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Blame bad
rules, not capitalism
By Eamonn Butler
With turmoil in the world’s markets,
politicians and commentators have been demanding more regulation and
control of the financial sector. Their reaction is entirely predictable
– but entirely wrong.
This crisis was not caused by capitalism being fatally
flawed. It was caused by politicians forcing the banks to give out bad
loans, monetary authorities flooding the West with cheap credit and
regulators being asleep at the wheel.
Indeed, one can date its origin precisely, to 12
October 1977, when US President Jimmy Carter signed the
“anti-redlining” law. Before then, lenders generally denied loans to
people in poor neighborhoods, believing that the local mix of low incomes
and a weak housing market would lead to many people defaulting. But the
politicians – with good intent – wanted to make home ownership
available to all Americans. Therefore, lenders were forced into giving out
risky mortgages, which we now call “sub-prime” loans.
By 1985, this torrent of bad business had nearly
bankrupted America’s saving and loan institutions. So the government
took on their bad debt and encouraged them to consolidate – unwittingly
making them too big to be allowed to fail.
Meanwhile, several other problems worried the monetary
authorities. In 1987, the US stock market plummeted, fearing that other
lenders could collapse. Asia’s markets sank. Mexico, Argentina and even
Russia defaulted on their loans. Over-valued dotcom stocks crashed and
then the 9/11 incident occurred. Each time, the Western authorities
responded by flooding the markets with cash.
After 9/11, the Federal Reserve took US interest rates
down from 6.25 per cent to just 1 per cent; fearing this blow to investor
confidence could sink the markets. But again, their action boosted the
wrong market by sustaining the credit bubble. With loans now six times
cheaper, mortgage applications soared. Lenders, awash with the Fed’s
cash, happily issued more sub-prime loans. With more people buying homes,
house prices soared. Buying a house seemed a certain money-maker, so more
people got more loans and bought more houses, continuing the spiral.
In London, that other great financial centre, a decade
of government overspending saw public debt soaring. Private debt, and
house prices, soared even faster.
So for ten years, economies boomed. But it was
financed by fake money – printed by the authorities solely to keep the
economy in a boom. When the dawn of realisation broke, the long boom
turned into the inevitable setback, which we still suffer from today.
The regulators, meanwhile, were unconscious on the
floor. The US mortgage institutions, Fannie Mae and Freddie Mac, had 200
regulators on their case but still went bust for US$5 trillion. These
semi-governmental companies allowed investors to believe the bad mortgages
were guaranteed by government, causing credit rating agencies to give
their dodgy bonds high scores.
Mortgage lenders re-packaged these bad debts round the
world but nobody cried foul. Institutions were lending thirty times their
asset base. Though the Bank of England knew that the huge mortgage lender
Northern Rock was failing, the 2,500 staff of Britain’s financial
regulator seemed to do nothing until it actually collapsed six months
later. Even then, they had no coherent plan.
When the government is persuading the casino to hand
out free chips and the regulators are standing drinks at the bar, you
shouldn’t be surprised if the customers place a few risky bets. It’s
the management and not the system that deserves our scorn for breaking the
basic rules of economics. Any sustainable solution has to get finance back
to those basics. But the bail-out package includes so many treats for
special interests that it could save the culprits without helping the
victims.
China, now the world’s fourth biggest economy, it
continues to grow at nearly 10 per cent. India and other is an emerging
economy which is also expanding. Even with the West in recession, world
growth next year will probably be near 4 per cent, which has a positive
outlook.
Western capitalism has been dealt with a severe blow
by inept politicians and officials. But global capitalism continues to
pull hundreds of millions of people out of poverty.
— (Dr. Eamonn Butler is Director of the Adam Smith
Institute think-tank, London, and author of Adam Smith – A Primer.)
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