In a great article on Reason.com, the view that the Fed caused our current crisis is highlighted in great detail. While the article focuses on the anti-Fed movement in general, you can see from the quotes and understanding of politicians and economists that the Fed is responsible for the housing boom.

Blame-the-Fed sentiment now stretches across the spectrum of economic thought, from Keynesians such as DeLong to monetarists (who generally want the bank to maintain a fixed rate of money supply growth). In October 2008, the monetarist Anna Schwartz, co-author with Milton Friedman of one of the most important books of monetary economics, A Monetary History of the United States, told The Wall Street Journal: “If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object.”

While Anna Schwartz believes the Fed is neccessary, she admits that the Fed’s expansive monetary policy causes a boom in an asset market, the most recent being the housing market. The last one being the tech bubble.

Even the Obama administration has gotten into the act. “Monetary policy around the world was too loose too long,” Treasury Secretary Tim Geithner told PBS interviewer Charlie Rose in March. “And that created this just huge boom in asset prices, money chasing risk. People trying to get a higher return. That was just overwhelmingly powerful.”

Even Geithner, although he doesn’t blame Greenspan and the Fed directly, basically said the Fed’s low interest rate policies caused the spike in housing prices and encouraged the risk that politicians now blame on greed. Did Geithner forget he was on TV?

In this time of political ferment, Stephen Axilrod, a longtime Federal Reserve staff director and monetary policy guru, has issued a memoir from MIT Press titled Inside the Fed. Axilrod admits that Fed interest rate actions precipitated the crisis without letting that fact dent either his admiration for the institution or his belief in its necessity. Still, Axilrod notes something that should encourage Fed skeptics of all varieties: that “a country’s monetary policy is almost necessarily limited by conditions generated from the political, philosophic, and social ethos of the time.”

Here former Federal Reserve, and lover of the Fed, admits the Fed’s actions caused the housing bubble. He then says the Fed is only as powerful as political, philosophical, and social conditions permit.

But the Fed doesn’t have a stellar track record of timing monetary shifts with scientific precision, and any actions that rein in inflation, thereby cutting off the short-term stimulative effect that governments love, are bound to be politically dangerous both to the Fed and to the president who appoints its overseers. As Bernanke admitted at his televised town hall meeting in July, the Fed can maintain its independence only if it can “show that we are producing good results,” and while he added lip service to independence, the people he must show those results to are Congress and the administration. Though he was appointed to a new four-year term in August, if he flubs inflation, Bernanke will be facing a whole new wave of political attacks.

Bernanke states here that the Fed must show results to Congress and the Administration, which highlights the biggest problem with the Fed. While we have plenty of confirmation that the Fed caused the housing bubble, we still have politicians that want it to exsit. Why?

Because they want the Fed to, as Bernanke said, “produce good results.” What are good results? Was all Americans owning a home a good result? Was refinancing your equity away to drive up consumer spending a good result? Was as Austrian economist show, driving up unwarranted business investments a good result?

This is at the heart of the problem for any government institution. While the Fed claims its independence, it is swayed by politics.  The market delivers based what billions and billions of individual transactions say. It is fine tuned by every transaction made. Government on the other hand tries anticipating what the market needs, and it is always wrong. This is why communism was an abject failure. Government cannot conceive of the circumstances and motivations of billions of transactions. There is no difference in the ability of communist dictators trying to decide the right amount of light bulbs to be produced, and the Fed trying to decide what interest rates should be. Both of them are trying to decide for the market what they believe should be over what would normally be decided by millions of individuals acting in their own interest.  It has never worked, and it will never work. It eventually led to the collapse of the Soviet Union. Now let’s hope it leads to tearing down the wall of the Fed.

Since the mortgage crisis began, the left has used the repeal of the Glass-Steagall act as a battering ram to break down the pro-free market argument. The left, the media and even some conservative politicians claim it was not having enough regulation that caused the mortgage crisis and ultimately the economic melt down that we are currently experiencing.

