Did Fannie Mae and Freddie Mac cause economic meltdown?

Conservatives, as the economy began to melt down quickly in 2008, began to target one of the programs that they truly hated, the Community Reinvestment Act. They pointed to this one program, which started back in the Carter administration, as the root of all evil. The conservative argument goes something like this — the community reinvestment act asked banks to lend more money to minorities and Americans who lived in impoverished areas. Therefore, the banks were forced to hand out riskier mortgages. This whole operation was funded through a mandate of Fannie Mae and Freddie Mac. So, with Fannie and Freddie pumping money into the mortgage financial system and bankers being “forced” to lend money to people who were obviously not qualified, there’s no surprise that these mortgages ultimately failed in a spectacular fashion.

This tale is like many tales that come out of the conservative movement. There is a shred of truth located deep within the story. Unfortunately, there is only a shred of truth. First, it is important to understand how the mortgage industry works. I thought, if I go to the bank, Friendly Bank, and I’m approved for a loan, Friendly Bank gives me the money to purchase a house. I thought that the loan stayed at Friendly Bank. I was wrong. That’s the way loans worked in the old days. Now, Friendly Bank will take my loan and do one of two things — sell the loan to another financial institution or package the loan with other loans and then sell that to a financial institution. This is where mortgage securitization comes in, along with derivatives and collateralized debt obligations and much more craziness. Fannie and Freddie worked in the secondary markets. It is true that Fannie and Freddie injected liquidity into the housing market. They are able to buy qualified loans (notice the word “qualified”) from banks and then pass those loans on to other financial institutions. “The riskiest mortgages, however — the ones that were pushing the housing bubble to dizzying heights — were simply off-limits to Fannie and Freddie.” (From Simon Johnson’s book 13 Bankers, p 145.) Fannie and Freddie were barred by law from handling these risky subprime mortgages.

When you look at the subprime mortgages that were issued at the height of the craze, between 2004 and 2006, Fannie and Freddie only sold approximately 24% of those loans. In 2006, 84% of subprime mortgages were issued by private lending institutions. These loans were then passed on to other private institutions, bypassing Fannie and Freddie. Although Fannie and Freddie Miami have wanted to get into the fray, they were unable to participate. “Private investment banks — not Fannie and Freddie — dominated the mortgage loans that were packaged and sold into the secondary mortgage market.” Over 66% of these loans stayed in the private sector.

This reason that conservatives continue to push a story that they know is not true is because the truth is very scary to them. The truth is capitalism worked the way it was supposed to work. Capitalism is about greed. Capitalism is about looking out for your own interest. This is exactly what these private investment banks did. The point of the federal government is to constrain the excesses of capitalism. Put another way, people always look for ways to make money. If there are no regulations, then people will make money any way that they can. Some will even rip off their own grandmother to make an extra dollar. Alan Greenspan and Henry Paulson (and almost everybody on the Bush financial team and unfortunately, this includes most of Obama’s financial whiz’ also) believed in self-regulating markets. They believed that the purer the market was, the better the market would regulate itself. Unfortunately, they did not factor in one of the most important things in human nature — greed and deception. No investor will always have all of the information. Financial institutions have intentionally created an atmosphere where they hold most of the cards. They only reveal the cards they want you to see; therefore, no investor is fully informed.

So, in summary, Fannie and Freddie did not cause the economic meltdown. The Community Reinvestment Act did not fuel the economic meltdown. There was a climate of deregulation, mortgage derivatives and collateralized debt obligations, which were designed to hide risk and were sold to investors as safe. These mortgage securities were stamped with triple-A ratings,duping investors into thinking that they were safe. Because the primary lender had the ability to pass off loans to someone else, there was less worry about the quality of those primary loans. There you have the cycle. You have a nearly infinite supply of investors who want low risk, yet high yield investment opportunities. These mortgage-backed securities were sold as exactly that — low risk and high yield. Unfortunately, for all of us, they were not low risk. Not even close.

  • Joe White

    Still in denial that the Clinton administration saddled banks with quotas, I see.

  • ecthompson

    Not at all. I freely admit that. Unfortunately, that burden did not cause the economic meltdown as you suggested.

    BTW, if this “burden” was so terrible why didn't the Bush administration reverse it? After all he was the CEO President.

  • Brad

    Hundreds (if not thousands) of years of predatory monopolies, fraud, insider deals, and virtually indentured servitude have shown that free markets do not work. *Competition* works, and the role of regulation is to preserve competition.

  • Joe White

    Yes, Bush should have reversed it.

    No doubt a large factor in why he did not was because of the way the program was set up.

    Anyone opposing it would be labeled 'racist', just as we see Obama doing anytime someone opposes his policies.

    These mortgages were intitiated, then bundled and sold, bundled and resold over and over til nobody knew (still today nobody knows) exactly how many of them anybody has.

    This was admitted by all when the TARP program was passed. The difficulty would be in figuring out who owned how many of what.

    This is the one thing that makes financial markets go down every time — uncertainty.

    Markets can deal with known bad conditions because they can plan their way around it, or plan to wait until favorable conditions appear, or plan how to counteract it…..the point is, they can plan.

    With uncertainty, businesses get nervous and panic sets in.

    These mortgages, which never should've been written, were injected into the financial system and a perpetual game of hot potato ensued.

    Your article points this out.

    “I thought that the loan stayed at Friendly bank. I was wrong. That’s the way loans worked in the old days. Now, Friendly bank will take my loan and do one of two things — sell the loan to another financial institution or package the loan with other loans and then sell that to a financial institution. “

    The reason banks quit doing business as they had 'in the old days' (i.e. writing a mortgage and happily holding it for 30 years to make a nice profit) is that now they were forced by the feds to write what they knew to be bad loans. It was just a matter of time before many of them turned sour, and bankers knew it, but had no choice.

    It's funny, very funny, to hear you say that you 'freely admit' that the feds put quotas on the banks, because you haven't freely admitted it at all.

    You tried to spin the quotas as 'requests'.

    You put 'forced' into quotation marks as if the banks weren't really forced at all.

    Subprime mortgages were at the heart of the economic chaos. Both Democrats and Republicans know it.

    So, why were there so many subprime mortgages in the system to begin with? Because Hilly and Billy wanted to get re-elected in '96.

    They bought votes with bad loans and we're paying for it now.

    Shumer planned an early 'October surprise' for the 2008 election. He took advantage of his position on the Banking committee, divulging confidential information and caused uncertainty and panic at IndyMac. And a huge run on the bank ensued.

    Democrats have won elections by destroying the American economy.

    I bet you're proud to be a Democrat, arent you?

  • Bud Brooks

    Erri, in many ways you are correct with the events, but in others you are way wrong. All you have to do is Google the video of the congressional race pimps like Maxine Watters blasting the lenders and telling them that they WILL lend to those who need a home (the home they deserve and those that want the American Dream, blah, blah, blah) and you'll see the firebrand facing the banks. Either lend, or face discrimination and racism charges, the likes they have never seen before.

    And to simply say that “GREED” is the singular cause of this, is also way overboard. Yes, some people are greedy — always have been and always will be. You know what? The government is greedier. Always has been and always will be. But most people are not “greedy” the way you describe it. Greater wealth for some equates to greater wealth for all.

  • ecthompson

    Bud –

    Thanks for your comments.

    Maxine Watters can yak all she wants. The question isn't the desire of Watters and others, the question is what really happened. Did she pressure lenders? Did lenders respond to her bluster?

    Bud, Capitalism is greed. It works because you are rewarded for wanting more for yourself. The system removed consequences of risky loans on banks by passing on risky loans to other money machines. This is a no brainer.

    If you look at the government's role in the meltdown, I don't think that you can find any government greed at all. As a matter of fact, I that you see that the government regulators stepped back and allowed the financial fireball continue to roll in spite of evidence that it needed to be shutdown.

    Finally, there is NO data that supports your final statement. The last administration proves exactly the opposite. The top 1% took home tons of moolah but everyone else (the bottom 75%) had their incomes stagnant or decrease over the last 8 years. There is no trickle down effect. None. But we can talk about quoting dogma and not data later.

    Be well.

  • ecthompson

    Again your hatred of the Democrats is showing. You are talking and talking but not quoting any data. I have quoted data. I have shown you using data, that your assumptions are wrong. Keep clinging to your ideas.

    I have a couple of questions:
    1) Fannie and Freddie were not allow to play with most subprime mortgages, if Clinton was the problem then why didn't he (Clinton) change the law and allow Fannie and Freddie to play with the big boys in the subprime game? This would have generated more home loans in those zip codes that you like to point to.
    2) If the changes made in 1996 were the problem why did it take the subprime market 8 years to heat up? Were there other changes to financial laws between 1996 and 2004 when the market heated up (the answer is yes there were changes but you like to ignore those).
    3) Bush administration made several changes to the CRA from 2001 – 2006, what effect did that have on the law that you hate?
    4) Why did the Fed in reviewing the subprime market, point to other factors and not to your theory? Were they under Clinton's spell even though the report was written in 2006?

    Finally, I have stated several times that there were quotas. Big Deal. Those quotas were too low to account for the fuel of bad loans that lead to the meltdown.

    I'm just waiting for you to produce data. Data on Schumer. Data on CRA. Any data showing that your theory is more than hot air. Right now, you think that Schumer had this plot to destroy republicans. But you have no data to support your theory. Where are the internal memos. Why did the California Attorney General drop his investigation if Schumer was the cause? WE have never heard President Obama say that someone who is against Wall Street reform is racist. Obama NEVER said that opposing the War in Afghanistan was racist. Obama never said that if you oppose the stimulus package that you are a racist. You are way off base.

    I'm proud that someone is trying to help low income families. yep, I'm very proud of that.

  • Joe White

    Dr Thompson wrote:

    “Those quotas were too low to account for the fuel of bad loans that lead to the meltdown. “


    What were the quotas? Show your numbers.

    Oh, you don't know? I thought you were the data guy?

    The fact is that the feds did put a quota system in place to force banks to write loans that would go bad and poison the financial system.

    It doesnt take 100% of loans going bad to wreak havoc. It only takes an increase of a small percentage. Banks, like other businesses, operate on a profit margin measured in a few percentage points.

    I suggest you go back and look at what Fannie and Freddie did because your assumptions are incorrect.

    “In the late 1990s, Fannie Mae and Freddie Mac — the two government-sponsored mortgage giants — began buying up and guaranteeing subprime mortgages on a vast scale.

    By 2008, Fannie and Freddie held or guaranteed $1.6 trillion in dodgy loans, for which the taxpayers are now on the hook. Alarms had been raised earlier, to no effect. Efforts in the Bush administration to rein in the two mortgage giants came to naught.

    Sen. Chris Dodd of Connecticut helped derail the reform effort with filibuster threats. Rep. Barney Frank declared Fannie and Freddie perfectly sound. “These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” Frank said in 2003. “The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”” http://www.kentucky.com/2010/05/05/1249938/comm

    And again we see Democrats opposing sanity in the financial system as they pretend they are standing up for 'the little guy'.

    I wonder how many 'little guys' who've lost their jobs and homes when the subprime bomb exploded really appreciate the efforts that guys like Barney and Chris put forth in their behalf?

    Dr Thompson wrote:

    “I have stated several times that there were quotas. Big deal. “

    You were against it before you were for it.

    And yeah it is a big deal because it's a major factor in causing the mess we're paying for now.

    Not that you care, because you'd rather support your party.

    The Democrats used race baiting politics to destroy the economy.

    Are you proud of Obama and ACORN for suing Citibank to force them to write more loans to folks who couldn't pay them back and who would end up losing their homes?

  • ecthompson

    You are using a commentary to back your statements. The commenter states as you do that the government started it all but offers no data to support his opinion. He supports his statement with a statement from Chris Dodd. The problem is that in 2003 R's had rammed several things thru congress that they wanted including another tax cut. If Bush and the gang thought that Fannie and Freddie were going to bring down the American economy and end capitalism as we know it, they could have rammed changes to CRA thru congress also but they didn't. As a matter of fact, the changes that they made to CRA increased the available cash in the system.

    “The fact is that the feds did put a quota system in place to force banks to write loans that would go bad and poison the financial system.” This is nothing but conjecture on your part.

    Again here is data from the San Fran FED – Figure 1 shows some of the important differences between GSE-owned or guaranteed mortgages and mortgages that were securitized through non-agency channels or retained in the original lender's portfolio. The data are from 2006, the peak year for non-agency securitizations. Compared with mortgages purchased by the GSEs, non-agency securitizations were much more likely to involve adjustable-rate mortgages, including option ARMs, to be rated as subprime, and to have less-than-full documentation of borrower income and assets. The median FICO credit score for the non-agency securitizations was about 30 points lower than for the mortgages held or guaranteed by Fannie Mae or Freddie Mac and much closer to the credit scores typically associated with loans guaranteed by Ginnie Mae. Compared with Ginnie Mae, however, the non-agency securitizations tended to involve a much greater share of adjustable-rate mortgages. Indeed, in 2006, non-agency securitizations appear to have gained market share by partially displacing Ginnie Mae's position among borrowers with low credit quality and expanding into the market for jumbo loans, which exceed GSE size limits.

    Thanks for your comments.

  • Joe White

    Dr Thompson wrote:
    “The fact is that the feds did put a quota system in place to force banks to write loans that would go bad and poison the financial system.” This is nothing but conjecture on your part.

    Which is conjecture? that there were quotas? or that it was easily predictable that many of the loans given to people with poor credit would go bad?

    I thought that you 'freely admitted' there were quotas….?

    So, what is so hard about predicting that many of the loans given to people with poor credit would go bad?

    The bankers surely knew this. That is why it became common practice to sell off mortgages in bundles rather than hold them for the duration (as they did 'in the old days' )

    The feds could force them to write the ticking time bomb loans, but they didn't force them to hold them til they blew up.

    Dr Thompson wrote:
    “but offers no data to support his opinion.”

    He documents Democratic opposition to reform and buries your assertion that “Fannie and Freddie were not allow to play with most subprime mortgages” by noting that they had over $1.6 trillion on the line

    Highly paid directors such as Rahm Emmanuel looked the other way and collected fat salaries for doing so as Freddie and Fannie spiraled out of control.

    By Rahm's own admission, his involvement was minimal. His neglect borders on criminal. ( He is really in a Catch 22. If he admits greater involvement in running Freddie, then naturally the question arises why did he allow it to take the wrong path. But if he says 'I wasn't very involved as a board member' then his negligence is just as devastating, if not more so because he had a fiduciary responsibility.

    At the very least, Rahm should be as far away from the levers of power as possible.

    But no, Obama wants him front and center which is understandable given Obama's own role in suing banks to force them to write bad loans.

  • John Madden

    This discounts the green light Freddie and Fannie quotas created. It was not till that green-light signal was strong enough that private lending stepped in to the extent they did. This, like the conservative take, contains a grain of truth to project a political view. Several things are easy to agree with but the impact and leverage created by gov't signals is ignored in an effort to project a view that absolves gov't and convicts the markets. Nor does it speak to the signals sent to the market of bailing out the boat you helped sink. Rewarding bad behavior that gov't behavior encouraged deserves a mention, to say the least.

  • ecthompson

    John –

    thanks for your comments.

    I discussed my thoughts on the economic meltdown here, here and here. I think they address your concern. I completely agree that government removed restrictions which allowed greed to run rampant.

    Thanks again.

  • Joe White

    Imposing a quota is not 'the removal of a restriction'.

    It's over-regulation, not de-regulation.

    Amazing how you come to the exact wrong conclusion.

  • John Madden

    Thanks for the additional links. I just read them. What I find so intriguing (and frustrating) is that in so much of my reading I see people digesting the same material and taking away exactly the opposite views. Opposing camps are constructed from the same factual material. One camp puts the primary blame on government and the other puts primary blame on the market, or capitalism in general.

    I was a political science major and am a conservative, although THAT label is nebulous. Let’s say I’m an advocate of the Adam Smith version of markets and industry, meaning I don’t define capitalism as “greed” and don’t define self-interest as “bad”, merely natural and in most instances a good thing, as the energy from self interest is what makes your shoes and your golf clubs. I am likewise an adherent of F. A. Hayek (who did not foreswear regulation but rather thought when necessary, it should have as it’s aim ‘greater competition’, not less) and I am a believer in limiting government.

    Yet I understand that government has to regulate else we would all live in a ‘buyer-beware’ world where our medication and even the paint on our toys were suspect. Yet what I see is the government failure at every step of every responsibility they arguably own. Government doesn’t even take care of our borders, which is THE primary responsibility of the federal government. Sticking to the financial responsibility here, if you look at the every step of financial reform from the 1980s till now, under left and right leaning administrations, government has sold those they represent down the drain, and done that selling to those who fund their campaigns. Keep in mind this does not even speak to the inertia of bureaucracies but simply to the motives of your representative. Of the few times I agree with Obama, it would be that corporations don’t have the same rights as a citizen, but it is to corporations that government listens to the loudest. And it is to corporations and lobbying industries that government sells, as if to the highest bidder.

    The ‘OK’ given to adjustable rate mortgages is but one case in point. Even today, it is the financial industry itself which government has turned to for the writing of much that is in the financial reform congress considers today. I just don’t see how anyone can continue to blame market players, when they do what they’ve always done, that is work the system once their size enables the spin off of a lobbying element, while the evidence at every turn is that government, often represented by those screaming the loudest for regulation, are the ones putting regulators and previous legislative safeguards on a choke chain.

    Markets and free enterprise have provided the highest standard of living in all of history to western developed nations. It is not markets that fail, it is corrupt government that fails. And the bigger it gets the more areas in which it fails. If individuals could get over their partisanship long enough to see that both parties cater to everybody BUT who they are supposed to, i.e., the citizen, more would come down on the side that demands better from those who are supposed to represent us. I’m leaning towards the camp that says “throw all the bums out” and starve the beast. The beast wants more turf, he has crowded out the states in his reach for greater and greater power and yet he doesn’t even guard well the turf he has claim. I say we have some senate hearings with some educated citizens grilling senators and asking them “do they blame themselves for the meltdown”, much like they kept demanding of Goldman. Coburn was the only one I heard that spoke with integrity and truth in 11 hours of testimony. Diversion and deflection, it is the greatest government skillset these days. Guess you can tell which camp I’m in.

  • John Madden

    How sweet that little bit of truth is. How bit of truth is. Government seldom improves that for which it crusades.

