Powerful Government Forces suppressing the Economic Principles of Friedrich Hayek in China and America

Posted by PITHOCRATES - November 16th, 2013

Week in Review

Large governments like to control their economies.  And their people.  Because those in power always want one thing.  More power. 

The United States became the world’s number one economic power before the federal government grew into the thing it is today.  Way too big.  Reaching way too far into the private sector economy.  Before Keynesian economics became all the rage to empower the growth of governments there was classical economics.  With simple principles.  Thrift.  People thought long-term and saved their money instead of buying everything they wanted today.  Banks collected their savings and transformed them into investment capital.  The more people saved (i.e., the thriftier they were) the more capital there was available to loan to entrepreneurs.  Thus lowering interest rates.  There was also sound money.  Backed by gold.  In various forms of the gold standard.  That held the value of money over time.  And the federal government taxed little.  Regulated little.  And spent little.  These classical economic principles stimulated strong economic growth.  (Principles similar to the Austrian school of economics championed by Friedrich Hayek.)  And it is these principles that we have moved away from as we turned to Keynesian economics.  And a form of state-capitalism that we have today.

During the Nineties China turned to classical economic principles.  As they slowly allowed people some economic liberty.  But just a taste of it.  For the ruling Chinese communists did not want what happened during the collapse of the Soviet Union to happen in China.  The Chinese Communist Party would not collapse like it did in the former Soviet Union.  While there were free thinkers that embraced the principles of Friedrich Hayek the state kept them on a short leash.  A leash that appears to be even shorter these days (see A Lonely Passion: China’s Followers of Friedrich A. Hayek by DIDI KIRSTEN TATLOW published 10/30/2013 on The New York Times).

Hayek believed that economic planning by the state leads to a loss of individual liberty, and that a private economy run by people whose rights are protected and enlarged by good laws delivers the best life.

‘‘There is some distance between Hayek and the current realities’’ in China, Gao Quanxi, a prominent Chinese Hayekian and law professor at Beihang University in Beijing, said in an interview this week.

Mr. Gao was probably choosing his words carefully. The gap is enormous, as he explained last Friday in a talk at the Unirule Institute of Economics, a think tank in Beijing…

In his talk, titled ‘‘Reconsidering Hayek’s Theoretical Legacy,’’ Mr. Gao did not mince words: China is less free now than 10 years ago, at the end of the Jiang Zemin era. There is no ‘‘free market of ideas’’ in universities. Publishing on topics the authorities disapprove of has become more difficult. The state is on the march…

Capitalism, several participants said, functions in China according to the unwritten rules created by the power holders, not by good laws, as Hayek urged.

‘‘Communism has failed. Socialism has failed. What we have here is statism. And Hayek really opposed that. So how should we understand Hayek in the context of today’s China?’’ asked Mr. Gao…

Many economists, scholars and politicians believe that China is facing deep challenges to its economic model, that it needs to shift from a fixed investment-fueled economy, where the hand of the state is heavy, to one with more private enterprise and market forces.

President Obama and the Chinese communists share something in common.  They both are trying to move their economies in the same direction.  Only the Chinese communists don’t publicly bash capitalism as much as President Obama and his fellow Democrats do.

When China was enjoying double digit GDP growth the liberals in the United States wanted to do what the Chinese were doing.  To manage the economy more.  As they thought they were even more brilliant than communist state planners in China.  And could even outperform the Chinese economy.  If they could only control it.  Decide what we make.  Like solar panels.  And electric cars.  Of course, most of China’s economic growth produced exports.  And they sold well because of China’s low wages.  Which is pretty much all they had going for them.  Their middle class did not grow.  And with the worldwide decline in economic activity thanks to Keynesian economic policies by state planners everywhere who think they are smarter than the market their export market cooled.  As it cooled so did their GDP growth.

China is suffering a little economic malaise now because they don’t have a thriving middle class of entrepreneurs starting small businesses.  All they have are large state-run factories.  That produce exports.  Because they don’t have a thriving middle class to buy these products.  Which is what happens when you don’t have individual liberty.  Friedrich Hayek understood this.  Pity the Chinese communists don’t.  Or President Obama and his fellow Democrats.  Then again, perhaps they do.  But they know the price of individual liberty is less government power.  And that’s just something anathema to communists.  President Obama.  And Democrats.