This really is a silly argument on its face. How does removing an act, which separates commercial and investment banking, cause risky behavior? Causation is what the statists are claiming. This would be like saying removing a guard rail is what caused me to drive off the road and into a tree. I’m sure we can all agree, it wasn’t the guard rail. It was my reckless driving. Similarly, it wasn’t the removal of the Glass-Steagall act that caused the current mess, it was the risky behavior. But, why was there risky behavior? Why would I drive off the road and hit a tree? Something must influence these actions.

In the case of driving off the road and hitting the tree, maybe I was drinking, or maybe the speed limit sign said 100mph. Both of these influences would be considered the the causes, would they not? Also, by the standard of the left, removal of the guard rail would cause every driver to drive recklessly and hit the tree. If all drivers fly off the road and hit the tree, surely there must be something that causes them to do so. It would have to be a 100mph sign heading into a blind bend, or maybe a mandatory rest stop where all must fill up on liqueur before heading back down the road. Either way, both would cause the reckless behavior.

Similarly, in the mortgage crisis, something influenced the behavior of the entire market. Bankers didn’t wake up one day and say, “Hey, let’s be really risky.” Bankers were enticed into being risky by the government. The government encouraged the risky behavior with artificially low interest rates by the Fed and legislation (ie. regulation) by congress that was trying to promote so called affordable housing. “Everyone should own a home” was the mantra of the past decade.

First, the government and community organizing groups through their power of controlling and influencing how banks operate forced the banks to lend to borrowers that would otherwise be deemed risky. This was not just the left. The Bush administration jumped on board with similar pushes. Fannie Mae and Freddie Mac’s purpose was to push affordable housing, and they are the ones who basically establish the market in which bankers operate. Who do you think created the mortgage backed security instrument of which this monster was created?

Second, another part of the Glass-Steagall act that everyone forgets, but which everyone loves is the establishment of the FDIC. While it may seem like an excellent idea, how does saying, “Don’t worry. If you fail, the government will bail out your depositors.” effect behavior. Would that not increase risky behavior, knowing that you cannot harm the customers? Doesn’t that make customers less critical of who they deal with for their banking knowing that they have nothing to lose?

Third, the Federal Reserve artificially lowered interest rates to a historic low, reaching a negative real interest rate. In order to lower the interest rate, the Fed increase the money supply and encourages the banks to push out that money via loans. The whole point of this is to cause an expansion in the economy. Well, we got an expansion alright. As, Thomas Sowell says, “You can open the flood gates, but you can’t control where the water goes.” In this case, the water went into real estate. One could argue that the government did control the water somewhat with their push for affordable housing and their everyone should own a home legislation.

Another problem for the statists argument is if the guard rail of the Glass-Steagall act was still there, would we have still had a meltdown? While I cannot prove something that didn’t occur, one only need to look at the last meltdown with the dot com bubble. That was also Fed induced with money flooding the market. With the Glass-Steagall act in place, the money was forced into another sector, and we still had a meltdown. One can say it was not as big of a meltdown as our current one. The problem there though is the argument is just a matter of proportion. We didn’t have the historic low interest rates in the last meltdown and we didn’t have government passing legislation saying, “Everyone should own dot com stocks”.

Now we could get into the consequences of our entire banking structure and the problems with fractional reserve banking, but that would require too long of a post, and it would probably take me into deeper waters than I’m prepared to swim. The point of this post is to demonstrate that the anti-free market crowd doesn’t seem to understand causation. You can’t hold the free market accountable for something it did not create. Removal of the Glass-Steagall act was not the cause, just like removal of a guard rail doesn’t cause the driver to hit the tree. It both cases, it is outside influences, and in our current meltdown causation lies with the government.

Apparently, one of the tweeps I was debating on Twitter was so hot and bothered by my blog, he thought he would set me straight. The problem for him is when debating, feelings don’t count and distortions are against the rules. Here is the criticism with my response and corrections interspersed.

The other day I had an interesting back and forth on Twitter about healthcare. The debate was whether to let the free market have its way or whether the Federal government should have a stronger hand in a “Medicare Part E” plan for everyone. At the end of the discussion I was pointed to an article on Jason’s The Proud Profiteer website entitled Health Care Reform – The red herring of the pre-existing condition. I read every word of the article and have some thoughts about the free market as it exists today and where I think the author is wrong about where we should go.

