Shuttering Fannie Mae & Freddie Mac

Fannie & Freddie as the Katzenjammer Kids

Both the Bush and Obama administrations engaged in misguided interventions in the financial sector. In turn, they injected $465 billion in capital along with loan guarantees worth $285 billion and placed insurance on assets worth $418 billion.

It is comforting that part of the capital injections, about $175 billion, has been repaid.

Yet the worst offenders behind the mortgage bubble, Fannie Mae and Freddie Mac, will eventually get between $200 billion and $300 billion that is unlikely to be repaid to taxpayers.

Congress eliminated the cap on funds that can be granted to these financial basket-cases. While the sky is not the limit, at $1.5 trillion in exposure in their mortgage-guarantee and mortgage -securitization programs, it is damned close!

Fannie and Freddie operated with all the swashbuckling arrogance of hedge-fund buccaneers, including lavish salaries and bonuses for top managers. Yet they are being coddled by both sides of the aisle of Congress.

Despite their cute and cuddly nicknames, these evil cousins need to shuttered so taxpayers are not on the hook for an open-ended series of bailouts.

Can there be justice without freedom?

While reading a recent article by Amartya Sen concerning the contributions of Adam Smith, he mentioned “justice” numerous times without addressing “freedom” or “liberty”.

While Sen is often identified as a “liberal,” the Nobel Laureate in economics is far from being a libertarian. Indeed, his criticisms of theories of justice include the insight that he does not consider them to be sufficiently egalitarian.

Considering Sen’s past musings, he seldom concerns himself with how freedom fits in a “just” society. Instead, he opines on operational aspects of democracy that might somehow deliver justice.

Seeking a just order under the rubric “social justice” without including commitments to individuals & human freedom is likely to lead to tyranny in some form.

Justice should be a guarantor of freedom & not a delivery mechanism for flavor-of-the-week notions about what constitutes a “good” welfare state.

Singapore’s litigious, leading (not-so-dynastic) family!

Past is prologue when it comes to Singapore’s litigious leaders as once again the International Herald Tribune (IHT) retreats from a profound’ commitment that journalists should “speak truth to power.”. Reporting on the case includes a redux of my own run-in with the Lee family.

As shown during a pair of court hearings, I was convicted of libel for authoring an IHT article even without mentioning Singapore nor (Senior Mentor; ex-Senior Minister, ex-Prime Minister) Lee Kuan Yew by name.

In the end, the episode led to my first book that dealt with authoritarian capitalism, an issue I discussed relating to China in my previous posting.

CHINA & AUTHORITARIAN CAPITALISM

Dateline: Hong Kong
Despite China’s recent experience with high economic growth, some questions arise about whether its policies & institutions impose a binding constraint upon continued success.

To its credit, Beijing recognizes private property, allows private profit seeking & the Communist Party invites businessmen to join its ranks. But China’s corporatist state regulates business enterprises to the disadvantage of truly-private firms or those that operate principally in the domestic sector.

Given the limits of expressions of individuality and undermines individual rights and freedoms, “authoritarian capitalism” aptly describes China’s approach to development. Whereas, communist regimes contrived to have an economy without prices, authoritarian capitalism presides over a market-like economy with few guarantees of individual freedoms & rights.

While authoritarian capitalism shares similarities with “authoritarian socialism”, it has not draw the same criticisms. This is interesting since these systems have similar likelihoods of failure.

Recent success with economic growth has made China’s regime seem to be a model for other single-party regimes to follow in Asia or elsewhere. But a Panglossian view overlooking the long-run costs of authoritarian capitalism is fraught with peril.

Accepting China’s authoritarian capitalism as a viable development model reflects a presumption that economic & political liberties are not interdependent. Similar reasoning induced promoters of authoritarian socialism (communism) to overlook its internal & fatal contradictions.

Indeed, the collapse of communism suggests that ignoring the importance of incentives & repressing individual freedoms eventually undermines sustainable economic growth. While authoritarianism can bring short-run economic gains as in China today or the heady days of Soviet experiments, there are logical & economic limits to these results.

One set of problems associated with China’s authoritarian capitalism arises from a tendency for commerce to be politicized & politics to be commercialized. The politicization of commerce occurs when success or profitability depends more on relationships with the ruling party than the efficient use of scarce resources.

The commercialization of politics involves actions by the ruling party to develop its own sources of revenues through business transactions. These activities include privileged, insider access to economic data that benefit the party whereby party functionaries & cadres enjoy private gains. At the same time, “cronyism” emerges whereby camp-followers & sycophants of the ruling party receive special favors or protections. In Chinese communities, this reliance upon connections is known as “guanxi”.

