The recent dramatic and sudden intervention actions of our government to “rescue” the economy come with terrible consequences. The severity of the state of our country cannot be stressed enough: the freedom of the people of the United States of America is rapidly diminishing. America has quickly moved from operating with the efficiency of the free market to relying on the government to control many aspects of the economy. This can otherwise be defined as socialism; the exact opposite of the foundation of the United States.

America was based on notoriously non-socialistic ways, especially in the economic realm, which is what sets the United States apart from others and gives us such a great economic advantage. Unfortunately, as a result of the current financial crisis, the government has steadily increased its involvement in financial markets. For instance, in most recent news, the government has constructed a plan to buy equity stakes in the nation’s top financial institutions. It was stated that “some of the big banks were unhappy about the government taking equity stakes, but acquiesced under pressure from Mr. Paulson.” This forceful intertwining of the banking sector with the federal government is a perfect example of how socialism is quickly creeping up on the American people. Now is the time to step up and take a stand and not overlook the severity of the new socialistic state our country is in.

This new socialism, or collective ownership (i.e. equity in the major banks, etc.) the government now has in financial markets, is undoubtedly going to lead to a halt in the motivation of the American people to thrive and produce. Motivation is a very simple concept and can very easily be disrupted if freedom and choice are dramatically reduced.

Motivation can be defined as an internal state that arouses, directs, and maintains behavior. The key component is that motivation “maintains behavior.” The free market easily maintains passionate behavior for the people to produce because there are endless possibilities. When a need arises, people have a great desire to succeed at fulfilling that need; simple supply and demand. Further more, this healthy and strong motivation creates competition among others, which ultimately leads to impeccable quality and numerous choices. With the free market, the peoples’ incentive to expand the economy is ever-present and quality is at its highest.

Socialism, on the other hand, dramatically minimizes the motivation of the people because they are restricted by the government’s control. The government is an entity in and of itself, leaving little power for the people. The impulsive broad power the government has taken in our financial markets will without a doubt result in limited competition, poor quality of products, and most importantly, minimal drive of the people to efficiently increase productivity.

As a part of a naturally tendency, when people are restricted and convinced there is no escape, they are left with a feeling of helplessness. This can be described as a concept called learned helplessness. Learned helplessness takes place when we experience repeated exposure to aversive events that are out of our control. Many Americans are most likely currently experiencing this uncomfortable feeling because of the great amount of uncertainty and lack of control.

The scary aspect is that it can lead to the American people surrendering to the government. At first, the vulnerable feeling strikes up fear and panic, but soon after, if people realize their behavior has little effect on the environment, they easily give up. This act of conceding to the government is detrimental. When people feel that have little chance to freely engage in the financial markets without restrictions, it can quickly leads to permanent reduced effort and success.

Do not be fooled that the strong government intervention in our financial markets is needed. Do not quit. Do not give up. Socialism is being pushed upon us and it must not be taken lightly. Before learned helplessness sets in all of us, action needs to take place. Now is the time to stand up and be a voice of reason. It is imperative that the lack of control we are all experiencing is not taken over by the powerful learned behavior of “giving up.” Instead of backing down to the government out of fear, the people of the United States of America must realize the challenge which has arose and persevere for the sake of our freedom.

To paraphrase the greatest of economic polemicists, Frédéric Bastiat, the difference between the good economist and the bad is the very extent to which they perceive what is “unseen”. The bad economist can only grasp the façade of the issue, while the good economist penetrates the obvious and see down the path- sees the intended as well as the unintended consequences of the action- they see what is unseen.

With the election on the horizon, Arizonans have begun to debate various propositions to which they get to decide. One of which is Proposition 200. Prop 200 entails the restructuring of payday loans. In this article it would be irresponsible of me to advocate one side or another as I lack intimate familiarity with the details of the law. What I wish to do today is instead discuss the problem with popular economic reasoning that has been used to attempt to discredit the bill.

Frédéric Bastiat

The argument goes that the proposition should be voted no on grounds that Payday lending is exploitative because they charge interest rates that are exponentially higher than the standard financial institutions rate of interest. If this bill doesn’t pass, in 2010 ( I believe) the current law permitting this sort of lending will expire forcing these “predators” out of the state. I am not sure whether this is indeed correct, but the point of writing here is much less about this actual bill and much more about the theory of usury.

The left has always had a tendency to magically and arbitrarily determine which and how much profits can be labeled as “obscene”. They live in a dichotomous world where everyone fits neatly into the categories of either oppressor or oppressed. Through the prism of this worldview, they see victims everywhere, unaware of the unscrupulous and pernicious intentions of the exploiter. They want to help out. They want to protect the ignorant and uneducated victim from the victim’s own well intentioned, but misguided actions- to protect the victim from themselves.

