Monday, October 13, 2008

US Debt 3: Crisis of Irresponsibility

The ongoing economic turmoil in the US and the rest of the world has been termed a “credit crisis,” a “financial meltdown,” a “market free fall,” and even worse, a “crisis of capitalism.” The use of the latter phrase is implying that the current economic woes could be the beginning of the “end of capitalism,” and the rise of what? Rise of socialism, or Hugo Chavezm, or other forms of statism?

For lack of a more apt term to describe the ongoing financial troubles in major economies around the world, this writer would rather use the term “crisis of irresponsibility.” Here are some reasons why.

One, borrower irresponsibility. There is general acceptance, if not consensus, that the immediate cause of the current global financial trouble was the widespread default of sub-prime borrowers in the US for the houses they bought. People who have small or no stable income were allowed to buy houses whose price are much higher than what those borrowers could really afford to pay if some explicit or implicit subsidies were absent. The immediate symptom showed up in July 2007 after Wall Street investors started pulling out their money after learning those huge sub-prime homeowners’ loan default.

Two, lender irresponsibility. Anticipating continued “housing price bubble,” the lenders – developers, commercial banks, mortgage houses, investment banks, insurance companies – lent even to sub-prime borrowers, people who have questionable capacity to pay those high-priced houses, and charged them higher interest rates.

Three, housing policy irresponsibility. When a government policy forces banks to give out bad loans, then more bad loans will be given away. Eamonn Buttler in his article, “Blame bad rules, not capitalism”, wrote “(On) 12 October 1977, US President Jimmy Carter signed the ‘anti-redlining’ law. Before then, lenders generally denied loans to people in poor neighborhoods. But the politicians – with good intent – wanted to make home ownership available to all Americans. So lenders were forced into giving out risky mortgages: what we now call ‘sub-prime’ loans.”

And four, plain BIG government irresponsibility. Making a bad public policy even bigger and worse. For instance, after the “anti-redlining law,” semi-governmental companies Freddie and Fannie made investors believe that the bad mortgages they made were guaranteed by government, creating a “moral hazards” problem wherein complacency can be rewarded with bailout, not penalized with bankruptcy.

Now, the public in the US and around the world is bombarded with “more government financial regulations please” mantra. Really? But the US government cannot even properly discipline itself, generating hundreds of billions of dollars of budget deficit every year (at least $480 billion by end-2008, for instance). And worse, the Federal government is facing an estimated $56 trillion debt.

In a commentary, “America's $53 trillion debt problem,” David Walker wrote: “The nation's real tab amounted to $53 trillion as of the end of the last fiscal year (September 30, 2007). That was the sum of our public debt; accrued civilian and military retirement benefits; unfunded, promised Social Security and Medicare benefits; and other financial obligations… The rescue package and other bailout efforts for Fannie Mae, Freddie Mac, AIG and the auto industry, escalating operating deficits, compounding interest and other factors are likely to boost the tab to $56 trillion or more by the end of this calendar year.”

The US' gross domestic output (GDP) in a year is about $14 trillion. The cumulative debt of the federal government alone will be about 4x of GDP! GDP is the combined production of goods and services by the federal, local and state governments, private corporations and households.

So, can an institution that can irresponsibly accumulate various debts amounting to 4x of GDP, be the "bright guys" to provide “leadership” in regulating further all corporations, earning or misbehaving, private corporations? This does not look good.

From one big government intervention (encouraging or forcing sub-prime and risky loans and fiscal irresponsibility) to another xx billion dollars for Fannie and Freddie, $85B for AIG, and the enacted $700 billion bailout or “rescue package,” and higher future taxes to pay past and current bailouts and borrowings), there seems to be no logical conclusion or timetable for the never ending big government intervention and taxation.

US capitalism needs the current "electric shock" to deliver real hard lesson for both the American capitalists and the American government. Private enterprises should be allowed to grow big or go bankrupt – without government intervention. The job of the government is to ensure the rule of law, that parties honor their obligations and contracts with other parties, and that robbers, killers and other criminals along the way are neutralized.

The US stockmarket and the rest of the economy have so far shed several trillion dollars of losses and failures because their debt culture (federal debt + local and state governments debt + corporations and household debt) has bloated the economy by trillions of dollars. The bubble should pop, the excesses should be removed, and irresponsibility (personal, corporate and government) should be checked and controlled.

