Saturday, September 13, 2008


(Week 7 - Saturday, Sept. 13)

Over that last year, the reading and viewing public has been increasingly regaled with personal horror stories about vulnerable people being lured by shady mortgage brokers into signing contracts using deceptive practices and on falsified terms. Such contracts typically were loaded with questionable financial gimmicks such as "adjustable rate mortgages," "balloon payments" and "zero-principal mortgages," and had principal loan balances that were simply beyond the financial reach of the borrower.

It is becoming evident that the "sub-prime housing crisis" is only the tip of the proverbial iceberg. Now it appears that the nation's two largest mortgage finance companies, Fannie Mae and Freddie Mac, will need a massive injection of capital (some reports say as high as $300 billion dollars), or an outright takeover by the Federal government, to keep them in business.

So, what has gone wrong? The media is filled with finger-pointing and recrimination about how with the "sub-prime," and now the "prime," mortgage industries have been driven to the verge of collapse. There seems to be a growing consensus that the politically ballyhooed deregulation of the financial industry over the last three decades has allowed unscrupulous financial entrepreneurs to run amok, and that this is the prime cause of the crisis. If only, so the wistful thinking goes, there had been sound financial management in the industry this crisis would never have happened.

That unscrupulous financial entrepreneurs have run amok is beyond doubt, but does it follow that had more prudent financial stewardship been in place, then arriving at a point of crisis would have been avoided? Let us examine the question.

Suppose that the financial industry had not been deregulated and/or had been more conservatively managed. Then hundreds of thousands, if not millions, of these reckless loans would presumably not have been made. This also means, it should be noted, that many billions of dollars of new money would not have been created by the banking system, and loaned into circulation.

When a bank makes a loan for a mortgage, the new money this transaction generates goes from the pocket of the buyer, to that of the seller, and then continues to circulate as he spends it into the money supply. Over the last several decades, the mortgage market has been flogged by government policy and financial practice for all it is worth as an engine of new money generation for the economy. If there had not been all this bloated "prime" and "sub-prime" borrowing, hundreds of billions of dollars that are circulating in the economy right now would not exist. That means that much of the money in the typical person's wallet or bank account would not be there. With a greatly diminished monetary pool, there would be much less money in circulation to make payments on mortgages that had been contracted before the latest wave of borrowing, and less circulating to meet the needs of commerce.

This is a classic catch-22 situation. If we borrow more money from the banks, then we experience a bubble of prosperity, followed by a crisis of excessive "debt" when the payments come due. If we refrain from borrowing, then not enough money enters into circulation to meet old "debts," plus maintain an adequate money supply to do our business. For the last half-century we have chosen the path of rapidly increasing borrowing. The more frugal option, then, is the road not taken, and so we do not experience its effects. Nonetheless, there is a "debt" crisis at the end of either scenario.

The answer to the mortgage crisis is to stop borrowing our money supply at "interest" from a private banking system, and start issuing it publicly through the U.S. Treasury. This would take away the impetus to manipulate the housing market towards higher prices decade-after-decade as the primary engine for "debt"-money creation. Publicly-issued money is the path, I suggest, to a stable market with prices that are consistent with the actual physical cost and human effort required to build and maintain the housing we live in.

None of this is to say that the cavalier conduct of unscrupulous financial entrepreneurs is in any way justified, or that it has not greatly exacerbated the cost in personal suffering of the "debt" crisis. The reality, though, is that a "debt" crisis was sure to emerge, in one form or another, regardless of their conduct. Fiscal stewardship is an administrative problem, but the mortgage crisis is at root a consequence of faulty money creation.

Already in the newspapers I see proposed various schemes to fix the mortgage industry, virtually all of which involve borrowing ever more massive quantities of money to finance so-called "bailouts," and giving yet more control to the people and institutions that have presided over the present fiasco. This is the wrong answer.

Richard Kotlarz

The complete set of columns from this series is posted at the following websites: