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July 13, 2019 - Freedomain Radio - Stefan Molyneux
21:16
The Financial Crisis and the Free Market Cure | John A. Allison and Stefan Molyneux
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I was incredibly pleased to have a conversation with John A. Allison, who is the president of Cato, the Cato Institute, which you can find at cato.org, and he is past chairman and CEO of BB&T.
He's written a book called The Financial Crisis and the Free Market Cure.
Hold that up nicely.
Which I would strongly, strongly recommend.
It's a fascinating book to dig into and an engaging and enjoyable writer and I was very pleased to have a conversation with him about his book.
So, one of the things that is, I think, so often misunderstood in the media is the degree to which we don't live within a free market paradigm.
It's like they divide the economy into two parts.
Government, which is generally good, and the free market, which is generally blamed for all the problems that come out of usually government policy.
What are the major areas of the economy that you would really like people to understand don't operate under free market principles?
That's a great point.
We live in what's called a mixed economy in the United States, and the mixture is that government is involved in almost everything from an economic perspective.
However, it varies a lot by industry.
Probably the least regulated industry in the U.S.
is technology, which has done very well right through the financial crisis.
The most regulated industry in the world is financial services.
It's not surprising that the most regulated industry, the least free industry, is the one where we've had the biggest problems in terms of the financial crisis.
And this hyper-regulated industry sits on something which is fundamentally socialist, which is the monetary system, as you point out in 1913, that was nationalized by the government.
It's almost hard to think of a free market economy which is resting on the most common currency, the money, which is controlled by the government.
So what aspects of government control of currency and interest rates do you think had the greatest driving forces to this current economic catastrophe?
It is very important for people to realize that we don't have a private monetary system in the United States.
The Federal Reserve literally owns a monetary system.
There are no private banks.
We used to, before the Federal Reserve, there was a private banking system in the United States.
We had great economic progress when we had private banking.
When you think of financial crisis, if the government owns a monetary system, by definition, it's a government problem.
It's like if interstate highway bridges were falling down, people would say, hey, the government owns the highway, the bridges are falling down, it's the government's fault.
And so risk in the banking system is never created by individual banks.
It's created by policies of the Federal Reserve.
In this case, what led to the financial crisis, the Federal Reserve, under Alan Greenspan, in order to Avoid a minor correction in the early 2000s created what's called negative real interest rates.
That meant you could borrow at less than the inflation rate and you could borrow at much less than the interest appreciation that was happening in real estate.
So the Federal Reserve created a huge incentive for people to over leverage, to over borrow specifically in housing.
And also if you think about it, We had a big bubble in residential real estate.
We built too much real estate.
How can you have a bubble unless the Federal Reserve provides the money, since they're the only people that can make money in the United States, can create money in the United States.
One of the things I thought was a great insight in the book was the degree to which you talk about the excess liquidity in the money supply converted housing from a consumption good into a production good.
I wonder if you could flesh that out a little bit more for people.
Well, what I was trying to say is, if you think of housing, a lot of people want to think of it as production.
You quote, build a house.
But it's not a manufacturing plant.
A manufacturing plant makes goods and services, makes widgets after it's built.
Houses we consume.
We consume a house just like we consume an automobile.
So, through Freddie Mac and Fannie Mae, combined with the Federal Reserve's policies, and the affordable lending policies in general for subprime lending, We incented people to build too many houses, buy too many houses, build too big of houses, and that is really inciting excess consumption.
And when you excessively consume, you reduce your ability to produce in the future because you don't have the capital for future production.
A great analogy is a farm analogy.
When you grow a corn crop, if you eat it all, if you don't save any seeds for the future, Then you've reduced your ability to have corn in the future.
In a certain sense, we ate our seed corn by building too many houses, which are consumption, when we should have been saving for real investment and raised our standard of living in the long term.
Yeah, of course, one of the most heartbreaking things about studying economics is recognizing the degree to which everything you see is everything else you don't see.
So the fact that we have, or America has, a huge amount of excess housing stock means that it also has a huge deficiency, at least I would argue, in capital investments, in all of the things that would actually drive the economic growth in the future.
They're like tombstones over the factories that could have been.
That is absolutely true.
Yeah, so that's how we are, in fact.
America is, in fact, sort of eating its seed crop by providing conspicuous consumption in the here and now at the expense of the kind of investment that drives future economic growth.
Well, and it's a double whammy in this sense.
At the same time, through things like Social Security and Medicare, we're promising huge future benefits.
At the same time, we're reducing our ability to produce those benefits through economic growth.
Now, John, you may have heard this.
I mean, it's been very rare in the media, but occasionally you might hear something that goes along the lines of this, which is, well, you see, we used to have a very tightly regulated financial system, John.
But the problem is that the government deregulated as a result of pressure from the financial industry, and it is this deregulation, it is in fact the market elements, the expansion of the market elements that has caused all the problems that we're now facing.
What are your thoughts on that?
Well, the statists have done a great job of creating a myth.
And the myth is that the financial crisis was caused by the deregulation of the banking industry, financial services industry, and greed on Wall Street.
Well, here's the fact.
The banking industry was not deregulated under George Bush.
George Bush was not a capitalist.
There was a massive increase in regulation.
There were three major new laws.
The Privacy Act, Sarbanes-Oxley, and the Patriot Act.
These were huge new regulatory impacts on the industry.
The industry was not deregulated.
We were misregulated.
And then secondly, You know, in my 40-year career, there's always been plenty of greed on Wall Street, but there's not one shred of evidence there was any more greed than usual.
That's just kind of a myth that people made up to provide an explanation instead of dealing with the fact that the government incented this misinvestment through housing policies and through subprime lending through Freddie Mac and Fannie Mae, these giant government-sponsored enterprises.
Now, you also point out in the book that a lot of this was driven with the goal of getting some minorities into housing.
Of course, that's the great American dream, the white picket fence and, you know, the quarter acre or whatever it is.
In what way did government policy through preferential loans to minorities help to drive some of the later failures of the mortgage industry?
Well, I think government policy was the primary driver.
It goes back to something called the Community Reinvestment Act, which started in the early 1970s That basically made banks get into the affordable housing i.e.
subprime lending business.
Banks are not designed to do high-risk lending because we're lending other people's money.
But the really big event occurred in 1999 when Bill Clinton, who was president at the time, required Freddie Mac and Fannie Mae, these giant government-sponsored enterprises that would never exist in a free market, to have at least half their loan portfolio in affordable housing.
And the problem with that is the affordable housing market is not that big, the legitimate affordable housing market.
So it's Frannie and Freddie, who could only exist because the government guaranteed their debts, had to reach this affordable housing goal.
They had to buy deeper and deeper and deeper.
They had to make more risky and risky loans.
And because they dominate the mortgage lending business, people don't realize this, but they absolutely dominate the business because the government had been guaranteeing their debts.
And so, as they went deeper and deeper, they sucked the whole industry down in doing more and more affordable housing lending, long past any kind of rational criteria.
And that was driving all house prices, because if you drive up the entry-level house prices, you drive up the next level of house prices, you drive up the next level of house prices.
So this binge lending to people who really didn't have a prayer of paying their loans back, Created the bubble and drove the bubble in the housing market.
Now, one of the things that I think is very powerful in the book and really struck me deeply was when you really, I think, talked about what has been termed in third world countries regime uncertainty.
Of course, the financial industry tends to work with just about the longest range predictions and projections of any industry around.
And facing regime uncertainty, the government not enforcing certain laws, depending on which administration is currently in power, laws either being enforced or not being enforced.
To what degree do you think regime uncertainty is paralyzing the banking structure at the moment?
I think it's a huge issue.
We don't, unfortunately, have rule of law in the United States anymore.
We have rule of regulators.
Congress passes these sound good laws.
The regulators decide what the laws are going to be.
They make the laws with these very broad parameters.
And then when they're under a more conservative president who's not interested in getting too much regulation, they don't regulate very much.
And then when they get a current administration which thinks the government knows all and does all right, the regulations tighten up radically.
So we've had a radical increase in the regulatory environment in the United States on the banking industry, which is making banks less willing To make small business loans in particular.
They've tightened up the lending standards.
In fact, they're the tightest lending standards in my 40-year career.
And of course, the crisis, the financial crisis itself, was largely a result, in the short term, of how poorly the regulators handled the situation.
In other words, we had an economic correction that was necessary, but it didn't need to turn into a crisis.
We had big economic corrections in the early 80s and the early 90s, but neither one of them turned into a crisis.
Now, this was during a Republican president, but the regulators, Bernanke, that headed the Federal Reserve, and Paulson, who was Secretary of Treasury, ruled very arbitrarily.
They decided they were going to let Wachovia, a big bank, fail, and they were going to save Citigroup.
They saved Bear Stearns.
They let Lehman Brothers fail.
There was no rule of law, and businesses, banks in particular, can't Decide how to make decisions or what kind of risk to take when there's just this arbitrary process going on.
So they took what was a difficult situation where we were going to have an economic correction and turned it into a panic because of how arbitrary their decisions were.
There was no logical reason in the decision process and no consistency.
Yeah, it sort of always reminded me of the scene in Atlas Shrugged where Ayn Rand describes the aristocracy of pull.
It's no longer merit.
It's no longer pleasing customers.
It's no longer discipline.
It's no longer honesty or integrity.
It's who you know and how much influence you have in Washington.
And if you're outside that particular inner circle, then what are you supposed to do?
I guess just cross your fingers and hope you can worm your way in.
But it's a long way from, I think, honest business.
Very true.
In fact, one of the things that helped precipitate the actual panic When Lehman Brothers failed, Lehman, everyone on Wall Street knew, was much more important than Bear Stearns, and the government had saved Bear Stearns.
That was a mistake.
They shouldn't have saved him, but they had saved him, so the assumption was that they would save Lehman.
They chose not to save Lehman, and the belief on Wall Street, fair or unfair, was that Lehman wasn't saved, not for economic reasons, but because Paulson, who was Secretary of the Treasury, hated Lehman.
He had run Goldman Sachs, And Lehman wouldn't help Goldman Sachs get bailed out on a previous problem, what's called a long-term capital crisis, and so he hated Lehman.
And there was a strong belief in the market that he let Lehman fail because he didn't like him.
And if you've got somebody in that powerful position who's making decisions based on who he likes and who he doesn't like, how can you do anything but panic?
Because there's no predictability.
You're right.
It's the whim of the individuals, all under pressure, all with lots of people demanding particular benefits.
It becomes very much random.
It turns from a market to a casino based on political pull.
Right.
Exactly.
At the very deepest level as well, you know, I mean, if people understood the degree to which the government ran money, ran interest rates, ran regulations, ran industries, and ran them randomly sometimes as well and unpredictably, I think that helped them to understand it's a lot closer to fascism than it is to the free market.
But I think you point out in the last part of the book very well the degree to which it's really not about economics fundamentally.
It is fundamentally about our philosophical values which really do seem to be have disintegrated prior to the disintegration of the market.
So what are the fundamental philosophical values that you would really like to sort of send up like a flare into our current cultural landscape to light the way?
You know it's interesting.
I'd really like to restore the principles of the founding fathers as Interpreted after the Industrial Revolution.
Life, liberty, and the pursuit of happiness.
Each individual's fundamental moral right to their own life.
Each individual's fundamental moral right to the pursuit of their own happiness.
Each individual's fundamental right to the product of their labor.
If you produce a lot, you get a lot.
Including the right to give it away to whoever you want to, for whatever reason you want to.
That's what the Founding Fathers envisioned as a free society where people could pursue their personal happiness based on their beliefs, their values, and when they were successful economically, they got the product of that labor to use however they wanted to use it.
And that looks like a very limited government.
It doesn't look like the government micromanaging every area of economic activity and regulating every aspect of our lives.
You know, at Cato, our mission is really to create a free and prosperous society based on the principles of individual liberty, free markets, limited government, and peace.
And we think that's consistent with what the Founding Fathers really intended for the United States.
Yes, the Constitution has problems like slavery and some other big issues, but the idea Of course.
the individual's right to his own life, that he's not appalled to be used for the collective, and that he has the right to pursue his happiness.
Those are very profoundly important ideas and created a great country, and those are the ideas that have died.
We're now dominated by collective.
It's so tragic the degree to which I think that America was an experiment in how small you could make government, and instead it's turned into the oldest historical experiment of all, which is how big can we make government until the whole thing collapses?
It really has gone quite the opposite direction.
But one of the things that I wanted to ask you about, I've made the case a number of times that This is not a recession in that I don't see any particular numbers which are going to indicate how we're going to get out of this.
I mean, I don't know if it's going to be a two decade style Japanese zombie bank situation or whether this is just the new decaying normal.
Do you see any way or any Well, that's a great question.
The truth is the odds are against us.
soon?
Because it seems to me the economic numbers, the continued growth of government, unfunded liabilities, increased regulation, increased regime uncertainty, that this does not seem like this is the new normal, or is there something that can change?
Well, that's a great question.
The truth is the odds are against us.
I don't know what the probability distribution is, but if we continue our current path in 15 to 20 years, it's mathematically certain the United States will go broken.
That's just a fact.
The unfunded liabilities under Social Security, Medicare, Obamacare, unfunded government pension plans, over $120 million.
If we did a balance sheet for the United States government like you do for a business, we'd have a $40 trillion negative net worth and we're losing $2 trillion a year.
Those are stunning numbers.
However, it is at least theoretically fixable And the main driver would be a much more rapid growth rate, along with having the courage to deal with the entitlement program, Social Security and Medicare in particular, having some discipline in those programs.
Driving a faster economic growth rate, ironically, would be easy if we would simply go back to the principles that made America great, which is limited government, radical reduction in regulation, radical reduction in government interference in the marketplace.
The United States is naturally an entrepreneurial society.
We should be driving a 4 or 5 percent compound growth rate in our economy, given the advances in technology on so many fronts.
It's tragic we're not growing as fast as we could.
And it's because of the regulatory environment, the monetary policies, the fiscal policies, all things which reduce the ability of businesses to grow and produce, create unnecessary uncertainty.
But the irony is we just need to get rid of that kind of stuff.
We don't have to add anything.
We don't have to invent anything.
We just need to get rid of all the balls and chains we put on our economy.
In theory it's fixable.
The real question is whether we've got the courage to fix it.
I read this report the other day that said if regulations had stayed the same size or with the same amount of complexity as they did in 1948, we would have, America would have a GDP of over 53 trillion dollars instead of 15 and change.
And that's the kind of gap that I want people to see.
The lost opportunities.
We don't have to have this sclerotic half zombie life economy.
We could have something incredibly vibrant and growing.
I mean, imagine if America had a GDP of over 50 trillion dollars, there would be no involuntary poverty.
We would have enough money to fund anything we could imagine.
I don't mean through the government, I just mean through charity and through having such an excess amount of income.
And that's kind of the vision that I think is tough to sell to people, because for a lot of people it's hard to see what isn't already there.
Yeah, they don't understand.
I've seen that in my career.
When I joined BB&T, it was 1971.
And the increase in regulatory cost across all industries in my lifetime, in my career, is just stunning.
I mean, on every front, the regulations are four or five times more expensive, more destructive than they were in 1971.
We had plenty of regulations then.
I mean, it's not like there weren't any regulations.
There's been a number of estimates that regulatory cost exceeds taxes for businesses, and I think that's true.
So it's a huge hidden burden on the economy.
Well, think of how many people are entrepreneurs who look at the complexity of the regulatory jungle that they might be plunging themselves into and say, ah, I think I'll just go work for somebody and let them handle it.
There's no question about that.
This is kind of a double thing.
A lot of regulations are contradictory.
In the banking industry, the Privacy Act and the Patriot Act, you literally cannot comply with.
They have absolutely opposite requirements.
So what do you do when you're running a business?
In a certain sense, you're always Not intentionally, but you can't not violate the law.
So they can get you anytime they want to, and they want that because then they can leverage businesses and force them to do anything they want them to do.
Yeah, you can make a business do something without the hassle of going through the legislative process if you can threaten them.
It's sort of how the criminal justice system works.
Just threaten people with hard time and then they'll plead out a soft time and you call it justice.
Anyway.
Right.
Listen, I know I only have you for 20 minutes, which is heartbreaking, but I really do appreciate your time.
It's Cato.org to get to the, you're of course a president of Cato, to get to some fantastic free market information on the web.
And of course, I'll provide a link to the book.
I strongly recommend.
Do you have an audio book of this at the moment?
Yes, there's an audio book of the Financial Crisis Free Morning Care, yes sir.
And you can get electronic copy, you can get electronic e-books too.
Okay, fantastic.
Well, I'll put links to that on the show.
Thank you so, so much for your time and for writing the book, which is engagingly and well written.
I always try to remind people who write about kind of dry topics, you and Tom Woods and some other, Jeff Tucker and some other writers have real flair for communicating information in a very enjoyable way.
So I really want to thank you for that.
And thank you so much for your time today, John.
Thank you.
Thank you very much.
Have a great day.
Take care.
You too.
Bye.
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