So naturally, it should be no surprise that they see Payday loans as predatory sharks preying on the people “most vulnerable”- to quote the official line of the Arizona Democratic Party. How can a just society allow rich capitalists to profit so obscenely from those most vulnerable?

My question is: how can a just society not?

Payday loans, Cash Advancement Centers, and all Loan sharks in general serve a function that people desire. I am not even going to waste my time elaborating on the obvious point that if something is profitable on the free market, then it must be by definition demanded. What I wish to point out is that often well intentioned, caring individuals often only see what is seen: relatively extreme rates of interest, but fatally misunderstand what is not seen.

What is not seen? What is beyond stage one? Consumers utilize these services because they have some sort of need for them. These institutions allow individuals experiencing a liquidity crunch to avoid default. Perhaps their mortgage is due and they didn’t budget correctly. Perhaps their child had a sudden illness. Perhaps they did. The list continues indefinitely. There are countless amount of reasons why someone would need money fast and upfront- even if it requires a hefty fee. And that is the point: they alone determine what is best for them and what is the better trade off.

It is so easy for bourgeois leftists who don’t depend on these institutions when they need money quickly. They are accustomed to calling their parents or friends or busting out their platinum credit card. Why would anyone use this service they ask. Its inconceivable- they must be getting tricked.

But what these well-intentioned activists fail to realize that if these services are eliminated, many will have few other options. They might go to straight up mafia loan sharks, they might commit some other criminal act, or most likely- they will just default.

It is not necessary to point out that the high rate of interest exists as a risk premium for the high level of default that occurs in this line of business. No justifications needed. This article isn’t about whether these institutions are evil or not, it is about whether in a free society an individual should be able to decide on their own what are the best trade-offs, what is the best action to improve their current state of affairs.

A free society requires choice and it requires personal responsibility. The individual alone possess the ability to know what actions are most beneficial, not some paternalistic, arrogant, big brother who lacks any insight into what is unseen.

When the socialist party ran a candidate for President in 1928 it received less than 1% of the popular vote, but its platform has been adopted by both major political parties. What follows is an excerpt from Milton and Rose Friedman’s book titled Free to Choose. Most of it is directly copied from the book and only select parts are amended by me. All dollar figures are from the date it was written so are not accurate today. The book was published in 1978. You may find many areas that I have not amended that could easily be added to with the legislation that has passed since 1978, but this will give you a general idea of how close the government of these United States is to being socialist today.

Herewith the economic planks of the socialist party platform of 1928, along with an indication in parentheses of how these planks have fared. The list that follows includes every economic plank, but not the full language of each.

1. “Nationalization of our natural resources, beginning with the coal mines and water sites, particularly at Boulder Dam an Muscle Shoals.” (Boulder Dam, renamed Hoover Damn, and Muscle Shoals are now both federal government projects.)
2. “A publicly owned giant power system under which the federal government shall cooperate with the states and municipalities in the distribution of electrical energy to the people at cost.” (This is a generally accepted process across the country.)
3. “National ownership and democratic management of railroads and other means of transportation and communication.” (Railroad passenger service is completely nationalized through Amtrak. Some freight service is nationalized through Conrail. Private railroads are strictly regulated by the Federal Government. The FCC controls communications by telephone, telegraph, radio, and television.)
4. “An adequate national program for flood control, flood relief, reforestation, irrigation, and reclamation.” (Government expenditures for these purposes are currently in thee many billions of dollars.)
5. “Immediate governmental relief of the unemployed by the extension of all public works and a program of long range planning of public works . . .” (In the 1930s, WPA and PWA were a direct counterpart; now, a wide variety of other programs are.) “All persons thus employed to be engaged at hours and wages fixed by bona-fide labor unions.” (The Davis-Bacon and Walsh-Healey Acts require contractors with government contracts to pay “prevailing wages,” generally interpreted as highest union wages – also the national minimum wage.)
6. “Loans to states and municipalities without interest for the purpose of carrying on public works and the taking of such other measures as will lessen widespread misery.” (Federal grants in aid to states and local municipalities currently total tens of billions of dollars a year.)
7. “A system of unemployment insurance.” (Part of Social Security system.)
8. “The nation-wide extension of public employment agencies in cooperation with city federations of labor.” (U.S. Employment Service and affiliated state employment services administer a network of about 2,500 local employment offices.)
9. “A system of health and accident insurance and of old age pensions as well as unemployment insurance.” (Part of Social Security. Full global health insurance proposed widely.)
10. “Shortening the workday” and “Securing every worker a rest period of no less than two days in each week.” (Legislated by wages and hours laws that require overtime for more than forty hours of work per week.)
11. “Enacting of an adequate federal anti-child labor amendment.” (Not achieved as amendment, but essence incorporated into various legislative acts.)
12. “Abolition of the brutal exploitation of convicts under the contract system and substitution of a cooperative organization of industries in penitentiaries and workshops for the benefit of convicts and their dependents.” (Partly achieved, partly not.)
13. “Increase taxation on high income levels, of corporation taxes and inheritance taxes, the proceeds to be used for old age pensions and other forms of social insurance.” (In 1928, highest personal income tax rate, 25 percent; in 2008, 35 percent, above 40 percent proposed by Obama; in 1928, corporate tax rate, 12 percent; in 2008, 35-39% percent with proposed increases by Obama; in 1928, top federal estate tax rate, 20 percent; in 2008, 48% with proposed increases by Obama.)
14. “Appropriation by taxation of the annual rental value of all land held for speculation.” (Not achieved in this form, but property taxes have risen drastically.)

Imagine for a minute, that you’re a middle aged guy in the southern Orange County enclave of Monarch Beach, California at the St Regis Hotel and Spa enjoying a back massage from an attractive, busty Swedish female in a tight white golf shirt and curving white pants. You’re on an expense account with your colleagues, living the life you dreamt about as an early 20s college grad. All those years of school, all those reports, all of those business meetings you slogged through, have culminated into this climatic high of total relaxation and visual pleasure. You deserved it, you think.

On the other hand, the company that is sponsoring this trip is on the brink of losing one of its key businesses that insures mortgaged back securities. That company is AIG. Should you be on this business trip at all? It his just some selfish indulgence? Let’s briefly review what exactly AIG does today to help answer this question.

AIG is a diverse multinational conglomerate that has over $1 trillion in assets and almost $80 billion in equity. They sell almost any insurance you can possibly imagine and they have side businesses as well; anything from leasing planes to ski resort ownership.

As you perhaps know, AIG was hemorrhaging money in their insurance of mortgage-backed securities, sometimes called credit default swaps (CDS). This was an investment, a bet if you will, that AIG offered to people in hoping that certain mortgages would not be paid and go into default. In the wake of the current mortgage crisis, many people are now owed money off of homeowners defaulting, and as such, AIG has been paying out a lot of money, to the tune of $18 billion over the last three quarters.

With this large loss, AIG asked for help from the federal government to shore up their balance sheets, and on 16 September 2008, Treasury Secretary Henry Paulson with the help of his friends at the United States Federal Reserve extended to AIG an $85 billion bridge loan if they needed it. The terms of this loan are highly unfavorable to AIG: Interest rate of 8.5% on top of the 3-month LIBOR rate, which hovers somewhere around 4.5%, in addition to the feds seizing almost 80% of AIG’s equity and using virtually all of AIG’s assets as collateral. Since then, the federal government has made available an additional $37.8 billion. Since 3 October, AIG has drawn $61 billion from the government’s loan.

Contrary to my libertarian leanings, I think this loan was a great opportunity both for the United States government and AIG. The unfavorable terms of the loan give AIG motivation to become a more streamlined business. If AIG eventually fails, then the government will be the owner of their trillion dollars worth of assets, many of which are quite profitable.

But right now I’d like to get back to the ethics of spending $400,000 of company money on a resort vacation weekend in Southern California. One of the ironies of all of this, is that the money was being spent in an area that was hard hit by the mortgage crisis. At least they are flowing money to the local economy. Practical amusement aside, many people in the general public met this story with immense outrage.

Anderson Cooper dedicated almost 35 minutes of his program to it. He wants to “keep ‘em honest.” Local news in Houston led the newscasts with people on the street interviews expressing outrage. But, in fact, I think a lot of the outrage is rooted in the primitive emotions of jealousy. The company sponsored the trip before the government loan, and the persons who went on the trip were part of their life insurance business, which is based out of Houston, Texas, not even in the same stratosphere as the CDS business based in New York.

Sure, $400,000 is an extravagant amount to spend on a week of vacation for high-performing executives, but who are we to say that they didn’t deserve it? It is ultimately up to AIG how they want to spend the money the government gave them. If they want to depreciate their assets by blowing $400 grand on a week in California, so be it. It’s either their gain, or their loss.

And it’s apparent from the terms of their loan, they have much to lose.

I have heard my fill about how the rogue free market system got what was coming and finally collapsed under the weight of its own greed – particularly with respect to “predatory” lending to unworthy borrowers.

Bullocks, I say.

The free market system consists of billions of people making decisions that reflect what is in their own best interest. Every corporation, banks included, has one main obligation – make their shareholders money. If these banks that lent money to unworthy individuals and other entities were irresponsible with their lending practices, or any other practice for that matter, then it will eventually result in them losing money or facing legal consequences, both of which are obviously bad for shareholders. As a result, all of the responsible parties will lose money and will be less likely to repeat their mistake (I’d like to point out that shareholders are indeed responsible parties because they are the ones that elect the board of directors, who in turn hire top executives). As such, there is an inherent incentive for all parties to make as much money for the longest period of time as is possible, this requires them to play by the rules and be ethical. The problem only comes when the rules are made to be counterproductive.

Because I’ve made it clear that I do not feel that the free market is to blame for the current economic crisis we are enduring it would only be natural for me to make a case for what or whom I feel is to blame. It should come as no surprise to any regular reader that I feel the blame rests squarely on the shoulders of our government.

It all began back in 1977 when our Congressmen and Senators that like to think of themselves as generous, charitable, economists passed what is called the Community Reinvestment Act. The Act “is a United States federal law designed to encourage commercial banks and savings associations to meet the needs of borrowers in all segments of their communities, including low- and moderate-income neighborhoods.” Respectable as this may sound it ended up backfiring in a most remarkable manner. Lucky for the citizens of the United States, this Act was difficult to enforce and the market for mortgages to low- and middle-income borrowers was still very small.

This began to change in 1992 when the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 was passed, which “required Fannie Mae and Freddie Mac, the two government sponsored enterprises that purchase and securitize mortgages, to devote a percentage of their lending to support affordable housing.” Now lending institutions had an avenue to sell the loans that they wrote to less-than-worthy borrowers. Though this would seem sufficient to write overtly risky loans, the Clinton administration felt that low-income borrowers were still being under-funded by lenders, and in 1995 the government amended the Community Reinvestment Act to make the lending process to low-income borrowers even more streamlined. Thus began “sub-prime lending” (to those that have been hearing that phrase for years now and still have no idea what it means, it simply describes a loan to a person or entity that would not typically get the loan because of the likelihood that they will default on that loan). The government essentially told lending institutions that they had to lend to borrowers that were unlikely to repay the loan or else they would face the consequences that are typically faced when breaking the law. Borrowing from Wikipedia:

During March 1995 congressional hearings William A. Niskanen, chair of the Cato Institute, criticized the proposals for political favoritism in allocating credit and micromanagement by regulators, and that there was no assurance that banks would not be expected to operate at a loss. He predicted they would be very costly to the economy and banking system, and that the primary long term effect would be to contract the banking system. He recommended Congress repeal the Act.

Needless to say, Congress did not listen and the Act was actually revised again and again to improve lending to sub-prime borrowers.

Source: Wikipedia

Though it may be a necessary requirement for the economic crisis we are in today, the government demanding that banks lend to sub-prime borrowers is not a sufficient requirement for the carnage we have seen. The other necessary, and perhaps even sufficient, requirement would be that the government would need to supply banks with tons of cash that they have to lend then within two years take all that cash back, drying up balance sheets and forcing higher rates. But the government wouldn’t do that, would they?

Following September 11, 2001 the Federal Reserve took action by lowering interest rates. They do so by purchasing government securities (Treasury Bills and Bonds) from financial institutions holding these securities. This provides these institutions with tons of cash instead of securities. Since cash does not appreciate, the banks must lend the money or invest it elsewhere to make a profit for their shareholders. The increased amount of cash in the financial system creates greater competition among lenders and interest rates fall (the opposite is true when the Fed “raises rates”, for more see my blog on inflation). Without going into too much more detail, the Fed lowered the Fed Funds Rate (see blog on inflation again) to 1%, where it stood in 2004. This absurdly low Fed Funds rate required the Fed to flush the financial system with cash to encourage competitive lending. The financial institutions did just that, lent money at competitive rates in order to make money and stay in business. On top of that, they had to lend a portion of that money to sub-prime borrowers, per the government’s demands.

Essentially, anybody that wanted a loan got a loan. This led to record numbers of home purchases and small business loans. Malinvestment ran amuck. By having such easy access to cheap capital, people were able to invest in risky and unproductive assets simply because there was so much cheap money. This absurd level of investment led to prices of virtually everything, housing especially, to skyrocket far above their actual value. It is a simple lesson of supply and demand. The supply of money became greater and cheaper so the level of demand became higher. As the people invested this money the supply of assets dropped while demand remained the same, increasing the price. Because the price of these assets, particularly houses, grew to such great heights people decided to supply more to the market to make a profit. Soon enough there were tons of assets, houses in this case, in the market and not enough demand to support them all, thus the fall in prices.