  • Joe White

    Liberals like to define capitalism as 'greed'.

    But it can also be defined 'service' because in a market system you get what you want by FIRST providing for someone ELSE something THEY want.

    iow, in the market transactions are made by mutual agreement, whereas in a statist system (such as the new health care system that liberals are working toward) one person/group is able to take property/goods from another person/group without it's consent. (the old fashioned word for that is 'covetousness')

  • ecthompson

    It is because I'm stupid.

    Glass-Steagall have been around for over 40 years and it wasn't a major bank failure. Glass-Steagall gets repealed in less than eight years later bank failures are a common occurrence. You're so right. I don't know why I didn't see that overregulation was the problem. Keep trying Joe. Keep holding on to your dream that somehow the Clinton administration responsible. Keep it up. Don Quixote never gave up and neither should you. Your great company. Sean Hannity still believe that the weapons of mass destruction, hundreds of tons of it, were placed on trucks and moved to Syria.

  • ecthompson

    I have no idea what this means. Maybe it's because I'm stupid. “Government seldom improves that for which it crusades.” What are you talking about? Are you talking about the Star Wars program? The missile defense shield? Or are you talking about landing a man on the moon? Are you talking about the desire to connect many major cities with interstate highway? Are you talking about the war on drugs?

    Thanks for your comments.

  • ecthompson

    John, I appreciate your comments. Especially as you take the time to explain them thoroughly. From my standpoint, I think there's a lot of different things going on. First of all, Bill Clinton moved the Democratic Party toward corporations and away from their traditional base. We look at who he chose to run the financial aspects of the administration, Robert Rubin, Larry Summers and Alan Greenspan, you can see that the Democratic Party move towards business a big way. This increased campaign donations which made many Democrats extremely happy. When you look at Chris Dodd and Barney Frank they have received enormous sums on the financial industry just as multiple Republicans have. The Glass-Steagall act was overturned during Clinton's ministration. Sure, Republicans pushed the measure but powerful Democrats supported the measure also.

    I think both parties like the revolving door. You go into politics for a little while then slide into a nice corporate job making six or seven figures. Or, you can start a think tank and have that funded by your corporate buddies. After you've made “enough” money, you can go back into politics.

    Finally, I'd like to touch on something that you and Joe have both talked about — capitalism and greed. Without regulatory constraints, capitalism does not stop. The tenets of capitalism are more, more and more. If you've cornered the market in widgets, you then increase the price of widgets. This way, quarter after quarter you can show an increased profit. The bottom line is not that you're making profit but that you need to make more profit. There is never a ceiling. There's never a time when a corporation can say I've quarter the market I don't need to make any more profit. Yet, you and I both know that there is a finite amount of money out there. Even the most efficient company, sooner or later will stop making profit because they have completely saturated the market. In capitalism, this is never okay. The company must branch out into other fields or acquire other companies in order to continue to expand or the stock market will hammer that company for not increasing their profits.

    I don't have any problem with capitalism. We just have to understand that capitalism must have constraints. We have seen in our own country in the 1850s, the 1890s, the 1920s, Enron, the S&L debacle and hundreds of other scandals which all boil down to people wanting to make more money. Yet, with appropriate constraints and appropriate enforcement, capitalism will work just fine.

    Thanks for your comments.
    (Dictated with Dragon NaturallySpeaking and poorly proofread.)

  • John Madden

    Dr Thompson,

    Crusades, as I intend the meaning here, are the goals of bureaucrats and feel-good politicians that have too little consensus to start with and oftentimes for which the Federal Government was not forged and sometimes not even authorized to address. But to give an example of our stellar success; how about sex education in our schools, how about our education system in general? How about Lyndon Johnson’s war on poverty… that went well. How about the unintended consequence of welfare in general? Please tell me you are not one who defends the single headed household and the incubation of social problems that correlate overwhelmingly with the demise of that institution, an institution deleteriously impacted by “your checks-in-the-mail” intellectuals, intellectuals who mostly inhabit the commanding heights of opinion making institutions like our academia and our entertainment industry. Again I use a term loosely but I’ll risk it, ‘intellectuals’ I mention are that class defined by their quintessential eliteness, their relative values, their objection to American exceptionalism which they poison as if the very well from which they drink; they are defined often by their very aloofness and woefully out of touch values from those of most hardworking Americans. But to return to government’s successful crusades: How about the Department of Energy, which was created with the stated mission of ending our dependence on foreign oil. Look at the size of it’s workforce (above 16,000 last I looked) and look at it’s budget it now consumes, if you dare, and ask yourself exactly how much energy it produces. How about our government’s self anointed mission to spread democracy on the other side of the globe where political and religious values are antithetical to our own? How about immigration reform of the sixties where Johnson assured us at the signing that precisely WHAT IS happening today WOULD NOT happen at all. I suppose I could have used a more targeted term than crusade but to me it conjures up a lot of do-good, politically correct notions that make proponents feel good but don’t in any way address, before or after, the unintended consequence of governmental power. Social Security and your own example of the Interstate are programs I’d chalk up to a better grade of Americans than the vast numbers now with their hands out, well trained by the elite opinion makers and now gimping along on victim-crutches. And what’s become of that Social Security? The initial surpluses and again the surpluses of 1986 reform have been gobbled up by hungry politicians with yet more crusades. I worked for a DoD agency for 17 years with a budget of some 70 million and I’ve seen the corruption and waste first hand. I’ve been told point blank, “take your taxpayer shirt off on this one”… why, because I dared draw a line from proposed grandiose plans back to the cost to taxpayers. Government MUST do SOME things well, for that is it’s only justification to exist. But the thing it does best is to expand and to seek out new missions. They are their own constituency and their number one self appointed mission is to find a new needy class. A friend recently defended as ‘worthy’ the goal of expanding homeownership in America. Not a difficult thing to say but I doubt very much that those defaulting on their loans appreciate what’s been perpetrated on them. And I’m not calling ALL of them victims. Many share responsibility for their situation. It does not take rocket science to know what you can afford now or even next year. But we don’t produce many rocket scientists out of our schools now do we. I believe we import many of them, just like we do so many of our doctors. So, enough with the crusade explanation. I’ll conclude by saying this: finding areas where government objectives have succeeded is not a lot different than saying the stimulus is providing jobs… hmmm, at what cost per job? The question is, could the same objective have been achieved outside government, and perhaps at lower costs? And perhaps it would be instrumental if government were to compile a list of successes and failures. But then who’d be defining their failures. It seems all you need do is find one sad anecdotal scenario for the evening news to create a constituency nowadays. Hayek addressed quite pointedly the phenomenon of government (read politicians) espousing noble schemes that sound, well, noble, but then bogg themselves down in strife once the political debates disclose the details, the liberties and the cost which grand schemes require. And so here we are today… with many Americans beginning to wake up. Despite what they are being told in grade school and by our opinion shaping ‘commanding heights’ they are discovering what their fathers always knew, that government does not give what it does not first take.

  • John Madden

    I appreciate your reply as well Dr Thompson. We differ some obviously, but I think we likely agree on a some as well. Monopoly is bad. Read Hayek and even Adam Smith and both attest to the same. And these are the best known proponents. And it was Roosevelt who went on the Anti-trust binge and was the first great monopoly buster, no? But if you look deep enough, advantages achieved by the very large are often those bougtht at the government trough. Once the steam roller starts it's hard to stop, if for no other reason they have more money to spread around campaigns. I'm all for regulation if it does like Hayek says, increases competition. I read Adam Smith and F.A. Hayek's “Road to Surfdom” this summer. Both should be required reading in our schools and in our congress. I wouldn't waste time on the standing congress I'd put in jail were I king for a day. I'd hand it out to the new members taking their place.

  • Dr. Thompson, your post is well written and researched but I disagree with your conclusion. Is capitalism about greed, perhaps, if you have no moral objections to blind greed. It is about self interest, yes. In other other words: Life, Liberty and the Pursuit of Happiness.

    What I disagree with is your position that free markets don't work, when the example you give is not a free market. You describe how getting a mortgage in the old days worked, that is, you went to your bank and if they approved your application AND they had sufficient capital to add your loan to their balance sheet you could get the loan. If they didn't have the capital, they had to go out and get more depositors or raise more equity. With the introduction of Fannie Mae and Freddie Mac, they could make a loan and sell it to Fan anf Fred, make another loan and sell it to Fan and Fred, etc. Do you see the thin edge of the wedge that would allow more loans to be written without limit? In a free market, if I am a bank with $1 million I can't write 1,000 mortgages for $100,000 each, I don't have the money to lend. I can only lend the capital I have, after keeping a certain percentage in reserve so my depositors can get their money on demand. To extrapolate beyone Fannie and Freddie to where Goldman, Bear Sterns, and Lehman got involved and then conclude Fannie and Freddie are blameless is like saying the reason your house burnt down is becasue it was made of wood, not because of the guy with the gas can and the match.

  • ecthompson

    Free markets can't work because of self-interest, you will never give the buyer all of the information necessary to avoid getting screwed. It is in the seller's best interest to withhold data. If we look back to the late 1800's we see free markets. From 2001 – 2008 that's as free as we have gotten in the US and it ended in the biggest meltdown since the great depression – with everyone hoping that things were going to be okay. I'll take the slow steady growth of the 50's and 60's.