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It will be Easier and as Expensive to Smoke Marijuana in Colorado than Regular Cigarettes

Posted by PITHOCRATES - March 10th, 2013

Week in Review

The stoners, the high school and college kids and the baby boomer-hippies of yesteryear are ecstatic about Colorado decriminalizing marijuana.  For now they don’t have to sneak around and buy their weed from some shady drug dealer.  No, today they can walk down the road any time and walk into Harry’s and hold their head up high and say in a loud steady voice, “Harry, I want you to sell me some marijuana.  In fact, today I think I’ll have some Acapulco Gold, for I am a Coloradan.  But people in other states?  They cannot.  Because their states have never made the great leap out of the Middle Ages and the domination of alien Episcopal supremacy.”

(Okay, so I borrowed a little from Monty Python’s The Meaning of Life.  And by a little I mean a lot.  From the scene where the Protestant goes on about being able to buy condoms unlike his Catholic neighbors.  You can see a clip of that scene here but be warned.  It is not appropriate for the workplace.  And not suitable for young children.  If you’re not a man-boy with a somewhat sophisticated yet sophomoric sense of humor you may find this scene somewhat offensive.  But if you are go and buy the two-disc collector’s edition for your personal collection.  So you, too, can impress your friends by quoting these scenes verbatim.  Or alienate everyone around you.  Depending on who your friends are.  But I digress.)

Where was I?  Oh yes, Colorado has solved all of their problems.  They’ve decriminalized marijuana so responsible adults can enjoy this drug responsibly while no kids will.  (Yeah, right.  Pull the other.)  And they’ve figured out a way to bring more money into the state treasury by encouraging people to smoke marijuana.  Even though they frown on people smoking regular cigarettes.  And pretty much banned cigarette smoking everywhere.  For that stuff can get into your lungs and kill you.  First-hand smoke.  Second-hand smoke.  Even third-hand smoke.  That ashtray smell left behind long after a smoker extinguished his or her cigarette.  So Colorado is serious about the harmful effects of smoking tobacco.  Unless it gets you high.  Then apparently the smoke isn’t that bad for you after all.  But just don’t dare light up a cigarette in public anywhere in Colorado.  But if you do, to be safe and save yourself from the judgmental stares of others just make you regular cigarette look like a marijuana joint.  And then you can light that up anywhere and everyone will be cool with you.  Apparently.

So Colorado is doing the responsible thing for responsible adults who will now all follow the letter of the law.  Even though they used to violate state and federal law before Colorado decriminalized marijuana.  Which was and still is classified as a schedule I controlled substance.  Along with heroin and cocaine.  Which carry some pretty stiff penalties if you’re caught carrying.  So these people were willing to break a law that carried stiff penalties when the drug was still illegal.  But that shouldn’t be a problem now that it’s legal (see Tax, and tax again: America’s first market for recreational marijuana will be far from free posted 3/9/2013 on The Economist).

FREE-THE-WEED campaigners speak not of “legalising” marijuana but of “taxing and regulating” it. True to their word, the ballot measure they placed before Colorado’s voters last November, which won the support of 55% of them, was called the Regulate Marijuana Like Alcohol Act and contained provisions for a 15% excise tax. Now that the law is taking shape, the signs are that one of the world’s first fully legal marijuana markets (Washington state also backed legalisation) will have all the taxes and rules anyone could have wished for…

Most importantly, the group wants to maintain, for three years, the “vertical integration” model that has governed Colorado’s medical-marijuana industry. Under this system retailers must grow at least 70% of the dope they sell. This forces licence-holders to master a suite of skills from cultivation to distribution. The task-force also suggests that for the law’s first year, only established medical-marijuana dispensaries should be granted retail licences. Some campaigners mutter about protectionism, though grudgingly admit that dispensaries deserve some reward for their pioneering (and risky) work.

Mr Finlaw admits that vertical integration makes it hard to apply the excise tax: licence-holders will have an incentive to undervalue their product. That may help explain another proposal: to slap a tax on marijuana sales, on top of existing state and local sales taxes and the proposed excise tax. No figure will be presented to the legislature, but an “example” of 25% was floated in hearings.

