Guys, here’s a great video on the free market. Pay particular attention to who the immoral actors were in the mortgage crisis.

By Donald J. Boudreaux Friday, October 16, 2009

Political discourse has more than its share of question-begging words.

For example, ponder the word “fair.”

“Fair” is perhaps the most misused word in all of politics. By definition, everyone this side of masochism and sociopathy favors “fairness.” No one believes that society would be a better place if only it were less fair.

The difficult question, though, is “What is ‘fair’?”

We have little difficulty distinguishing fair from unfair in small settings. If Mom bakes a pie and Junior scarfs down three-quarters of it before any other family members sit down for dessert, that’s unfair of Junior.

If I agree to mow your lawn in exchange for you washing my car and then renege on my part of the bargain after you wash my car, that’s unfair of me.

But distinguishing “fair” from “unfair” in large, complex settings is vastly more difficult than politicians make it seem.

Consider the distribution of income. Is it unfair that some people earn multiple times more dollars — often hundreds of times more dollars — than other people earn?

Seems unfair to many folks. Why should Sal the surgeon take home a salary 50 times larger than the salary taken home by Tony the teacher?

If Sal and Tony were assigned to their jobs by some authority and if that authority pays Sal more than it pays Tony simply because Sal has a more beautiful sister than does Tony, that would be unfair.

But in market economies persons aren’t assigned to jobs. Each of us chooses our career. If Tony chose to become a teacher, that means he chose not to become a physician.

Also in market economies, salaries are determined by impersonal market forces rather than by some authority.

So how can it be unfair that Tony doesn’t earn a salary as high as Sam’s? In a very real sense, he chose not to do so.

Tony’s reasons for choosing a teaching career (and avoiding a career in medicine) might be admirable or understandable. Perhaps Tony loves working with children. Perhaps he relishes having long holiday breaks and summers off. Perhaps he cannot stomach the sight of blood. Perhaps he was put off by the prospect of spending all the extra time in school required to become a physician.

Whatever his reason, he clearly gained — or expected to gain — by making the choice that he made. In Tony’s mind, when all the expected costs and benefits — monetary and nonmonetary — of practicing medicine were weighed against those of teaching, he obviously concluded that teaching offered him the better standard of living.

Of course, it’s true that Tony would have preferred to have all the benefits he gets from teaching — for example, long holiday breaks — and the higher salary paid to a surgeon.

But that option was never on the table — not for Tony, not for Sal, not for anyone.

It’s also true that Tony might come to regret having chosen to become a teacher rather than a surgeon. But so, too, might Sal come to regret his choice to become a surgeon.

Our imperfect capacity for making decisions, or for seeing the future more clearly, is unfortunate, but it’s no source of unfairness.

The bottom line is that looking merely at one aspect of people’s lives — the amount of money they earn — provides far too little information for determining if their lots in life are “fair” or “unfair.” All things considered (and it would be unfair not to consider all things!), Tony’s lower salary as a teacher does not seem unfair when compared to Sal’s higher salary as a surgeon.

Another possibility is that Tony wanted to become a surgeon, but he doesn’t have the brains to get into medical school.

Under these circumstances, we might feel sorry for Tony. But, once again, there’s no unfairness in the picture. No one broke the rules of the game. No one singled Tony out, or singled out the ethnic group to which Tony belongs, to prevent him from becoming a surgeon.

I wanted to play quarterback in the NFL, but I utterly lack the physical requirements for that job. All the desire in the world would never have enabled me to earn my living on the gridiron.

Feel free, if you wish, to pity me. But neither you nor I can find anyone or anything to accuse of being “unfair” toward me.

When politicians thunder about “fairness,” they too often focus on only a handful of facts, selectively chosen to portray eminently fair situations as being unfair. And that’s unfair!

via Fair’s fair — right? – Pittsburgh Tribune-Review.

Today, the Wall Street Journal has an article about the battle being waged between Wal-Mart and Amazon to be the dominate book discounter on the web.

Wal-Mart Stores Inc. launched a brash price war against Amazon.com Inc. on Thursday, saying it would sell 10 hotly anticipated new books for just $10 apiece through its online site, Walmart.com.

That was just the beginning.

