consumers as well
as companies. Corporate profits will slump. The revenues of central
and state governments will fall, curbing their ability to alleviate
distress. The stock markets will fall further, and the Sensex may fall
below 10,000. Tighten your seat belts: we are running into rough
weather.

An Open Letter to my Friends on the Left

An Open Letter to my Friends on the Left

http://myslu.stlawu.edu/~shorwitz/open_letter.htm

Steven Horwitz
Department of Economics
St. Lawrence University
sghorwitz@stlawu.edu
September 28, 2008

My friends,

In the last week or two, I have heard frequently from you that the
current financial mess has been caused by the failures of free markets
and deregulation. I have heard from you that the lust after profits,
any profits, that is central to free markets is at the core of our
problems. And I have heard from you that only significant government
intervention into financial markets can cure these problems, perhaps
once and for all. I ask of you for the next few minutes to, in the
words of Oliver Cromwell, consider that you may be mistaken. Consider
that both the diagnosis and the cure might be equally mistaken.

Consider instead that the problems of this mess were caused by the
very kinds of government regulation that you now propose. Consider
instead that effects of the profit motive that you decry depend upon
the incentives that institutions, regulations, and policies create,
which in this case led profit-seekers to do great damage. Consider
instead that the regulations that may have been the cause were
supported by, as they have often been throughout US history, the very
firms being regulated, mostly because they worked to said firms'
benefit, even as they screwed the rest of us. Consider all of this as
you ask for more of the same in the name of fixing the problem. And
finally, consider why you would ever imagine that those with wealth
and power wouldn't rig a new regulatory process in their favor.

One of the biggest confusions in the current mess is the claim that it
is the result of greed. The problem with that explanation is that
greed is always a feature of human interaction. It always has been.
Why, all of a sudden, has greed produced so much harm? And why only in
one sector of the economy? After all, isn't there plenty of greed
elsewhere? Firms are indeed profit seekers. And they will seek after
profit where the institutional incentives are such that profit is
available. In a free market, firms profit by providing the goods that
consumers want at prices they are willing to pay. (My friends, don't
stop reading there even if you disagree - now you know how I feel when
you claim this mess is a failure of free markets - at least finish
this paragraph.) However, regulations and policies and even the
rhetoric of powerful political actors can change the incentives to
profit. Regulations can make it harder for firms to minimize their
risk by requiring that they make loans to marginal borrowers.
Government institutions can encourage banks to take on extra risk by
offering an implicit government guarantee if those risks fail.
Policies can direct self-interest into activities that only serve
corporate profits, not the public.

Many of you have rightly criticized the ethanol mandate, which made it
profitable for corn growers to switch from growing corn for food to
corn for fuel, leading to higher food prices worldwide. What's
interesting is that you rightly blamed the policy and did not blame
greed and the profit motive! The current financial mess is precisely
analogous.

No free market economist thinks "greed is always good." What we think
is good are institutions that play to the self-interest of private
actors by rewarding them for serving the public, not just themselves.
We believe that's what genuinely free markets do. Market exchanges are
mutually beneficial. When the law messes up by either poorly defining
the rules of the game or trying to override them through regulation,
self-interested behavior is no longer economically mutually
beneficial. The private sector then profits by serving narrow
political ends rather than serving the public. In such cases, greed
leads to bad consequences. But it's bad not because it's
greed/self-interest rather because the institutional context within
which it operates channels self-interest in socially unproductive
ways.

This, my friends, is exactly what has brought us to the mess we are now in.

To call the housing and credit crisis a failure of the free market or
the product of unregulated greed is to overlook the myriad government
regulations, policies, and political pronouncements that have both
reduced the "freedom" of this market and channeled self-interest in
ways that have produced disastrous consequences, both intended and
unintended. Let me briefly recap goverment's starring role in our
little drama.

For starters, Fannie Mae and Freddie Mac are "government sponsored
enterprises". Though technically privately owned, they have particular
privileges granted by the government, they are overseen by Congress,
and, most importantly, they have operated with a clear promise that if
they failed, they would be bailed out. Hardly a "free market." All the
players in the mortgage market knew this from early on. In the early
1990s, Congress eased Fannie and Freddie's lending requirements (to
1/4th the capital required by regular commercial banks) so as to
increase their ability to lend to poor areas. Congress also created a
regulatory agency to oversee them, but this agency also had to reapply
to Congress for its budget each year (no other financial regulator
must do so), assuring that it would tell Congress exactly what it
wanted to hear: "things are fine." In 1995, Fannie and Freddie were
given permission to enter the subprime market and regulators began to
crack down on banks who were not lending enough to distressed areas.
Several attempts were made to rein in Fannie and Freddie, but Congress
didn't have the votes to do so, especially with both organizations
making significant campaign contributions to members of both parties.
Even the New York Times as far back as 1999 saw exactly what might
happen thanks to this very unfree market, warning of a need to bailout
Fannie and Freddie if the housing market dropped.

Complicating matters further was the 1994 renewal/revision of the
Community Reinvestment Act of 1977. The CRA requires banks to to make
a certain percentage of their loans within their local communities,
especially when those communities are economically disadvantaged. In
addition, Congress explicitly directed Fannie and Freddie to expand
their lending to borrowers with marginal credit as a way of expanding
homeownership. What all of these did together was to create an
enormous profit and political incentives for banks and Fannie and
Freddie to lend more to riskier low-income borrowers. However
well-intentioned the attempts were to extend homeownership to more
Americans, forcing banks to do so and artificially lowering the costs
of doing so are a huge part of the problem we now find ourselves in.

At the same time, home prices were rising making those who had taken
on large mortgages with small down payments feel as though they could
handle them and inspiring a whole variety of new mortagage
instruments. What's interesting is that the rise in prices affected
most strongly cities with stricter land-use regulations, which also
explains the fact that not every city was affected to the same degree
by the rising home values. These regulations prevented certain kinds
of land from being used for homes, pushing the rising demand for
housing (fueled by the considerations above) into a slowly responding
supply of land. The result was rapidly rising prices. In those areas
with less stringent land-use regulations, the housing price boom's
effect was much smaller. Again, it was regulation, not free markets,
that drove the search for profits and was a key contributor to the
rising home prices that fueled the lending spree.

While all of this was happpening, the Federal Reserve, nominally
private but granted enormous monopoly privileges by government, was
pumping in the credit and driving interest rates lower and lower. This
influx of credit further fueled the borrowing binge. With plenty of
funds available, thanks to your friendly monopoly central bank (hardly
the free market at work), banks could afford to continue to lend
riskier and riskier.

The final chapter of the story is that in 2004 and 2005, following the
accounting scandals at Freddie, both Freddie and Fannie paid penance
to Congress by agreeing to expand their lending to low-income
customers. Both agreed to acquire greater amounts of subprime and
Alt-A loans, sending the green light to banks to originate them. From
2004 to 2006, the percentage of loans in those riskier categories grew
from 8% to 20% of all US mortgage originations. And the quality of
these loans were dropping too: downpayments were getting progressively
smaller and more and more loans carried low starter interest rates
that would adjust upward later on. The banks were taking on riskier
borrowers, but knew they had a guaranteed buyer for those loans in
Fannie and Freddie, back, of course, by us taxpayers. Yes, banks were
"greedy" for new customers and riskier loans, but they were responding
to incentives created by well-intentioned but misguided government
interventions. It is these interventions that are ultimately
responsible for the risky loans gone bad that are at the center of the
current crisis, not the "free market."

The current mess is thus clearly shot through and through with
government meddling with free markets, from the Fed-provided fuel to
the CRA and land-use regulations to Fannie and Freddie creating an
artificial market for risky mortgages in order to meet Congress's
demands for more home-ownership opportunities for low-income families.
Thanks to that intervention, many of those families have not only lost
their homes, but also the savings they could have held onto for a few
more years and perhaps used to acquire a less risky mortgage on a
cheaper house. All of these interventions into the market created the
incentive and the means for banks to profit by originating loans that
never would have taken place in a genuinely free market.

It is worth noting that these regulations, policies, and interventions
were often gladly supported by the private interests involved. Fannie
and Freddie made billions while home prices rose, and their CEOs got
paid lavishly. The same was true of the various banks and other
mortgage market intermediaries who helped spread and price the risk
that was in play, including those who developed all kinds of fancy new
financial instruments all designed to deal with the heightened risk of
default the intervention brought with it. This was a wonderful game
they were playing and the financial markets were happy to have Fannie
and Freddie as voracious buyers of their risky loans, knowing that US
taxpayer dollars were always there if needed. The history of business
regulation in the US is the history of firms using regulation for
their own purposes, regardless of the public interest patina over the
top of them. This is precisely what happened in the housing market.
And it's also why calls for more regulation and more intervention are
so misguided: they have failed before and will fail again because
those with the profits on the line are the ones who have the resources
and access to power to ensure that the game is rigged in their favor.

