Okay, so its been a long time since I've written a blog, but I am tired of people who don't know what the heck they are talking about trying to explain this current financial crisis. I am not an economist, but I have been doing some reading and thinking about the issue and have come to some conclusions:

1. Any move that congress makes, whether it be purchasing these bad assets or pumping more money to prop up the system is only putting a band-aid on the situation. A used band-aid that is infected with 700 billion bits of bacteria.
   


2. In order to make any headway in fixing this economic crisis, Congress must look at the primary causes of the financial meltdown, instead of trying to patch up the secondary effects.
   


3. Although many on the left want to blame this on corporate greed or George Bush, the finger needs to be pointed at the government, in the Community Reinvestment Act of 1977, The Federal Reserves manipulation of interest rates, over-spending in Congress which has devalued our currency, and FDR's creation of the quasi-government monopoly Fannie Mae and later the formation of Freddie Mac.
   


4. Unfortunately, I believe the financial system needs to fail so that the market can correct itself which would probably put us in a recession. However we would be avoiding a larger recession or even a Depression if we continue with the same policies.
   

This crisis can be traced back to the 1930s, where the government started to get involved with housing policy. The Federal National Mortgage Association (Fannie Mae) was created as part of Roosevelt's New Deal in 1938 to provide liquidity to the mortgage market and along with Federal Home Loan Mortgage Corporation (Freddie Mac, which was created in 1970 to create "competition") holds a virtual monopoly on the mortgage-backed securities market. They are also backed by the government as a conservatorship, which basically means that if they fail, then the government is obligated to bail them out. The problem with being backed by the government, besides the socialistic tendencies that follow that idea, is that they are encouraged to make riskier investments, and hold little obligation to the consumers.

In 1977, the housing market became more complicated and the government stepped in again with the Community Reinvestment Act. This act required banks to make loans to lower-income segments of their respective communities, forcing banks to lend to people who normally would be rejected as bad credit risks. The CRA was originally lobbied by radical left groups like ACORN who supported the Carter Administration. They believed that banks were discriminating against lower-class loan applicants and wanted the Federal government to curb "discriminatory lending." The problem with lending to people who are lower-income segments of the community? Well, they are lower-income segments of the community, which means they may not be able to pay back the loan.

With this overflow of lower-income applicants for loans came the lowering of interest rates by the Federal Reserve. This is turn, led to a housing boom. The Fed's lowering of interest rates made it cheaper to borrow money. Longer-term and more capital-intensive projects, projects that would be unprofitable at a high interest rate, suddenly became profitable. When the Federal Reserve cuts interest rates, they have to make it up by pumping more money into the market. The increase in money created the housing boom, instead of consumer demand. This results in investing into sectors of the market where there is insufficient demand, otherwise known as mal-investments. In the housing market, this is an over-building of homes and real-estate. However, when the builders realize that they reacted to a distortion in the market, they drastically lower-prices in order to get back some of the money. The builders are able to equalize supply and demand, bringing the economy back into balance by lowering the prices. At the same time, there are major winners (those who are able to find affordable housing, who normally wouldn't) and big losers (builders and other sectors of the economy that are tied to the real-estate market which suffer set-backs). Unfortunately, the government doesn't like this so it tries to keep the prices artificially inflated. This sort of government intervention occurred during the Great Depression and kept it going so long.

So now the system is suffering from these bad decisions of the past creating so much distortion in the market. And what is the government doing? Trying to buy these bad assets which have been flowing through the market because of the mal-investments. They are seeking to prevent the liquidation of bad debt and worthless assets at market prices, and instead try to prop up those markets and keep those assets trading at prices far in excess of what any buyer would be willing to pay.

So what's the problem? More money in the market means that things go back to normal right?

Sorry, doesn't work like that. The chance that financial institutions will make riskier investments in the future is increased because they will think that if they are big enough then the government won't allow them to fail and bail them out as well. The businesses who are the least productive, least efficient, and least concerned with customer service will be rewarded. In a true free-market, businesses with these characteristics would fail and another institution would take its place. In the free-market scenario, the best businesses who manage their investments properly succeed and the ones who don't, fail. By continuing these bail-out policies, the government is ensuring further market instability.

More government spending (which causes more inflation) and more government intervention to solve this problem that was created by too much spending or inflationary measures and too much government intervention doesn’t really make much sense at all does it? Government intervention leads to distortion in the markets which then causes the governments to react to the distortion by enacting new laws and regulations which then creates more distortion and so on and so on.

The solution to this problem is not a bailout, but it is not pretty either. The financial market will have to suffer in order for the sector to correct itself and flush the mal-investments out of its system. We will likely face a large recession, but no where near a Great Depression like George W. Bush or Henry Paulson, the Treasury Secretary, would have you believe. The market has natural inevitable ups and downs, and no matter what the government does, they are going to occur. In most cases, when the government gets involved in slowing these downturns, they usually last longer and take on a more gruesome form.

For the future, the government as well as the Fed must act to remove its grasp on the market, if there is ever going to be any financial stability. These bailouts are only prolonging the primary problems and covering up the secondary effects. Spending must be dramatically reduced in Washington and the Fed must stop manipulating interest rates which encourage these bad investments. They also must stop the practice of printing money out of thin air, which inflates the currency, and return to a monetary system that is backed by gold.

In conclusion, this bail out is a used, infected band-aid that will only add more bacteria to the wound and cause a larger, nasty effect on the body that is our financial system.

Justin Hayes

Please Check out my new radio show on Owl Radio, Friday's from 2-4 p.m. at http://www.ksuradio.com , click "listen live."
The Wenk And Gerb Show