    So, you are saying in a free market you would eliminate derivatives? As a mentioned and documented above the majority of the risky loans bypassed Freddie and Fannie and were bought up by Bear and Goldman, etc. So you would still impose regulation. Not truly a free market.

    Thanks for your thoughtful comments. I truly appreciate it.

  • Dr. Thompson how do you find patients? Are they directed to you from a government program? If not, do you withhold information from them to avoid “getting screwed”? In a free market you would be able to offer your services to any and all comers and if you are a good doctor as I am assuming you are, they will freely choose you because of your service and reputation.
    Now let's introduce some government intervention, say, Affirmative Action. When I go to Dr. Thompson do I wonder whether Dr. Thompson is standing before me because he is the best doctor for me, or because he checked a box on his application saying he was part of a disadvantaged group? The goals of Affirmative Action may be laudible, but do you share with your patients your school transcripts to prove you were top of your class or do you withhold that information? Do you tell them you left the box blank because you knew you didn't need a leg up because you were that good?
    I don't know where in the Constitution it gives the federal government the power to get involved in housing. But get involved they did beginning with Fannie Mae under Roosevelt, privitizing Fannie Mae under Johnson to get it off the federal books, the Community Reinvestment Act under Carter, having Fannie and Freddine expand involvment into sub-prime loans under Clinton and HUD Secretary Cuomo, and going further under Bush this hasn't been a free market for nearly a hundred years.
    You ask that in a free market, would I eliminate derivitives? That seems the opposite direction from “free”. I don't have a problem with derivitives provided the players own the risk. If it goes belly-up, they lose their investment, they don't come looking to me and you and our tax dollars. By implicitly backstopping these ventures the goverment (more intervention) allows and even encourages these private firms to take riskier positions.

  • Joe White

    Dr Thompson is finally getting around to admitting what all liberals believe: People don't know enough to make their own decisions, so they need government to hold their hand and make their decisions for them, i.e Liberals believe people are dumb sheep who need the Good Government Shepherd.

  • John Madden

    Mr Bill O'Connell, You have such a refreshing logic as well as an agreeable style.

    I think a lot of people need to go back and study Adam Smith and the then read Freidrich Hayek (The Road to Serfdom should be required reading in High School) as a primer for understanding the mechanisms of self interest and the unintended consequence of intervention at so many levels. Nor are Hayek or most free market economists all absolutists. They recognize need does impinge on liberty in the market but it is a slippery slope that should be approached with great caution. Intervention should be based on the question “does it increase or does it inhibit competition”? Competition and free markets have given the world its greatest level of prosperity, enough that many socialist ideas have lived long on the carcass they feed upon, and in which in all cases sustain them.

    State planners and their proponents don’t like to recognize that much of government intervention is to give a leg up to someone with influence in the first place. And the premise that free market does not work because buyers know too little is simplistic at best, and flies in the face of modern economic world history. The free market premise, which is as near irrefutable as it gets, is that the signals which make up a market are so vast they simply CANNOT BE replicated by planners.

    In my view, our recent cries for more regulation are a little like the gun control crowd or the immigration issue. We have the laws (or regulation) we simply don’t enforce or execute them. With both the financial AND the recent tragic oil spill we had the mechanisms in place but government made choices or exerted influence to chain the watch dogs. Our current immigration issue, which is being allowed to fester to the boiling point, is but another example of this wonderful duplicity of ‘government’.

    I am perplexed by calls for more of anything that performs so poorly.

  • ecthompson

    that's not what I'm saying but you can read it any way you want. If you turn your head to the right and read it again it says, “Paul is dead.”

  • ecthompson

    Bill – you should have looked at what kind of doctor I am before asking the question. I'm a trauma surgeon. My patients are directed to the nearest trauma center by a government (state) system. The patient goes to the nearest trauma center. So, yes to answer your question. Hey, don't get embarrassed.

    I don't know what your point was with affirmative action.

    The answer to the housing question is the commerce clause. The Supreme Court has already ruled on this, a couple of times.

    Finally, on your last point, you haven't explained how to create a free market in which all of the risks of an investment are disclosed without government intervention. Also, I would like to know what you would do with 6 largest banks in the US, now. They have combined assets greater than 60% of our GDP. If one of these banks fail, again, the economy is going down with them. So, what would you do?

    Thanks for your thoughtful comments.

  • Boconnel

    My apologies, doctor for not reading your resume before replying to your post, but I am not embarrassed. I understand what you are saying about government directing your patients to your trauma center. Are you saying in the absence of government decree patients would be taken to the furthest treatment center? If you work for the government and your practice is a salaried job rather than a practice, my analogy doesn't work for you.