I know, my friends, that you are concerned about corporate power. So
am I. So are many of my free-market economist colleagues. We simply
believe, and we think history is on our side, that the best check
against corporate power is the competitve marketplace and the power of
the consumer dollar (framed, of course, by legal prohibitions on force
and fraud). Competition plays mean, nasty corporations off against
each other in a contest to serve us. Yes, they still have power, but
its negative effects are lessened. It is when corporations can use the
state to rig the rules in their favor that the negative effects of
their power become magnified, precisely because it has the force of
the state behind it. The current mess shows this as well as anything
ever has, once you realize just what a large role the state played. If
you really want to reduce the power of corporations, don't give them
access to the state by expanding the state's regulatory powers. That's
precisely what they want, as the current battle over the $700 billion
booty amply demonstrates.

This is why so many of us committed to free markets oppose the
bailout. It is yet another example of the long history of the private
sector attempting to enrich itself via the state. When it does so,
there are no benefits to the rest of us, unlike what happens when
firms try to get rich in a competitive market. Moreover, these same
firms benefited enormously from the regulatory interventions they
supported and that harmed so many of us. The eventual bursting of the
bubble and their subsequent losses are, to many of us, their just
desserts for rigging the game and eventually getting caught. To reward
them again for their rigging of the game is not just morally
unconscionable, it is very bad econonmic policy, given that it sends a
message to other would-be riggers that they too will get rewarded for
wreaking havoc on the US economy. There will be short-term pain if we
don't bailout these firms, but that is the hangover price we pay for
15 years or more of binge lending. The proposed bailout cannot prevent
the pain of the hangover; it can only conceal it by shifting and
dispersing it among the taxpayers and an economy weakened by the
borrowing, taxing, and/or inflation needed to pay for that $700
billion. Better we should take our short-term pain straight up and
clean out the mistakes of our binge and then get back to the business
of free markets without creating an unchecked Executive branch
monstrosity trying to "save" those who profited most from the binge
and harming innocent taxpayers in the process.

What I ask of you my friends on the left is to not only continue to
work with us to oppose this or any similar bailout, but to consider
carefully whether you really want to entrust the same entity who is
the predominant cause of this crisis with the power to attempt to cure
it. New regulatory powers may look like the solution, but that's what
people said when the CRA was passed, or when Fannie and Freddie were
given new mandates. And the very firms who are going to be regulated
will be first in line to determine how those regulations get written
and enforced. You can bet which way that game is going to get rigged.

I know you are tempted to think that the problems with these
regulations are the fault of the individuals doing the regulating. If
only, you think, Obama can win and we can clean out the corrupt
Republicans and put ethical, well-meaning folks in place. Think again.
For one thing, almost every government intervention at the root of
this crisis took place with a Democratic president or a
Democratic-controlled Congress in place. Even when the Republicans
controlled Congress, President Clinton worked around it to change the
rules to allow Fannie and Freddie into the higher-risk loan market. My
point here is not to pin the blame for the current crisis on the
Democrats. That blame goes around equally. My point is that hoping
that having the "right people" in power will avoid these problems is
both naive and historically blind. As much as corporate interests were
relevant, they were aided and abetted, if unintentionally, by
well-meaning attempts by basically good people to do good things.The
problem is that there were a large number of undesirable unintended
consequences, most of which were predictable and predicted. It doesn't
matter which party is captaining the ship: regulations come with
unintended consequences and will always tend to be captured by the
private interests with the most at stake. And history is full of cases
where those with a moral or ideological agenda find themselves in
political fellowship with those whose material interests are on the
line, even if the two groups are usually on opposite sides. This is
the famous "Baptists and Bootleggers" phenomenon.

If you've made it this far, I am most grateful. Whether or not you
accept the whole argument I've laid out here, I do ask one thing of
you: the story I told at the start of the role of government
intervention in this mess is true, whatever your grander conclusions
about the causes and cures are. Even if you don't buy my argument that
more regulation isn't the cure, to blame this mess on "the free
market" should now strike you as an obvious falsehood and I would
hope, in the spirit of fair play, that you would stop making that
claim as you speak and write about the ongoing events of the last two
weeks. We can disagree in good faith about what to do next, and we can
disagree in good faith about the degree to which government
intervention caused the problems, but blaming a non-existent free
market for a crisis that clearly was to some extent the result of
government's extensive interventions in that market is unfair. So if I
have persuaded you of nothing else, I hope deeply that I have
persuaded you of that.

