Revolution USA, repeat history with a twist

by Don Hank

A look back at the French revolution reveals many surprising commonalities with today’s situation in America.

Yet, if the Tea Party Revolution succeeds, it will not be due to a revolutionary mindset as best described by Olavo de Carvalho (my review; full text). It will be the opposite, but with a similar historical lead-up and tactics ( hopefully with less bloodshed).

The main factors in both revolutions are:

Economic

Intellectual

Spiritual

Political

One of the main factors in the French Revolution was an economic one: worldwide famine caused by a weather anomaly. What later came to be known as the Little Ice Age contributed mightily to the timing of the revolution, as detailed by Brian Fagan.

In our case, while there is no famine, there is a shrinking economy, and a looming double-dip recession or even a full-blown depression, as predicted by economist Paul Krugman. Many realize government policy actually caused the initial failure of banks and the consequent economic slide. Most do not.

Regardless of the origin of this current economic malaise, it will eventually parallel the situation in France in 1788/9. Already, the number of unemployment recipients is staggering and is further gnawing at our national treasury, just as the excesses of Louis XV and XVI gnawed at and eventually drained, France’s treasury.

Added to this in France was the intellectual factor, i.e., the wide circulation of the ideas of the enlightenment, which generally called for equality among all people, undermining the notion of divine right of the nobility. In fact, the successful American Revolution added fuel to this equality movement.

But the American Revolution also contributed in a political way to the revolution: In an attempt to vindicate his father’s waste of national funds in the unsuccessful Seven Years War against traditional enemy Britain, Louis XV, Louis XVI, the incompetent king and husband of Marie Antoinette, decided to help the Americans in their war with Britain. Success in that war did not translate into political success for Louis XVI, however, because the aid the French had sent us bankrupted France and further undermined the King’s authority and popularity. Other political factors include the popularity of revolutionary-minded Minister Jacques Neckar and of Maximilien Robespierre. The former’s dismissal gave more fuel to the movement while the latter’s oratory inspired the people to revolt.

It bodes ill for Michelle Obama that her extravagant vacations and leisure life are garnering her the monicker “Michelle Antoinette” – even among Democrats.

It is intriguing that the scenario of the French Revolution is now being turned upside down:

Economically, while most of the ills caused by the government in France were unrelated to the will of the public, the ills in our country were by consent of the governed, who foolishly installed politicians imbued with Keynesian economic ideas. A close look at globalist G.W. Bush, son of globalist George Bush Sr., would have shown us this flaw in his character. Obama, obviously driven by leftwing ideology, could scarcely have been expected to reject the idea of bailouts for banks and businesses, which then could be controlled by the government. This amassing of power in the hands of globalists and Marxists was accomplished by stealth, but it was ultimately the uncritical masses who chose them.

Intellectually, while the ideas that bolstered the French Revolution were strictly leftist revolutionary, the ideas of the Tea Party, promulgated by media personalities and a few politicians, and increasingly, by bloggers and internet activists, are spreading and causing a new kind of movement that could best be called antirevolutionary, if we accept the definition of the Revolution as set down by revolutionaries themselves over the centuries (again, I refer to the masterful work by Olavo de Carvalo).

Spiritually, the French revolution marked an upsurge in the religion of humanism, which has held for centuries, while the tea party revolution marks a turn toward traditional Christian values and beliefs that the French would call “reactionary.” It is no exaggeration to call humanism a religion in this context. The spiritual descendants of Voltaire include Sartre, Camus and a host of artists dedicated to proselytizing for atheistic humanism. A look at French cinema (works like “Jean de Florette,” “The Stranger” and “Madame Bovary,” for example) make this fanatical missionary spirit abundantly clear. Meanwhile, in America, the new heretics, like Jim Wallis and wishy-washy feel-good, “cool” pastors are being rejected for what Americans see as the “real thing,” solid men of God dedicated to the winning of souls from perdition.

Politically, the situation is similar between France then and the US today. The National Assembly in the 1780s had been at loggerheads with the King over issues like equality of taxation (only the commoners were taxed, nobility and clergy were exempted). It was the people against the tyrant at the top. Today we see the will of the people in Arizona, for example, being thwarted by the heavy hand of Obama and an activist court.  In reaction to the general perception of such tyranny, the true patriot tea party candidates (as distinct from the GOP-led imitations) are overthrowing incumbents in many elections. The GOP establishment, even with endorsements from once-popular heavy hitters like Sara Palin and Jan Brewer, is no longer able to sell their wishy-washy candidates at face value. Given the economic climate, the established church is no longer able to sell open borders and amnesty to their parishioners. Even popular icon Ann Coulter can’t pied-piper her followers into accepting a coalition with the homosexual agenda. The establishment is slowly cracking.

Conservatives and libertarians are forming a natural coalition and spreading the ideas of liberty and constitutional government but without the leftwing claptrap.

