By G.L.C., on July 20th, 2008
The subprime crisis in the U.S. has resulted in the decline of many companies. Many banks including large ones had to write off millions. The decline is not limited to banks and home loan companies alone.
Out of the total $12 trillion in mortgage debt today, two companies – Fannie Mae and Freddie Mac – own or guarantee half of the debt. Both were established by Congress to make homes affordable for lower and middle income families. They do not provide home loans. Both buy mortgages from banks and home loan companies allowing them to make even more mortgages. They take on the risk of possible default.
The decline of Fannie Mae and Freddie Mac is not an overnight event. It has been building up over the years. Some experts feel the main reason for the decline is their unfair insulation from the real world – they are not subject to the same financial standards and taxes as their competitors. They are also exempt from state and federal taxes.
To be fair, the government did try to regulate them by setting up the Office of Federal Housing Enterprise Oversight in the early 1990s.
They were required to meet certain capital reserve requirements but still much less than their competitors. When the accounting scandals broke out at both companies a few years ago, the government had the perfect chance to set up a powerful regulator and rein them in, but the fear of stemming the housing boom probably held the government back.
It would be wrong to blame the lack of regulation alone for the decline of these two companies. The Securities and Exchange Commission tried to get more actively involved in regulating them, but both companies stymied their efforts.
Instead of addressing their critics, these companies forged alliances with them and other activist groups and made huge contributions to non-profit groups. These alliances and contributions were made to buy off the activists and groups and to make it more difficult for them to criticize the companies.
Congress is now debating on a legislation which if passed could give these companies even more power and allow them to venture into new mortgage-related businesses. Instead of making these companies more powerful, what Congress needs to do is to set up a regulator who can effectively regulate these companies and, at the same time, decide on some sort of a capital cushion for them.
The value of Fannie Mae and Freddie Mac’s mortgage assets are declining along with home prices everywhere. If these companies fail, the taxpayers could be left with the losses.
By J.D. Seagraves, on July 20th, 2008
One issue that differentiates economists from the vast majority of the general public is free trade. Economists overwhelmingly support international trade, with little or no regulation or taxation, and abhor protectionism—trade policies designed to “protect” domestic jobs. Meanwhile, upwards of 80% of American citizens believe that the U.S. government should be protectionist—or at least that’s what they say when asked. Their choices as consumers, however, tell a different story.
First it should be established what we mean by “free trade.” The term has taken a beating due to its association with non-free trade agreements and organizations such as NAFTA and the World Trade Organization. Real “free trade” is unilateral—it does not require an “agreement” between nations, only an agreement between the two parties involved in a given transaction. This laissez-faire philosophy rests upon the principle that people have property rights and they may dispose of their property as they see fit, so long as they do not infringe upon the rights of their peers. Thus, it is illegitimate for a national government to place tariffs or other taxes on imports or exports, even in retaliation for another country’s actions, because in doing so, it is only inhibiting the freedom of its citizens to buy or sell as they please. (More specifically, trade embargoes are ineffective in fighting human trafficking.)
That is the moralistic argument. Now here’s the utilitarian one: many “economic nationalists” (i.e. protectionists) believe that the U.S. should erect literal or figurative walls around its borders and laws should force consumers to support only domestic producers. It is reasoned that this would keep jobs from being “exported” overseas or to Mexico and Latin America. Thus, these misguided souls believe wages could be kept higher, presumably at the expense of greedy corporations and their insidious profits. (Read G.L.C.’s blog for a lawyer’s take on laws against outsourcing.)
If this were true, then it would also be true that a state, such as Michigan, would benefit from restricting trade to within its own state borders. After all, keeping jobs in Michigan rather than having them shipped out of state would be an imperative of Michigan’s governor, just as keeping jobs in the U.S. would be the president’s. If the U.S. can produce everything Americans need, then couldn’t Michigan produce everything Michiganders need?
Can we take this logic further? Why not keep commerce restricted to products produced within a county? Within a city? Within a neighborhood? Within a household?