In the end, all I can ask of you is that you continue to think this
through. Explaining this crisis by greed won't get you far as greed,
like gravity, is a constant in our world. Explaining it as a failure
of free markets faces the obvious truth that these markets were far
from free of government. Consider that you may be mistaken. Consider
that perhaps government intervention, not free markets, caused
profit-seekers to undertake activities that harmed the economy.
Consider that government intervention might have led banks and other
organizations to take on risks that they never should have. Consider
that government central banks are the only organizations capable of
fueling this fire with excess credit. And consider that various
regulations might have forced banks into bad loans and artificially
pushed up home prices. Lastly, consider that private sector actors are
quite happy to support such intervention and regulation because it is
profitable.

Those of us who support free markets are not your enemies right now.
The real problem here is the marriage of corporate and state power.
That is the corporatism we both oppose. I ask of you only that you
consider whether such corporatism isn't the real cause of this mess
and that therefore you reconsider whether free markets are the cause
and whether increased regulation is the solution.

Thanks for reading.

Steve

http://myslu.stlawu.edu/~shorwitz/open_letter.htm

F.A. Hayek’s Dreaming of Swatantra

Dreaming of Swatantra

Modern India's only stab at a successful liberal party started in
August 1959; the Swatantra Party would have entered its 50th year this
month, if it had survived as a national political force

Cafe Economics | Niranjan Rajadhyaksha

Nobel laureate Amartya Sen — who is not a free-market liberal — has
spoken on how contemporary India needs a right-wing political party
that is both secular and committed to an open economy. This is a good
time to go back to the issue, for two reasons. First, we have seen how
economic reforms were blocked by the Left to begin with and have now
been hijacked by the crony capitalism of the Samajwadi Party. Second,
modern India's only stab at a successful liberal party started in
August 1959; the Swatantra Party would have entered its 50th year this
month, if it had survived as a national political force.

Countries with low levels of trust and high levels of corruption tend
to be more wary of free market capitalism Fifteen years of high
growth, thanks to economic reforms, should have created a strong
political base for liberal party. It hasn't. I am often surprised at
how even people who have benefited from economic reforms still believe
that the government should control prices to beat inflation or that
companies are making too much profit at the cost of society. Is it any
wonder that no party is ready to face the electorate with a free
market agenda?

The interesting question is why this happens. The answer involves more
than political failure. The nature of Indian society and capitalism
are also part of the answer.

An interesting new research paper by Philippe Aghion of Harvard
University, Yann Algan of the Paris School of Economics, Pierre Cahuc
of the Ecole Polytechnique and Andrei Schleifer of Harvard University
offers one set of clues. They have mapped the relationship between
demands for regulation in a country and the level of distrust between
its citizens.

What these four economists show from their study of rich nations is
that people ask for more government regulation when they do not trust
their fellow citizens. They have used a concept that has attracted a
lot of attention over the past decade and more — social capital. Any
economy needs physical capital (tools), financial capital (money) and
human capital (skills) to grow. It also needs social capital (trust).
Economist Kenneth Arrow once said that virtually "every commercial
transaction has within itself an element of trust, certainly any
transaction conducted over a period of time. It can be plausibly
argued that much of economic backwardness in the world can be
explained by the lack of mutual confidence."

Aghion and his three fellow authors show in their July paper,
Regulation and Distrust, that countries with low levels of trust in
other persons, companies and political institutions are more likely to
have more regulations on economic activity. But this regulation leads
to low growth and corruption, as we know from our own experience of
the licence permit raj. "What is perhaps most interesting about this
finding…is that distrust generates demand for regulation even when
people realize that the government is corrupt and ineffective; they
prefer state control to unbridled production by uncivil firms," say
the economists.

The way companies earn profits does affect the popularity of
capitalism. In a paper published in 2006, Rafael Di Tella of Harvard
Business School and Robert MacCulloch of Imperial College ask: Why
Doesn't Capitalism Flow to Poor Countries? They say the most important
factor is corruption, which cuts into the "moral legitimacy of
capitalism". Di Tella and MacCulloch add: "Existence of corrupt
entrepreneurs hurts good entrepreneurs by reducing the general appeal
of capitalism."

These two pieces of research show that the popularity of a free market
political party will depend on both the level of trust in a country
and whether profits come from competitive markets or oligopolies
protected by the state.

Economic historian Douglass C. North and his colleagues have given us
what they call a conceptual framework to interpret human history. They
say that societies emerge as "limited access orders". Here, the
political system is used to limit economic participation and impose
social order. The lack of economic competition leads to excess profits
that are used to limit violence and maintain political stability.

North says that some societies later evolve into "open access" orders.
Here, there are few restrictions on economic and political
participation, which is another way of saying that these societies
have open economies and open political systems. Order is maintained
through the competitive process.