Hours later, Amazon matched the $10 price, squaring off in a battle for low-price and e-commerce leadership heading into the crucial holiday shopping season. Wal-Mart soon fired back with a promise to drop its prices to $9 by Friday morning — and made good on that vow by early evening Thursday.

via Wal-Mart, Taking on Amazon, Launches Price War on Books – WSJ.com.

This is how the free market works without government intrusion. Competitors work to gain market share by delivering either a better mouse trap or a cheaper mouse trap. The winners are the ones, who can deliver it cheaper and better, and the consumer who gets to benefit from the competition. There is no market in existence that must be taken out of this type of economic activity in order to better deliver it to the people. This includes health care. Are we to believe if health care was opened up to competition that you wouldn’t have the Wal-Marts of the world stepping in to deliver solutions? Just because it’s health care doesn’t mean it’s market is different.

The truth is the government is not in health care to better deliver a service. It is in the market for control. It wants to decide who gets what advantages, and who get what services. It wants to profit itself from the consumption of health care, and it wants to gain the power from that is derived from controlling access to health care. If you want to see health care flourish for all people and to deliver progressively better and cheaper mouse traps, get the government out of health care. We will all be better off for it.

While doing some research on health care, I found this little nugget on Youtube.

The health care debate has been taken to the next level since Barack Obama’s election. While I completely disagree with his approach to fixing health care, I must say it is a good thing to bring the issue to the forefront and try to come up with some solutions. As mentioned in an early post though, you have to look at the root causes to see what problems you need to actually address.

For those of you who might not have read my previous post, the problem with health care is the third party payer model we use, which blocks price signals from properly stabilizing the supply and demand of goods and services. In other words, we take actions that drive up the demand for more services and products while not increasing the supply of those services and products at the same time. We also add unnecessary costs on top of those services and products that then is passed onto the consumer or the insurance company.  A government take over will not address the issue of increasing demand without rationing of either quantity of services or quality of services. I know, “Hey fella, the Baucus bill doesn’t have a government take over.” The Baucus bill is leading the way to a government take over. It is creating a massive amount of increased cost on individuals, employers and medical companies. Once merged with other bills, we’ll probably end up with a government take over trigger. This is setting up a straw man that is doomed to failure. It shouldn’t be called a trigger but a lit fuse slowly moving to the bomb of government health care. Instead, we should see bills that address these problems with free market solutions.

So, what are the free market solutions? While I don’t claim to have the genius to provide all the solutions, I do believe there are some simple but hard solutions that can be implemented. Free market solutions must address the issue of rising demand that is the result of third party payer and the state of health for average Americans.

To address the third party payer problem, we must look at the biggest provider of health insurance, employers. Employers offering health care benefits was originally used to compete for employees. It quickly evolved into something that was encouraged by the government and expanded by unions. Government encouraged the expansion via the tax code and mandates. With this constant push towards more and more coverage, insurance began to take care of everything a person needs or wants in regard to health, dental, vision, and mental health.  One can quickly see that more and more people demanding ever expanding coverage only has one effect, increased cost of insurance. Then the very nature of insurance, where it takes the end consumer out of the value decision of the purchase, drives up the cost of the actual service or product. This must be addressed by fixing the root cause, which is third party payer of the insurance by the employer and the third party payer of the service or product by the insurance company.

The first step has already been enacted, but needs to be encouraged and sold to the public. Under President Bush, Health Savings Accounts, or HSAs, were passed into law to address the health care crisis. Like every other issue under Bush though, it was never sold to the public. It’s just not as sexy as “free” health care, even though it actually works.  The gist of an HSA is people purchase high deductible, low premium health insurance that would cover expenses after a certain dollar amount. In addition they can put tax free money into their HSA to cover the deductible. When they go for a doctor visit, they write a check to the doctor from their account. Once their deductible has been reached, the insurance company takes over.

The HSA addresses many of the issues that result from the unique insurance model that is used by the health care industry. In no other insurance model, does insurance take care of everyday occurrences. Insurance is to guard a person or organization against risk. The best example is car insurance. We buy car insurance to make sure that we can get our car repaired or paid off if we are in an accident. We also get liability insurance to insure ourselves against a law suite if one is filed by the other party in a vehicle accident. We do not use our car insurance for oil changes, new tires, or even an expensive item like a transmission replacement. These are wear and tear issues that are guaranteed to happen, while accidents are not. If we are responsible, we plan for things that are guaranteed to happen, and we insure against those things that may or may not happen. This model of insurance is why you can get an oil change for under $20, but a new fender for some reason costs thousands. Notice the part of vehicle repair that is paid by insurance is much higher compared to the part that is paid out of pocket. When we pay out of our pocket, we shop around and demand better deals. When insurance pays, we could care less.