Pure Restrictionism
Imagine if you had to produce everything you consumed—the ultimate in trade restrictionism. Think of the time you’d waste sewing your own clothes, building furniture, hunting and/or farming for your own food and providing your own entertainment. Your standard of living would be extraordinarily low. Now imagine that trade opened up to include everyone in your county. Now you could focus on the one thing you did well—say, drawing comic books—and you could trade the comic books you produced for the clothes, furniture and food you needed. You would end up with a greater quantity and a higher quality of goods and services since the best seamstresses, woodworkers and hunter/farmers in the county would be working solely on the activities they did best, thereby increasing the total quantity and quality of goods and services produced in the county economy.
If trade then expanded to include everyone in your state, then perhaps the local seamstress would be put out of business as entrepreneurs combined to create more efficient methods of producing clothing. Maybe she’d have to take a job in the clothing factory for less pay than she previously received. But now the new clothing factory would be producing more clothes at a higher quality and a lower price than ever before. The seamstress’s dollar would stretch farther in the growing economy, and even though she may be nominally worse off than she was before, in real terms, her living standard would improve. Meanwhile, the demand for your comic books goes up as the state gives you a broader customer-base to which you can market your wares.
You should be able to get the idea. The greater you expand the pool of individuals working to produce the goods or services in which they have a comparative advantage—i.e. the activity that allows them to maximize their utility—the higher the standards of living for everyone in the country and the world. This principle is known as division of labor, and it is the building block of capitalist economics.
The Austrian Take
Now, it must be reiterated that although things like NAFTA and CAFTA might expand trade, and thus many economists see them as “good things,” the Austrian School of Economics does not. That’s because Austrians oppose government intervention into the economy, and trade agreements such as NAFTA and CAFTA are nothing but interventionist. They are agreements between nations that contain several thousands of pages of rules and restrictions designed to benefit special interests. Most people who oppose NAFTA, CAFTA and the WTO do so because they’re opposed to free trade. The Austrian school and its most prominent proponent, Ron Paul, do so for exactly the opposite reason.
Restrictions on trade are not only inefficient, but they’re also immoral. If you don’t want to support another country’s development, even though doing so would be to the immediate and long-term benefit of you and the rest of the world, then fine; don’t buy products produced there. It is hubristic to agitate for the passage of laws restricting your neighbor’s choice to do so. And the fact that 80% of Americans, the vast majority of whom regularly shop at the People’s Republic of Wal-Mart, say they want protectionist laws shows a great deal of American hubris.
So give free trade a chance. It is the traditional American view declared by Washington, echoed by Jefferson and then somehow drowned out amid the clamor of Lincoln’s war. But just like our traditional non-interventionist foreign policy, free trade is an American tradition worth revisiting. The two go together, in fact, as Washington proclaimed his support for “commerce with all nations, entangling alliances with none” in his farewell address. Maybe it’s time to listen to the man on the one-dollar bill who could not tell a lie. He certainly was telling the truth about free trade.
By Jennifer Bunn, on July 20th, 2008
As the recent campaign for the Democratic nomination has shown, there is always much debate surrounding the issue of delivery of healthcare; specifically, what is the best way to deliver healthcare to citizens in the most cost-efficient manner? The U.S. healthcare system has provoked criticism due to its high cost and the fact that there are approximately 45 million people in the U.S. with no healthcare insurance.
The Canadian healthcare system has been offered up as an example of what Americans can aspire to; yet it has its own share of problems. Although every Canadian is entitled to free healthcare by law, wait times for some procedures and surgeries, as well as a shortage of doctors in some specialties, means that there is an increasing number of Canadians who believe that privatizing Canada’s healthcare system is the answer to the problem.
Is there a happy medium? Why is it that a model of healthcare hasn’t been developed that takes the best of each system and combines these virtues into a healthcare system in which every citizen has equal access to insurance that is affordable?
It has been suggested that the Canadian government should allow privatization of some parts of the healthcare system, such as diagnostic and surgical centers, in order to decrease wait times for some procedures that have excessively long wait times. Most Canadians have balked at this idea and fear that allowing privatization in some areas will lead to a two-tier system. Yet something must be done as the system is foundering.
The U.S. healthcare system is also foundering as many of the nation’s population have no access to healthcare despite living in one of the richest and most powerful nations in the world.
There is no easy answer to the problems of either country. Undeniably, each country will have to continue to look for a cure for their own particular woes. And, although we are allies, it is unlikely that the U.S. and Canada will look to each other for answers to these problems because then we would each have to admit that we have a problem.