There is a famous story about Margaret Thatcher. Soon after she became
head of the Conservative Party in the UK, she is said to have reached
into her briefcase and pulled out a copy of F.A. Hayek's Constitution
of Liberty, a book that explains with great clarity why liberal
systems lead to freedom and prosperity. Interrupting the speaker, she
is said to have banged the book down on the table and said: "This is
what we believe."

Is there any Indian politician who has similar convictions — and the
guts to make them public?

Your comments are welcome at cafeeconomics@livemint.com
http://www.livemint.com/2008/08/13000901/Dreaming-of-Swatantra.html

Aleksandr Solzhenitsyn Is Dead at 89

Aleksandr Solzhenitsyn Is Dead at 89

http://www.nytimes.com/aponline/arts/AP-Obit-Solzhenistyn.html?_r=2&hp&oref=slogin&oref=slogin

MOSCOW (AP) -- Aleksandr Solzhenitsyn, the Nobel Prize-winning author
whose books chronicled the horrors of the Soviet gulag system, has
died of heart failure, his son said Monday. He was 89.

Stepan Solzhenitsyn told The Associated Press his father died late
Sunday, but declined further comment.

Solzhenitsyn's unflinching accounts of torment and survival in the
Soviet Union's slave labor camps riveted his countrymen, whose secret
history he exposed. They earned him 20 years of bitter exile, but
international renown.

And they inspired millions, perhaps, with the knowledge that one
person's courage and integrity could, in the end, defeat the
totalitarian machinery of an empire.

Beginning with the 1962 short novel "One Day in the Life of Ivan
Denisovich," Solzhenitsyn devoted himself to describing what he called
the human "meat grinder" that had caught him along with millions of
other Soviet citizens: capricious arrests, often for trifling and
seemingly absurd reasons, followed by sentences to slave labor camps
where cold, starvation and punishing work crushed inmates physically
and spiritually.

His "Gulag Archipelago" trilogy of the 1970s shocked readers by
describing the savagery of the Soviet state under the dictator Josef
Stalin. It helped erase lingering sympathy for the Soviet Union among
many leftist intellectuals, especially in Europe.

But his account of that secret system of prison camps was also
inspiring in its description of how one person -- Solzhenitsyn himself
-- survived, physically and spiritually, in a penal system of
soul-crushing hardship and injustice.

The West offered him shelter and accolades. But Solzhenitsyn's refusal
to bend despite enormous pressure, perhaps, also gave him the courage
to criticize Western culture for what he considered its weakness and
decadence.

http://en.wikipedia.org/wiki/Aleksandr_Solzhenitsyn

Mao's "Cultural Revolution" - Real facts

http://members.fortunecity.com/stalinmao/China/Cultural/Cultural.html

The Cultural Revolution was launched by Chinese Communist Party
chairman Mao Zedong during his last decade in power (1966-76) to
renew the spirit of the Chinese revolution. Fearing that China would
develop along the lines of the Soviet model and concerned about his
own place in history, Mao threw China's cities into turmoil in a
monumental effort to reverse the historic processes underway.

During the early 1960s, tensions with the Soviet Union convinced Mao
that the Russian revolution had gone astray, which in turn made him
fear that China would follow the same path. Programs carried out by
his colleagues to bring China out of the economic depression caused by
the Great Leap Forward made Mao doubt their revolutionary commitment
and also resent his own diminished role. He especially feared urban
social stratification in a society as traditionally elitist as China.
Mao thus ultimately adopted four goals for the Cultural Revolution:
to replace his designated successors with leaders more faithful to his
current thinking; to rectify the Chinese Communist Party; to provide
China's youths with a revolutionary experience; and to achieve some
specific policy changes so as to make the educational, health care,
and cultural systems less elitist. He initially pursued these goals
through a massive mobilization of the country's urban youths. They
were organized into groups called the Red Guards, and Mao ordered the
party and the army not to suppress the movement.

Mao also put together a coalition of associates to help him carry out the
Cultural Revolution. His wife, Jiang Qing, brought in a group of
radical intellectuals to rule the cultural realm. Defense Minister Lin
Biao made certain that the military remained Maoist. Mao's longtime
assistant, Chen Boda, worked with security men Kang Sheng and Wang
Dongxing to carry out Mao's directives concerning ideology and
security. Premier Zhou Enlai played an essential role in keeping the
country running, even during periods of extraordinary chaos. Yet there
were
conflicts among these associates, and the history of the Cultural
Revolution reflects these conflicts almost as much as it reflects
Mao's own initiatives.

