Was the Mortgage Crisis Proof of Capitalistic Greed?

Posted by Jason | Posted in Economics, Government | Posted on 06-10-2009


In my last post, I mentioned that I would address the mortgage crisis separately,  because it was a little more difficult to explain. As shown in my previous blog, Capitalism has nothing to do with greed, but that doesn’t answer why the mortgage crisis happened. Most people have heard that it was caused by Wall Street’s greed.

I’m not going to argue that Wall Street took advantage of the situation, but one has to ask was the home owners being “greedy” when they bought homes that were way out of their price range? Everyone involved in the mortgage crisis, including Wall Street, mortgage brokers, real estate agents, and home buyers would have to be considered greedy. That would include a large chunk of our society. So are we to believe that we are all greedy individuals, and that Socialism would have prevented this? Why would we not still be greedy under Socialism and look to take advantage of that system in anyway we can?

The reason is we are not greedy. Under normal circumstances in the Capitalistic system, all parties to an economic transaction act rationally in their self interest. There are only two circumstances that could change this. One, fraud, which was mentioned in my previous post and would have to be committed by one of the parties. Again, this isn’t a Capitalism issue. This is criminality committed by one of the parties actions. That would not be different under another system. The other is outside intervention.

So who could intervene in these transactions and have an effect on millions and millions of individual transactions. There is only two sources that can cause massive irrationality on a massive scale. One is the Government, and the other is the Federal Reserve, which is a private institution that holds the power over our monetary system. In this instance, the vast majority of the blame lays at the Federal Reserve.

In most of the play by plays of why this crisis happened, the media has been focusing on Wall Street, mortgage backed securities, CDOs, etc. The question is if this was Wall Street’s doing, why did they just start doing this now? Why wouldn’t they have done this in the past?

To find out how the Federal Reserve instigated this crisis, we have to go back to before the crisis began. The problem is you get into this crisis begot this crisis and that crisis begot that crisis, so I could end up taking us back to the founding of the Federal Reserve. To make it more simple, let’s start in 1998.

In 1998, the Asian markets had a crisis, and there was concern that it would cause a world wide crisis. As usual the Federal Reserve stepped in and flooded the market with money to head off the crisis. So, where did this money go? In the late 90s, I’m sure we all recall the tech bubble. The money found it’s way into the stock market propping up then completely worthless stocks. Eventually, this came to a head with the bursting of the DotCom bubble and the recession of 2001.

In order to ease the recession of 2001, which really had a lot of the same traits as The Great Depression, the Federal Reserve again stepped in and began a massive growth of the money supply. Interest rates were dropped to 40 year lows. Interest rates are the means the Federal Reserve uses to manipulate the market, and to manipulate interest rates, they increase or decrease the money supply (This is simplified explanation for my monetary theorist friends out there).

So again, we are back to the same type of circumstance we had in the late 90s. This time though, we learned our lesson not to invest in the stock market on worthless stocks. What can we invest in that has real value. Oh, I know. How about real estate? So money has to flow somewhere. In this case, it flowed into real estate.

“OK”, you say, “that explains where all the money came from, but that doesn’t explain why Wall Street and the home buyers were greedy. Why did the home owner buy something they couldn’t afford and why did Wall Street take advantage?”

In every business transaction, risk is weighed against return. Returns are adjusted for inflation. So, for example if I’m going to look at in investment, let’s say lending money, I’m going to look at the interest rate. So, I’m going to charge 6% interest. Now, what is the cost of the money I’m going to lend. The Federal Reserve took the Funds rate, which is what is used by banks, from 6.5% in May of 2000 to 1% in June of 2003. That is a huge difference, and that is a lot of new money. So now, if you are a bank, you can borrow at 1% and lend out at 6%. That is a 5% spread. That is a very nice return for banks. But, the calculation isn’t complete. The calculation doesn’t take into account inflation. If inflation is 3%, you are really borrowing money at 3% from the bank, and the bank is borrowing it at -2%. How many times have you heard the term free money in the past decade? As you can see, the home owner is getting almost 0% financing and the banks are borrowing at blow 0%. The banks are paying back the money at lower cost than they got it for. Doesn’t this seem like it would change your rationality a bit?

As you can see, Wall Street did not just willy nilly come up with this mortgage crisis. They were coaxed on by the Federal Reserve. Wall Street is in the business of investments. If you look at your risk and return based on the cost of money that the Federal Reserve put in place, you cannot fault Wall Street. You also cannot fault the home owner. Lastly, you cannot fault Capitalism. Under the circumstances, created by the Federal Reserve, both parties were acting rationally.  The fault of the mortgage crisis lays squarely at the feet of the Federal Reserve.

Now you won’t hear this type of analysis on the news channels. This is too complicated for them to explain. Instead it’s easier just to say Capitalism, greed, or Wall Street is to blame. As with most cases, the media blames the cancer for the patient’s death, when the root cause was the patient’s years of smoking.

Meanwhile, with the uproar created by these allegations, the Federal Government takes more of our freedoms away, and the Federal Reserve is back to printing money again to stave off this crisis. What sector will the next greedy Capitalist be in?

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