The Political Roots of the Financial Crisis

In the midst of the worst financial crisis since 1929, people are asking, "Who's fault is it?"

It is human nature to find someone to blame. We all want to know who the culprit is. Some blame greedy and incompetent executives who over leveraged their firms and drove them to the ground. One favorite target are the speculators who shorted financial instruments.

All these could have parts to play in the debacle. But commentators have so far over looked one important point - the political system that contributed to the debacle.

The current crisis is at its heart a housing crisis. Housing prices rose as a result of easy loans made by banks and other financial institutions. Loans were made to people who could not afford to buy property. These are called "sub-prime" mortgages.

Banks knew that they could not pay but felt that they could get away with it by pooling these mortgages into Mortgaged Backed Securities or Collaterized Debt Obligations. These were sold off by investment banks like Merrill Lynch or Lehmen Brothers to investors who assumed the risk of default in exchange of a higher rate of return.

This blew the housing bubble even higher. As housing prices grew, there was no problem. Buyers of property could always sell off their property to pay off their mortgages. But as in all bubbles, it has to pop sometime.

Sub-prime mortgages started to go sour. The problem was that instead of flogging all these sub-primes to gullible investors, Citibank, Merrill Lynch, Lehmen Brothers kept much of them in their own books. I guess they believed in their own marketing hype. Since they were highly geared, they became insolvent. Unfortunately, the biggest buyer of sub-prime mortgages were Fannie Mae and Freddie Mac. That's where the politics come in.

Politics in democracies is mostly about competition between the winners and losers of society. Generally, there are two main parties. One fights for the winners and the other the losers. Both parties behave like business companies and their customers are the voters.

The party of the losers (in the case of the USA, the Democratic Party) tries to transfer income from the winners by taxing them and spending the money on their customers - the losers. The Republicans, try to win votes by cutting taxes and thereby helping their customers, the winners to keep their winnings.

So it came to no surprise that it was the Democrats who took the lead to help lower income groups to own property. After all, they were their number one customers. The first seed of the bubble was planted during the Carter administration when Congress passed the Community Reinvestment Act.

Prior to the Act, banks typically targetted lending money to folks from the better neighborhoods, a process called "redlining".

This Act lacked teeth till it was strengthened under the Clinton administration. What is does basically is to pressure banks to make loans to people they normally would not want to. It was to address the so-called problem of banks preferring to loan to people with higher incomes. Banks who wanted to expand or merge must have a good CRA rating. To achieve this, they must meet certain quotas that includes lending to the Party of Losers' preferred borrowers. For a while, Countrywide Financial was regarded as a role model. Of course, we all know what happened - it went bust and had to merge with another bank.

Next we have Freddie Mac and Fannie Mae which were set up by Congress to help Americans to buy homes - a noble idea. Under an implicit and now explicit guarantee by Congress these two giants were able to borrow money at lower rates than banks could which they then use to buy mortgaged backed securities thereby lowering mortgage costs. Trouble was that the two giants were permitted to have 50 times leverage instead of 10 times for banks. In other words, Freddie and Fannie could lend out $100 for every $2.5 in capital. The rest - $97.5 can be borrowed!

Another outrageous rule change during the Clinton administration was to allow Freddie and Fannie to buy sub-prime mortgages. This fueled the bubble even further. In 2005, Alan Greenspan warned Congress of the monster they have created. The Senate Banking Committee passed a Reform Bill to curb the activities of Freddie and Fannie. Senator McCain was one of the sponsors.

But Senators Obama, Clinton and Dodd and others protected Fannie and Freddie and killed the Reform bill. They of course knew that stopping the two monsters would be unpopular with their constituency - the losers and hurt their political careers. Of course, donations from Franklin Raines, ex-CEO of Fannie to Obama and Dodd may have something to do with it.

But don't blame them. Its all the fault of the system. If they did not behave like that they won't be elected. Someone else would and the same thing will happen. If this financial crisis teaches us something, it is that democracy needs to be reformed so that votrepreneurs don't need to behave irresponsibilly to get elected.

Democracy not working - essay by Fjordman

Currently, the democratic system is in my view not working properly in any Western country. It is more or less dead in Western Europe, where most of the real power has been transferred to the unelected organs of the European Union, anyway. Virtually all Western countries have lost control over their borders. This is not a sustainable situation. You can call your political system a democracy, a dictatorship, a republic, a monarchy or whatever you want, but a country that does not control its territory will eventually die. It's inevitable.The situation is made worse by the fact that globalization of transportation has put severe pressure on our nations in a manner which was unthinkable only a few decades ago. When the first Christian Gospels were written down at the end of the first century AD, the population of the Roman Empire was about 60 million people. This mirrors the annual global population growth in the early twenty-first century. In other words: The global population grows by another Roman Empire every single year. Our system wasn't designed for such numbers. It needs fundamental change, or it will soon collapse into civil wars or dictatorships or both. We also have a situation where some left-wing parties in particular deliberately import Muslims and others because they vote overwhelmingly for left-wing parties. A political system where it pays to import enemies obviously isn't sustainable.When I criticize democracy, this should not be taken as an indication that I believe in elitist rule. I criticize it because it clearly doesn't automatically ensure freedom of speech and security for life and property, which is the hallmark of true liberty. Another problem is that it isn't always the best system for long-term decisions because people tend to prefer short-term gains. I still believe, however, that there should be a powerful element of real public influence, to curtail the potential for absolute rulers and abuse of power. We have clearly veered too far in the direction of the latter with the EU, where the ruling elites have skillfully eliminated any constraints on their power.The democratic system has significant flaws, but it worked to some extent as long as there was sense of being a demos, a people with a shared identity and common interests. What we are witnessing now is the gradual breakdown of this demos, starting from the top down. Powerful groups frequently have more in common with the elites in other countries than they have with the average citizen in their own. If you no longer believe in your nation as a real entity with a specific culture, it simply becomes a tool for obtaining power, a stepping stone for your global career. Without a pre-political loyalty, emotional ties or even a pragmatic interest in supporting nation states, the democratic system becomes a vehicle for distributing favors to your friends at home and abroad, for fleecing the voters while in power and hopefully ensuring a lucrative international career along the way. You will have few moral inhibitions against importing voters from abroad for maintaining power or because your business buddies who give you financial support desire it. This process is related to technological globalization, but it has gone further in the self-loathing West than in any other civilization.Average citizens who still identify with their nation states thus keep electing people who betray their trust. Since the elites identify little with the nations they are supposed to serve, more power to them will only make matters worse, as it already has in Europe. Corrupt and incompetent individuals will always exist. If you get a corrupt leader every now and then you are dealing with a flawed individual. If you constantly, again and again, get corrupt leaders you are dealing with a flawed system. Our political system is now deeply flawed. The problem is that I cannot easily see how to fix it.The most important thing to realize is that democracy is a tool, a means we use to achieve an end. Too many people now confuse it with the end itself. "Democracy" has come to mean something that is good, something everybody wants, a bit like sex or chocolate. But there is no rational reason to assume that democracy of universal suffrage is uniformly good and can be applied with equal success in all circumstances, a huge mistake Americans made in Iraq.Any political system must first and foremost ensure the survival, the continued physical existence, of the community it serves. After that comes ensuring the prosperity and liberty of this community in the best possible way. However, when I look at the situation in Western countries today, I cannot see that democracy always ensures our liberty or prosperity, and in many cases it functions so poorly that it threatens our very survival. Perhaps in order to ensure our continued existence, we need to supplement democracy with other tools in our toolkit.

The year of the unknown votrepreneurs

Sarah Palin's selection as the Republican Vice Presidential candidate has shaken up the race. Currently polls shows a reversal of fortune as McCain surges ahead of Obama in the polls.

First the American voter turned to an unknown politician, Barack Obama in great enthusiasm and now they are turning again to another unknown politician, Sarah Palin, with equal entusiasm. What's going on here?

Americans are tired of the war in Iraq and worried about the economy. They want their country to take a new direction. Bush has low approval ratings at around 35%. Congress has even lower approval ratings at around 17%. This desire for change was shrewdly spotted by that brilliant votrepreneur, Barack Obama who embodies that possibility. He is black and talks well.

The fact that they don't know much about him allowed voters to fill him with their hopes which can never be fulfilled without blood, sweat and tears. It is very scary that someone as unaccomplished and inexperienced as Obama could be so close to getting power in the world's most powerful country. After all, he was Senator for only three years and part of that time was spent campaigning for the Presidency. Well, that's democracy for you.

Now McCain is also campaigning as an agent of change by picking Sarah Palin as his running mate. Calling himself a maverick, he is going to distance himself as far away from Bush and his Republican Party as possible. Making promises that can never be kept is the stock in trade for votrepreneurs.

Can either candidate make the changes they promised? I doubt it though once in a long while, someone comes along and actually does something. The problem is systemic. Its not the votrepreneurs' fault. They have to labor under the constraints that the system imposes.

I have long written about the flaws of democracy - the short term nature of the decision making, the difficulty in giving out necessary but bitter medicine etc - that I will not repeat myself here. But for meaningful change to come, the electorate must be pushed to the point where their backs are at the edge of the cliffs before they will respond to a Statesman's call for sacrifice instead of a votrepreneur's selling of more snake oil.

The American voter is not there yet.