Mao formally launched the Cultural Revolution at the Eleventh Plenum of the
Eighth Central Committee in August 1966. He shut down China's schools,
and during the following months he encouraged Red Guards to attack all
traditional values and "bourgeois" things and to test party officials
by publicly criticizing them. Mao believed that this measure would be
beneficial both for the young people and for the party cadres that
they attacked.

The movement quickly escalated; many elderly people and intellectuals were
not only verbally attacked but were physically abused. Many died. The
Red Guards splintered into zealous rival factions, each purporting to
be the true representative of Maoist thought. Mao's own personality
cult, encouraged so as to provide momentum to the movement, assumed
religious proportions. The resulting anarchy, terror, and paralysis
completely disrupted the urban
economy. Industrial production for 1968 dipped 12 percent below that of 1966.

During the earliest part of the Red Guard phase, key Politburo leaders were
removed from power--most notably President Liu Shaoqi, Mao's
designated successor until that time, and Party General Secretary Deng
Xiaoping. In January 1967 the movement began to produce the actual
overthrow of provincial party committees and the first attempts to
construct new political bodies to replace them. In February 1967 many
remaining top party leaders called
for a halt to the Cultural Revolution, but Mao and his more radical
partisans prevailed, and the movement escalated yet again. Indeed, by
the summer of 1967 disorder was widespread; large armed clashes
between factions of Red Guards were occurring throughout urban China.

During 1967 Mao called on the army under Lin Biao to step in on behalf of
the Red Guards. Instead of producing unified support for the radical
youths, this
political-military action resulted in more divisions within the
military. The tensions inherent in the situation surfaced vividly when
Chen Zaidao, a military commander in the city of Wuhan during the
summer of 1967, arrested two key radical party leaders.

In 1968, after the country had been subject to several cycles of radicalism
alternating with relative moderation, Mao decided to rebuild the
Communist Party to gain greater control. The military dispatched
officers and soldiers to take over schools, factories, and government
agencies. The army simultaneously forced millions of urban Red Guards
to move to the rural hinterland to live, thus scattering their forces
and bringing some order to the cities. This particular action
reflected Mao's disillusionment with the Red Guards because of their
inability to overcome their factional differences. Mao's efforts to
end the chaos were given added impetus by the Soviet invasion of
Czechoslovakia in August 1968, which greatly
heightened China's sense of insecurity.

Two months later, the Twelfth Plenum of the Eighth Central Committee met to
call for the convening of a party congress and the rebuilding of the
party apparatus.
>From that point, the issue of who would inherit political power as the Cultural Revolution wound down became the central question of Chinese politics.

When the Ninth Party Congress convened in April 1969, Defense Minister Lin
Biao was officially designated as Mao's successor, and the military
tightened its grip on the entire society. Both the Party Central
Committee and the revamped Communist Party were dominated by military
men. Lin took advantage of Sino-Soviet border clashes in the spring of
1969 to declare martial law and further used his position to rid
himself of some potential rivals to the succession. Several leaders
who had been purged during 1966-68 died under the martial law
regimen of 1969, and many others suffered severely during this period.

Lin quickly encountered opposition. Mao himself was wary of a successor who
seemed to want to assume power too quickly, and he began to maneuver
against Lin. Premier Zhou Enlai joined forces with Mao in this effort,
as possibly did Mao's wife Jiang Qing. Mao's assistant Chen Boda,
however, decided to support Lin's cause. Thus, despite many measures
taken in 1970-71 to return order and normalcy to Chinese society,
increasingly severe strains
were splitting the top ranks of leadership.

These strains first surfaced at a party plenum in the summer of 1970.
Shortly thereafter Mao began a campaign to criticize Chen Boda as a
warning to Lin. Chen disappeared from public in August 1970. Matters
came to a head in September 1971 when Lin himself was killed in what
the Chinese asserted was an attempt to flee to the Soviet Union after
an abortive assassination plot against Mao. Virtually the entire
Chinese high military command was
purged in the weeks following Lin's death.

Lin's demise had a profoundly disillusioning effect on many people who had
supported Mao during the Cultural Revolution. Lin had been the high
priest of the Mao cult, and millions had gone through tortuous
struggles to elevate this chosen successor to power and throw out his
"revisionist" challengers. They had in this quest attacked and
tortured respected teachers, abused elderly citizens, humiliated old
revolutionaries, and, in many cases, battled former friends in bloody
confrontations. The sordid details of Lin's purported assassination
plot and subsequent flight cast all this in the light of traditional,
unprincipled
power struggles, and vast numbers of Chinese people began to feel that
they simply had been manipulated for personal political purposes.

