The following debate is a fictional exchange between two people who are discussing the Occupy Wall Street situation as well as the issues that our financial system has been facing in the past decade. It’s a dialogue that brings to light a perspective on the financial crisis which is ignored by mainstream media, but which everyone should consider (based on the Austrian school of economics). It’s a stellar contribution by Alex B., who, like many of us, would like to see changes in the status quo. You may or may not completely agree with the arguments here, but these are points that we should think more deeply about.
End The Fed Guy (ETF Guy): Why are you here?
Occupy Wall Street Guy (OWS Guy): To protest greedy bankers getting rich at our expense.
ETF Guy: What do you think should be done?
OWS Guy: To start, throw the lot in jail.
ETF Guy: Okay. But do you think the next lot will be any less greedy?
OWS Guy: Good point. The real problem is that the banks were deregulated.
ETF Guy: Actually, from 1980 to 2001, Congress passed 4 sets of banking regulations for every act of deregulation. There were 4 bills that increased regulation on financial services for every bill that reduced regulation. And between 2001 and 2008 there were 9 sets of regulations and no deregulation. The banks were not deregulated — they were mis-regulated.
OWS Guy: We need better regulations then!
ETF Guy: Yes, but for better regulations we need better regulators. As we’ve seen, the way the financial markets work can evolve and change: take for instance, the invention of derivatives. So to have a good regulatory system, we need good regulators who can foresee problems and act in advance. Regulations become obsolete. A good regulatory system needs regulators who can stay on top of things.
OWS Guy: Right, and we need regulators who are not buddies with the bankers.
ETF Guy: Agreed. But for a regulator to know what’s going on, they will need to be familiar with Wall Street. Finding qualified outsiders is challenging.
OWS Guy: Challenging, but possible. The problem is that the bankers buy the politicians.
ETF Guy: Okay. What should be done about that?
OWS Guy: Corporations should not be allowed to give money to politicians.
ETF Guy: How do you do that?
OWS Guy: With laws.
ETF Guy: With laws? Money will always find its way to those in power. It flows around laws like water around a rock. As long as politicians have something to sell, there will be ways for people to buy it. It’s the nature of the beast.
OWS Guy: Dude, you’re a downer.
ETF Guy: And I’m not done. Regardless of corruption, political officials are not good regulators because they do not want to tell people what they don’t want to hear. Take derivatives, for example. Before the crash, the derivatives market was allowing the public to buy houses they could not otherwise afford, while giving the appearance that the economy was doing well. Putting the brakes on the derivatives market would have been politically unpopular. Government regulators had the ability to regulate derivatives, and they considered it, but they decided not to. The decision not to regulate derivatives may have been disastrous for the country, but for the regulators themselves, it was a good call. If they had regulated the derivatives, they would have probably lost their jobs because everyone would see the economy “suffer” and no one would ever know that a crisis had been avoided. The regulators kept their jobs by not rocking the boat.
OWS Guy: And then the boat went off a waterfall.
ETF Guy: Right, but did the regulators lose their jobs then? No — people blamed the market. So it’s not surprising that government officials avoid making regulations that people don’t want.
OWS Guy: But people want regulations now!
ETF Guy: Sure, after a crisis they’ll implement regulations. When it’s too late. The real question is: can we expect government regulators to prevent crises, not just react to them? Given that government regulators
a) are outsiders (or “former” insiders)
b) can be bought
c) are incentivized to do only what is popular
and
d) experience no repercussions if they “miss things”
Logic and history tell us No.
OWS Guy: So who should regulate?
ETF Guy: The lenders.
OWS Guy: The lenders?
ETF Guy: Yes. In a free market system, lenders are the “watchdogs of prudence.” Unlike investors, lenders don’t share in a company’s upside. A lender only cares that a company stays solvent so that it can back the loan. If a lender thinks a company is acting recklessly, it will not lend to it, or will at least charge a high interest rate.
OWS Guy: Well that didn’t happen. The investment banks were leveraged to the hilt!
ETF Guy: You’re right. The more they borrowed, the more derivatives they could buy, and the more profits they made. Sure, they risked going bankrupt if the housing bubble burst, but they were so leveraged that only about 5% of the money was theirs. The possibility of losing their 5% equity was well worth the risk relative to the fortunes they were making with the borrowed 95%. The question is: why were the institutional lenders lending to them?
OWS Guy: Maybe they believed that real estate prices would never fall.