Despite impressions to the contrary, China’s authoritarian capitalism involves extensive economic interventions. Most obvious is a highly-interventionist foreign exchange policy to support industrial policies that target specific industries as part of an export-led economic growth strategy. And Beijing directs bank loans, investment funds & subsidies toward areas of economic activity that comport with policy objectives rather than commercial logic.

These policies have made China highly-dependent upon foreign investment funds or technology or both & on export for most of its growth. Dependency on outsiders is exacerbated by institutional arrangements that work against domestic entrepreneurs to provide an indigenous source of economic growth.

In the post-reform period, China’s economy has benefited from increased efficiency & productivity from disappearing distortions & irrationalities of central planning. More recently, economic growth has come from increased government spending or directed lending with state-owned enterprises (SOEs) being the prime beneficiaries. But “input-driven” growth driven by increased labor and capital inputs eventually runs up against the law of diminishing returns.

Meanwhile, diverting resources to SOEs with subsidies & artificially-cheap inputs undermines private-sector development & continues the imbalances introduced by export-led growth. For example, the massive & expanding stock of foreign reserves held by Beijing should invite alarm as an indicator of suppressed development of the domestic sector of the economy.

China could gain from increased productivity based on inventiveness & free thinking. Yet, its policies of authoritarian capitalism suppress individualism & intellectual freedom that undermines the independence of entrepreneurs as well as their access to capital.

China’s regime seems unwilling or unable to modify policies & institutions that make them dependent upon the financial capital or the creativity & inventiveness of other countries. In the long run, economic arrangements associated with authoritarian capitalism are unlikely to provide the levels of high economic performance recorded in recent years.

Meanwhile, China’s authoritarian capitalism is accompanied by the politicization of crime & the criminalization of politics. Crime is politicized with selective prosecutions & executions motivated by an urge to remove political challenges or challengers rather than eradicate a public menace. The success of this tactic is reinforced by the fact that political officials face few external checks & balances.

Politics in China is criminalized given that organized opposition to the regime is absolutely not tolerated. But refusing to allow political dissent eventually leads to greater social & political instability. Public dissent & political debate offers a “safety valve’ for the release of social tensions. By contrast, allowing dissenters to demonstrate publically or start & join political parties or vote current leaders out of office certainly provides stability to democratic regimes.

Blindness to the shortcomings of the intricate and extensive elements of their development strategies has left the leadership in Beijing open to a potentially-serious political crisis. But instead of the forces of modernization that prompt political change in China, it may be that its economic structures fail first.

On the one hand, entrenched dependencies with developed economies are a serious long-run challenge. On the other hand, the incentive structures of China’s authoritarian capitalism impede the emergence of local entrepreneurs or researchers conducting original research.

Of more immediate concern is that China’s economy exhibits classic symptoms of “bubbles” driven by loose credit policy, vigorous stimulus spending & the logic of export-led growth. Regardless of Beijing’s tight controls, there is no reason to expect that the record of centuries of collapsing bubbles can be changed. As such, the question of bursting or deflating speculative bubbles is a matter of when, not if.

China’s leadership knows that monetary tightening and reduced deficit spending are necessary. And the State Council called for rebalancing consumption and investment back in 2003. Even so, economic imbalances have worsened.

Beijing anguishes over slower economic growth leading to social unrest from increased unemployment but rising inflation could also bring social unrest. Coping with these economic imbalances is like having a “tiger by the tail” in that any move involves very high risks.

Continued reliance on exports for growth requires propping up exporters to keep employment high as a key to social stability. But this undermines economic restructuring & efficiency-enhancing steps by the export sector that would push up unemployment.

As Beijing pressures producers to keep prices low rather than reduce their workforce, their profit margins shrink and they demand subsidies. Domestic consumption is crimped by subsidies and is also dampened by an inflated exchange rate that deters imports. All this perpetuates the trade imbalances that lead to a dangerously-larger pool of foreign reserves.

While China should enjoy rising economic fortunes and more global political influence, it is naïve to extrapolate recent economic performance as an indicator of future success. As it is, the contradictions of China’s economic policies within a framework of authoritarian capitalism will undermine its future economic growth prospects.

Among my pet peeves….

I have a suspicion that whoever coined the phrase “crony capitalism” believed that it was just another example of the moral defects of a market economy. As such, this reflects the spirit of vexatious claims by Marx & Marxists of the “fatal and internal contradiction” of capitalism that would lead to its inevitable and exorable demise. (And, of course. from their perspective: good riddance!)

