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July 14, 2019 - Freedomain Radio - Stefan Molyneux
20:34
House, MD - The Real Cause of the Current Financial Crisis
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Hi everybody, it's Stefan Molyne from Freedomain Radio.
This is House, MD, Diagnosing the Financial Crisis, a presentation from Freedomain Radio at freedomainradio.com.
Alright, what happened here?
There are a couple of basic facts to understand before we look at the causes of the real estate crisis in particular and the resulting cascade in financial crisis.
So, the year 2000-plus, housing prices rose enormously.
This actually started in the late 90s.
Second quarter, 2006, housing prices take a steep decline.
Not too surprisingly, the next quarter, mortgage default rates shoot up by mid-2007.
The financial system, which had invested heavily in securitized mortgages, in other words, mortgages which had been converted to buy-sell financial instruments, they all began to To collapse.
Foreign economic systems, which had bought highly risky mortgages as repackaged, financial securities began to experience unprecedented losses, and of course the inevitable government bailouts, subsidies, nationalizations, etc.
began to occur.
So let's have a look at our usual starting place, the data.
Real U.S. Housing Price Index, 1890 to 2007.
You can see here the enormous increase that occurred in the mid-90s.
Let me just take the mouse here.
It went right up to nutty, nutty levels and then, of course, declined enormously and was quite a bit different from any time other than the catastrophic losses that occurred in the 20s and 30s.
Decline, sorry, decline.
Lower housing price is not bad if you can afford it.
So what's other data? The yearly real home prices, starting in 1987 here on the left, goes up a little, down, and then 1997 begins to rise, rise, rise, rise, rise, doubles.
Oh, we peak around 2005 and then we go down 2006-2007.
Yearly home ownership rates from 1970 to 2007.
Here we can see that it was hovering around 64%, 63%, 65% until the mid-90s when it began to increase enormously.
And we'll sort of look at the reasons for that in a sec.
Last but not least, foreclosures started, trundled along fairly average percentage of houses, 0.3%, 0.4%, and then went up to almost 1%, Q4, 07.
Huge rise starting from end of 2005, beginning of 2006.
So, mortgage failures.
So, well, these failures, these mortgage failures, these foreclosures, occurred in a strong economy, and before housing prices had fallen significantly.
So, what was going on? These foreclosures occurred at the same time and at the same pace in both the prime and the subprime mortgage markets.
So, you'll always hear that it is a subprime mortgage crisis.
This is not statistically true.
The foreclosure rates occur at the same pace in both the prime and subcrime mortgage markets.
The increased foreclosures lowered the value of mortgage-based securities, which were, quote, insured, both explicitly and implicitly.
And this brought government-sponsored enterprises like Fannie Mae, Freddie Mac, to the point of bankruptcy.
So that's the quick view.
Now, of course, all you will hear about, for the most part, is that it's a market failure.
In other words, that something is wrong with the free market, as Sarkovsky said, the French premier said.
It's over for laissez-faire.
The free market is the problem.
It's a market failure. It's the greed of Wall Street.
It's the greed of the capitalists that has brought this.
It is irresponsible.
It is Gordon Gekko-like, and we need stern mommy-daddy regulator to come in and whip things into shape and get these kids into the naughty corner and all this sort of nonsense.
Now, of course, if freedom is considered to be the problem, the cause of these disasters, regulation, coercion, government, violence, and so on, will be seen as the solution, right?
So, to continue the House analogy, you know, they always say, it's lupus!
Well, it's not lupus.
It's not freedom that is the cause of these things.
There are four central causes of the current financial crisis.
None of them have anything to do with the free market whatsoever.
So, of course, the good old regular suspect, fiat money.
Low interest rates, of course, set by the Fed.
Forced loans to high-risk borrowers and government loan guarantees.
So, these, of course, none of these have anything to do with the free market whatsoever.
They're quite in opposition to the free market.
So, of course, fiat money...
The Fed, which is not a federal institution, the Federal Reserve, has about as much in common with the federal government as Federal Express does, founded in 1913, and has presided over a 95% decline in the value of the US dollar, with the attendant catastrophic rises and falls in the economy.
1971, US dollar taken off the gold standard, so money no longer had to represent anything real.
And the best way to understand this is that if you could type whatever number you wanted into your bank account, how much would you spend?
Well, the answer is of course quite a lot.
Low interest rates. Well, to stimulate growth, of course, the Fed is very keen on low interest rates, particularly before elections.
So here, there's two here, which are two graphs here, two numbers here on the graph.
The red is important here because the red represents the actual rate of interest, right?
So if the interest rate is 3% but inflation is 4%, the interest rate is actually minus 1%.
So here we can see that, of course, in the late 70s and then again starting, I guess, 92, 93, and then starting in January 02, we had negative interest rates.
And this, of course, is very important.
You put high and rising housing prices together but low interest rates, you're going to get rampant speculation.
And there's credible estimates that 25% of housing transactions starting from the mid-90s onwards, particularly late 90s to 2005, 25% of these housing transactions were speculation for purposes of flipping.
There's nothing wrong with speculation, of course.
It's an essential part of any free market economy, but we'll go and have a look at why this is not good, right, in this particular regulatory environment.
But the big issue, in my opinion, forced loans to high-risk borrowers.
This has nothing to do with the free market at all.
In a free market are pretty conservative about who they lend money to.
Because if you're a banker and you're making, you know, bankers follow what they say, the 3-6-3 rule.
Borrow at 3%, lend at 6%, go and play golf at 3 o'clock in the afternoon.
That's the 3-6-3 rule.
If a bank is making an average of 1 or 2 percentage points on every loan, then every loan which does not get paid back needs 50 to 100 additional loans to make it up in terms of profitability.
Loans which are catastrophic are enormously bad for banks and avoided like the plague.
And that's why they have these cutoffs for viable people to lend money to.
So let's go back to, like all messes, it goes back in time.
We'll start in 1934.
Homeowners facing huge credit difficulties during the Great Depression, also started and exacerbated by the government, of course.
You can read Murray Rothbard if you'd like to know more about that.
So the government created the Federal Housing Administration, which guaranteed mortgages.
So if somebody didn't pay back, you just get your money from the government, which eliminates bank risk, and of course, they can just hand out money like candy then.
1938, Fannie Mae was created to purchase these mortgages.
Then in the 1970s, we have the Community Reinvestment Act, which of course has nothing to do with community or reinvestment.
And I guess you could call it an act, but even that is a euphemism for what the government actually does, which is force people to do stuff.
So this was passed in 1977, and it required banks to do business irrespective of geography.
So if you did business in a state, you could not discriminate between downtown and the suburbs and so on.
So this, of course, was driven by the poor minority attempting to get their votes and so on.
The Home Mortgage Disclosure Act, 1975, banks had to publish detailed information on mortgage applications, which, of course, would be highly sensitive and private information in a free market.
And the government would then score these banks on CRA compliance, right?
Are they giving enough loans to poor people?
1991, racial statistics were required, and the government then did a huge botch-up of all the data analysis and accused banks of rampant prejudice, which of course you know is simply not the case in a free market.
If there is a huge untapped minority market for loans that will be paid back, banks will stampede to get them, because there's good profit there, right?
I mean, the only color of money is green, right?
So the banks were then forced, violently forced, to lower lending standards.
So let's have a look at the collapse of these standards.
So the government passes all this completely fuzzy legislation with no particular targets.
It all comes down as it does in any fascistic dictatorship or quasi-dictatorship.
It comes down to the whim of the bureaucrat.
So if you even accused of not following these new regulations, here's a quote from one of them.
Liability for punitive damages can be as much as $10,000 in individual actions and the lesser of $500,000 or 1% of the creditor's network In class actions, right?
So that's a lot of money to threaten banks with the theft of.
So basically, banks are no longer allowed to use credit history.
The ratios of income to mortgage payments should be no more than a quarter or so, a fifth or a quarter.
And they have to accept credit counseling as proof of financial ability.
In other words, if you have watched a video called Manage Your Money for 20 minutes, then suddenly you have great financial ability, even if you've never paid back a loan in your life.
As well as accept unverified income statements, they're not allowed to actually go and check the incomes.
This creates what's called liar loans, which is make up whatever you want.
The government also forces these banks to accept things like gifts, welfare, unemployment benefits, and other one-time or short-term, quote, incomes as collateral.
Of course, to pay off a house takes years, if not decades, so one-time gifts or short-term benefits like unemployment and welfare are not valid as criteria for accepting a loan to buy a house.
Lenders are allowed to take second mortgages down.
They're allowed to take out second mortgages for down payments.
This, of course, is a catastrophic non-performance thing, right?
And it's sort of important because if you put 20% down on a house, the house value can go down 20% and you're still ahead, up to 20% and you're still ahead of the game.
But if you only put down 2%, then as soon as the house value drops 3%, you're in a losing proposition and you're going to bail, right?
I mean, at least a lot of people will, particularly in places like California.
Where the bank cannot go after your personal assets for non-payment of mortgage.
So we got negative interest rates or low plus easy loans plus rising prices equals rampant speculation.
Now this, as the prices keep going up, defaults are hidden because if someone can't afford to pay his mortgage, he simply sells it to someone else at a profit because the prices are always going up.
So when you do a statistical analysis on the default rate, despite the lower lending standards, they seem to be perfectly fine.
So it sort of masks the problem, if that makes sense.
However, the moment that prices begin to peak and decline, defaults begin to rise immediately.
And of course, when mortgage rates begin to increase, variable mortgage rates go up, the price you pay for variable mortgage goes up, which means it's less profitable to flip houses, and you're going to get out as quickly as you can, and that causes the price to go down because more people are selling than buying.
Now, the difference is not between prime and subprime in terms of where these defaults occurred, but between variable and fixed-rate mortgages.
Now, fixed-rate mortgages are, and that's what I have, right?
I mean, fixed-rate mortgages are when you plan to stay in the house, right?
So my wife and I got a five-year fixed-rate mortgage because we're sticking around in the red room, or at least I am.
Whereas if you're interested in flipping, you're going to get variable rate mortgages.
Why? Because you're not planning on being around for too long, right?
So when the interest rates went up, variable rate mortgages, which were clustered around speculators, and the speculators were, by the majority, from lower income brackets.
Because those people are not so big sometimes on the hard work.
So... These are the people who began to default very quickly.
The people who had gotten loans that they wouldn't otherwise have gotten in the free market unless the government had forced the banks to provide them, and who had gone for variable rate mortgages.
So what are the general effects?
When demand is artificially stimulated, resource allocators get the wrong price signals, right?
When the price of houses keeps going up, people think, oh, there's a huge demand for houses.
So they build, they renovate, they pour a huge amount of time and resources into flipping houses, buying, selling, upgrading, and building.
And of course, that's really good for large sectors of the economy, like those who build and supply the building of houses and so on.
So when defined that demand is artificially stimulated, the resource allocators, they get the wrong price signals.
They start pumping all these resources towards that which is considered to be in demand, but which in reality is not.
It's artificially stimulated.
So labor and capital gets incorrectly invested in the housing market.
And, of course, those who are investing in the housing market continue to buy off the government.
I mean, there's a study that's out now that the majority of people in Congress or in the Senate who voted to bail out the financial industry had received enormous campaign contributions from...
What could it be?
What could it be? The pet industry?
No. Well, from the finance industry, of course.
So those investing in this market continue to lobby, pressure, and buy off the government.
And of course those in the government want to keep the bubble going so they can pretend that they're good at managing the economy.
Now eventually, like any drug high, the crash occurs.
This is when the artificial stimulation of demand simply cannot be sustained.
This results in rapid resource allocations, where money drains out of housing and goes into other areas, causes job losses in housing, and before the investment occurs in other areas, there are job losses before the new jobs get created.
And of course, those who are losing their jobs are very vocal.
Those who get jobs they otherwise wouldn't have gotten don't even know that they've gotten a benefit, because this compared to what, right?
So this rapid resource reallocation is called a recession.
If the government attempts to sustain this artificial demand through bailouts, say, then the incorrect allocation of resources continues and deepens.
This is also known as a depression, which, well, anyway.
So what are the true causes?
I mean, we're just looking at symptoms really fundamentally.
But there is a fundamental cause here that I think is so absolutely essential for us to understand and to communicate to people as widely and as persistently as possible.
So, running through the two-step obedience to the gun, if you don't obey government edicts, they send you a bill, if it's financial.
If you don't pay the bill, they take you to court.
If you don't go to court, they come to arrest you, or if you lose at court.
If you resist arrest, if you pull out a gun, then the cops are going to shoot you, of course, right?
If you go to jail, then you're very likely to be beaten and raped, not to mention, of course, incarcerated.
So what we're really talking about here is not a financial crisis.
It's not subprime mortgaging problems.
It's not refinancing problems.
It's not fiscal problems or currency problems or fiat money problems.
What we're fundamentally talking about here is violence.
The true cause of the economic meltdown is coercion.
Using the threat of murder Kidnapping, imprisonment and rape to solve social problems like home ownership is utterly evil.
You simply cannot solve complex social problems by waving guns in people's faces.
The essence of government activity is violence.
Government is a coercive monopoly that initiates the use of force against others.
We can no more rationally expect the government to solve problems like how many people own a home than we would expect the mafia to solve the problem of poverty.
It's not going to happen. Never going to happen.
So if you really want to, in my opinion, do some real good through this terrible transition, of course, become aware of the facts.
But most importantly, most importantly, most importantly, when people complain about the crisis or this or that or Oh, greedy Wall Street and these investor bankers and corporations and government and this and that.
I mean, there's no easier way to do it, but you've just got to keep saying it over and over.
This is called the broken record negotiation technique.
It is something that just has to be done when you're trying to affect a moral awakening and shift in ethical understanding within society.
Like, Slavery is bad, or women are equal, or children should be protected and not spanked.
Whenever you're trying to alter a fundamental ethical illusion, bring truth to the darkness of ethical and moral mythologies, you simply have to keep repeating over and over and over again.
Violence does not solve social problems.
You see, we sit in a sea of violence.
We swim. In blood.
The entire society that we live in, and I don't care where you are around the world, every society is statist.
Or, if you want to pull out Somalia, they are funded by, the weapons are all funded by external governments.
But we swim in a sea of blood.
And like any fish in an ocean, we don't really notice it.
It is just the environment, any more than you are consistently aware of the fact that you're breathing.
You have to concentrate and figure this out.
But our system is founded on coercion.
Our system is founded on pulling out guns and threatening people with the rape rooms of modern prisons if they don't obey.
That is the essence of what our current society is.
And eliminating statism is as necessary and essential a moral step for mankind as eliminating slavery, as eliminating the abuse of women and children, and the call to end war, which will always continue as long as we have governments.
So, helping people to understand, to open their mouths and to taste the blood that they swim in is a very difficult emotional process.
It's highly confrontational. It's highly volatile.
I've been doing it for...
Oh, a while. And it's very difficult, but it is absolutely essential.
This is where the real moral battle for the future of mankind occurs, is getting people to understand the violence that they are surrounded by and immersed in, and helping them understand that the solution to waving a gun in people's face is not to get another gun.
Right? It's not lupus.
It's Luger. Freedomain Radio.
A wide variety of materials are available to help you understand what is actually going on in the world.
How to solve it through non-violent means.
This is the link to an article that I got some information in some of the graphs from here.
Highly recommended. At Freedomain Radio, there are feeds specifically devoted to economics and politics.
If such is your bag, your game, so to speak.
freedomainradio.com forward slash economics.html and forward slash politics.html.
A copy of the presentation is linked on the economics page.
And I hope that you will drop by.
Check out Mises.org.
Also has great materials on this stuff.
Thank you so much for watching and for listening, of course.
For more on the philosophy of personal and political liberty, please visit the entirely user-sponsored number one 4 million downloads a year philosophy show, Free Domain Radio.
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