Initially, Premier Zhou Enlai benefited the most from Lin's death, and from
late 1971 through mid-1973 Zhou tried to nudge China back toward
stability. He encouraged a revival of the educational system and
brought back into office a number of people who had been cast out.
China began again to increase its trade and other links with the
outside world, and the economy continued the forward momentum that had
begun to build in 1969. Mao personally approved these general moves
but remained wary lest they call into question the basic
value of having launched the Cultural Revolution in the first place.

During 1972, however, Mao suffered a serious stroke, and Zhou learned that
he had a fatal malignancy. These events highlighted the continued
uncertainty over the succession. In early 1973 Zhou and Mao brought
back to power Deng Xiaoping. Zhou hoped to groom him to be Mao's
successor. Deng, however, had been the second most important purge
victim at the hands of the radicals during the Cultural Revolution.
His reemergence made Jiang Qing and her followers desperate to firmly
establish a more radical path.

>From mid-1973 until Mao's death in September 1976, Chinese politics shifted
back and forth between Jiang Qing and those who supported her (notably
Wang Hongwen, Zhang Chunqiao, and Yao Wenyuan, who with Jiang Qing
were later dubbed the Gang of Four,) and the Zhou-Deng group. The
former favoured ideology, political mobilization, class struggle,
anti-intellectualism, egalitarianism, and xenophobia, while the latter
promoted economic growth, stability, educational progress, and a
pragmatic foreign policy. Mao tried unsuccessfully to maintain a
balance between these two forces while he struggled to find a
successor who would embody his preferred combination of each.

From mid-1973 until mid-1974 the radicals were ascendant; they whipped up a
campaign that used criticism of Lin Biao and of Confucius as a thinly
veiled vehicle for attacking Zhou and his policies. By July 1974,
however, the resulting economic decline and increasing chaos made Mao
shift back toward Zhou and Deng. With Zhou hospitalized, Deng assumed
increasing power from the summer of 1974 through the late fall of
1975, when the radicals finally convinced Mao that Deng's policies
would lead eventually to a repudiation of the Cultural
Revolution and of Mao himself. Mao then sanctioned criticism of these
policies by means of wall posters (ta-tzu-pao), which had become a
favoured method of propaganda for the radicals. Zhou died in January
1976, and Deng was formally purged (with Mao's backing) in April. Only
Mao's death in September and the purge of the Gang of Four by a
coalition of political, police, and military leaders in October 1976
paved the way for Deng's subsequent reemergence in
1977.

Although the Cultural Revolution largely bypassed the vast majority of the
people who lived in rural areas, it had serious consequences for China
as a whole. In the short run, of course, the political instability and
the constant shifts in economic policy produced slower economic growth
and a decline in the capacity of the government to deliver goods and
services. Officials at all levels of the political system learned that
future shifts in policy would jeopardize those who had aggressively
implemented previous policy. The result was bureaucratic
timidity. In addition, with the death of Mao and the end of the
Cultural Revolution (the Cultural Revolution was officially ended by
the Eleventh Party Congress in August 1977, but it in fact concluded
with Mao's death and the purge of the Gang of Four in the fall of
1976), nearly three million party members and countless wrongfully
purged citizens awaited reinstatement. Bold measures were taken in the
late 1970s to confront these immediate problems, but the Cultural
Revolution left a legacy that continued to trouble China.

There existed, for example, a severe generation gap; individuals who
experienced the Cultural Revolution while in their teens and early
twenties were denied an education and taught to redress grievances by
taking to the streets. Post-Cultural Revolution policies--which
stressed education and initiative over radical revolutionary
fervour--left little room for these millions of people to have
productive careers. Indeed, the fundamental damage to all
aspects of the educational system itself took several decades to repair.

Another serious problem was the corruption within the party and government.
Both the fears engendered by the Cultural Revolution and the scarcity
of goods that
accompanied it forced people to fall back on traditional personal
relationships and on bribery and other forms of persuasion to
accomplish their goals. Concomitantly, the Cultural Revolution brought
about general disillusionment with the party leadership and the system
itself as millions of urban Chinese witnessed the obvious power plays
that took place under the name of political principle in the early and
mid-1970s. The post-Mao repudiation of both the objectives
and the consequences of the Cultural Revolution made many people turn
away from politics altogether.

Among the people themselves, there remained bitter factionalism, as those
who opposed each other during the Cultural Revolution often shared the
same work unit and would do so for their entire careers.

