Let the Free Market Work

10/06/2008 12:01 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

We’re caught in a mess—and with Friday’s passage of the financial bailout bill by the House of Representatives, government is deeply involved in the solution.

Aside from the ugly politics that have been revealed by this debate, the good news is that the American public is more involved in a tax protest than at any time since the Boston Tea Party in 1773.

The bailout/rescue controversy is billed as a difference of opinion over free markets. There are those who say that free markets caused this mortgage problem—too little regulation, too much freedom.

In fact, the truth could be viewed as quite the opposite—that interference from the government in the workings of the free markets actually causedthis problem.

After all, it was the government that created and subsidized home ownership through tax policies, including the sacred deductibility of mortgage interest.

And it was the government that created mortgage-making agencies Fannie Mae and Freddie Mac, giving their debt an implicit guarantee that is now quite explicit.

And it was the government that passed the Community Reinvestment Act, mandating loans to basically people who couldn’t otherwise qualify.

And it was the government that encouraged low interest rates and the expansion of the Fannie/Freddie portfolio to continue to subsidize the housing bubble.

Do you remember Alan Greenspan recommending that everyone take out an adjustable- rate mortgage? Sure, the Federal Reserve cooperated. And Alan Greenspan protests to no avail.

The government, the Fed, and the bankers who figured out how to game the system all contributed to the downfall of the financial system. Let’s not blame the free market system itself for the misdeeds of the participants.

And what about the solution? The free market solution is obvious to all of us. Every bubble must burst; every excess in one direction must be followed by a cleansing purge in the opposite direction.

We let that happen in the dot-com bubble in the stock market. Lots of people lost money, through greed or ignorance. Even though Enron executives were convicted of fraudulent behavior, no one has “bailed out” the retirees or other investors who lost the money they held in company stock.

The free market solution to this current problem would allow any homeowner who cannot live up to the terms of his or her mortgage to be foreclosed. And then for the banks to sell those homes at a market price. And for the market to find its own bottom.

Then, those who played by the rules, lived frugally, and saved up money will get their chance to buy homes at prices that reflect reality, not dreams.

But there will be no real free market solution to this mortgage mess. No politician will allow foreclosure on the American dream. The only question is how far our solution will move us toward government control over resources ranging from the financial system to home ownership.

Should the government take partial ownership in the companies it “rescues” with taxpayer dollars? Should the government re-write private contacts, such as mortgages? Should the government actually own the housing of those who cannot pay?

Do you think this situation was so difficult to foresee? Well, take a look at what Thomas Jefferson wrote in a letter to his Treasury Secretary Albert Gallatin in 1802—over two hundred years ago:

“If the American people ever allow private banks to control the issue of their money, first by inflation and then by deflation, the banks, and the corporations that will grow up around the banks, will deprive the people of their property until their children will wake up homeless on the continent their fathers conquered.”

Our founding fathers were so wise. I wonder what they would think of what has happened to their high ideals, as they watch politicians of both political parties fight over the spoils and citizens demand to be bailed out for their own mistakes.

What do you think? Please have your say now.

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