By Greg Beatty, on July 20th, 2008
I don’t know about you, but I grew up reading children’s books. I loved them. From Curious George’s adventures with the man in the yellow hat to cheering for Max in Where the Wild Things Are (let the wild rumpus begin!), I lived and died with these characters. When I got older, I graduated to what are now called young adult (YA) books. These were more serious and ambitious, and some of them were pretty brutal (To Kill a Mockingbird, anyone?).
However, none of these prepared me for the harsh economic realities of The Astonishing Life of Octavian Nothing by M. T. Anderson. This is supposedly a YA novel—it won the National Book Award in that category in 2006—but to be honest, I wonder how many kids would willingly read this.
Why? Because Octavian is a slave, and this book hammers home what it means to be a thing rather than a person. This isn’t totally an economic matter; it is also a scientific matter, as Octavian is being raised as part of a scientific experiment to see just how smart Africans are (through how they respond to Western education).
Most of the book’s told from Octavian’s perspective, and it is, to be frank, both heartbreaking and hard to read. Octavian’s tutored into an elevated style from a young age and to reason and logic. If he cannot rationally justify a claim, it is given no weight. At one point, for example, Octavian discovers he has poisoned a dog he loved; he poisoned it accidentally from his perspective but as part of a scientific experiment on the part of his masters. He is then reasoned through his tears rather than being consoled.
The men running these experiments on Octavian measure every part of him, down to weighing his feces. Octavian’s life is completely rationalized. If he weren’t a thing—a slave—he would be the perfect economic man. That this scientific endeavor rests upon an economic base is brought home when the Earl of Cheldthorpe, patron of the entire experiment, dies. The new earl doesn’t have the same interest in abstract science, and the entire college is redirected to practical studies. Each science must justify its existence economically just as Octavian must do so rationally. As for Octavian, his study is redirected to serve the interests of those new backers now funding the investigation. This means he is turned from showpiece to house servant, that they try to hire him out (he’s a musician) to nearby parties, and that his education is reworked. It also means that the one possible justification (even in the period) of his treatment disappears. He’s no longer being raised for pure science. He’s being raised in a biased fashion, to fail in order to justify the economic interests of the slaveholding class.
There’s a lot more to The Astonishing Life of Octavian Nothing—the sub-economy of slaves in which personal energy is secreted away, the use of sexual desire as an economic counter—but Octavian’s position’s at the core of it. If you want to glimpse the dark side of economic forces (and get a sense of how much kids’ books have changed), you might dip in to The Astonishing Life of Octavian Nothing.
Editor’s note: Think slavery is no longer a part of today’s world? Read Mary Nichols’ report on human trafficking and how ineffective governments’ efforts are to stop it.
By Greg Beatty, on July 20th, 2008
The Red Queen among Organizations: How Competitiveness Evolves. By William P. Barnett. Princeton University Press, 2008. 296 pages. $29.95.
 There are several pillars to free market economics. Among these are private ownership of property, price regulation though market action and competition among firms for profit. Given the centrality of competition, one would expect many works out there on how it functions, but the truth is, there are relatively few. Oh, there are tons on how to become more competitive, either overall or in specific areas, and there are countless justifications of the need for competition. But actual examinations of competition per se?
The Red Queen among Organizations: How Competitiveness Evolves is one such book. In it, author William P. Barnett examines competition among organizations. One of his central tenets is implied in the metaphor that provides his title: as the Red Queen in Alice in Wonderland ran faster and faster to stay in the same place, so firms must compete more and more intensely to stay even with their competition. On one hand, that sounds frustrating, but on the other, this continual attempt to accelerate is, quite literally, the price of doing business.
Before I go on, let me be clear on one all too painful subject: Barnett is an academic. While this means he engages in careful research and took the time to let his theories evolve, this means several things for potential readers of Red Queen. First, know that the book is difficult to read. These difficulties range from (unnecessarily) dense prose delivered in smallish font to curious organizational choices in manuscript organization—referring readers in Chapter 3 back to a diagram in Chapter 1 rather than replicating it, for example. Second, Barnett examines two fields in meticulous detail: the commercial banking industry and computer manufacturers. From a learning perspective, I welcome Barnett testing his concepts so thoroughly; as a reader, I got bogged down. Third, the balance is off. At various points Barnett touches on genuine breakthroughs, but he stays so wedded to working out his core ideas that he doesn’t follow them up in the detail they deserve. A prime example of this is Barnett’s discussion of organizational learning. He argues that organizational learning occurs through competition and that individual members of the organization need not be consciously aware of what was learned so long as organizational behavior changes to match market pressures.