Regulators say they need the funds to enforce their rules. But set taxes too high, fear campaigners, and you leave the illegal market in place, which destroys one of the principal purposes of legalisation in the first place. Either way, any new taxes will have to be approved again by Colorado’s voters, probably in November.

With that level of taxation it is unlikely to make it any less expensive than the weed they used to buy.  And now that the penalty for buying ‘improper’ marijuana may be only as severe as being caught with cigarettes on you purchased in a low-tax state.  Unless you have a tractor trailer full the punishment will be a slap on the wrist.  When Canada raised their cigarette tax drug dealers turned to smuggling cigarettes.  Just as lucrative.  With far less risk.  Yes, the illegally imported marijuana may sell at a lower price than in the past but with it being legal they will be able to make up for a lower profit per sale on volume.  Because a lot more people will be smoking marijuana now.  Besides, a lot of those kids will not be able to walk into Harry’s.  They’ll still need to buy their stuff on the black market.

Over-tight rules create opportunities for and cosy relationships between the industry and regulators. But Colorado’s legislators must perform a balancing act, because they are being watched by the federal government. Marijuana remains illegal under federal law…

Some members of the prohibition industry are running out of patience. On March 5th the president of the International Narcotics Control Board, an arm of the UN, said that marijuana legalisation in America violated international treaties and threatened public health.

Ironic, really.  It’s the Left that is pushing for the decriminalization of marijuana.  Despite their relentless assault on Big Tobacco and making it pretty much illegal to smoke a regular cigarette anywhere outside your home or car.  And they’re closing in on those, too.  If you have children.  Because of that third-hand smoke.  It is also the Left that wants to keep ceding power and sovereignty to the United Nations.  And here they are.  Violating an international treaty of that august body that they hold so dear.  Go figure.

The Left is an inscrutable bunch.  With politics driving their every action.  They champion individual liberty when it comes to sex and drugs but want to put you in jail for smoking a legal cigarette.  Because smoking is bad for your health.  Unless that smoke is from marijuana.  Then it’s no big deal.  They want a big world government to pass environmental regulations they can’t pass in their own country to regulate and punish capitalism but then ask who does the UN think they are telling them they can’t violate a treaty they don’t like?  Like decriminalizing a schedule I controlled substance?

Individual liberty for those who think like them.  And oppressive and punishing regulations for those who don’t.  This is the political Left.  Which is also the way things were in an absolute monarchy.  A totalitarian fascist, Nazi or communist regime.  An Islamist theocracy.  And any other oppressive regime where those in power lived by a different set of rules than those who they ruled over.  Despite expressing equality and egalitarianism it was more times than not like life for the poor animals on George Orwell’s Animal Farm.  Where everyone was equal.  Only some were more equal than others.

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Singapore and Great Britain affirm their Good Relations

Posted by PITHOCRATES - July 28th, 2012

Week in Review

Singapore is doing very well.  It has one of the strongest economies in the world.  And has one of the highest per capita wealth.  Not surprisingly it was one of the original Four Asian Tigers.  Along with Hong Kong.  South Korea.  And Taiwan.  Singapore and the United States have something in common.  Besides bustling economies (well, it was once bustling in the United States).  They were both once part of the British Empire.  And remain on good relations with Britain (see President Tony Tan underlines warmth of longstanding S’pore-UK ties posted 7/28/2012 on Channel News Asia).

President Tony Tan Keng Yam underlined the warmth of longstanding relations between the United Kingdom and Singapore, during a reception at Buckingham Palace hosted by Queen Elizabeth II on Friday.

Just something else to think about as you watch the 2012 Olympics in Great Britain.  Just how much Britain gave the world.  A lot of people like to pick on Britain.  But just look at some of the best places in the world in terms of individual liberty and the standard of living.  The United States of America.  Canada.  Australia.  Hong Kong.  And, of course, Singapore.  To name a few.  And what do they have in common?  They were all once part of the British Empire.  All achieved greatness in large part due to their British heritage.  And grew into nations based on the rule of law.  Representative government.  Free trade.  And free market capitalism.  Giving us our individual liberty.  And our high standards of living.  All in all not a bad trade for a little colonial imperialism.

