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An examination of money and religion a paradox

This is a topic I necessarily had to deal with before closing the series. The financial upheaval which the world has suffered has dealt a body blow to liberty. I could not pass it over with a few general comments. Let me state from the very beginning the paradox of money: The effects of this abuse go further than upsetting the financial equilibrium of market economies and reducing their productive progress. It undermines the whole philosophy of liberty.

If laissez faire has to be suspended in the field of money and credit and if the most important institution for trade, contract, saving and investment cannot be left to be managed by individuals and firms, then what is left of our personal self-government? As David Laidler has recently said on the causes of the Great Recession: More than competing ideas about the proper conduct of counter-cyclical economic policy were at stake here […]. Profound and ideologically loaded questions about the capacity of the market economy to function smoothly without the benefit of constant attention from government, and hence about the appropriate political framework that should underpin macro-economic policy, were also getting renewed attention in 2008.

The Paradox of Money

I must confess that I did not expect the depth of the Great Recession that hit our world from 2008 to 2011 to 2013 for the Eurozone. I discounted the warnings those few economists who said that another Great Depression like that of the thirties was coming.

I thought central banks had the instruments to contain the recession, without having recourse to extraordinary monetary and fiscal measures. There must have been something wrong in my understanding of our financial world when I underrated the danger of the turmoil getting out of hand and paralyzing banks, stock exchanges, Treasuries and firms.

I was not seeing the whole picture.

I am not alone in having failed to foresee what was coming. There was no real attempt to understand what had gone wrong with the financial and indeed economic system as a whole. Government, the primary cause of the financial crisis For more on these topics, see Financial Crisis of 2008an Econlib Resource for college students and teachers. I will now marshal the arguments that lead me to maintain that the present financial crisis was primarily caused by defects of the State.

In my view, it is contrary to fact to say that the Great Recession was due to a failure of the free market. I concur with George Selgin, Larry White, John Allison and other authors who have for many years been charging governments with the same wrong, that of being the principal cause of the Great Recession.

How did we get there? The Fed and other central banks To take a broad and fundamental view of what has happened to our advanced market economies we need to go back some years: The explanation for the setting up of a nationalized central bank was that the financial system of the United States had been subject to excessive volatility and repeated crises, in the absence of a central institution in charge of monetary policy.

The record of the Fed, however, has been dismal, both from the point of view of financial stability and of inflation.

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As to stability, Selgin, Lastrapes and White 2010 find that the record before World War II is much worse than the National Banking System that existed before 1913; and though they see some merit to the performance of the Fed in recent years, I wonder what they think now after the Great Recession.

The task of the Fed was made especially difficult by Congress in 1977: The Fed would always be there to prevent significant market corrections. Greenspan served from mid-1987 to the end of 2006, under four Presidents: Bush, Clinton, and George W. Greenspan then had no qualms about pushing it back to 4. Over the whole period, the Greenspan Fed oversaw a massive though highly irregular increase in the money supply. On his appointment, Bernanke proceeded along the same lines, placing the Federal Funds Rate at a peak of 5.

John Allison is at his most instructive when writing on the destructive effects of inverted yields on banking business. Bernanke held the inverted an examination of money and religion a paradox curve with long term interest rates below short for more than a year, up to January 2008. If you are managing […] a commercial bank […], an inverted yield curve is a disaster. Banks borrow short at lower interest rates and lend long at higher interest rates.

If short term rates are higher than long term rates, banks are faced with negative margins. Allison, page 29 This kind of policy has two effects: Two remarks are pertinent here. The second is that such irregular and volatile moves, coupled with drastic changes in money creation must have been destructive for the economy.

In any case, the ructions started in the United States. Most other issuers of money, with the notable exception of the Central Bank of Canada, to which I have given some attention in my courses, followed suit in pursuing lenient and irregular monetary policies. The European Central Bank is especially interesting, since it issues a currency, the euro, which has tried to stay above politics and to mimic the gold standard: My provisional conclusion at the sight of this sorry spectacle is that, despite all the arguments presented by writers of a monetarist persuasion for an active monetary policy, continuous and systematic intervention by central banks is in the end counterproductive.

Deposit insurance and regulation Another controversial element of the monetary arrangements of the advanced world is the institution of bank deposit insurance. It was started by President Franklin Delano Roosevelt in 1934, after the widespread failure of United States commercial banks in 1931-34.

Its compass has been widened continuously, especially during the current crisis. It has been imitated around the world. This scheme has two negative consequences on the banking sector. The first is that it reduces the perceived need for discrimination by investors as to where to place their money. This allows more adventurous or less scrupulous bankers to solicit funds less wisely than if their clients felt less secure.

This unfair competition often pushes solid banks further up the risk curve than they would like. The second is that all deposit insurance schemes are usually financed by the banking sector itself, so that solid banks have to face an examination of money and religion a paradox cost of guaranteeing the deposits left hanging by failed banks.