    You make the common mistake of those on the left that conservatives do not want ANY government. If that were a true statement we would be for burning the Constitution not reading and following what it says. The free flow of information is the essence of the free market. If information is widely available, and there are consequences for ignoring it, you have a free market. I believe government should require businesses to disclose material information that the consumer, and I don't mean that only in a retail sense, would not have access to. In a free market, that information will be willingly disclosed by the business that has an edge on their competition. However, if government provides a safety net to bad decisions and bad behavior, it creates a moral hazard, that people ignore the information, don't read the contract before signing, take outsized risks because they are “too big to fail”, etc. What I am saying is that if Goldman wants to take a big bet and they lose, they pay, even to the point of going out of business. Government regulations should prevent their bad behavior from spreading elsewhere through the economy.

    With regard to affirmative action, my point was government banning discriminiation = good. Govenment putting in place reverse discrimination = bad. It paints every group that was previously discriminated with a broad brush, that they can't cut it without government involvement. It also discriminates against others for whom there is not proof of prior discrimination, just because of their skin color. Where does it end? Does it end when 53% of the American people elect an African American president, or does it continue until 100% of the people one day elect an African American president?

    The commerce clause says, “To regulate Commerce with foreign nations, and among the several States, and with the Indian Tribes.” So tell me again how that empowers the federal government to buy my mortgage from my bank? Just because the Supreme Court ruled in a particular way, does not make it right or an issue not to be revisited. If you want some proof of how ridiculous the Supreme Court has ruled on the Commerce Clause just look up, Wickard v Filburn (1942).

    As one pundit put it, “if they are too big to fail, make them smaller.” One of the way to regulate the safety of banks is with captital requirements, meaning they have to have a certain percentage of their assets on hand, in cash. This number can be adjusted based on some risk assessment. In the midst of the financial crisis the government conducted “stress tests” of the major financial institutions, to determine how much of a hit from defaults they could take and still survive. This could be the way to accomplish it. The higher the risk they take, the more they have to carry in their vaults.

  • ecthompson

    This is going to take a lengthy reply. I appreciate the time and thoughtfulness of your answer. I'll have significantly more to say later on today.

    Thanks again.

  • Boconnel


    Three of the most heavily regulated industries in America are Oil, Financial Services, and Health Care, but to here people talking about it is that they are proof that free markets are out of control. To here President Obama talk about it, eight years of the Bush administration cut loose all regulations and created this mess. However, the Bush administration issued more pages of regulations, hired more people into the regulatory agencies than any prior president. Things went wrong when he expanded government, not the other way around. His housing policies at HUD, took what Andrew Cuomo did and turned the dial up. His spending excess was far from conservative. I could go on and on, but I don't want to take up too much of the good doctor's blog. If you want to read more go to libertyslifeline.com

  • John Madden

    Thanks Bill,

    It is fascinating how opinions of fairly articulate people can differ so drastically but I've appreciated the civility of the discussion.

    I agree that many of the Bush failures have much to do with acting too much like a big spending democrat. I though him to be a decent man who acted mostly on decent motives. But his record of vetoes, his spending, and some of his positions & lack of action on immigration puts him 'below the line'in my books. The discussion about regulation is ludicrous, here and elsewhere; most who have a handful of facts disclose those that support their contention only. A full picture paints a complex picture seldom captured and certainly never by mainstream media's 10 second sound-bytes. The Dr is correct that both parties are culpable concerning legislative changes, albeit we likely have different basis for laying blame.

    I will go so far as to say that both Republicans and Democrats have failed America but regulation is a little like gun control… if they'd just enforce what they have instead of demanding more every time someone gets shot. Of course, evolving practices have to be corralled and with some of the derivative markets, that is a lacking. One thing sure, if the financial industry writes the bill, as they have, while carefully avoiding some of the old firewalls, then it's just a rigged and paid for game. I'm of the mind that congress, both parties, are bought & paid for, unless you are a rare Colburn or some other.

    I am however dumbfounded by the statement “Free markets can't work because of self-interest…” I don't even need to read what follows that contention, although in the same sentence he adds, “you will never give the buyer all of the information necessary to avoid getting screwed”.

    Free markets work precisely BECAUSE of self interest, whatever else are their shortfalls, including a nebulous complete accounting concerning “information”. The thing is, free-market advocates don't generally maintain the market is without shortfalls. They simply maintain what history has demonstrated for at least a hundred years, that free markets provide more than any other economic construct. And the more free they are, the more they provide their participants. No one needs to argue the degree that markets are NOT free. NOTHING IS ENTIRELY FREE. But the more free, the more they provide society… and this is precisely due to self interest. Based on this one statement of the doctor's I concluded that we differ on underlying fundamentals to the point that debate goes only so far.

    Thanks for the reference… I'm always interested in more input.


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