ETF Guy: Maybe. But doesn’t that seem unlikely? Sure, people wanted to believe that real estate prices would never go down: home buyers did, because it meant they could buy nicer houses (risking little of their own money), investment bankers did because it meant they could keep getting rich (risking little of their own money), and the politicians did because it made it easier for them to keep their jobs (risking none of their own money). But what about the lenders? The only thing in it for them was a low interest rate. And it was THEIR money. Why would sophisticated institutional lenders risk so much, for so little return, on the fanciful notion that the housing market would never crash?
OWS Guy: Why?
ETF Guy: Because the institutional lenders believed that the U.S. Government would not let the whole thing fall apart. The housing bubble was the government’s baby. Using the Federal Reserve, they kept interest rates low, guaranteed loans to low income buyers, and publicly promoted the stability of the housing market. Furthermore, since 1970, the Fed had set a precedent for bailing out large institutions that became insolvent. So over time, lenders became less wary of large institutions defaulting. Thanks to the history of bail outs, lenders believed it was safe to lend to companies that were “too big to fail.”
OWS Guy: So we should have laws against bail outs!
ETF Guy: But bail outs can take many forms, and it would be impossible to outlaw all the ways that a government might creatively bail people out. And during a crisis, the government finds ways around laws.
OWS Guy: So what do you propose? Clearly, you are going somewhere with this.
ETF Guy: End the Fed.
OWS Guy: Cool. That’s one of our slogans!
ETF Guy: I know. See my sign?
OWS Guy: Yeah, it’s nice. So why end the Fed?
ETF Guy: Because without the Federal Reserve’s ability to create money out of thin air, the government cannot do things like instantly generate trillions of dollars to bail out banks. With no Fed, lenders would not have had a safety net. With their money at risk, they would have been the watchdogs of prudence. The Wall Street shenanigans and the sub-prime ridiculousness would have never gotten off the ground. The lenders — the savvy insiders who have their own money at stake — would have regulated.
OWS Guy: Hmmmm…
ETF Guy: Furthermore, if we ended the Fed, we’d get our interest rates back.
OWS Guy: Get our interest rates back?
ETF Guy: Yes. When determined by the market, low interest rates signal an abundance of savings to borrow from. When interest rates are low, it’s a good time for companies to invest, or for individuals to buy homes, because the underlying wealth is there to support it. High interest rates signal the opposite. Tragically, the Fed replaces the market interest rates with a rate of their choice. They force interest rates to be artificially low, especially before elections, because it encourages spending and makes the economy appear healthy. But it’s an illusion because the underlying wealth is not there. The resulting spending produces “malinvestments”, such as trillions of dollars of houses we couldn’t really afford.
OWS Guy: So the Fed works both sides.
ETF Guy: Exactly! By manipulating interest rates, it tricks investors into bad investments. By bailing out the lenders, it makes the lenders careless about financing bad investments. Yes, it works both sides. And the result is a death spiral.
OWS Guy: But aren’t there things the Fed is good for?
ETF Guy: Sure:
- it lets the government enter wars with no concern for cost.
- it allows for a federal health care system with no budget.
- it increases the gap between the 1% and the 99%
- it …
OWS Guy: Wait. Explain that last one.
ETF Guy: Happy to. The money created by the Fed is lent at low interest rates to politically connected corporations in industries such as banking, military, health, etc. This new money dilutes the current money supply, eventually causing inflation. But it takes time for the inflation to take effect, so the corporations get to use the new money before it loses value. By the time they pay it back, inflation has struck, so they are paying back less than they borrowed. Meanwhile, this same inflation is devastating for the poor and middle class who see their savings or fixed incomes lose value. The inflation caused by the Fed is the government’s most regressive tax.
OWS Guy: You’ve given me something to think about.
ETF Guy: Oh good.
OWS Guy: But could you summarize?
ETF Guy: Sure. The problems we face are not due to a few bankers committing fraud. Nor is the problem “corporate greed” in general. The problem is that there has been a fundamental shift away from capitalism toward crony capitalism. There are 3 ways for companies to make money:
1. Provide a valuable service or good that people happily pay for.
2. Defraud people.
3. Get money from the government.
Capitalism is mostly #1. Crony capitalism is mostly #3. We should encourage #1. We should outlaw #2, as we do. And we should watch #3 like a hawk. Crony capitalism used to be limited by the money that government could raise through taxation or public borrowing. The money was thus limited and easy to track. But then in 1913 came the Federal Reserve, and #3 went off the rails. Now government could create unlimited money without having to ask. The ensuing programs met with public approval because the benefits were immediate and visible, while the costs were hidden and delayed. But now we know the costs. Thanks to the Federal Reserve, our federal government has:
1. Created a corporate safety net that removes the need for lenders to be prudent, thus destroying the market’s ability to regulate itself.