For some reason though, with health care, we ignore this model, and we buy health insurance for our human wear and tear. We all know we are going to get sick. We all know we’ll need check ups. If you have kids, you know they will need vaccinations. For these items, we should be planning financially to pay for these. What we should be insuring against are things like cancer, heart attacks, or situations that can lead to hospitalization. With this change, you will see consumers shopping around and demanding better pricing. With this change in behavior, medical companies would have to compete more fiercely for your dollars, which would drive costs down.

While this addresses the third party payer issues from the actual medical purchase side of the issue, it still doesn’t address the third party payer side of the insurance purchase. Just as employers were encouraged to add health benefits via the tax code, they should now be encouraged to get out of the health care business. Businesses waste vast amounts of resources on the shopping, buying, and administering health care insurance for their employees. Does this add to their business production and to the larger production of our country? No it doesn’t. If employers handed the health care insurance purchasing decision to their employees, they would then be able to focus on what they do best, which is grow their businesses. They also would be relieved of a huge (huge really doesn’t do it justice) expense. This massive reduction in expenses would result in more jobs. There is no doubt that the cost of health care insurance has resulted in many companies not hiring that extra person. It’s a return on investment hurdle that is much higher as a result of the extra cost. In addition, the reduction in the cost of doing business would result in lower prices of the goods or services delivered by the company. As Thomas Sowell points out in his blog, Magic Numbers in Politics, prices are interconnected and the reduction in the price of one good filters through the economy and lowers the price of other goods. He uses a great example.

What does that mean? It means that a huge increase in the demand for ice cream can mean higher prices for catchers’ mitts, among other things.

When more cows are needed to produce more milk to make ice cream, then fewer cows will be slaughtered and that means less cowhide available to make baseball gloves. Supply and demand mean that catchers’ mitts are going to cost more.

via Thomas Sowell : Magic Numbers in Politics – Townhall.com.

As you can see, there would be a butterfly effect in the cost of goods in our entire economy. This would unleash business and job growth. “Hold up there buddy,” you say, “ultimately the worker would carry the burden of health insurance.” This is true, but as explained above, insurance is not meant to cover those things that are guaranteed to happen. If workers buy their own insurance, they will make wiser purchase decisions. They will plan for maintenance, and they will insure against the unknown. This will drive down the cost of health care insurance. In a future segment of this blog, I will expand on this more, but for now you can see the effect of this when seen in conjunction with the interconnectedness of prices. Also, the end user making day to day “maintenance” purchases will drive down the cost of those purchases. In May 2008, Watson Wyatt Worldwide released a study that argues that the rising cost of health care insurance is a huge factor of why employee pay has been stagnant for decades. With the removal of health insurance from the employment process, salaries would undoubtedly rise. Salary increases will also be the result of higher competition for employees. Many employees pick a job based on health insurance. With that removed from their decision, they will choose to go where the work and the salaries are better. They will also not be trapped in a job because they can’t afford to lose their insurance. They will have picked their own insurance, and it would not cease in the result of a change in employment status.

In the next segments of this blog on health care solutions, I will address the unique issues of health insurance that make it much more expensive, how our country’s obesity problem is a major factor in rising health care costs, and how the market has already taken steps in the right direction to address the rising costs. As you can see though, removing the market distortion of third party payer would be better for every part of our economy and every participant involved in health care purchasing. As I said in previous posts, when listening to the health care debate, ask yourself how the proposed solution addresses the root causes of rising costs. A government take over does not remove the third party payer issue, it does not increase competition, and it will actually increase costs. With out fierce competition, the only way for costs to be driven down is by mandate. The end result is a reduction in the availability of services and/or the quality of services.

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?

Since the economic down turn began, I have heard countless politicians, media pundits, and average Joes smear, besmirch, and out right lie about Capitalism. These people are either ignorant or liars. I prefer ignorant, so we can still assume the best of our fellow man.

In order to prevent further spreading of this ignorance, I have decided to outline some of the arguments against Capitalism and the truth that is evident as logic presents itself. Over the next few blogs, I will present the reasoning and logic of Capitalism. First let me apologize to my liberal friends. I will not use my feelings to present my argument. As we all know, feelings can be easily manipulated, which is why you don’t base policy on feelings, well, shouldn’t anyways.