But applying crony to accompany capitalism disregards the fact that competition is an essential element of markets. As such, it is surprising to find advocates of free markets using this oxymoronic term.

While markets use prices as an instrument to coordinate individual actions & interaction, the social function of prices depends upon private property rights operating within a competitive framework.

As it is, the notion of “cronyism” is a feature of public-sector governance and is found in virtually every form of governance. A better way to describe this sort of influence peddling is “rent-seeking” behavior, though the latter phrase has ambiguous import to non-economists.

What is “fair” about (progressive) taxation?

US President Barack Obama”s administration & Congress are seeking greater progressivity in the taxation of earning of Americans. It has been proposed that income tax rates be raised on couples earning over $250,000 a year & single individuals earning over $200,000.

You would think that those in higher income taxes are already paying more than their “fair” share. According to the US Congressional Budget Office (CBO), the top 20% of all income earners in the US paid 86.3% of all income taxes in 2006. And taxes paid by the top 1% exceed what is paid by the bottom 95% of all taxpayers.

But it seems to be an article of faith that imposing a tax rates progressively linked to income is “just” and that governments do so to create a more “fair” distribution of income.

Economists, especially those teaching public finance, have provided intellectual cover for taxation with notions like “tax neutrality” and so-called optimal tax rates. And they offer support progressive taxation with arguments about “horizontal” equity (i.e., taxing equals in an equal manner) and “vertical” equity (taxing unequals differently). And they often refer to the “ability-to-pay” principle that implies that wealthier individuals should pay more simply because they can; a notion completely devoid of any moral logic.

Implicit to all these conceptualizations is that citizens do not have first claim to their earnings * that their rights to acquire property are contingent upon the requirements of the state. As such, the whims of the ruling class made up of politicians & bureaucrats are “privileged” over the rights of citizens that operate in the private sector as members of the productive class.

But progressive taxation violates various moral markers including Kant”s categorical imperative that specifies a rule is “just” if it is general & applies to every person in the same way. This also contradicts the “rule of law” that requires each be treated as all others without prejudice for or against those with unequal income, wealth, power or other attributes.

And taxes that aim to impose a progressive burden interfere with market-based rewards based on private agreements between an employer & employee. Such a system supports the politics of envy that contributes to a sense of entitlement by those at the receiving end of income redistribution.

If “fairness” is interpreted as equality of sacrifice, it is better served under proportional rather than progressive taxation. This is because unequal rates of tax can only generate equal rates of sacrifice if each unit of money is worth less to those with the most than to those with less. As it is, income tax progressivity discourages working hard, saving, investing & entrepreneurial initiatives.

Will cheap credit & loose money bring high & rising price levels?

Most economists that now or once considered themselves to be “Austrian” economists expect high & rising price levels from the effect of recent “stimulus” policies. The combination of loose monetary & credit policy along with massive fiscal deficits is seen as a lethal cocktail that only delays an inevitable “bust” after an illusory recovery.

Yet questions arise as to the tame increases in price levels during the “boom” over the early 2000s that set the stage for the Great Correction that is still before us. Central bankers have heralded that period as evidence that their taming “inflation” was one of their great triumphs.

It is hard for me to find much about central bank policy that deserves congratulatory remarks. So, let’s look elsewhere to see what might be behind the global record on price rises. Ignoring, of course, the ruinous experiences in Zimbabwe & Venezuela.

Part of the answer is that increasingly-dynamic competition brought by globalization along with rapid technological change should be deflationary. This means that price indices understate or mask the real extent of price increases.

Another factor might be seen in changing demographics that the way in which time preference relates to market interest rates & how price levels change.

For example, many industrialized economies are experiencing a rising average age in their populations. As such, a question arises over the impacts that this demographic shift might have on intertemporal decisions of firms & households concerning consumption, saving & investment.

If young people are “high discounters” requiring higher compensation to forego current consumption, lower average age would lead to increased scarcity of loanable funds. In turn, this lower propensity to save would bring higher market rates of interest, ceteris paribus.

Contrariwise, “graying” populations might reduce the sensitivity of consumer price indices to actions by central banks to inflate the money supply. If this is the case, the rising price levels that are being predicted might be more muted than expected.

Anyway, it was ust a thought off the top of my head…comments welcome….

Under the “rule of law”, unequals must be treated as equals!

“The law, in its majestic equality, forbids the rich as well as the poor to sleep under bridges, to beg in the streets, and to steal bread.”
Anatole France

And so, regardless of whether income or wealth inequalities exist or if people are unequal in terms of political power, all must be seen as equal before the law.
Someone should remind our self-important elected officials & bureaucrats of this fact.