Wow, the author couldn’t even get out of the first paragraph without showing the weakness of his argument. Saying “some thoughts about the free market as it exists today” shows the the author doesn’t understand the free market. I was not arguing for the status quo. I was arguing the problem with the current health care isn’t a lack of government meddling but too much government. The government currently accounts for 50% of all health care spending. If government was the solutions, we would have already seen improvements. The fact that health care costs have risen above inflation since the government inserted itself into the market shows the government actually makes the problem worse. It also proves that the problem isn’t the free market. The problem is you don’t have a free market. As soon as you introduce government coercion, you no longer have a free market. It is no different than if the government took away you freedom of speech. You technically are still free, but you are less free than you were.

I’m all for freedom and principles in this country. The author is correct in pointing out that the country was founded on the freedom and the need to get away from tyranny, taxes and religious persecution. Now the drumbeat throughout certain people in this country is that free markets and freedom will be the pill that will cure the country’s ills. Just get government out of the way of everything but defense and we will be a better place for it. Make it “small enough to drown in a bathtub,” to coin a phrase used by one of our most memorable politicians.

One of the ways we applied these principles was to allow mortgage companies, insurance giants and auto makers to, as the author says it, be free to succeed or fail. They’re good at what they do, so why not turn them loose to thrive and then we can all benefit at their success. So how do you explain the story of Goldman Sachs, AIG and the Freddie/Fannie debacles? Weren’t these companies free to pursue their own fortunes? And what would’ve happened if they were allowed to just fail? I guess those that would’ve allowed the complete meltdown wouldn’t mind what is happening in their free market 401(k).

Surely, this part had to be a joke. The author, if he has any understanding of the free market, would not have used the examples above to discredit the free market. The entire mortgage crisis was created and encouraged by the very government that the author claims is the solution. The artificially low interest rates by the Fed spurred on by affordable housing legislation and pressures caused the bubble, and it was only a matter of time before it burst. While the author may think he had me nailed here, people that know me, know that I predicted this bubble was going to go down very soon at the height of the housing bubble. The thing is if you understand economics, you can recognize business growth from bullshit.  This disaster was the culprit for the so called failed examples above. Freddie and Fannie are government sponsored agencies for pete’s sake. They are told what to do by the government and they are the ones who invented the securitization of mortgages that the evil banks were selling.

“But we should still get out of the health insurance company’ way,” you say. “Once they have complete freedom they’ll offer a virtual cornucopia of health insurance options that every thirst will be slaked. You’ll see that there will be lots of companies and options.” If you Google health insurance company monopoly, you will quickly discover that for several years large companies have had a lock on providing health care for people. If we get out of the way, what do the Blues, Aetna and the rest do? Do they allow rigorous competition and thousands of new companies to spring up? I think they either buy up those companies to stifle competition or squash them. I was told in the Twitter conversation that we should force these companies to compete with each other. So which is it – get out of their way with no regulation or force them to compete?

Hmm, not sure who said you have to force competition. It sure wasn’t me. My whole point in my post was that force is the evil. The role of the government is to prevent force from being used by one person against another. If you are tying in another conversation you had, don’t credit it to me. As far as your argument, again you are talking about a market that is not free. Companies cannot acquire a monopoly and stifle competition unless they have government backing, or they are the absolute best at what they do. If they are a monopoly because they are the best at what they do, then we all benefit.

The fact that health care and insurance are so heavily regulated now is what prevents many competitors. What you don’t seem to realize is regulation equals costs. When you have extensive regulation the costs get so high that they are a barrier to entry and only the big boys can afford to play the game. Don’t blame the free market for lack of competition. Your argument is easily disproved by looking at less regulated industries, such as the IT industry. The less regulation you have the more innovation, the more competition, and the quicker you see costs driven down.

If government is our own worst enemy as the author’s comments point out, why not just get rid of everything? Courts – who needs them? You’ve gotta beef with someone, handle it yourself and if you don’t get anywhere, kick the person’s ass or kill them. If one of those purely good companies make a product that turns out to seriously injure or kill people and you’re one of the poor schmucks that gets hurt or killed, tough luck bud. Like I just said, take a truck of Anthro and fuel and have at it.