2. Distorted the price signals from interest rates, leading to malinvestment and bubbles.
3. Continued failed programs and wars with little heed to cost.
4. Invisibly taxed the poor and middle-class with inflation.
And while America suffered, the politically connected made out like bandits. I don’t think it was a conspiracy. I think people generally had good intentions. But when you have a system where benefits are visible and costs are obscure, bad things are going to happen. As long as those in power can create money, the negative results will be diverse, unpredictable, and without limit. This problem is too pervasive and too systematic to solve with regulations. Nor can we expect politicians to exert sufficient wisdom and self-restraint to resist the lure of the money printing press. Like it or not, politicians who create money to spend are more likely to be re-elected than those who do not. It is inevitable that the government will find one reason after another to create, and thus take, our money. There is only one way to keep the government from abusing its power to create money:
Remove its power to create money. We must end the Fed.
OWS Guy: Can I see your sign?
ETF Guy: All yours.
More Thoughts On Occupy Wall Street
Yes indeed, so how should we proceed at this point? Perhaps change needs to permeate deeper than it has ever been at the government level in order to restore long term health to our economy and financial industry. Is Occupy Wall Street truly the answer?
In order to bring more attention to these difficult questions, we also bring you thoughts on Occupy Wall Street put forth by other financial publishers and bloggers:
- What is Occupy Wall Street and Should You Care?
- What Do You Think Of Occupy Wall Street?
- Should you “Occupy Wall Street”?
- Infographic: Who Is Occupy Wall Street?
Your turn?
Created November 19, 2008. Updated November 7, 2011. Copyright © 2011 The Digerati Life. All Rights Reserved.
{ 9 comments… read them below or add one }
ETF Guy is a boss in this argument! He deserved to win.
One nice thing about the Fed: it has decreased the volatility of inflation. In the pre-Fed era, deflation was actually a common occurrence.
Not saying that the Fed is the right entity to put in charge of currency – like Hayek proposed, money could be denationalized. Interesting stuff!
I usually really enjoy the posts on here, but I felt that this was your first real entrance into the political sphere and I would recommend against it in the future. I just don’t think this fits with the general theme of the site. If you were trying to introduce people to the different views with respect to the Federal Reserve, why not present a fair, balanced argument for and against it rather than this clearly one sided rant?
There have obviously been some questionable decisions at the Federal Reserve throughout its life, but it has also contributed to some of the best times that our country has seen. Look at the Eurozone and the situation they are currently facing. With no Central Banking power to control the money supply they are completely powerless. Countries are failing and bailouts are happening anyway. Run properly, the Fed is meant to control inflation and unemployment. Sure, you would have a “purer” economy with no Federal Reserve but that also means dealing with the fallout that comes with it.
I honestly don’t know how I feel on the situation and still have a lot of reading to do on the subject before I have a perfectly clear thought process, but stuff like this doesn’t help at all. There are positives and negatives to every story, I urge people to read both sides.
@PKamp3,
Very great reads you’ve presented. I always enjoy Political Calculations, and visit on occasion to get some insight on macroeconomics, especially. We’re of course, talking about some big ideas here, and whether or not they take off, we’ll see. But it’s a hard road ahead to cure the ills of a system that we’ve had forever.
@60th Percent,
Understood. I don’t usually enter into politics (or religion for that matter) on this site, but thought to introduce some ideas here that may be far afield but could be pondered and even dissected. It may seem like a knee jerk idea to “erase the Fed” but it’s clearly not something that would happen that easily and certainly far from quickly. As you mentioned, there are ramifications to any big change. There are also reasons why it’s not the popular option — however, it’s food for thought, especially in light of what’s been occurring with protesters the world over on this particular matter. Something is not working, and we’re prone to addressing the problem with band-aid solutions. Are we going to keep stumbling along down the same road?
I agree that there is so much involved and at stake in implementing change. And sometimes, it’s impossible to say whether even a radical solution is the answer because society/humanity are unpredictable. We don’t know if lenders are ultimately going to be the “true watchdogs of prudence” that we’d expect them to be if indeed there was no or minimal regulation involved. For instance — who’s to say that corruption within the private sectors/lending industry won’t cause inefficiencies and problems in this “pure” system? Can we trust privatization and markets to really function more cleanly? But I’m keeping an open mind to see what possible solutions are out there that can address the current plight of our financial industry. Maybe we need a “modified” Fed — my take here is that the piece is about abolishing the current version of the Fed, not necessarily to get rid of it entirely. But the author can correct me if I’m wrong.