Failing big business should not marry big government. But it is happening now, nonetheless. The Treasury Department, the Fed, the White House and Capitol Hill think that to "solve" previous and current government failures, even bigger government intervention, regulation, borrowings and taxation should be introduced

Plenty of news stories these days say that many American households are cutting back on their consumptions except the necessities – food, health care, education, etc. – which means Americans feel they are poorer now, or they anticipate they will be poorer in the coming days. How can they be made to feel "richer"?

One option is a large-scale income tax cut. Allow them to keep more of their monthly or annual income, let them spend the "de facto" wage increase. Someone's spending is somebody else's income. But all the above US government agencies can think of are retain, if not increase in the future, current high income taxes – to finance more government spending, more bailouts, and possibly, more printing of money. The few tax cut measures in the multi-billion bailout was more of a “sweetener” so that more Republican legislators will support the huge bailout bill.

The author of the book, “In Defense of Global Capitalism”, Mr. Johan Norberg, has some good arguments on why the “more government financial regulations please” mantra is wrong. In his paper, “Regulators cannot avert next crisis”, he wrote: “Every crisis has led to thousands of new pages of regulation. Why is it that regulation doesn't stop crises from happening again? Look no further than the US federal institutions in Washington, DC, and we find 12,113 individuals working full time to regulate the financial markets. What did they do with the powers they had?.. So we get new rules that target the mistakes that everybody already knows they must avoid. The next possible crisis and its causes are so far unknown, and our regulations may have no effect or even make them worse...”

To sum up, is the current “crisis of irresponsibility” leading to continuation or death of irresponsibility?

Based on the above discussions and ongoing global development, the answer seems to point to a continuation, if not expansion, of irresponsibility. But as mentioned earlier, a crisis is short-lived and will not drag for a long time. There is a $56 trillion debt somewhere, and that’s for the US federal government debt alone. Not included there are several trillion dollars debt by US local and state governments, plus trillion dollars more by other central governments of other rich countries (Europe and Japan).

So there should be more crisis ahead in the coming years. But one really big crisis out there will definitely be resolved in favor of death of irresponsibility, especially of big government irresponsibility that encourages, directly or indirectly, personal and corporate irresponsibility. When people around the world assume more personal and parental responsibilities in running their own lives, their own households and communities, and expect less “government responsibility”, then societies will be headed to a new world order and ultimately, world peace.

Greed and Responsibility

Can greed be good, both for the individual and society?

I think Yes, if it is coupled by personal responsibility and not causing harm to other people in the process of being greedy.

Example. A person salivates at the prospect that the price of the 2nd house that he is about to buy will double, if not triple, within one or two years. So he moved to buy that house by recalling his investments elsewhere, took a loan of only 30 percent or nothing, to buy that house cash. He never robbed or kidnapped for ransom anyone to get additional money. From plain pure savings and borrowings with earnest desire to pay the loan.

This still falls under "greed", right? Greed with personal responsibility.

Another variation is greed with personal irresponsibility.

A person who has no money even for a downpayment, or has enough income for his current consumptions and amortization payment, but took another mortgage with zero or very little personal equity for a high-priced 2nd house with the same salivating desire to make big money after a year or two. This is a very risky practice with some harm to other people happening if that person will default on his loan.

The current financial woes in the US and elsewhere is a result not too much of greed per se, but of greed + debt culture. Living beyond one's means, living on borrowed money, living on an illusion of big money in the future that may or may not materialize. There is lot of personal irresponsibility involved.

With this view, the current situation therefore, is good. It is a self-correcting mechanism by the market. Those with bloated assets suddenly experience their assets shrink, if not become bankrupt. As my favorite finance whiz kid Gina would say, "the market will correct itself with or without government intervention."

People with bleeding hearts for corporate failures simply don't get it.
Capitalism without failure is like religion without sin.
Or like Christianity without hell.

The sins of the past will haunt the sinner today, or in the future.
Once the sin has been atoned or "paid" and corrected, life will go on.

Incidentally, there's a good article from the IHT today, "Debt is whittling away US economic power",

The debt culture will catch up on America. It has caught up now, but not entirely. There's more debt and bubbles down the carpet and bed of the US government, both federal and state/local government, than currently admitted.

With the current bail-outs and planned ownership stakes in a number of private banks, the US government's debt is changing from bad to worse. Applaud more borrowings and more regulations!

* See also
US Debt 1: How Bloated is the US Govt? May 08, 2006
US Debt 2: Private Sector Bailout of Government, September 26, 2008

No comments: