[Part 1 is here.]
Some might answer any defense of the free economy by pointing to the housing and financial crisis that came to a head in 2008, holding it up as proof positive the free economy is a wrecking ball swinging through communities and leaving all manner of economic and cultural destruction in its wake. The financial crisis did enormous damage, but the major drivers of the crisis were a series of public policies that manipulated the market in pursuit of certain desired ends.
It all began modestly enough. The federal government built incentives into the tax code in favor of taking out a home mortgage. Many local governments also provide property tax breaks to home owners unavailable to renters. While people who are forced by circumstances to rent might question the fairness of such tax breaks, these measures are seen by most as relatively benign. Eventually, however, other top-down manipulations of the housing market were piled on top of these tax breaks.
The U.S. government offered implicit backing to mortgage giants Fannie Mae and Freddie Mac so that the companies understood that if they got into financial trouble, Washington would bail them out. This allowed Fannie and Freddie to offer low interest home loans to high risks borrowers, since the companies knew the government would come to their rescue if too many of these borrowers started defaulting on their loans.
The government also passed regulations that actually pushed mortgage companies, including Fannie and Freddie, to provide home loans to people with bad credit—subprime loans.
Finally, the Federal Reserve held interest rates artificially low to stimulate the economy. This fed the housing bubble since many people thought to themselves, the interest on a home loan is lower than the rate that houses are rising in value. Buying a bigger or fancier home than I need is actually a smart investment—I borrow at 5 or 6 percent, get a return of 8 or 9 or 10 percent. The return more than covers the interest costs—magic!
For a while this thinking became a self-fulfilling prophecy as more and more people rushed to buy bigger homes and second and third homes. The increased demand pushed prices even higher. Everyone was making money. Everyone was happy. But of course, it was a Ponzi scheme in disguise, an economic bubble. Such bubbles expand for a time, usually thanks to artificially easy credit, but eventually they pop.
The first stage of a bubble bursting is when it finally dawns on enough investors that the thing everybody is rushing to invest in because it keeps going up, up, up can’t possibly keep going up, up, up, since people only have limited resources.
Some of these investors then realize that if and when it starts to go down, they’ll get hammered because they used the atmosphere of easy credit to borrow and invest on margin. So, for instance, if a man who borrowed $90,000, added his own $10,000 to it, and then invested the resulting $100,000 in MegaBubble Enterprises, the sector would need to decline only 10 percent to completely wipe out his original $10,000 investment, leaving him with nothing but a debt from the interest he still owns the lender.
The savviest and luckiest investors exit near the top of a bubble, before the contraction begins, but their exit begins the process of dampening demand for the bubbly it-thing everyone has been rushing to invest in, and so the price decline begins. In a highly leveraged investment situation of this sort, a small decline can wipe out one’s entire investment, so the contraction accelerates rapidly once it begins, popping like a bubble.
The housing bubble was no different from other economic bubbles except in its being bigger and in its involving numerous bubble investors who weren’t looking for a clever investment but merely wanting to buy a home for their family and just had the misfortune of being ready to do so near the top of the market. When this massive bubble finally burst, it precipitated the financial crisis, throwing the economy on its back, sparking a flood of foreclosures, and economically ruining many people.
All this occurred thanks in large part to people in government promoting an ownership society from the top down. Thus, the crisis wasn’t the outworking of a free economy run wild but of government efforts to control and channel the market.
Some things can be done to effectively cultivate a responsible ownership society; it’s just that a program of top-down market manipulations and lending mandates by the federal government isn’t among them. An ownership society grows up from a culture of strong families, churches, and civil institutions, which instill in each new generation the ability to work hard, delay gratification, and practice thrift. It also helps if people see themselves as steward of creation rather than as mere consumers or cogs in a machine.
The effective way to cultivate such attitudes and virtues isn’t through government mandates. It’s through the hard, patient work of cultural renewal—among families, churches and civic organizations, and through discourse grounded in truth and reason.
Part 11 is here.]