The Eclectic Quill

July 19, 2008

The High Cost of Free Enterprise

Filed under: Politics — Kelly @ 3:01 pm

Friday Phil Gramm announced his resignation from the McCain campaign. It seems that the mainstream media has determined that gives McCain a pass on his relationship with Gramm and, by extension, his advice. However this looks past a 30 year relationship between the two that is built on a common philosophy. This is the overriding economic philosophy of the Republican Party since the Reagan years and it has cost the tax payers literally hundreds of billions of tax dollars in bailouts and even more in lost money in the three most tragic economic crises of our times. In each case the philosophy that free enterprise does everything better resulted in the removal of protective regulations which precipitated an economic disaster. However, the hidden costs of this philosophy is even greater.

In 1982 the Garn-St. Germain Depository Institutions Act deregulated the Savings and Loan industry. The net effect was this allowed the S&Ls to effectively gamble with other people’s money. They were allowed to make reckless investments, only partly vested (backed by capital) with little risk to them (as the money they were gambling with was insured by the FDIC). Things looked to be going well initially but when a recession hit Texas (home of the majority of the S&Ls) everything started to go belly up. When things started to south the S&Ls started going bankrupt. The end result was a cost of over 500 billion dollars borne by tax payers. McCain was circumstantially involved with one of the key players, Charles Keating, but not guilty of any wrong doing. Recently he has called the bailout excessive, failing to realize that the problem here was not the bailout, but the removal of regulations that necessitated the bailout.

While there is a whole of host of things that could be discussed about with Phil Gramm and the Commodity Futures Modernization Act which he snuck through at the last moment as an amendment to the budget the motive here is not to expose corruption, but rather a fundamental flaw in the Republican paradigm. The deregulation which Gramm sought and got was at the behest of Enron and was a big part of the reason that the ensuing Enron scandal was allowed to emerge. Attempts by the Democrats to repeal this since it went through have either been voted down by a Republican majority in Congress, or more recently by Bush veto. This same legislation is also very much tied in with the current mortgage crisis in allowing "swap markets" to provide incentives to perpetuate irresponsible lending practices, which brings us to the present.

The subprime mortgage crisis has its roots in deregulation in a host of ways. Regulations were removed that protected debtors from predatory lending tactics. Brokers sought out people and promised them mortgages with variable rate loans which would often have enormous jumps after a two or three year period. They’d explain these jumps by saying they could refinance after they established a payment history or lying in other ways. Additionally they marketed middle class areas and people who qualified for prime mortgages were still extended subprime mortgages, a practice  which is completely unethical. So eventually this allowed for a whole lot of loans being issued which were almost inevitably going to default. Then a bunch of these bad loans would get bundled together and sold as bonds in what are called "swap markets". Now part of the problem here is the degree to which these bundles were leveraged, which at times would be as much as 30 to 1. The easiest way to understand what this means is that I only need to invest 1 dollar to get 30 dollars worth of mortgage, which is great so long as the value of the bond goes up, because that means that I make a whole lot of money on my investment. In essence a 3 percent rise in the housing market basically means I double my money. However, it works the other way around too, where a 3 percent dip in the housing market means I lose all my money. Now instead of thinking of 1 dollar or 30 dollars start thinking of that as 10 million dollars to get 300 million dollars of mortgage. You can see where there’s a lot of risk going on here.

To offer up a metaphor it is like betting on bets. Imagine I bet a hundred long shots and then sell you that bundle of tickets. Essentially you would be buying that bond with the hope that enough of those bets are going to pay off to make it worth your while. In a very rough way that is what the swap markets were doing by buying and selling these bonds. Now of course if you were going to buy the bets you’d want to know what they were. However, if there are too many bets it wouldn’t be worth your time to go through and analyze every single bet. So let’s say there’s a third party that analyzes these bets and gives them grades like AAA, implying that this particular bundle of bets has a high chance of winning. You’d probably be willing to pay more money for something like that. However you’d have to have an implicit trust in that third party who is estimating the quality of those bets. Another problem involved with the subprime mortgage crisis is that the folks who were grading the bonds were often working for the people who were selling the mortgages, which is a little bit like putting the fox in charge of the hen house. Coupled with the subprime mortgages that were destined to fail these grades often were, shall we say, generous?

It is apparent from the bottom to top there’s a host of opportunities for abuse in this system and abuse occurred. This is why when Phil Gramm’s legislation that removed the "obsolete depression era regulations" the inevitable abuse followed. We shouldn’t be surprised by what happened—it is the natural extensions of absolute borderline religious belief in the "free market" as the answer to everything. I certainly wouldn’t argue that the free market is bad, it is essential to a sound economy. However its basic motive, profit (or greed) needs to be bridled by regulation. It seems the media is making an earnest effort to suggest that neither party bears unique responsibility. This is not entirely true. The fact is that the notion of "free enterprise" as a sort of economic panacea is peculiar to the Republicans. It is also specious. It is not that we as a civilization started with a set of regulations and the progress of society has been to steadily remove them as we move towards freedom. Rather it’s quite the opposite. Origins were more feudalistic and the earmark of a progressive society is to move towards an enlarging middle class. However money has a tendency to flow up, as idioms like, "It takes money to make money" and "the rich get richer" 

In fact over the last 28 years since the Reagan years and the assault on regulation begin there’s been a consistent increase in the amount of money that goes to the rich compared to  everyone who is not rich. It isn’t just the poor who are getting less, it’s the bottom 90 percent of the country!  The first chart portrays the change in distribution of income by percent and the second shows an imaginary distribution of $100.00 among 100 people. The table on the left has one line much higher than the others. This shows the top 1 percent of the population. Effectively the incomes of the top 1 percent of the population have tripled their incomes (adjusted for inflation). The top 10 percent have pretty much held serve. Everyone else, the bottom 90 percent of the country, have actually seen a dip in their "share" of the "pie." While the conservative would look at this language and cry "communism" such a reaction deflects the very real point—a progressive society is earmarked by the growth of the middle class and our society has been moving in the opposite direction for the last 25 years. Since our society has taken this road of deregulation progress has been undone and the effect is not just seen in the huge scandals that garner the media attention. It’s more apparent in the slow steady war on the middle class, a war which we are losing.

It’s a good thing that Gramm is removed, at least openly, from the McCain campaign, but I haven’t heard anything from McCain to suggest that his fundamental philosophy of the economy has changed at all. Until that happens we shouldn’t give him too much reprieve for doing the politically obvious.



  1. The problem with measures of “distribution” is in the premise of the question. The premise of your argument is clearly that the “share” of your hypothetical $100 should be distributed equally, or perhaps even weighted toward the lowest brackets in your chart.

    But why?

    What dictates that it is “wrong” that the higher brackets are increasing their “share” of the dollar? Are those not the same “top 1%” who have invested the lions’ share of the capital to fund the businesses who employ the other 90% of us?

    The American Dream used to be that a family work hard enough that they could buy a house, a piece of land, an automobile, keep the kids fed, and then send those kids out into the world. More of us are able to do that than at any point in our nation’s history, thanks to free enterprise!

    The problem with the premise of the question is that leftists, possibly like yourself, have lulled a growing number of Americans into believing that this is a zero-sum game: if the evil “rich” get “richer,” then I get poorer. This is clearly not the case.

    The problem with these wealth distribution charts and scenarios is that they don’t take into account that the pie is getting bigger. Maybe the top 1% have a bigger share of the pie, but because that 1% bought us a bigger oven, the whole-darned pie is bigger, and we’re all benefiting.

    Economic growth is not a zero-sum game, and wealth redistribution is a liberal ploy for control of a civilization that let’s itself be duped into buying it.

    Comment by Andy Vance — July 20, 2008 @ 4:25 pm | Reply

  2. Actually you’re putting words in my mouth. I didn’t say that everyone should have an “equal share of the pie.” What I said is that the progress of society is measured by the growth of its middle class. The chart clearly shows that our middle class is in decline.

    As to the employment of the 90 percent, I think your logic is specious. The same can be said for a feudalistic society. In that system one person may be “employing” 99 but the inequality is appalling.

    Finally, you’re arguing hypotheticals while I’m arguing in reality. It doesn’t matter if the “pie is getting bigger” when it takes more “pie” to survive. That’s the significance of this chart. It actually is the case that while the rich are getting richer the poor are getting poor, as are the middle class and as are the moderately wealthy. Real income has dropped over the last 30 years.

    I certainly haven’t argued that economic growth is a zero sum game. It is the habit of conservatives like yourself to erect strawmen. I appreciate discussion on my blog but please limit your arguments to what I’ve said, not what you extrapolate and warp from what I say.

    Comment by kelly — July 20, 2008 @ 4:33 pm | Reply

  3. As someone who was constantly hiring crews and had employees in 2001, I have had to continually slash costs (labor being one) since then. My slice of the pie has largely gone to Canada (with its incentives) to the tune of 10 billion in film business, which the current administration has refused to compete for. Local clients tied to the auto industry are also failing, but that’s another topic.

    Thanks to statewide incentives – that after five years of wallowing have finally passed – things are improving. However, my competitors (largely friendly because there was once enough to go round) have been decimated. Those we once employed are largely working lower paying jobs.

    With less to invest, my new ventures have grown much more slowly. Ironically, or not, one of my largest sources of income has been derived from faith based charities, which are on the rise and seeking to raise additional funds. The fact that these group’s board members are rather handsomely compensated has sent me scurrying in search of a more wholesome clientele (mostly start up businesses) that leave a better taste in my mouth.

    These charitable groups are a topic I’d love to see you tackle and perhaps hear about your own experiences. Much like the failing auto companies with their highly paid executives these groups seem a part of a general trend.

    BTW. thanks for the link.


    Comment by Mary — July 21, 2008 @ 8:10 am | Reply

  4. “The American Dream used to be that a family work hard enough that they could buy a house, a piece of land, an automobile, keep the kids fed, and then send those kids out into the world. More of us are able to do that than at any point in our nation’s history, thanks to free enterprise!”

    I wonder if the author of this comment can provide statistical evidence that either of these claims is true, particularly the second one (esp. if “more” means a higher percentage of the population). It seems like the opposite is true… that people are finding it harder to have that little American dream. People are losing their homes, struggling to pay for expenses.

    While you might argue that economic difficulties are their own fault, for whatever reasons, it’s beside the point if the argument is that more people are living the dream and the opposite is true.

    Moreover, when that little American Dream did come true for a massive middle class, it was not due to Free Enterprise, but one of the most successful government programs in history: The G.I. Bill.

    Comment by Kurtis — July 21, 2008 @ 8:39 am | Reply

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