That extended caveat out of the way, there are a number of useful points about Barnett’s study. He approaches market competition through an extended ecological metaphor and treats market niches like ecological niches. An advantage here is that it frees you up from overly limited understandings of your competition. Firms don’t just compete against firms in industries formally named as the same; niches shift and blend as the new forces move through the economy.
Second, Barnett’s emphasis on competition as (among other things) a form of learning means that there is a limit to how completely a firm can research a market niche before it enters. Economic action is a kind of study and leads to the purest form of market learning. Though he does not explore it in detail, this suggests the limits to economic intervention by the government. It also suggests that, as in ecological matters, there will always be unexpected side effects to economic intervention. Barnett also sketches in how organizational actions that are justified in terms of learning, such as a firm forming partnerships with others, may actually thwart organizational learning. (If you don’t compete, you don’t have to develop the capacities competition would force you to.) He spends more time on competition works to create economic/ecological fitness.
Third, his discussions of the “logics of competition” of individual markets and his insistence that competition is always multiple and changing rather than binary and fixed provides a much richer and more accurate framework for understanding competition.
Fourth, these combine via Barnett’s ecological thinking: just as a successful organism changes its surrounding environment and so changes the pressures on it, so organizations change their markets and the logics that run through them. Whether they win or lose, their actions in turn change their market.
Fifth and finally, throughout the book, in approaches ranging from the schematic and theoretical to the historical and specific, Barnett discusses, describes, and analyzes not just how competition works on organizations when they are competing against one another, but also how competition functions within organizations. He shows how this competition drives innovation—this is especially clear in the discussion of the computer industry—and change the economy. All this is very useful even if it only allows readers to better understand the effort involved in…standing still.
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By Anthony Luafalealo, on July 20th, 2008
For Wine Enthusiasts
I received a press release last week that may be of interest to those of you who are into wines. Hart Davis Hart Wine Co. will be auctioning off over 1,700 lots on September 19 and 20. Their top 10 lots include: 1990 Romanée-Conti, Domaine de la Romanée-Conti; 1982 Château Pétrus; and 1990 La Tâche, Domaine de la Romanée-Conti. The auction will be at the company’s Chicago auction house, but you can also place your bid and follow the auction via phone, fax, or the Internet at www.hdhlive.com. Read the press release for more information.
Got an Economics Question?
Economics is on everyone’s minds these days, from the upcoming election to the increasing price of gas to bank failures to the falling value of the dollar. So you must have a few economics-related questions that you want answers to. Well, we have the best source for you: our resident economist Stephan Zimmermann. Stephan is a former department chair for economics and taught at various colleges and universities at both graduate and undergraduate levels. Send your questions to Stephan by reading his post “Got an Economics Question?” and submit your questions in the comments section there.
Poll Results
Amateur Economists‘ first poll results are in. The question, “How much has your home’s value decreased in the last 12 months?” ran from July 7 – July 16 and received 163 responses. Here is a breakdown of the results in descending order:
- None of the above. My home’s value has actually increased. – 30% (49 votes)
- 0%-10% – 23% (39 votes)
- I don’t know. – 20% (34 votes)
- 10%-20% – 15% (25 votes)
- 25% or more – 7% (12 votes)
- 20%-25% – 5% (8 votes)
First, the disclaimer: this isn’t a scientific poll. It was displayed on the homepage, and voting was open to all visitors during the above dates, although respondents could only vote once. (Check out the current poll on the homepage.)
I recommend reading Cheryl Grey’s article “Seeking a Shallow Bottom: The U.S. Economy Going into the Second Half of 2008″ to help put the results in perspective. For example, major losses in house values only affect California and Nevada, according to a government news release. Also, some regions may be experiencing house devaluations as a direct result of more people moving out of those regions than moving in.
So how accurately do the government’s findings reflect your situation? Live outside of California and Nevada and your house’s devaluation is in the double-digits? Or is the declining housing market limited only to a few states and not as widespread as many believe?
Final disclaimer: your responses here may lead to more scientific results than the poll.
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