It is too early to predict anything, but the climate is right for a revolution that is, like the first American Revolution, not a revolution at all but rather a return to common sense, natural law and the God of our fathers.

Subprime crisis: the overall picture

Subprime crisis : the overall picture


By Vincent Benard

 

In many aspects, the current financial meltdown that brought many banks and insurers to insolvency may be compared to the nuclear meltdown that affected the Chernobyl power plant. And whatever Big Government pundits may tell us endlessly – without real in-depth arguments – inappropriate state intrusions in the economy are as much responsible for the financial crisis as poor state management of nuclear facilities by USSR was for the Chernobyl disaster.

If the mechanisms of the so-called “Chinese syndrome” can be described as a process of ignition, amplification, and then propagation of atomic reactions, likewise, the current crisis is a story of state interventions in the economy, that ignited, amplified, and then propagated the meltdown from its original core to the whole financial system.

Ignition

The main factor that ignited the current crisis is how politicians forced two state regulated enterprises, Fanny Mae and Freddie Mac, to refinance a growing part of unsecured loans to low and very low income families. In exchange, Fannie and Freddie were exempted from some accounting requirements generally expected from ordinary firms, allowing them to leverage too much credit compared to their equity, by an extensive use of off balance “special purpose vehicles.” All these operations were made under an implicit taxpayer provided safety net, as the statutory rules of the department of Housing and Urban Development made possible the nationalization of Fannie and Freddie in the case of bankruptcy.

These government provisions, coupled with a law mandating banks to find ways to originate loans to some high risk-profiled borrowers (the much discussed and controversial Community Reinvestment Act), reversed the usual prudential rules governing company CEOs: first, don’t fail, and then, make a profit. Due to their government backing, Fannie and Freddie only had to expand their volume of business, without too much consideration of the underlying risks. The purchase of so many bad loans by two state-backed giants encouraged reckless lending by banks and mortgage brokers to many risk-unaware families.

This behavior was greatly helped by Alan Greenspan’s decisions to lower and maintain very low interest rates in the early 2000s without consideration of the obvious asset bubble that was emerging in the housing sector. When credit is too cheap, borrowers tend to be less careful in their investments.

Amplification

But these facts do not explain by themselves how big the housing bubble has become. The average Joe, in the mortgage broker’s office, was not as unsophisticated as generally described. He could lose his common sense and succumb to easy credit only because the brokers could show him impressive Case-Schiller index curves, which seemed to show that any housing investment could gain more and more value every year, making the purchaser richer even while he was sleeping. Without this apparent housing inflation, many people wouldn’t have jumped so recklessly onto the easy credit bandwagon.

But this housing inflation did not occur everywhere in the country. Some of the most dynamic metro areas, in terms of population growth, haven’t experienced any housing bubble. Recent Nobel Prize Paul Krugman, supported by several research papers, notably from academics like Ed Glaeser or Wendell Cox, explained it by land use regulations: when these regulations are flexible and tend to be respectful of the property rights of the land owner, housing bubbles cannot even get started. But when regulations allow the existing real estate owners to prevent farmland holders to build the houses required to satisfy all housing needs, housing prices start skyrocketing.

Housing mortgage debt owed by families grew from 4.8 to 10.5 trillion USD (from early 2000 to late 2007. But had every city in the USA had the same flexible land use regulations that they had in the fifties, and that still exist in fast growing areas like Houston or Atlanta, this exposure to risk would have been much lower, by 3 to 4 trillion. More borrowers would have qualified for the prime credit market and its less risky loans, since the lower price of the purchased homes would have resulted in better credit ratings. So, despite the bad lending practices mentioned above, the risk of a general collapse of the credit market would have been nearly equal to zero.

Propagation

At this point, we just explained the roots of a mortgage crisis. What is still missing is the way it has spread throughout the financial system. Once again, bad laws are to blame.

First, this crisis shows how risky the bank’s business model, grounded on low equity and very high leveraging ratios, has become unsound in these time of high volatility of some assets. Some will blame banks for this, but you should be aware that before the creation of the FED in 1913, most banks’ business models were based on equity levels over 60%: the shift from a high equity to a low equity model comes first from tax policies which have, in nearly every country of the world, severely taxed capital gains, but encouraged debt by deducting the interest payment from the corporate tax base. The second reason is that central banks, as “last recourse lenders,” usually with a state’s warranty, have themselves favored this shift to a highly leveraged model: borrowing  money was de facto a cheaper resource than raising capital to finance operations.

But of course, this doesn’t explain how a 10% default risk on a credit niche market (the subprimes), totaling less than 10% of the total housing debt (12 trillion at the end of 2007), itself less than one fifth of the total assets being exchanged on American financial markets, generated such turmoil.

