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The Lighthouse is the weekly email newsletter of the Independent Institute.
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Volume 10, Issue 40: October 6, 2008

  1. Anatomy of the Mortgage Meltdown
  2. The Bailout of Abominations
  3. Absent from First McCain/Obama Debate: Big Ideas
  4. Defense Secretary Gates More Truthful Than Rumsfeld
  5. This Week in The Beacon

1) Anatomy of the Mortgage Meltdown

Sloppy press coverage about the financial crisis has spawned a host of widely believed myths. Take, for example, one of the popular names for it—the subprime mortgage meltdown. This is a misnomer: houses financed by subprime and prime mortgages were foreclosed upon at equal rates and at the same time. Instead, the crucial distinction is between adjustable-rate mortgages and fixed-rate mortgages, according to University of Texas at Dallas economist and Independent Institute Research Fellow Stan J. Liebowitz.

“The main driver of foreclosures was adjustable-rate mortgages, both prime and subprime” writes Liebowitz in his new Independent Policy Report, “Anatomy of a Train Wreck: Causes of the Mortgage Meltdown,” an adaptation of his chapter in a forthcoming book on housing in the United States.

Adjustable-rate mortgages (and mortgages requiring very low or no down payments and no income verification—so-called “no doc” loans and “liar loans”) were the highly combustible raw ingredients that served as kindling for a financial meltdown ignited by the end of the housing price surge. Lenders promoted these “innovative” loans ceaselessly—but not without a big push from the federal government. At the behest of Congress, Fannie Mae and Freddie Mac conducted a profitable but risky scheme to promote increased homeownership. Unsurprisingly, the status of Fannie and Freddie as government-sponsored enterprises sent a false signal to borrowers, lenders, and investors that these loans were safe, and so the usual precautions were tossed out the window.

“Since the housing and regulatory establishment consisted of mighty government agencies and highly educated academics,” continues Liebowitz, “it was not unreasonable for the lenders to assume that the claims made for flexible underwriting standards were correct. Unfortunately, the claims were not correct although most of the housing and regulatory establishment continue to argue otherwise.”

“Anatomy of a Train Wreck: Causes of the Mortgage Meltdown,” by Stan J. Liebowitz (10/3/08)

Also see Stan J. Liebowitz’s article, “The Anatomy of a Train Wreck,” in the October 20 issue of National Review. (Subscription required.)

Pre-order Housing America: Building Out of a Crisis, edited by Randall G. Holcombe and Benjamin Powell.

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2) The Bailout of Abominations

A Gallup poll conducted on September 30, one day after the House of Representatives voted 228 to 205 against a $700 billion bailout bill for the financial sector, found that only 20 percent of the respondents said Congress should pass a bill similar to the defeated bill. In contrast, 57 percent of respondents said they wanted Congress to “start over and come up with a new plan.” The bill the House passed 263 to 171 on Friday, however, resembles the old bill except in one respect: it’s worse. The Emergency Economic Stabilization Act of 2008 spells out unprecedented new discretionary powers for government officials to intervene in financial markets.

The bill gives the Treasury Secretary extraordinary latitude in buying “troubled assets”—a term it defines as any mortgage or mortgage-related security or instrument issued before March 14, 2008. (The secretary can also purchase any other financial asset so long as written permission is obtained from the Fed chairman and various committees of Congress.) Also, virtually any financial institution that operates in the United States can qualify for bailout bucks. Despite the act’s creation of an oversight board composed of the heads of sundry government agencies, this arrangement is wide open to waste, fraud, and abuse, according to Robert Higgs, Independent Institute Senior Fellow in Political Economy.

“If the secretary can’t find all of his friends, relatives, former colleagues, and political co-conspirators among the managers and owners of this expansively defined class of firms, then he’s not looking very hard,” writes Higgs in a new op-ed. “With $700 billion to throw here, there, and everywhere, for good reason or no reason, with no real accountability and no bottom line—if he can’t make himself the God of Chaos by exercising these powers, then nobody on this planet can create chaos. The potential for malinvestments, general misallocation of resources, and sheer financial tomfoolery confounds the mind.”

“The Bailout of Abominations,” by Robert Higgs (10/6/08)

“The Fatal Conceit of Congress,” by Michael Reksulak (9/30/08) Spanish Translation

Purchase Depression, War, and Cold War: Studies in Political Economy, by Robert Higgs.

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3) Absent from First McCain/Obama Debate: Big Ideas

The first presidential debate between John McCain and Barack Obama pitted two politicians almost tripping over each other to show their commitment to pragmatism: neither candidate expressed what Independent Institute Senior Fellow Alvaro Vargas Llosa called “a profound belief in what the government’s role should be.” Big Ideas were conspicuously absent.

“Obama has a big-government penchant, but he is too modern a politician to profess it without reserve,” writes Vargas Llosa in his latest syndicated column. “In the case of McCain, there is a fundamental contradiction between his neoconservative belief in the U.S. military as the agent of good in the world and his small-government positions on issues such as budgetary earmarks.” No one can confuse McCain’s rhetoric with that of Ronald Reagan.

Shouldn’t presidential campaigns be about something bigger? Vargas Llosa asks us to envision an election whose theme is explicitly centered around the extent of government power. Imagine, let us say, an election in which at least one major candidate argues in defense of civil society, as against too much state power. Think Goldwater versus Johnson, Thatcher versus Kinnock, Reagan versus Carter, or Vaclav Klaus versus the coalition of former Communists in Czechoslovakia in 1992. “Regardless of what side of the fault line one stood on, or what the ensuing administrations ended up doing,” writes Vargas Llosa, “those elections were memorable in that the players understood exactly what elections should be about.”

“Where Is the Big Idea?” by Alvaro Vargas Llosa (10/1/08) Spanish Translation

Purchase Lessons from the Poor: The Triumph of the Entrepreneurial Spirit, edited by Alvaro Vargas Llosa.

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4) Defense Secretary Gates More Truthful Than Rumsfeld

Telling the truth has often come at great cost to political players. It’s refreshing, therefore, when some high-level politician or bureaucrat, usually near the end of his tenure in office, says what would have been unthinkable before he became a lame duck. In his latest op-ed, Independent Institute Senior Fellow Ivan Eland offers the example of outgoing Israeli prime minister Ehud Olmert. Olmert told his compatriots that to advance the cause of peace, Israel should withdraw from nearly all of the West Bank and East Jerusalem or compensate the Palestinians by providing them with other Israeli land—essentially a reversal of long-standing Israeli defense doctrine.

Similarly, U.S. Defense Secretary Robert Gates, only a few months before his presumed exit from office, has displayed refreshing candor, especially in comparison to his predecessor Donald Rumsfeld, argues Eland. “Gates criticized the U.S. military establishment for neglecting counterinsurgency warfare at the expense of buying new generations of technological warfighting gizmos,” Eland writes.

Gates spoke the truth, but he fell short of telling the whole truth, according to Eland. That’s because the U.S.-trained Sunni Awakening militias, who have helped implement U.S. counterinsurgency policy, could easily resume fighting the civil war—especially now that they are increasingly turned over to the hostile Shi’i-dominated Iraqi government. Concludes Eland: “What Gates should have said was that the historical record indicates that military invasion by a foreign power rarely changes deep-rooted political, economic, social, and cultural norms...usually rendering such armed adventures pure folly.”

“In Politics, If You Have to Be Honest, Wait Until the End of Your Term,” by Ivan Eland (10/6/08)

Purchase The Empire Has No Clothes: U.S. Foreign Policy Exposed (Updated Edition), by Ivan Eland.

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5) This Week in The Beacon

Here is the latest from The Beacon—the blog of the Independent Institute:

As always, The Beacon is open for your comments.

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