Police and fire – we don’t need them, right? I’m sure there’s a security company that would be glad to give you your own security detail cause it’ll “fill a need.” Don’t have enough money to hire a security agency? Deal with it. There’s lots of crime victims out there. Go find the turkey yourself and dispense justice.  The 911 system is a socialist, government run system – get rid of that too. You’re having a heart attack, stroke? Get someone to put you in their car and drive you to the doctor. We don’t need no stinkin’ government run ambulances and medical staff. Hire some doctors and paramedics to stand by if you think you’ll need them.

Like you all say, for every need there’s someone to fit the bill at competitive rates, and since we’ll all be SO much more profitable when everyone gets out of free market’s way, we’ll be able to afford all these new things, right?

“But these are all ESSENTIAL government services,” you say. “You can’t take that away!” You know what, here’s where I want you to draw the line. Black & white. Think of all the things that you might need in life. Tell me why you would keep or privatize them. Then tell me why health care is not as important as 911, police, fire & paramedics. Why would you want to keep 911 as a government service but leave health care – the ability to live or die – as a FOR PROFIT endeavor.

Here is where you take my arguments and just completely distort everything. My argument is governments role is to prevent coercion. Now where does that say get rid of the courts? Where do you think government would enforce laws against coercion? Where do you think contract breaches would be adjudicated? Again, you take my argument and add a bunch of your own ridiculous arguments to it. Where did I say handle it yourself, kill people, etc? I’m pretty sure that would be included in the coercion I said the government should prevent, which is the whole point of founding a government. Your argument is very childish.

This police argument is not new. You haven’t had a brilliant brain fart. This is the typical response from socialists. The problem is police are a part of the government role to prevent coercion. What the hell do you think police do? As far as fire, in most communities the fire department is funded by charity. They hold fund raisers, and the fireman are volunteers. Apparently, you think that is socialism? In cities, this could be privatized, and it would probably be cheaper than paying your taxes. It would be no different than paying for security monitoring on your house. I’m not sure if you’ve read a newspaper lately, but there are many “government” services, such as trash collection being privatized. Do you think it’s being privatized because it’s worse?

Lastly, even if you leave these as government roles, which I personally don’t have a problem with, they are not federal programs. Apparently, you don’t seem to recognize the difference between local services provided and agreed upon by local citizens, paid for by their local taxes with Federal entitlement programs.

If you can’t afford heath insurance, Jason says that you’ll have to turn to charity. Leukemia and unemployed – charity. Stroke leaving you the inability to walk, speak or do your job – charity. Born with cerebral palsy or autism and your parents or unemployed/underemployed – charity. Jason, do me a favor, a little experiment. Take you & your son down to a doctor’s office you’ve never been to before. Tell the receptionist that you’re out of work and need your child seen for whatever – you name the illness. After they get done telling you to pay cash or you don’t get seen, take the amount of money the doctors wants you to shell out and start calling some churches. Give them the same story and tell them that you’ll probably need that same amount of money each month since your child might need special ongoing treatment. When you find the charity that’ll dole out that money month after month, let me know. The difference in your opening paragraphs – each of these families you mention probably has at least ONE working member in the household providing pay for health insurance. If I’m wrong, tell me how they’re handling things on charity.

To start, I said in my blogs that you should pay out of pocket for day to day care, and you should buy a low cost catastrophic insurance plan for things, such as the ones mentioned above. The purpose for insurance is to be there for catastrophe. Again, you distort my argument.

Second, I can guarantee you I have way more experience dealing with health care than you do. My son does have cerebral palsy, and while you and Obama discredit doctors as profit seeking devils, I’ve seen first hand the charity of doctors. Doctors don’t go through 8 years of schooling followed by years of residency because of the money. It’s a calling, and they do it to help people. Most of them already do charity. Also, charities already help people every day. You many want to check them out. Most liberals claim to love charity, but it’s usually only the charity from someone else’s pocket via goverment coercion. Who do you think fled down to New Orleans after Katrina? It was the charities on the front lines getting the hard work done, while the government, as usual, stumbled and caused more harm than good.