Nobody really noticed the huge differential between the supply of assets and the demand for those assets because the financial system was so flush with cash that anybody could borrow at low rates. However, this all changed between 2004 and 2006 as the Fed began to raise rates (aka decrease the supply of money in the financial system). The Fed raised rates from 1% to 5.25% all within a span of two years (2004 to 2006). This stripped financial institutions of their cash and thus caused a hike in interest rates across the board. A lower supply of cash and more expensive cash lowered the level of demand for that cash and thus lowered investment in assets. As investment in these assets, particularly houses, fell the prices of the assets fell with it. Because the previously increased level demand for these assets caused prices to inflate, once the demand fell as the supply of money fell the prices of the assets fell very rapidly. With falling asset values people began to be at a point where their loan was larger than the value of the collateral, the asset, more specifically house. Soon enough it would become profitable for the borrower to default on his or her loan instead of keeping it. Additionally, the interest rates had increased so even if they wanted to hold onto the asset they would have a more difficult time because they would have to pay more than they had previously imagined. As a result there were mass defaults on loans and financial institutions began to fail. As financial institutions fail, other financial institutions take measures to save themselves, which includes lending at higher rates or not lending at all for a small period of time to guarantee that they will survive as a going concern.

This is where we are at today.

Everyone finds someone else to blame in these times because nobody is willing to blame themselves – that includes our government. You will undoubtedly hear numerous government officials stating that the free market was out of hand and is to blame for this debacle and it will undoubtedly be repeated by members of the media, all of whom have no real understanding of economics or the recent history of this nation. Don’t be fooled, look at the facts and use your reason. What is on the surface is not always the true story, in fact it usually is not – you must dig deeper to know the real story. It may be ironic for me to tell you to second guess everything you hear and read after I write this, but I believe that you should even be skeptical of my writings. Do as much research as possible on these important topics, they warrant it.

I’ll close with this: government got us into this mess, as they usually do, and the only way out is through the free market. We have already been thrown into the fire by our government; don’t let them pour more gasoline on us. Learn and react. With the free market the United States is guaranteed to prevail, without it we are guaranteed to fail.

With the world markets uncharacteristically taking a faster-than-usual landslide over the past 2 weeks, perhaps it’s time to revisit one of the staples of corporate life: the 401(k). First, I would like to point out that, even during the Bush administration, the markets have sunk to lows more epic than what we’re seeing as of 10 October 2008.

When the markets opened after 9/11, the Dow sunk to around 8236. There was another trough on 19 January 2002 when the Dow hit 8020. On 4 October 2002, America saw the Dow reach its lowest point during the Bush Administration, when it hit 7528.40. Previous to which, during the last year of the Clinton administration, on 14 January 2000, the Dow was at 11,723. As far as the NASDAQ is concerned, it has never (and probably will never) recover from its all time high of 5048.62 on 10 March 2000. We are seeing, as of today, the NASDAQ at around 1500-1600.

I am neither a finance major, nor an MBA grad, nor an economist by any stretch of the imagination, but what I see is an opportunity to fill up on stocks for retirement. My armchair prediction is that the Dow will see some resistance at around the 7500 mark. With it hovering on the day at around 8100, the time to max-out 401(k) contributions for the rest of the year is right now, if you have adequate enough savings to do so. I would suggest, no matter what your age, going for a broad yet aggressive fund of companies with a solid forward P/E ratio to recoup losses. The maximum contribution rate for this year is $15,500. Dollar-cost average your percentage of the salary withheld to your 401(k) to the end of the year to reach that contribution limit.

One benefit of a bad economy is this: You can always recognize the tough times more than you can recognize the good. When the Dow hit above 14,000 a year ago, the feeling was quixotic, as if the money was reigning in from the heavens and would never stop. The robust economy was like the euphoric feeling of drinking a lot and having a good time, only to feel half dead and mentally destroyed the morning after. What we are now suffering is that hangover. “I’ll never do that again,” you’ll say. But you undoubtedly will.

We should have no choice but to think that the best days in America are still ahead of us. If we’re suffering

from what both Obama and McCain call “the worst financial crisis since The Great Depression” and I can still sit in my underwear on a Friday, watch television, and pick up baby back ribs from Chili’s to-go, then we must ask ourselves how bad is it really.

There’s no reason not to be optimistic when looking at our history. We’ll get through it; perhaps more luxuriously than we ever thought possible.