You are invited to read the latest commentary from the Free Enterprise Foundation. It will make you think!

The Only Thing We Have To Fear…

“I am certain that my fellow Americans expect that on my induction into the Presidency I will address them with a candor and a decision which the present situation of our people impels. This is preeminently the time to speak the truth, the whole truth, frankly and boldly. Nor need we shrink from honestly facing conditions in our country today. This great Nation will endure as it has endured, will revive and will prosper. So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance. In every dark hour of our national life a leadership of frankness and vigor has met with that understanding and support of the people themselves which is essential to victory. I am convinced that you will again give that support to leadership in these critical days.” (Franklin Roosevelt First Inaugural)

As 2008 races to meet 2009 our financial markets are in turmoil and fear stalks Wall Street. On Main Street we are beset by $4.00 a gallon gasoline, and for those who need to move, credit market instability has made it a “renters market.” Basic industry and most of the service markets, while not robust, continue to operate with small gains over last year. This is not 1933, and The United States non financial sector economy is basically sound. Let me say that again so I am sure you get it. The United States nonfinancial sector economy is basically sound.

My children sometimes accuse me of being a Philadelphia lawyer, and, indeed, there was a caveat in my pronouncement. In the absence of the spreading fear and the mindless paralysis it breeds, with rare exception for some truly global enterprises, the failure of small parts of the financial structure do not jeopardize the economy. In the current situation, the institutions at risk are simply too entangled with the general national economy to be allowed to go down. If we do not act correctly and act now, the general economy is at risk of being caught up in the financial sector turmoil. The financial infrastructure and the smooth operation of markets are the rails over which our labor is transformed into value and on which all financial transactions travel to an expected outcome. It is, in truth, like the electric power grid, an essential public utility.

Regrettably the current presidential election season is not helping to keep panic at bay. Both candidates are guilty of distortions but are being supportive of the efforts by the Administration to get the financial sector righted before it pulls down the rest of the economy. The private sector, reeling from the mistakes it has made, is already fashioning solutions for much of what they have done wrong. As in most cases of capital excess, venerable institutions and financial sector employees have been hard hit by the destruction that has come with these solutions. Our market system, which I still firmly believe provides the greatest freedom and the greatest welfare for the most people, does not contemplate bailouts such as we have seen, and there is real concern that those who got us into this mess not be bailed out with the innocents

Let there be no doubt about it, the rescues now being proposed or chivied into being including a bad asset liquidator, whatever it may be called, are going to be very expensive for those rescued. They aren’t “bailouts”. The takeover of AIG, for instance, is a loan against solid assets with the sale of 79.8 percent of the company thrown into the bargain. That is a firehouse sale of a solid company if I ever saw one, and the taxpayer will not be hurt. The other implementation steps that I read about as I write are also going to be expensive to the rescued except possibly for the individual investor who purchased a home that he or she really couldn’t afford. Congress will insist on that.

Going forward there will be more government oversight and circuit breakers to assure that the excessive speculation and irresponsible risk taking that got us here will not be engaged in by the investment banking community. Insurance will probably end up with a national watchdog rather than state based gatekeepers. Fannie Mae and Freddie Mac are likely to be dismantled into a dozen competing mortgage underwriters, and AIG will end up in its formerly competing parts, but let me repeat, the actual dollar cost to the public will be nothing like the figures being tossed around today and may in fact yield a profit to the Treasury. What we are seeing is not socialism but a form of government vulture capitalism that may save the economy but leave many of the principle actors, shells of their former selves.

How did we get in this mess? There are a lot of ways to describe the cause. Unbridled Greed is one, but I don’t think it serves adequately to describe the many moving parts that have come together to create a perfect storm in financial markets. Certainly it starts with the unusually risky behavior by investment banks, irresponsibility by Freddie and Fannie, failure of the SEC to get at the naked short sale activity by hedge funds before the damage was done, and by its failure to decry the risky course being pursued by the investment banks years ago; FASB’s appraise to market rules; heavy borrowing by the Treasury; irresponsibly low interest rates set by The Fed for too long, along with the consequent huge increase in the cost of foreign oil. What a witches’ brew! Even my old bugaboo, Sarbanes Oxley, had a role to play, and now that we are in the storm, I am critical of The President for not being a more forceful source of information calming the public and putting the situation into a context the public can understand.

While I am happy to lecture on this subject as I have for my students, space permits here only an emphasis on a couple of the brew’s ingredients. While in normal times, the mantra that real estate values always increase may be useful, the investment markets, like tulip speculators of eons ago, have, through their blind greed shown the exception to the rule. They were abetted in their delusion by Freddie Mac and Fannie Mae, who while purchasing record numbers of qualifying mortgages, participated in much of the sub prime paper through their investment portfolio and fueled the myth regarding real estate values in the early years of this decade.

Contributing to the huge pocketbook for increasingly risky products was the exceptionally low interest rates created by Treasury’s deficit financing and maintained by The Federal Reserve. We had too much money chasing too few goods; in this case real estate, and the consequent building boom, acquisition of second and third homes became a foregone conclusion.

International commodity markets are sensitive to lack of balance between currency and other commodities. It was an open invitation to the oil market controlled by OPEC to take advantage of the disequilibrium, and they have with a vengeance. This has sucked huge portions of real value out of our economy, and from my prior articles, you know how I feel about that. As you sit around the kitchen table contemplating your own finances, I hope you won’t sour on free enterprise and will not throw out our reliance on vibrant free enterprise to secure our future.

The change that would occur by a return to 1930’s reliance on Big Government would undermine the productivity of the golden goose that is our wondrous economy. Change is needed but sensible change, not the terminal surgery contemplated by those who want a return to Big Government. Good Change comes in letting the system work but instituting tighter scrutiny of the financial sector. We also need reevaluation of the rules we have adopted to oversee runaway risk which instead have had a hand in bringing this situation into being. That an enterprise can become so large and so integrated with our economy that government has felt it had to take the steps it has, should also cause a re-evaluation of our antitrust laws. Risk and misfortune also bring opportunity, and like Warren Buffet who just put five billion in Goldman Sachs, I am bullish on America’s future and hope you will be also.

Copyright © 2008 by Robert E. Freer, Jr. All rights reserved

About the author: Robert E. Freer, Jr. is President of The Free Enterprise Foundation. He is a Visiting Professor, at The Citadel and elected in 2005 to be their first John S. Grinalds Leader in Residence. A regular contributor to the Mercury, He can be reached by E-mail at The Citadel . Copies of his earlier columns can be found The Free Enterprise Foundation.

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