This apparent security for investors is enhanced by the belief that financial corporations included in the deposit insurance schemes are overseen by regulators whose task it is to find badly run banks. The general failure of commercial banks around the world shows that in most cases regulation is no guarantee against business failure. Inspectors and regulators usually are civil servants, who are not very savvy about banking business and who tend to be more indulgent in times of boom.

In this crisis, regulation has proved to be pro-cyclical, since new and stricter rules are usually applied in a reactive manner, at the bottom of the cycle: Housing programs The tradition of Congress wanting to foster home ownership as a fulfillment of the American dream has also been replicated in many countries.

The whole crisis started with subprime mortgages being securitized and placed around the world.

  1. They are temporary and volatile because the users of money soon discover ways to minimize this underhand extraction of value by the sovereign issuer.
  2. Thirdly, there are well known ways to prepare for, and put in effect, bankruptcies, and they were simply not considered. Rating Agencies and Mark-to-Market Again in the case of rating agencies, the State is to blame for their malfunction.
  3. This is contrary to the accounting assumption that companies are rated as going concerns. Over the whole period, the Greenspan Fed oversaw a massive though highly irregular increase in the money supply.

A number of measures had been passed to make housing affordable for people who in the end should not have committed to home ownership but been content with renting.

As one can see, the programs go back a long way. The Farm Credit Administration was an insurer of home mortgages. But Fannie Mae started with the purpose of taking middle class mortgages contracted by banks on their books; and Freddie to buy mortgages on the secondary market, pool them, and sell them as a mortgage-backed security to investors on the open market.

So, who started the practice of selling mortgage-backed securities on financial markets? In the beginning these two GSEs pushed commercial banks away from the prime market. Private banks then took to unloading mortgages on those two instead of keeping them on their books. In 1990, Clinton set Fannie and Freddie on the path to grant subprime loans, as part of the effort to make the mortgage market racially fair.

This kind of competition led many commercial banks to follow suit. Interest rates were low, banks had to look for more rewarding investments, and mortgages seemed cheap to prospective homeowners.

An examination of money and religion a paradox

The housing market had been mined by politicians. There was a deadly combination of the constructivist introduction of the euro and politically governed local savings banks.

Half the banking market was made up of savings banks that were credit cooperatives with no shareholders. They were under the direct influence trade unions, political parties, and autonomous or state governments. When the crash came Spain was building 850,000 homes a year for a demand reckoned to have been in the 400 thousands at most. Rating Agencies and Mark-to-Market Again in the case of rating agencies, the State is to blame for their malfunction. If we add to this that they take refuge under the First Amendment of the United States Constitution, whereby their opinions are protected under the freedom of the press, their status constitutes an unwarranted interference with the market, which in the end has blown up in the face of the United States government.

Why the supply of such services cannot be left to the competition of the market is a mystery. I am sure that freedom would supply a better service, especially if the managers of pension funds and other public investment vehicles were made responsible for their investment mistakes, be they based or not on agency ratings.

A further intervention of the SEC changed the mode of compensation of these agencies: This made for dangerous conflicts of interest. European Union legislation in the pipe-line will open credit rating agencies to civil liability for intentional or negligent damages; and, in the framework of a fixed calendar for issuing sovereign ratings, governments will be able to react to a change in their rating before it is made public.

Another rule imposed by the SEC and generally adopted across the stock exchanges of the first world is that of forcing public companies and especially finance corporations to value their assets at their market price at the end of each year.

This is contrary to the accounting assumption that companies are rated as going concerns. It is wrong to impose such a rule, especially in times an examination of money and religion a paradox turmoil when there is no market for those assets and the company intends to keep them to maturity.

I have myself as a company director in a publicly quoted group experienced the unfairness of this rule when there is no price in the market, which caused a destruction of the worth of the group. Too big to fail The question of systemic risk has been the main reason for massive public intervention in financial markets put forward during the crisis.

My first remark is that the excessive size of some financial institutions may be due to mistaken public policies of the kind we have examined above. A financial market without deposit insurance and GSEs and the rest would lead to less risk-taking on the part of private bank directors and officials. The confidence that central banks and governments will save you if you are big enough gives rise to extensive moral hazard. Allison, page 173 The severity of the turmoil can confidently be traced back to the haphazard behavior of the US authorities in the matter of who can be allowed to fail without endangering the world financial system.

Citigroup was saved by the Fed but not Wachovia.

An examination of money and religion a paradox

Lehman would have found a buyer had not Dick Fuld been confident of a last moment rescue. No surprise that such erratic behavior led to a general seizure of financial markets round the world. Thirdly, there are well known ways to prepare for, and put in effect, bankruptcies, and they were simply not considered. Assets do not disappear when their owners fail: One of the welcome reforms made after the crisis is the obligation of large financial institutions to prepare a last will and testament for the possibility of failure.

The reward for running a good business is to have your worst competitors bailed out by the US government and then to have massive new regulations that punish your company for sins it did not commit. Allison, page 130 F.