Friday, February 20, 2009

We know the 'plan' is not the answer

Published in The Tennessean February 19, 2009

We know the 'plan' is not the answer

By Richard J. Grant, Ph.D

This current recession will end. But that will be no thanks to government "plans" and "packages."

The new "Financial Stability Plan" has something in common with its companion "stimulus package," It will do the opposite of what its name promises.

When Treasury Secretary Timothy Geithner introduced his plan, and the markets fell, it was said that the plan lacked adequate detail. But we don't really need the details to know that the plan is wrongheaded.

First, let's deal with the silly assumption that the current downturn was caused by a free market. In the U.S., governments account for almost 40 percent of all spending, and banking is one of the most heavily regulated, and distorted, sectors. The government even has a monopoly in the creation of currency, a power that it uses to interfere daily in the credit markets. It should be no surprise that we have problems.

Now Mr. Geithner wants to "expand lending," require "mortgage foreclosure mitigation," and to "drive down overall mortgage rates." What a nice man. Shouldn't we be happy? Not if we understand economics.

The Federal Reserve does not have a clue what interest rates should be, and neither does the Treasury Secretary. Interest rates are a market phenomenon. Pushing rates down artificially encourages people to act as though we have more capital available than is really the case. Home buyers believe they can afford bigger mortgages, and businesses believe it more profitable to expand. But the government has sent them false signals through the market. That is the kind of interference that got us into this mess.

Bureaucracy takes over
Pushing more money into the economy is not the same as creating more savings and capital. But it does temporarily reduce interest rates, thereby discouraging saving at a time when we need more capital.

As in all markets, when the government forces prices down, it creates shortages. Wonder why credit markets are "frozen"?

There is a mistaken belief that falling home prices are the cause of the crisis in the financial industry. The real reason is the failure of many borrowers to live up to their loan agreements.
Not understanding this, the Treasury Secretary wants to prop up home prices, and also wants to prevent foreclosures. To the extent that he succeeds, he will prevent the home market from adjusting to reality.

He will also further hurt consumers by weakening the usefulness of collateral to banks. Especially if judges or government agencies are brought in to rewrite mortgage contracts in favor of borrowers, banks will protect themselves in the future with far stricter loan requirements. The kinds of people the government claims to be helping now will be hurt later.
Even though government has demonstrated itself to be a poor regulator and an incompetent loan officer, Geithner's plan has the effect of expanding government influence over the banking system.

By taking government bailout money, rather than doing the honorable thing, bankers have abdicated their private moral authority. They used to be merely undercapitalized. Now, they have been bureaucratized.

Richard J. Grant is professor of finance and economics at Lipscomb University and a scholar at the Tennessee Center for Policy Research.

Copyright © Richard J Grant 2009