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
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?
Created November 19, 2008. Updated November 7, 2011. Copyright © 2011 The Digerati Life. All Rights Reserved.