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Conservative (kən-sûr’və-tĭv), n., One who adheres to the political philosophy of conservatism.

Posted by PITHOCRATES - October 20th, 2011

Politics 101

Conservatives tend to be Responsible Adults with Jobs in the Private Sector who Pay Taxes Instead of Consuming Them

What is a conservative?  For a start, it’s probably not what you’ve heard.

There is this perception that conservatives are just a bunch of old white guys.  Bankers.  Corporate fat cats.  And out of touch Republicans (in the U.S., at least).  The perception continues that they are rich, hate the poor and are both closeted racists.  And open racists.  These perceptions are wrong.

Conservatives tend to be grownups.  Responsible adults.  Parents.  And they typically have jobs.  Real jobs.  In the private sector.  They don’t consume tax dollars.  They pay tax dollars.  And they tend to pay their own way.  Who want to raise their children their way.  And live their lives their way.  Without government telling them what’s best for them.

Conservatives believe in Limited Government, the Rule of Law, Individual Liberty and Personal Responsibility

Conservatives believe in limited government.  And they respect the Constitution.  They don’t believe it’s a living document.  Open to broad interpretation.  Or that it is merely a suggestion.  They don’t believe the courts should be used to make law that can’t be legislated in Congress.  The courts interpret law; they don’t write it.  Per the Constitution.  And they don’t like radical, populist change.  That are all theory.  With no track record of success.  They know their history.  Their heritage.  Their traditions.  And are very cautious when it comes to changing the old ways.  Especially when the old ways have been proven by time.

Conservatives believe in the Rule of Law.  Individual liberty.  And personal responsibility.  Where everybody plays by the same set of rules.  Regardless of race, color, sex, creed, etc.  And cheaters shouldn’t prosper.  They favor true capitalism.  And abhor crony capitalism.  Which isn’t capitalism.  But government favoritism.

They favor the Austrian School of economics over the tax and spend Keynesian school.  They believe in sound money and would lean towards reinstating the gold standard.  So government can’t inflate the currency at will to pay for more Keynesian spending.  They also believe that free trade benefits the consumer.  By providing more competition, lower prices and higher quality.

Conservatives typically Go to Church, Believe in the Golden Rule and Love & Respect their Fellow Man

Conservatives tend to be older on average than liberals.  That’s because they have grown up.  And left the ignorant ways of their youth behind.  They have worked and paid taxes.  Been part of the free market economy.  They know how wealth and jobs are created.  And have learned how to think for themselves.

They carefully budget their money.  Scrimp and save to raise a family.  Which is why they are very sensitive to taxes.  They struggled to get by.  And sacrificed for their children.  So they can have a better life.  So they oppose higher taxes now.  And higher taxes later.  For their children.  And their grandchildren.

But they don’t hate the poor.  Or those in need.  Conservatives typically go to church.  Believe in the Golden Rule.  And love and respect their fellow man.  Which is why conservatives are among the most charitable of people.  Many tithe their church.  Donate their time in their communities.  And make great neighbors.

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FUNDAMENTAL TRUTH #52: “The political right is usually right.” -Old Pithy

Posted by PITHOCRATES - February 8th, 2011

Sitting in the French Legislative Assembly and Defining Future Politics

In politics we hear a lot about the Left and the Right.  What does that mean?  Where did these terms come from?  Probably the French Revolution.  So we need a small primer on the French Revolution.  So here goes. 

In late 18th century France, in the Ancien Régime (before the French Revolution), there were three main groups of people.  They called these the estates of the realm.  The First Estate was the clergy of the Catholic Church.  The Second Estate was the nobility (less the king).  And the Third Estate was everyone else (approximately 98% of the population).  The first two estates were exempt from most taxation and lived well and had full bellies.  The Third Estate paid the bulk of taxes, lived horribly and suffered a famine or two.

Well, this caused tensions.  The poor were deplorably poor and hungry.  Compounding this problem was the near constant state of war between France and Great Britain.  That and financing the American Revolution was bankrupting the Ancien Régime.  The régime had nothing to give to the poor and hungry.  So the poor and hungry revolted.  They met in the French Legislative Assembly of 1791 to debate the future of France.  Those in favor of the monarchy and the old order sat on the right.  The radicals who wanted to overthrow the old order sat on the left.

Right and Left become Conservative and Liberal

So that’s a brief lesson on the origins of the political labels ‘Left’ and ‘Right’.  They weren’t political parties.  They were just seating arrangements.  In those days, the Left were liberals.  Similar to our Founding Fathers.  In the classical sense of liberalism (it meant something completely different then than it does today).  Basically, the Left said the old ways just ain’t working anymore and it’s time to try something new.  The Right, on the other hand, was worried about losing their privileges.  As well as the potential chaos that could result from trying something new.  And for good reason.  The French Revolution got a little chaotic.  And a little bloody.

Since then the labels kind of morphed into new meanings.  Right and Left have become synonymous with conservatism and liberalism (or Progressivism, Socialism, Communism, Marxism, etc.).  Conservatives (the Right) believe in individual liberty, limited government, laissez-faire capitalism, low taxes, free trade, little business regulation, etc.  Liberals (the Left) believe in Big Government to redistribute the wealth, high taxes, strict controls on capitalism and business, oppose free trade and believes business operates best (and most fair) when ‘partnered’ with government.

So, to simplify, on the right you will find capitalists.  On the left you will find anti-capitalists.  On the right, people decide what’s best.  On the left, government decides what’s best.  On the right you keep more of your paycheck and buy what you want.  On the left you keep less of your paycheck so others can buy what they want.  And so on.

Free Markets and Planned Markets

The Right believes in free markets.  That if left alone, free markets will maximize employment and living standards.  The Right doesn’t believe that any one person is smarter than the collective of millions of individual decision makers in the free market.  The free market is always win-win.  When two people agree on an economic decision, they both prosper.  The seller gets what they value more (money).  And the buyer gets what they value more (what they bought).  When everyone is choosing what they value most in the free market, economic activity explodes.  This creates jobs.  Workers earn money to buy goods and services.  And taxes at low tax rates paid by the multitude of businesses and individuals swell the public treasury.

The Left, on the other hand, believe a free market economy is inefficient.  They prefer a planned economy.  They want to mettle.  To tinker.  To help people make economic decisions by regulating markets.  Enacting targeting taxing and targeting tax cuts.  To make us buy what they think we should buy (electric cars, for example).  And they think free markets are woefully unfair.  Because poor people can’t buy as much as rich people.  So they want to tax the rich to redistribute their wealth to the poor.  They call this stimulative.  Giving away other people’s money.  So other people can spend that money.  (So if you’re keeping score, net spending doesn’t change.  Just who is spending the money changes).

There’s a lot more to these political labels Left and Right.  But this will suffice for our purposes.  You will see more mature and elderly people on the right.  And more younger people on the left.  Remember the expression from the hippy counter-culture in the Sixties?  Never trust anyone over thirty?   You know who was saying this?  Inexperienced and ignorant young people.  Young college students who learned a thing or two from a radical professor.  You didn’t see many family breadwinners in the counter-culture movement.  Just a lot of people who hadn’t grown up yet or worked a job or raised a family.

Age, Experience and Family tend to make you Conservative

And so it is today.  The Left depends on the young.  That’s why they lowered the voting age to 18.  To get these people who haven’t experienced the real world yet to support things that sound good.  Yes, we should pay more taxes for a better education.  Of course, what the young don’t know is that they’ve been saying this for the last 50 years or so.  And the quality of our education has gotten worse.  Not better.  That’s why the older and more experienced voter tends to vote against these tax increases.  Not because they hate kids.  But because they’ve seen throughout their life that throwing money at education hasn’t helped any student.  Only the public school bureaucracy.

When you’re young and stupid you tend to think about today.  Your emotions easily sway you.  And your passions.  Your thoughts focus on having fun in the sun.  Going to a club.  Dating.  It’s a little different when you have a family.  You think about other things then.  Your kids’ school.  Paying a mortgage.  Putting money aside for your kids’ college education.  Putting money aside for your retirement.  Those kinds of things.  And, incidentally, those things require a good-paying job.  And tax rates that aren’t so onerous that you can’t afford those things you want for your family.