So, let’s start with the most rampant accusation against Capitalism. The socialist mantra goes “Capitalism equals greed”, “Capitalism is based on greed”, or “Capitalism is inherently greedy”. Now, where did this belief come from? Capitalism has been a defined economic system since 1776, when Adam Smith published “The Wealth of Nations”.  In the book, Adam Smith puts forth that in the pursuit of our own self-interest, we build a much more prosperous society.  Even though that isn’t our intent, that is what takes place.

It wasn’t until Karl Marx began the Communist revolution that Capitalism became tarred and feathered. Karl Marx invented the term Capitalism as a smear. Now, how do you convince someone to go against their own self interest, which is what Capitalism is by definition. Well, you need to play on peoples emotions, distort the truth, and play on their morals. More recently, the movie “Wall Street” used a ruthless character named Gordon Gekko that said “Greed is Good”. For some reason, this is what people associate with Capitalism.

Let’s walk through this piece by piece. First, greed has to do with morality. Capitalism has nothing to do with morality. You can be an altruistic capitalist, you can be a greedy capitalist, or you can be a regular capitalist. Notice, that you could just as easily substitute the word person with capitalist. That is because greed is an adjective to describe an object, in this case capitalist. The adjective isn’t the object.

Still a system based on everyone pursuing their self interest sounds really selfish. That is only if you are assuming that everyone’s self interest is the same, and that self interest is detrimental to the well being of others.

First, not all our self interest is the same. If everyone’s self interest was becoming rich and famous, we’d have no stay-at-home moms, school teachers, soldiers, etc. Everyone pursues their best interest by going after their dreams or what makes them happy. If you think money will make you happy, you may pursue wealth. You may also decide to stay at home with your kids and give up financial wealth for the emotional wealth of raising your family. As you can see, self interest is not interchangeable with money, wealth, or greed.

The second part of this selfish stigma has to do with people assuming that Capitalism is a zero-sum game, in which one person gains while the other loses. This couldn’t be further from the truth. This is actually what takes place in other economic systems, such as Socialism or Communism. Now, I know you aren’t going to let me off that easy, so let’s walk through an example.

Under Capitalism, I have a need. Let’s say I have the need for a coffee. This is what I currently want to make me happy (self interest). Now, the local Starbucks, by pursuing their self interest of building wealth, has decided to serve coffee. I walk into the local Starbucks, and we exchange my cash (hopefully not credit for a coffee) for their product, coffee. Now, as you can see, this was not a zero-sum transaction. I got what I wanted, and the Starbucks got what it wanted. We both valued the transaction at the exact same value without any outside force.

Ok, ok, that was a simple, but what about Scrooge. He was greedy. Scrooge was greedy, but by pursuing his greed, he creates jobs, innovates new products or services, and … hold on get this… he serves his fellow man. I know. That doesn’t sound selfish. Let me say (well type) this very loudly.

YOU CANNOT CREATE WEALTH AND BECOME RICH WITHOUT SERVING YOUR FELLOW MAN.

It is by this service that we build a better society. “Hold up”, you say. “What about Bernie Madoff, Enron, and this mortgage crises?”

Well, let me take Enron and Madoff first. Capitalism makes no claims that participants are angels. We all know we are all fallible. In order to protect each other from each other’s fallibility, we pass laws. Many of these laws are passed in order to prevent fraud, which is lying in order to take financial advantage of another. In both the case of Enron and Madoff, you had enterprises ran by criminals. This criminality has nothing to do with Capitalism. You would have criminals under any other economic system, because all systems are made up of men. Capitalism will eventually expose the fraud, because you have to continually produce economic value. Fraud does not produce value. Under competing systems, such as Socialism, these criminals can maintain their fraud much longer because Socialism isn’t concerned with economic value. The fraud could be propped by taking resources from another activity that does produce value.

Now, the mortgage crisis is much more difficult, because it did not involve criminality. “See”, you say. “I told you Capitalism was to blame for the mortgage crisis.”

Well, let me just end this blog, and we’ll dig into that accusation in the next blog. Let’s just say, Capitalism assumes people will make rational decisions, but rationality can be changed when outside forces are introduced.