I would disagree about the issue of sidestepping “rants” altogether since I’m all for open discourse and the purpose of this writeup was to hear all sides. You are right — this is one side that has been presented, but it’s there to be picked and panned. We welcome all opinions!
Here is an interesting video on how and why the gap between the rich and poor grows. Not everyone realizes that it’s built into our money/debt/credit system:
Personally, I’m uncomfortable with radical/extreme changes and usually prefer to take the middle road on many things — and you’ll see it reflected on my site. There is risk in change, and it can be massive. Even in my household, there is debate on these issues and how they should be approached. But we do agree on one thing — that we wouldn’t want to witness a repeat of the financial crisis (the way things stand, are we just a few bailouts away from imminent financial collapse?). Occupy Wall Street is after more regulation and “End The Fed” is for less regulation. Where do you stand? With what’s going on in developed nations right now, we need to be aware of the underlying issues.
I’ve also always advocated personal responsibility as much as possible. We provide financial tools and information to share through this site, but in order to use these tools, there needs to be financial accountability and responsibility. Piling on debt without knowing how to use a credit card is not responsible — repeating this across millions of households and we can see how our financial health can be in jeopardy.
Everything was on point. I just wish that the article didn’t make it sound like The Fed harms just the poor and middle class. The Fed harms the rich class outsiders too. Otherwise a strong article, major weakness is that is makes it sound like the rich class do not need to have “skin” in the game which is so far from the truth. Rich people lose more savings during hikes in inflation. Doesn’t everyone agree with that?
Great points. The current financial system needs to be reworked, but it’s a hard road. I’m from the camp that believes that we have to actually bite the bullet so things don’t get worse. So far, we are taking our medicine in small bits and this does not seem to be making much difference.
I agree that we’re all in the same bucket and we’ve all been taken down a very large notch — all classes included. The problem with a financial crisis — and the one we recently experienced — is that everyone pays and the hurt is shared across the board, while some are let off easier than others.
Hi, I’m the author of the post …
@PKamp3,
Thanks for the nice comment and link. I guess I’d rather have a volatile system where deflation balances inflation instead of a system where inflation smoothly goes up and up and up. Everyone nowadays thinks deflation is this really bad thing, but what is so bad about our money being worth more? Yes, deflation encourages people to save instead of spend. But despite what the Keynesian media and politicians want us to believe, saving is not always a bad thing. And thanks for bringing up Hayek – I love the idea of competing currencies!
@60th Percent,
My post was definitely a bold way for The Digerati Life to enter the political sphere! But I think SVB did a good job introducing it as the opinion piece that it is.
I’m curious as to how the Fed has contributed to the best times our country has seen.
As for Eurozone, they do have a central bank. Without the European Central Bank, it is unlikely that so much money would have been unwisely loaned to countries like Greece and Italy. Hence their crisis.
I agree that if the Fed was “run properly”, things would not be so bad. But a major point of my article is that it is not reasonable to expect the government to run it properly – because they are concerned about short term benefits more than long term costs. The fact that it is theoretically possible for something to be run properly does not make it a good idea if history shows that it is never actually run properly. Every time in history that a government has given itself the ability to arbitrarly control the money supply, it has driven the value of the currency to 0. Every time.
L.M.,
Completely agree. The Fed hurts everyone that is not politically connected, the rich included. Given that the focus of OWS is on the 99%, though, I thought I’d keep my focus there as well.
Thanks for the comments!
BTW, to get an Austrian economic perspective on various topics, I recommend listening to the EconTalk podcasts by Russ Roberts. They are conversational, informative, and usually easy to follow. They are at econtalk.org. Here’s the podcast which is most relevant to this post; it’s where Prof. Roberts distills what he learned from many prior podcast conversations regarding the financial crisis.
Also, I should say that I am not advocating ending the Fed overnight. According to Ron Paul, who has been trying to warn about the Fed for years, the first step is to Audit the Fed because most of what they do is in secret. Then we should have a national discussion about what our alternatives are.
Thanks Alex! This is really great information. I’ve mentioned EconTalk podcasts before, since it was something the “Digerati Spouse” recommended to me sometime ago to check out. Definitely a great place to learn more at the macroeconomic level.