That’s why we call these people on the right conservative.  They’re not too keen on change.  Because they have a lot of responsibilities.  And they’ve made commitments to meet those responsibilities.  It’s one thing to be footloose and fancy free and have radical thoughts.  I mean, what have you to lose?  But it’s quite another thing when you do have something to lose.  Any by that time in your life, when you’re making a pretty good living, you’re paying quite a bit in taxes.  Unlike those young radicals.  You have skin in the game.  They don’t.  They are, in fact, gambling with your money.  Those radical changes (health care for everyone, taxing the ‘rich’, carbon taxes to end global warming, etc.) they’re fighting for won’t impact their lives much.  They’re not paying the taxes.  Yet.  You are.  But those things will impact your life.  So much so that they may alter your life.  You may have to make a choice between a college education for your kids.  Or a comfortable retirement.

Radicals tend to Live in the Heat of the Moment while Conservatives look beyond the Moment

Part of the reason those on the right stood with their king in France was that they saw the danger in radical change.  The breakdown of institutions.   Of tradition.  Things that they knew worked.  Things that made France a great empire.  There may have been problems.  Some inequities.  But the collapse of the old regime may unleash chaos and violence.  Back then, that’s how power changed.  Through chaos and violence.  And sometimes an imperfect system is better than chaos and violence.

Over in America, a group of liberal radicals led their revolution.  But once they won their independence from Great Britain they got very conservative indeed.  In fact, they called some of the Founding Fathers ‘too British’.  Washington, Adams, Hamilton, Jay, to name a few, where attacked for letting down the spirit of ’76.  There were still a lot of passions in the states.  Still a bit of a civil war going on in the south between Patriot and Loyalist.  But it was time for the grownups to step in to win the peace.  Even if they were perceived as being too British.

Radicals are quick to point out your failings.  But they don’t often have the wisdom or experience to see the big picture.  They live in the heat of the moment.  And often act bold and impertinently.  Whereas wisdom and experience tend to make you act with restraint.  To be conservative.  To see beyond the moment.  Because some of the established institutions and traditions have worked.  And even have defined a people.

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LESSONS LEARNED #24: “You cannot lobby a politician unless he or she is for sale.” -Old Pithy

Posted by PITHOCRATES - July 29th, 2010

BUILDING A RAILROAD ain’t cheap.  It needs dump trucks of money.  Especially if it’s transcontinental.  And that’s what the Union Pacific and the Central Pacific were building.  Starting during the Civil War in 1863 (the year Vicksburg fell and Lee retreated from Gettysburg).  The Union Pacific was building west from Iowa.  And the Central pacific was building east from California. 

For the most part, Protestant, English-speaking Americans settled Texas.  Mexico had encouraged the American colonists to settle this region.  Because few Mexicans were moving north to do so.   The deal was that the colonists conduct official business in Spanish and convert to Catholicism.  They didn’t.  These and other issues soured relations between Mexico and the American Texans.  The Republic of Texas proclaimed their independence from Mexico.  America annexed Texas.  Mexico tried to get it back.  The Mexican-American War followed.  America won.  Texas became a state in 1845.  And that other Spanish/Mexican territory that America was especially interested in, California, became a state in 1850.  Hence the desire for a transcontinental railroad.

The U.S. government was very eager to connect the new state of California to the rest of America.  So they acted aggressively.  They would provide the dump trucks of money.  As America expanded, the U.S. government became the owner of more and more public land.  The sale of new lands provided a large amount of revenue for the federal government.  (Other forms of taxation (income taxes, excise taxes, etc.) grew as the amount of public lands to sell decreased.)  Land is valuable.  So they would grant the railroad companies some 44 million acres of land (i.e., land grants) for their use.  The railroad companies, then, would sell the land to raise the capital to build their railroads.  The government also provided some $60 million in federal loans.