In addition, my argument talked about charitable donations exploding because of more money remaining in the pockets of citizens. Do you think a rich guy who’s kid died from leukemia, wouldn’t setup a foundation to research and help other parents with children who have leukemia? Where do you think charitable foundations come from? Have you ever heard of Shriners? I’m pretty sure they offer health care and are a charity. How about this report, that charitable donations reached a record in 2007 under the Bush tax cuts. Oh, and that doesn’t even take into account time and labor. You may want to give your fellow man a little more credit.

When I’m buying a car or a toaster, I want free market competition. I want the government to stay out of the way UNLESS what those kind folks are selling is hurting people. When I’m having a heart attack or stroke, I want an ambulance and crew to show up as quickly as possible and save me life! I don’t want to have to think if I paid my premiums that month or that some FOR PROFIT company “with my best interest in mind” will deny me life saving treatment.

How does a publicly traded company, beholden to its stockholders and profits, have my best interest in mind? If I’m a stockholder that’s easy. If you’re a CEO with complete free market freedoms, how do you take care of people with serious medical problems and still make your bottom line? How would Ford survive as a company if most of the vehicle they sold were Pintos or some other high maintenance vehicle? What incentives and marketing schemes would they contrive to make it profitable?

via RIAsults may vary: Health Care Reform – The AIG, Freddie & GM pill. Take two of these and don’t call me in the morning.

You final argument just demonizes businesses. It’s silly to act like business people are evil, and that some how government people are angels. You may want to challenge your assumptions. Government employees and especially politicians have their self interest in mind as well, and it is more often than not detrimental to the public good. Private capital is rewarded by efficiency, which means it addresses the most needs at the least cost. That is why you can buy your toaster so cheap. This does not take place in government. In government, politics and inefficiency are rewarded, resulting in less needs being met.

While I appreciate the time you took to respond and I enjoy the debate, I really wish you would keep your arguments away from your feelings and would not distort my arguments. We are talking about a gigantic issue, and we cannot make this decision on feelings. We have to make it on reason. Just because you get a warm feeling in your belly when you talking about everyone having health care doesn’t make it so. You may want to read my other blogs on health care, where I talk about what the real problems with health care are and why government intervention will only make things worse. Then again, I’m sure that doesn’t feel good.

While I haven’t read this book yet, it will be on my list as soon as I finish Robert’s book, “The Politically Incorrect Guide To Capitalism”, which helps provide a lot of the fire power behind this blog. Although, Robert is a highly regarded economist, he brings the dismal science down to a level that even an average Joe like myself can understand. In this interview, Robert discusses his book on the Great Depression. It highlights the fallacies you’ve been sold by the liberal establishment. Want to know why Obama’s policies are not working? All you have to do is see why FDR’s did not work.  You can also check out Robert’s blog, Free Advice out at http://consultingbyrpm.com/blog/

“The Politically Incorrect Guide™ to the Great Depression and the New Deal”

June 6, 2009

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Everything they say about the Great Depression and the New Deal is wrong.

No economic myth these days is more pernicious than the myth that the free market caused the Great Depression and the New Deal got us out of it. That, as economist Robert P. Murphy points out is flat-out false. In The Politically Incorrect Guide to the Great Depression and the New Deal he provides irrefutable evidence that not only did government interference with the market cause the Great Depression (and our current economic collapse), but Herbert Hoover’s and Franklin Delano Roosevelt’s big government policies afterwards made it much longer and much worse (just as President Barack Obama’s extraordinary expansion of government promises to do today). Perhaps even more compelling, Murphy exposes the untold story behind the New Deal—how it operated by force, and why what’s really at stake is not only our economy but our liberty. The real “lessons of the Great Depression” are not what you’ve been taught.

via Financial Sense Newshour Expert ~ Robert P. Murphy 06.06.2009.

Today, the columnist Thomas Frank of the Wall Street Journal wrote a column in which he basically says modern day conservatives are bizarrely paranoid. From reading his article, he’s talking about those conservatives who believe in capitalism, are against government propaganda, and are against government social engineering. Here’s a snippet of his piece.

Back in Hofstadter’s day this sort of thinking at least had something supremely rational going for it: The existence of the Soviet Union and its desire to bring the West to its knees.

But take that away and the theories become something far more remarkable. Consider, by contrast, the widespread belief that President Barack Obama’s birth certificate was forged. What could have been his parents’ motives for committing such a bizarre deed, or his home state’s motive for colluding in it, or the courts’ motives for overlooking it?

Or consider the widespread conservative conviction that we are being marched secretly into communism or fascism. Why would someone bother? It seems equally likely, given today’s circumstances, that conspirators would trick us into becoming a colony of Belgium or the imperial seat of the Bonaparte family.

The paranoid pattern persists regardless. It is impervious to world events; a blurting of the American subconscious that has not changed since Hofstadter analyzed it 45 years ago. Consider the recent wave of fear that the hypnotic Mr. Obama was planning to indoctrinate schoolchildren. In “The Paranoid Style,” Hofstadter wrote, “Very often the enemy is held to possess some especially effective source of power: he controls the press; . . . he has a new secret for influencing the mind; . . . he is gaining a stranglehold on the educational system.”

via Thomas Frank: From John Birchers to Birthers – WSJ.com.

Let me start off by saying, I agree to some extent on the birth certificate issue. I don’t know whether the issue is valid or not, so I don’t claim that it is. It’s a distraction, and it let’s people like Mr. Frank lump all conservatives together and say they are nuts.

With that said, I do have a problem with the remaining arguments in Mr. Frank’s article. To say that conservatives are claiming we are marching secretly to communism or fascism, and that somehow that is nuts, should highlight how the intellectuals among us are so blinded by their supposed brilliance. Apparently, the government take over of our largest financial, automotive, and soon to be newspaper institutions is of no concern to Mr. Frank. That is just silly talk. So what if the government controls them, and they say what is going to happen in the market place. How is that communism or fascism?

In addition, I think Mr. Frank doesn’t realize that this isn’t a new march. Surely the government permanently impoverishing a large population with welfare and using Medicare and Social Security to induce fear when needed on another large segment of our population could be considered something other than just crazy, paranoia.

I guess, Alexander Hamilton was paranoid when he wrote in the Federalist Papers, “.. that a dangerous ambition more often lurks behind the specious mask of zeal for the rights of the people than under the forbidding appearance of zeal for the firmness and efficiency of goverment. History will teach us that the former has been found a much more certain road to the introduction of despotism than the latter, and that of those men who have overturned the liberties of republics, the greatest number have begun their career by paying an obsequious court to the people, commencing demagogues and ending tyrants” What kind of crazy is Alexander Hamilton warning us about those tenderhearted politicians?

We all know Jefferson was a loony, paranoid, nut case when he said, “A wise and frugal government, which shall leave men free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned – this is the sum of good government.” What a weirdo.

Don’t worry about the government trying to take over the 1/6th of our economy via health care. They would never use your health care to make you behave in a certain way. They would never hold it up at election time to scare people into voting for them. Why would you think that?

Surely, this “paranoia” that Mr. Frank so arrogantly puts down is nothing new. What most people would call skepticism has been with us since our founding. It is what led our country to revolution and then to form our union under a constitution.

As far as the school children, the media may have blew it out of proportion, but that was before the post speech exercise assignment was revised to not make it sound like the student had to do something that the President asked. I think it also went hand and hand with the video from Hollywood asking students to pledge allegiance to the President.  Surely, that’s just a little disturbing is it not? Surely, if this video and this homework assignment was from Bush, Democrats and the left would have rightfully went nuts. Oh wait, but that’s not paranoia. When Bush was in, he only purposefully let a couple thousand  New Orleanians die. Maybe I should go back and read Mr. Frank’s article on those crazy lefties.

Lastly, in part of the article that I don’t have sited here, you can read it at the Journal, Mr. Franks poo-poohs Glenn Beck as the master conspirator. Glenn Beck must be a lunatic questioning the Federal Reserve, oh along with all Austrian economists. Surely, the Federal Reserve had nothing to do with the tech bubble, followed by the housing bubble and who knows what bubble they are creating now.

Mr. Frank’s complete lack of historic and conceptional perspective is an embarrassment for my paper of choice. While, he’s entitled to his opinion, maybe he can keep his head in ground. We’ll pull him back out once we take our country back.

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?