Risk begets reward. It is the inherent truth to all economy from the dawn of man. Cave men risked their very lives to hunt beasts hundreds of times bigger than they were, in search of the reward of a massive harvest of high-protein sustenance for their families. Often times, however, their reward was their own demise. Sailors of the tall-ship era risked their lives and fortunes in search of trade routes where they could be made wealthy, but often times lost everything, including their lives, to an ill-timed gale. Businessmen invest their wealth in this venture or that in search of reward in the form of profit, and often lose their wealth as a result. Even a worker who seems to risk nothing for his wage gives up his time and labor in return for that reward, and to further prove my point, high-risk jobs always pay more money.
This risk vs. reward analysis is what has worked to constrain men into making rational decisions throughout history; if the reward is not great enough to offset the risk, then a rational man would not take that risk. If a wooly mammoth did not yield a bountiful harvest of protein for the cave man’s family, he most certainly would never have risked so much to harvest it. If the trade routes of the 16thcentury were not so lucrative, the risk of outfitting expensive ships and risking the lives of so many men would never have been taken, and those trade routes would have never existed. If the cost of King Crab was not so high, no rational man would even consider risking so much to fish the Bering Sea. If the job tying rebar while hanging from the side of a 150 foot bridge abutment didn’t pay better than the safe job of flipping burgers at McDonalds, few would consider doing it.
It is the risk that constrains: if risk is removed from the equation, then bad things always happen. Take, for instance, the recent sub-prime mortgage debacle, where the government encouraged banks to take massive risks in the sub-prime market, while guaranteeing them, sub-rosa, that any losses would be covered in exchange for participation in this scheme, thus eliminating the risk, and maximizing the reward.
Many blame the greed of the bankers. I do not doubt that many businessmen are greedy bastards who would sell their Grandma’s house out from under her for a nickel in profit. However, all this does is reinforce the fact that natural market risk vs. reward pressures must remain in place in order to check the avarice of the greedy among us. Once the risk is removed from the equation by government guarantee, all that is left is reward, and the avarice of these men can run unchecked – and so it did exactly that when our government made them that promise. These men made the riskiest choices possible, because risk begets reward; and why wouldn’t they? The government is actively encouraging them to do so! They have been promised by the government that if things go awry and the risk wins out over the reward, that they will be bailed out! There is no chance of anything other than a win for these guys doing things that they would never even consider risking if it weren’t for the government exerting pressure to perform in the way they desire, and guaranteeing against the risk of these horribly risky behaviors.
This boils down to the socialization of risk and the privatization of reward, which puts the taxpayers, not the banker, at risk for the decisions that the banker makes. If his decisions pay off, the banker keeps the reward, and the taxpayer gets nothing in return for accepting the risk (against his will, by the way). If his decisions result in disaster, the taxpayer picks up the burden, again against his will, and the banker continues to operate as if nothing happened. That being said, one wonders what the unforeseen consequences of taking the government’s dane-geld will end up being for these organizations – a smart CEO would not have been so quick to allow that rough beast’s nose under tent flaps, but that’s another story for another day.
All this has lead me to make a point that many people are surprised to hear me make, which is to say that this market meltdown was not a failure of the free-markets, as so many people were so quick to claim. This is a failure, yet again, of centralized government control by legislative fiat. It has happened so many times now: the Soviet Union; Cuba; Venezuela. You’d think that we would have learned by now, but we apparently did not.
Every time that the market “fails” to provide something that we think should be provided, such as home ownership for all, we chock it up to a failure of the market and push for government intervention to get us that which the market will not provide, and every time – EVERY. TIME. – it backfires. That which we desired to have, we discover, was never meant to be, and the unintended consequences of forcing the markets are far more terrible than we ever imagined. The markets weren’t failing to provide, they were simply choosing, through the invisible hand of a trillion transactions a day, to not provide these things because they weren’t meant to be because the risk vs. reward was out of balance.
In the case of the most recent blunder, it was the desire of many in government for every American to own a home – even those who could not afford one. The problem with this is that the folks tweaking the knobs and dials did not approach this “problem” with reality-based thought processes. Rather, they were blinded by how good it felt to forward these ideas, and proceeded blindly out of altruism. After all, what kind of a monster could possibly stand in opposition to universal home ownership? Yet again, the one-size-fits-all nature of government prevailed in a vain attempt by those in control to provide something for people that had no business having that thing. They also proceeded stupidly with the idea, and messed up huge with the following:
- Their goal was that everyone should own a home. What they did, instead, was gave everyone a mortgage. Often times, these were mortgages that could not be paid back under the terms in which they were written. So instead of universal home-ownership, the government was promoting universal crushing debt loads.
- They assumed that every person in America would benefit from owning a home, and that home ownership was good for all. As pointed out in #1 above, however, all they succeeded in doing was giving them a crushing debt load. It essentially “helped” these poor people by bankrupting them in droves. But beyond that was the assumption by these folks in DC that owning a home is necessarily a good thing for every person, when some people are far better off renting. I do not understand how the idea that home ownership should be universal became so mainstream. There are upsides and downsides to home ownership, not the least of which is the financial risk that your asset will lose value, and the not-unsubstantial costs of maintaining said home, both of which are eliminated in a rental. Home ownership is a matter of personal preference, but the government treated it like it was a prerequisite.
- That home values would inevitably continue to rise. As pointed out in #1, often times it was established and accepted at the time of signing that the home owner could not pay back to the terms of the sub-prime loan. These loans generally have a period of time, typically the first 5 years, where the loan payments don’t even cover the interest, so the actual amount owing goes up, not down, for the first 5 years. Then, on year 5, there is a huge balloon payment due to cover the interest owed, but not paid, to that date, and then the payment amounts reset to actually start paying down the loan. This could increase payments by a factor of ten, overnight.
The idea was that if home values continued to rise, that these folks would be able to refinance their homes under favorable conditions after 5 years, allowing them to avoid the “reset” and balloon payment.
What they failed to consider was the fact that when you flood a market with demand, as this sub-prime policy did to the real estate market, that prices will continue to go up for only as long as the demand remains. That is, in my opinion, what was causing home values to rise – not any actual real growth in the market, but a “bubble” created by external centralized command and control that had no understanding of the market that it was tweaking. However, the number of people desiring to buy homes eventually subsided as the demand was satisfied (ie, everyone that wanted a home had gotten one), and home values stabilized. Then, suddenly, all of these new homeowners found that their rates were resetting, and had to get out from under the massive burden that these homes were fixing to dump on them. Their credit-worthiness hadn’t gotten better – in fact, it had gotten worse in the aggregate because they were struggling to make mortgage payments now, and so they couldn’t refinance. Their only option was to sell…
…which they all did…
…at the same time.
Basic economic theory states that when you flood a market with supply, and there is no increase in demand (in fact, there was a net decrease in demand at the same time as supply skyrocketed), the prices of goods within that market fall. Real estate values plummeted from this massive increase in supply, and the rest is history.
The people whom the government was trying to help were bankrupted by governmental
incompetence, and even innocent bystanders, with no involvement in this scheme
at all, were stripped of trillions of dollars in equity and asset value.
The most important point in all of this is that it was 100% foreseeable to anyone with even a middle-school level understanding of economics. The people in government are not smarter than you or me. They are normal, everyday people, who make normal, everyday mistakes. The problem with government is that when they make small mistakes, it becomes a nationwide catastrophe because they have the ability and power to force their mistakes on us all. When individuals make the same mistake, the market doesn’t even notice, and people all over the country aren’t dragged into poverty, or stripped of their hard-earned wealth as a result. Again, this is proof that markets should be left alone to be driven by individuals within them, if for no other reason than to hedge against mass-catastrophes like this one, which are caused when you put one fallible individual or organization in control at the top.
Thus, we get to the meat of the matter, and the explanation as to why I filed this essay under “Unintended Consequences.” The intended result of this push for universal home ownership was to help the less fortunate by providing them with a method by which they could own a home.
The actual result, however, was a massive transfer of wealth from those same poor people, and also the middle class, to the wealthiest 5% of people in our nation in the form of TARP, bailouts, and stimulus spending to the banks. So, in an attempt to help the little guy get something that he didn’t need, couldn’t afford, and should never have had in the first place, the government ended up bankrupting that little guy, transferring his wealth and a massive portion of the wealth of the middle class to the wealthiest businessmen in the country, and stagnating the US economy for what I think will be more than a decade. Millionaires were made even wealthier, and the poor and middle class just got hosed, like always.
Furthering this to its logical outcome, there is now an entire cohort of businesses and businessmen in America who know that they are now “too big to fail” and will be bailed out if the risks that they have taken come home to roost. What effect will this have on their future business decisions? I suspect that I know, how about you? We’ve socialized risk, while keeping reward private, meaning that any organization that can reliably call themselves “too big to fail” no longer carries any risk, and therefore we all run the risk of this new corporatist policy causing big business to run amok – something they’d never be able to do if the government had just minded their own business and left the housing market alone.
To you socialists and communists out there, if this isn’t a clear, concise explanation of why your desire for central economic command and control will result in epic failure, I do not know what is. The people elected to government positions are not economists, bankers, or even all that smart, and yet you want them to be in control of everything. If you are so blind that you cannot see what an absolute disaster the socialization of any country will inevitably be, much less one so diverse as America, then I cannot help you any further. I suggest that you seek help for whatever mental problems you are currently experiencing, because I can find no other explanation for your zealous overconfidence in all things government.
And finally, if any of you think that the nationalization/socialization of the entire healthcare industry via Obamacare will result in any less of a debacle than the nationalization/socialization of only a small portion of the mortgage industry (risk on sub-prime mortgage loans), then I have some ocean-front property in Arizona that I’d like to sell you – you interested? The centralized command and control structure has failed every time it’s been rolled out. Are you ready for the healthcare bubble and collapse? Because it’s coming. Mark my words.
PS – Any time I bring up this conversation, the first counters to my statements of fact usually go something like: “it all started way before Obama, and that it was all Bush’s fault.” I’ve usually been flabbergasted by this statement, because I am not sure how it is even relevant to the conversation; at what point did I mention Obama in anything that I said above, other than by mentioning the Stimulus bill, which Obama signed (right next to my mention of TARP, which had Bush’s signature on it)? It is a scary exposition of the ability of people to comprehend an argument and develop a counter-argument of their own when they respond with a non-sequitor like that one. Who cares which President led us down this path to destruction? I could argue, and back it up with fact, that it was actually the actions of Clinton and a Republican congress during the Clinton administration that set this ball to rolling, with Bush and a Democratic majority congress doubling down on it, and Obama and a democratic super-majority congress enlarging it by a factor of ten. You can’t defend the actions of one President by saying that another President did it, too, especially when the guy you’re defending did it ten times more than the guy you are blaming for the problem.
But that isn’t even the point! It doesn’t matter who was President, or who was running congress, and any argument to the contrary is just silly tribalist nonsense, because both Republican and Democratic congresses and presidencies pushed this thing as if it was a good idea. The point that I am trying to make is bi-partisan –that NO GOVERNMENT, no matter which party is running it, can competently interfere in the workings of the free-market and expect to see the results that they’d intended when they made their interference. In fact, they would be better off expecting JUST THE OPPOSITE* to happen, as has been the case throughout the history of these interventions. In case you hadn’t figured it out yet, I am no fan of the Republicans. I see them as basically the same as the Democrats, wanting exactly the same thing – more power and control. They just want to do it more slowly and in slightly different ways, so you see me railing against the Democrats more on this blog because they are more aggressive about doing the things that I am against. Do not make the mistake of assuming that I support any person at all who desires more power over me and my personal, individual decisions, regardless of whether they have an R or a D behind their name.
*PPS – Here is what I mean, for example. The idea behind this push for universal home ownership was an attempt to better the lot of the poor man. They succeeded in making his plight much worse, to the betterment of the richest among us. This is the exact opposite of what they expected. Another good example is societal equality in Soviet Russia: that society was created under the idea that all men would be treated equally; that the state would ensure equality for all, and that no man would want while his neighbor had all he needed, ever again. The government there, however, managed to accomplish just exactly the opposite.
They created a de-facto ruling class that lived in luxury, had special lanes on the highway that the “little people” could not use (not that it mattered, very few of them had cars, anyway), and had their every desire met, while pretty much everyone else lived in poverty and feared the ruling class mightily. They failed to achieve equality – in fact, they only made the class separations even worse. They failed to eliminate need, want, or poverty – in fact, they made it much worse. They caused millions to live in fear and poverty for nearly 60 years before they figured out that their ideology – and thus, their ability to control everything that they thought they could control – was a complete failure.
Throughout history, governments have been responsible for indescribable amounts of suffering and death, and a good portion of it sprang from the unintended consequences of the actions of the well-meaning. The only hedge against this terrible fact is to realize that government needs to be constrained in what it does as strictly as possible, and that individuals, not government, should be responsible for their own success, and by proxy, the success of the nation. I know that this isn’t perfect, and that it will result in inequality, but it will result in far less inequality than any governmental attempt to fix this problem ever will.
”The inherent vice of capitalism is the unequal sharing of blessings. The inherent vice of socialism is the equal sharing of misery” - Winston Churchill
”Capitalism is the worst economic system ever tried, with the exception of everything else” - Mark Twain