What Politicians Can Do to Help the Economy

President Obama has been talking a lot about the economic "headwinds" that have caused his policies to amount to so little. This is a time when politicians--particularly Democrats facing re-election--are throwing up their hands and suddenly discovering the many limits that constrain what government intervention can accomplish.

In reality, there is an awful lot that our political leaders can do to help the economy. The problem is that what they can do is the opposite of what they want to do. What they can do, to borrow a line from Ayn Rand's Atlas Shrugged, is to get the hell out of our way.

A scan of some recent news items will give you an idea of the pattern. Despite all of the talk about "deregulation" being the cause of the financial crisis, what we actually see is private financial activity suffocated under mounds of regulation.

Richard Rahn recently explained how Sarbanes-Oxley, the draconian new regulations pushed through opportunistically in the wake of the Enron scandal, killed off the initial public offering, so that for the past three years, China has taken over as the world capital of IPOs. Rahn also credits newer regulations--Dodd-Frank and the Foreign Account Tax Compliance Act (FATCA)--for making sure the American IPO market will never recover.

This may all seem like old news, but reflect that the signature tool of financial markets in the booming 1990s was the IPO. After Sarbox killed the IPO, the signature financial tool of the bubbly 2000s was the derivative. We went from providing start-up capital directly to new productive ventures, to repackaging other people's loans in increasingly complex and inscrutable forms.

As for the "other people" who were creating those loans, Peter Wallison and Edward Pinto have sifted through new information from the SEC's investigation of Fannie Mae and Freddie Mac and found new evidence of the extent to which government sponsored entities generated the toxic debt that crashed the economy.

"All told, after adding the SEC's new data to our original estimates, there were approximately 28 million subprime and Alt-A loans outstanding on June 30, 2008, before the financial crisis, with a value of approximately $4.8 trillion. This was half of all mortgages in the United States. Of these loans, over 74 percent were on the books of US government agencies and firms subject to government housing finance policies. This shows where the demand for these low quality loans came from. Fannie and Freddie were themselves exposed to more than 13 million subprime or Alt-A loans, or 65 percent of the government total."

Suprime and Alt-A loans were loans given to people without much concern for, or documentation of, their income and creditworthiness. So naturally the Obama administration is looking to do the same thing all over again.

The latest move? President Obama has taken the extraordinary step of installing his favored candidate at the head of the Consumer Financial Protection Bureau through a recess appointment--while Congress is still in session. Which is to say that this is not a recess appointment but a blunt rejection of Congress's constitutional power to "advise and consent" to the president's executive appointments.

But this is just the warm-up. James Pethokoukis reports that the next step is for Obama to install his own man as the chief regulator of the government sponsored entities so that he can implement a mass government-sponsored refinancing. "My sources tell me the Obama administration has been eager to implement just such a plan, but needs to have its own man heading the FHFA to make it happen." Here is how one of the architects of the plan, Columbia University economist Christopher Mayer, describes it.

"Under our plan, every homeowner with a GSE mortgage can refinance his or her mortgage with a new mortgage at a current fixed of 4.20 percent or less.... To qualify, the homeowner must be current on his or her mortgage or become so for at least three months.... Other than being current, we would impose no other qualification or application, except for the intention to accept the new rate (that is, no appraisal, no income verification, no tax returns, etc.)."

In effect, the government will decree that we are all prime borrowers, entitled to a prime rate. No paperwork, no income verification, no appraisal. Does any of that sound ominously familiar? I know exactly what slogan they should use for this program: "The Power of 'Yes'."

(The real punch-line to the story: the other architect of this idea is Glenn Hubbard, an economic advisor to Mitt Romney.)

In addition to financing a lot of subprime loans at prime rates--a guarantee that taxpayers will be left on the hook--banking analyst Dick Bove points out that this will hurt investors by forcing them to survive on lower yields. "So the net effect is the people you are taking the money away from are the taxpayers and the investors."

The White House has since denied that they are considering such a program. But note that it is not just what is being done, but how it is being done. No one knows what will happen to the mortgage industry or the housing industry, because it could all be completely changed overnight by the unilateral decree of the president and one of his "czars." When no one knows what will happen, no one can know what anything is worth. So they put a low value on everything, just to be on the safe side. It's another example of how planning is chaos: how every plan made by some centralizing bureaucrat disrupts the ability of private individuals to make their own plans.

Yet there is a method to this madness. At the Financial Times, Gillian Tett describes how nominally private banks are increasingly being turned into "piggy banks for the state," tame buyers of unlimited quantities of government debt at favorable rates.

"[I]f you want to understand how the west cut its debts during the last great bout of deleveraging, namely after the second world war, then do not just focus on austerity or growth; instead, the crucial issue is that during that period, the state engineered a situation where the yields on government bonds were kept slightly below the prevailing rate of inflation for many years. This gap was not vast. But since asset managers and banks continued to buy those bonds at unfavorable prices, this implicit, subtle subsidy from investors helped the government to cut its debt pile over several years."

Similarly, Brett Arends explains why his "too big to fail" bank took a pass on lending for a private mortgage and didn't seem all that upset at losing his business.

"Why not? Under our current system, they can make money at the expense of taxpayers without any effort at all. Thanks to the Fed, they can borrow at nearly zero interest, then turn around and lend money back to the taxpayers at 2% or 3%. They win, we lose."

Get that? The banks get free money from the Fed, which they use to buy government debt at low interest rates. It's a cozy deal that diminishes any incentive to loan money to finance private economic activity.

One last example: Louis Woodhill sketches out a similarly corrupt triangular trade embodied in the recent extension of the temporary payroll tax cut.

"[L]et's look at what actually happened in 1Q2011.

"First, the Treasury borrowed $27 billion additional dollars. Then the $27 billion was (incrementally) distributed to workers via the payroll tax cut. What did those people do with the money? They saved it. Saved it how? On the margin, they saved it by buying the bonds that had been issued so that they could have the payroll tax cut. Who will ultimately have to pay off the bonds? The same people who got the tax cut. Isn't Keynesianism clever?"

(Woodhill's article, by the way, is worth reading if only for his devil's dictionary style summation of our political system: "America has a two-party system. We have a Stupid Party (the Republicans) and an Evil Party (the Democrats). Every so often Congress does something that is both stupid and evil, and we call this 'bipartisanship.'")

The overall pattern is to make private financial activity difficult, burdensome, and unprofitable, while arranging the financial system for the convenience of the government and its politically favored friends. And then when it all goes wrong, they either blame private "greed" or helplessly declare that it's all a natural debt cycle and there's not much they can do to make it better.

It is often claimed that the private financial industry is a giant scam that does nothing more than shuffle money around so that corrupt middlemen can take their cut. But this is precisely what describes the government's new dominant role in high finance. Money is supposed to be a living tool of production. Instead, under the government's direction, money is distributed to the American people in the form of government benefits, so that the government can borrow money from the American people, which will be paid back from taxes paid by the American people. While all that money is being shuffled into our and out of our pockets, the "too big to fail" banks get their cut, in the form of favorable interest-rate spreads, and the politicians get theirs in the form of re-election.

At least, until we decide to stop re-electing that kind of politician. If they won't get the hell out of our way, we'll have to remove them.