The culprits must be sought within a set of rules named “Basel II,” and their declinations in local laws in most countries, aimed at regulating the activities of banks or insurance companies. In some cases, poorly designed accounting rules may have contributed, too.

Basel II rules — and the like — mandate banks and insurers to hold a diversified portfolio of assets aimed at providing them the liquidities they need to face hard times: for a bank, a major loss of customers; for insurers, a series of major disasters. These rules were supposed to “protect” investors from reckless diversification policies. So institutional investors were mandated to own only high quality bonds, or to value some kinds of assets, like stocks, with a weighting that de facto prevented their securities from handling such assets directly.  

But banks and insurers needed the yields of “lower quality” bonds, or even stocks, to remain attractive to private investors. Otherwise they wouldn’t have been able to beat the performance of state labeled bonds, and thus wouldn’t bring any added value to their customers, forcing them out of the market.

So the late 80’s and the 90’s saw the onset of a huge market of “derivatives,” all based on the following principle: lower quality assets (like subprime based securities bonds) are put together in another security, which itself sells new bonds sliced into several “tranches.” The first slice, the “z-tranch,” is a very risky one, which is aimed at bringing a higher yield to unregulated investors as hedge funds but must absorb primarily the first percentages of any losses of the security. Other tranches bear a lower risk but serve a lower yield. The “cushion effect” of the high risk tranch allows the lower tranch bonds to receive an AAA rating from rating agencies, particularly if they are covered against credit default by a special derivative called a “credit default swap,” allowing lender and borrowers to reinsure themselves against defaults on their bonds. And there can be other “derivatives of derivatives” involved in these designs. In many cases, institutions issuing AAA tranches guaranteed the payment of the corresponding bonds.

So the current situation is that many institutional investors do not hold many real stocks or bonds in their portfolios. They mostly hold a majority of derivatives.

But all this incredibly complex financial engineering not only is extremely costly, but has one perverse effect: while reducing the probability of AAA tranches to default, it actually makes the amount of the risk higher in the event that losses are high enough to impact the AAA tranches. And all these complex designs of derivatives make it increasingly difficult to understand where the risks are located in complex securities mixing prime mortgages, subprime mortgages, and other kinds of credits. So when an AAA tranch is impacted by higher than forecast losses, nobody really knows what is the resulting worth of the best tranch if it has to be sold. Is it 95% of the nominal? 60%? Nobody seems able to value these bonds reliably.

So when the mortgage debtors began to be insolvent in a higher proportion than usual, the losses on subprimes derivatives began to exceed the “cushion” effect of Z-tranches. AAA bonds were impacted. Some holders of these bonds, forced to sell off in panic in order to get cash, couldn’t find purchasers, except some highly speculative funds that toughly negotiated the price.

But then, because of inflexible accounting laws, all institutions holding the same kind of toxic assets had to write down the values of these assets in their balance sheets, even if their treasury level didn’t force them to proceed to a fire sale of these assets. So they might have been declared virtually insolvent even if actually they were not. This affected their ability to borrow on short term liquidities markets, and thus led some of them ultimately to file for bankruptcy.

If no regulatory limitations had been placed on the assets that banks and insurers could hold, it is likely that they would not have found the use of exotic derivatives so attractive, and that early difficulties in subprime credits would have resulted in clear signals prompting securities managers to recompose their portfolios. Some investors’ failures could have occurred earlier, but would not have reached such proportions. 

Big Government is the culprit

So, at the root of every mechanism identified as a catalyst of the current crisis, we can find a bad federal or local regulation.

Does this mean that private institutions have no moral and technical responsibility in the current mess? Certainly not. They’ve deliberately chosen to take advantage of these poisonous regulations instead of fighting them, even though some of the underlying risks were clearly identified. Many of them ifnored warnings issued by economists like Nouriel Roubini, or atypical politicians like Ron Paul, and preferred to listen to reassuring assessments of the soundness of the system written by star economists like Joseph Stiglitz. People don’t like dream breakers.

Competition to overturn bad regulations doesn’t exonerate financial private institutions from having failed to do so properly. Whatever conditions are created by the states, firms must act wisely. Many of them obviously did not. But in the ranking of responsibilities, states’ inaccurate and inordinate regulations obviously rank highest. Had its diverse regulations and interventions focused on principles (honesty in contracts, no concealment of malpractice, full disclosure of operations, respect of property rights) and court litigation; had they let private individuals or enterprises decide what was good for them without trying to curb their behaviors in particular directions, none of the elements that allowed this crisis would have been in place.

Government’s economic interventions in human interactions once again have proved counterproductive and finally wrought havoc. This should make people very careful about government claims that new interventions are necessary to solve the crisis and avoid the next one!

 

Vincent BENARD is the president of the Hayek Institute, a French speaking think tank based in France and Belgium – www.fahayek.org . The institute has published several tribunes advocating the free-market point of view on the current crisis. His personal blog is www.objectifliberte.fr