But it didn’t end there.  The federal government came up with incentives to speed things up.  They based the amount of loans upon the miles of track laid.  The more difficult the ground, the more cash.  So, what you got from these incentives was the wrong incentive.  To lay as much track as possible on the most difficult ground they could find.  And then there were mineral rights.  The railroad would own the property they built on.  And any minerals located underneath.  So the tracks wandered and meandered to maximize these benefits.  And speed was key.  Not longevity.  Wherever possible they used wood instead of masonry.  The used the cheapest iron for track.  They even laid track on ice.   (They had to rebuild large chunks of the line before any trains would roll.)  And when the Union Pacific and Central Pacific met, they kept building, parallel to each other.  To lay more miles of track.  And get more cash from the government.

PAR FOR THE COURSE.  When government gets involved they can really mess things up.  But it gets worse.  Not only was government throwing dump trucks of American money down the toilet, they were also profiting from this hemorrhaging of public money.  As shareholders in Crédit Mobilier.

Thomas Durant of Union Pacific concocted the Crédit Mobilier Scandal.  As part of the government requirements to build the transcontinental railroad, Union Pacific had to sell stock at $100 per share.  Problem was, few believed the railroad could be built.  So there were few takers to buy the stock at $100 per share.  So he created Crédit Mobilier to buy that stock.  Once they did, they then resold the stock on the open market at prevailing market prices.  Which were well below $100 per share.  Union Pacific met the government requirements thanks to the willingness of Crédit Mobilier to buy their stock.  The only thing was, both companies had the same stockholders.  Crédit Mobilier was a sham company.  Union Pacific WAS Crédit Mobilier.  And it gets worse.

Union Pacific chose Crédit Mobilier to build their railroad.  Crédit Mobilier submitted highly inflated bills to Union Pacific who promptly paid them.  They then submitted the bills to the federal government (plus a small administration fee) for reimbursement.  Which the federal government promptly paid.  Crédit Mobilier proved to be highly profitable.  This pleased their shareholders.  Which included members of Congress who approved the overbillings as wells as additional funding for cost overruns.  No doubt Union Pacific/Crédit Mobilier had very good friends in Washington.  Including members of the Grant administration.  Until the party ended.  The press exposed the scandal during the 1872 presidential campaign.  Outraged, the federal government conducted an investigation.  But when you investigate yourself for wrongdoing you can guess the outcome.  Oh, there were some slaps on the wrists, but government came out relatively unscathed.  But the public money was gone.  As is usually the case with political graft.  Politicians get rich while the public pays the bill.

(Incidentally, the investigation did not implicate Ulysses Grant.  However, because members of his administration were implicated, this scandal tarnished his presidency.  Grant, though, was not corrupt.  He was a great general.  But not a shrewd politician.  Where there was a code of honor in the military, he found no such code in politics.  Friends used his political naivety for personal profit.  If you read Grant’s personal memoirs you can get a sense of Grant’s character.  Many consider his memoirs among the finest ever written.  He was honest and humble.  A man of integrity.  An expert horseman, he was reduced to riding in a horse and buggy in his later years.  Once, while president, he was stopped for speeding through the streets of Washington.  When the young policeman saw who he had pulled over, he apologized profusely to the president and let him go.  Grant told the young man to write him the ticket.  Because it was his job.  And the right thing to do.  For no man, even the president, was above the law.)

THE FINANCIAL WORLD fell apart in 2007.  And this happened because someone changed the definition of the American Dream from individual liberty to owning a house.  Even if you couldn’t afford to buy one.  Even if you couldn’t qualify for a mortgage.  Even, if you should get a mortgage, you had no chance in hell of making your payments.

Home ownership would be the key to American prosperity.  Per the American government.  Build homes and grow the economy.   That was the official mantra.  So Washington designed American policy accordingly.  Lenders came up with clever financing schemes to put ever more people into new homes.  And they were clever.  But left out were the poorest of the poor.  Even a small down payment on the most modest of homes was out of their range.  Proponents of these poor said this was discriminatory.  Many of the inner city poor in the biggest of cities were minority.  People cried racism in mortgage lending.  Government heard.  They pressured lenders to lend to these poor people.  Or else.  Lenders were reluctant.  With no money for down payments and questionable employment to service these mortgages, they saw great financial risk.  So the government said not to worry.  We’ll take that risk.  Fannie Mae and Freddie Mac would guarantee certain ‘risky’ loans as long as they met minimum criteria.  And they would also buy risky mortgages and get them off their books.  Well, with no risk, the lenders would lend to anyone.  They made NINJA loans (loans to people with No Income, No Job, and no Assets).  And why not?  If any loan was likely to default it was a NINJA loan.  But if Freddie or Fannie bought before the default, what did a lender care?  And even they defaulted before, Fannie and Freddie guaranteed the loan.  How could a lender lose?