Perhaps never before in human history has a political leader unleashed such
massive forces against the system that he created. The resulting
damage to that system was profound, and the goals that Mao sought to
achieve ultimately remained elusive.

http://members.fortunecity.com/stalinmao/China/Cultural/Cultural.html

Excess speculation or excess money?

Excess speculation or excess money?
By Swaminathan S. Anklesaria Aiyar

From ancient times, Indian rulers have always blamed inflation on the
perfidious bania. That is happening globally today. Politicians
everywhere are blaming speculators for high inflation.

Actually, inflation occurs when too much money chases too few goods.
Today, no great shortfall in goods is evident. World oil production is
rising, though slowly. Mineral and metal production is up. The FAO
predicts a record global harvest in 2008.

But the world has long been awash in money. The US kept interest rates
at just 1% for years after the 2001 recession. This encouraged
Americans to spend more than they earned, creating a huge US trade
deficit and corresponding trade surpluses in China and other Third
World exporters. Initially, this flood of dollars lifted all global
boats — world GDP grew at record rates in 2004-08. Inflation was kept
down by rising productivity, and by outsourcing manufacturing and
services respectively to low-wage centres in China and India.

Money supply expanded fast in Third World countries too (including
India). This was partly because central banks bought up dollars in
forex markets rather than let their currencies appreciate.

Alas, a flood of money cannot for long lift production alone. Soon it
starts raising prices. First the excess money raised housing prices,
and everybody was happy. Then it raised stock market prices, and
people were very happy. Finally, the flood of money raised consumer
prices, and suddenly people are very unhappy.

When world growth is so high that spending outpaces commodity
production, commodity prices will rise to signal that growth needs to
slow down. But this is politically unpalatable. Slower growth hits
jobs and incomes. Rather than permit this, governments everywhere try
to stimulate the economy with even more money.

The US Fed has not only slashed interest rates to 2% but provided
hundreds of billions of dollars to the stricken financial sector to
help it escape the consequences of its excesses. This new dollar flood
has worsened inflation.

World commodity prices have shot up in the last two years, spilling
over into higher consumer prices. Politicians globally are looking for
culprits, and finding them in speculators. Hundreds of billions of
dollars have gone in recent years into two investment areas. First,
purchases in forward commodity markets — contracts for delivery of
commodities at specified future dates. Second, commodity index funds —
mutual funds that mimic the price of a group of commodities by buying
and selling futures. Such funds have attracted $240 billion in recent
times.

Has this sent commodity prices skyrocketing? Very doubtful. Yes,
investors are buying forward contracts worth billions. But for every
buyer of contracts, hoping for rising prices, there has to be a
seller, hoping for falling prices. Speculation is necessarily a
two-way street. Besides, every contract expires and is settled at the
due date, so such speculation is self-terminating.

Forward trading is mostly paper trading, and must not be mistaken for
hoarding. World commodity stocks today are generally low by historical
standards. Massive forward trading has not translated into hoarding.

Academic studies have long attempted to find whether forward trading
causes a rise in current prices. No clear link has ever been
established. Price manipulation is possible in thin, weakly regulated
markets. It is not evident in big commodity markets. The US has just
enacted legislation limiting the size and financing of forward trades
in oil. Past experience suggests this will have a marginal impact at
best.

There is hardly any forward trading in iron ore, yet its price is up
76-95% in new contracts. By contrast, huge forward trading in sugar
has left world prices low. Nickel futures are down from a peak of
$60,000/tonne last year to just $22,000. Wheat futures once spiked to
$13/bushel but are now down to $9/bushel. There is no clear link
between forward trading and skyrocketing prices.

When the interest rate is lower than the inflation rate — economists
call this a negative real interest rate — money supply is definitely
excessive. India, the US and many other countries have negative real
interest rates today. A recent Merrill Lynch study suggests that a 1%
fall in the real interest rate increases commodity prices by 17% in 10
months. If this is even partially true, the main culprits have been
not speculators but governments printing excess money. Worse, this
excess money was often used to subsidise oil prices, stoking demand
further.

Today, at last, governments across the globe are reluctantly reducing
oil subsidies and starting to fight inflation through a monetary
squeeze, even if it means slowing growth. Squeezing money in India
alone will produce only limited results. For good results, central
bankers of the world should get together for coordinated action. But
no such initiative is in sight.

Politicians are quick to take the credit when the economy does well,
and to blame others when things go wrong. They must take the
responsibility for bad as well as good policies. Banias may be quick
to grasp the inflationary potential of bad policies, and profit from
it. But the root cause of rising prices lies elsewhere.

http://www.swaminomics.org/