Once upon a time, there was no safer loan than a home mortgage.  Why?  Because it would take someone’s lifesavings to pay for the down payment (20% of the home price in the common conventional mortgage).  And people lived in these houses.  In other words, these new home owners had a vested interested to service those mortgages.  Someone who doesn’t put up that 20% down payment with their own money, though, has less incentive to service that mortgage.  They can walk away with little financial loss.

ARE YOU GETTING the picture?  With this easy lending there was a housing boom.  Then a bubble.  With such easy money, housing demand went up.  As did prices.  So housing values soared.  Some poor people were buying these homes with creative financing (used to make the unqualified qualify for a mortgage).  We call these subprime mortgages.  They include Adjustable Rate Mortgages (ARMs).  These have adjustable interest rates.  This removes the risk of inflation.  So they have lower interest rates than fixed-rate mortgages.  If there is inflation (and interest rates go up), they adjust the interest rate on the mortgage up.  Other clever financing included interest only mortgages.  These include a balloon payment at the end of a set term of the full principal.  These and other clever instruments put people into houses who could only afford the smallest of monthly payments.  The idea was that they would refinance after an ‘introductory’ period.  And it would work as long as interest rates did not go up.  But they went up.  And house prices fell.  The bubble burst.  Mortgages went underwater (people owed more than the houses were worth).  Some people struggled to make their payments and simply couldn’t.  Others with little of their own money invested simply walked away.  The subprime industry imploded.  So what happened, then, to all those subprime mortgages?

Fannie and Freddie bought these risky mortgages.  And securitized them.  They chopped and diced them and created investment devices called Collateralized Debt Obligations (CDOs).  These are fancy bonds backed by those ‘safe’ home mortgages.  Especially safe with those Fannie and Freddie guarantees.  They were as safe as government bonds but more profitable.  As long as people kept making their mortgage payments.

But risk is a funny thing.  You can manage it.  But you can’t get rid of it.  Interest rates went up.  The ARMs reset their interest rates.  People defaulted.  The value of the subprime mortgages that backed those CDOs collapsed, making the value of the CDOs collapse.  And everyone who bought those CDOs took a hit.  Investors around the globe shared those losses. 

Those subprime loans were very risky.  Lenders would not make the loans unless someone else took that risk.  The government took that risk in the guise of Fannie and Freddie.  Who passed on that risk to the investors buying what they thought were safe investments.  Who saw large chunks of their investment portfolios go ‘puff’ into thin air.

SO WHAT ARE Freddie and Fannie exactly?  They are government-sponsored enterprises (GSEs).  They key word here is government.  Once again, you put huge piles of money and government together and the results are predictable.  In an effort to extend the ‘American Dream’ to as many Americans as possible, the federal oversight body for Freddie and Fannie lowered the minimum criteria for making those risky loans.  Even excluding an applicant’s credit worthiness from the application process (so called ‘no-doc’ loans were loans made without any documentation to prove the credit worthiness of the applicant.)  To encourage further reckless lending.  Ultimately causing the worst financial crisis since the Great Depression. 

And, of course, members of Congress did well during the good times of the subprime boom.  They got large campaign contributions.  Some sweetheart mortgagee deals.  A grateful voting bloc.  And other largess from the profitable subprime industry.  Government did well.  Just as they did during the Crédit Mobilier Scandal.  And the American taxpayer gets to pay the bill.  Some things never change.  Government created both of these scandals.  As government is wont to do whenever around huge piles of money.  For when it comes to stealing from the government, someone in the government has to let it happen.  For it takes a nod and a wink from someone in power to let such massive fraud to take place. 

www.PITHOCRATES.com

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