Topic: Economic Policy
PRSST and Why Free Enterprise "Failed" the Loan Markets The reasons that the free enterprise system failed the loan markets are the same reasons we must transform the discussion of Social Security privatization with the PRSST.by Paul Benedict
(libertarian)
Monday, March 23, 2009
The reasons that the free enterprise system failed the loan markets are the same reasons we must transform the discussion of Social Security privatization with a plan to apply Social Security payroll deductions to each wage earner’s primary residences. (For a broad outline of this plan please see my previous article on the PRSST plan in "Ending Social Security by Applying Payroll Taxes to Primary Residences"). Technically, because in a free market, "trade, or exchange, is engaged in precisely because both parties benefit" a free market cannot fail, it can only adjust. However, social forces, at times, intervene to make apparently free markets less than truly free. This is what happened to the American mortgage market over the last decade. The forces at work that demanded loosening standards for the subprime mortgage industry flooded the real estate market with money and generated a cycle of fraud and exploitation. Perhaps the original intent behind these forces was to allow more American home ownership, but these forces became exploitive as they were easily twisted first into a booming mortgage loan industry (see subsection: "Subprime Mortgage Lending") and ultimately, as the bubble expanded, into a series of speculative "get rich quick" schemes. Many of these schemes were based on graphing the influx of "easy money" into the housing market against the chance of "flipping" the house for a profit before the balloon payments hit (or the balloon burst). However, lenders were playing the exotic loan game with "house money," so the Casino came down. Worse, people were playing with the rent money, so homes were foreclosed.
The lenders could not have brought down the Casino if many of the borrowers weren't also gambling; however, the majority of the biggest risks were taken by owners of primary residences. This is because the free market was only apparently free. The law is, basically, 'borrower beware.' If you can't make the payments, you lose your down payment, the history of payments you've made, the home, your credit rating, and, in some cases, anything else the lender can get his hands on. On the other hand, common sense ought to tell lenders that investing one's precious capital in loans likely to fail will wreck the Casino. Certainly, the greed of the lenders was based on betting that home prices would continue upwards. If housing prices followed their silly graphs, the lenders bet, the foreclosed assets wouldn't be toxic at all. To the lenders we'd love to say, "Ha, ha, don't call this fire department! You've gotten what you deserve!" Enter the Bush bailout... Well, that's another story.
The real reasons the free market "failed," though, did not include the unfettered greed the lenders turned loose by deregulation. Greed is always self-centered and blind; self-interest is not. A genuine free market does not depend on greed (despite Milton Friedman’s obvious joy in blurring the distinction between greed and self-interest to turn the tables on his host in an interview with Phil Donohue). Instead, a genuine free market is a check against greed. In a genuine free market, the selfish and blind are dragged kicking and screaming to the light. They receive understanding when no one will buy their stinking products at the exorbitant prices they demand. No, instead, in the lending crisis of the last decade, the free market was distorted because of two deeper and more universal enemies of all free markets: firstly, a human frailty (like having eyes that face only forward) herein dubbed "the haze of the now" distorted the borrowers' apprehension of the lenders product, and, secondly, the hopeless situation of many borrowers defused the energy to explode in anger at the corruptions of the market.
The "haze of the now" refers to the inability of humans to factor future costs into exchanges and purchases that exist in the moment. This is the same phenomenon that has allowed for Social Security to continue unchallenged by the general populace for decade after decade. This is the same phenomenon that has led to unchecked deficit spending since the Great Depression. Humans are able to understand exact values when the full price of an exchange is considered; however, when it comes to factoring in future costs, human nature is naturally frail. This inability to focus on the future repercussion of a momentary decision has fueled the quests of millennia of young people for military glory and has, likewise, enabled armies of usurers to profit beyond the dreams of avarice.
The second reason for the easy exploitation of borrowers by lenders was the desperation of the borrowers themselves. Not every borrower was speculative. Often borrowers were seeking first homes; however, even with both adults in a household working, the prices of new homes were impossible to manage. ARM loans and interest only loans were given to first time homeowners who had no other choice than to rent apartments or condominiums in neighborhoods with high crime rates and dubious schools. The desperation of these honest, first time borrowers was only exacerbated by the influx of "easy money" pouring into the real estate market. Subprime loans and exotic loans so increased the bidding on the average home, that real estate agents and sellers could get almost any price demanded.
If the borrowers had been neither desperate nor human, they would have laughed these greedy lenders and their preposterous terms to scorn. Instead, the free market was not truly free and a financial disaster beyond measure ensued. Regulation rarely leads to markets that are freer; however, a PRSST program, a Primary Residence Social Security Transformation program would regulate the free market by the application of individual freedom of choice. For example, "the haze of the now" is why PRSST must talk in terms of applying Social Security payroll taxes to primary residences. The length of the payoff for privatizing Social Security becomes short enough for the average human to grasp its benefits without trusting in calculators alone.
A Primary Residence Social Security Transformation plan (a PRSST) can demonstrate that if worker’s Social Security payroll taxes were applied to primary residences over the forty-five years that Social Security defines as the working life span, a worker could purchase a primary residence for his own household and a primary residence for each of two children. For instance, the power of the Social Security payroll tax applied to a traditional thirty year loan at current interest rates would allow home ownership for the median American household in little over a decade (see the details in "Ending Social Security by Applying Payroll Taxes to Primary Residences" linked above). The home owner could give that residence to a child and begin the process all over again. He could pay for the second home and give that residence to a second child and begin the process yet again. By retirement all three households would never need to pay rent or a house payment ever again. That is the amount of wealth generating potential that is confiscated by the government over the life of an American worker. This is the wealth generating power taken by force by the federal government before that government has delivered on any of its constitutional obligations. Are we outraged that the Union Card Check bill threatens to take our hard earned money for union dues without a secret ballot and, hence, without representation? How much more should we be outraged that 12.4% of our wealth is confiscated by the government based on votes made over sixty years ago? Not one of those being thus taxed today has even had the issue of ending Social Security even broached! Why do Americans take this year after year? No, not only because they have a genuine compassion for those who are owed Social Security benefits, but also because "the haze of the now" blinds us to the real nature of the tyranny of Social Security.
A PRSST model need not endorse allowing beneficiaries to give their primary residence to their offspring, for that would result in a default on the government's obligation to those nearing the retirement age and to those who have retired. However, a PRSST shortens the time span that is part of the Social Security transformation by a significant amount. This will lead, naturally, to a better free market appraisal of the situation by voters. The results would be a significant change in voter attitude.
Just as a PRSST discussion cuts through the haze of the now so that voters can understand the need for change we can believe in, the hopeless situation of home mortgage borrowers would, ultimately, be much remedied by a PRSST passed into law. As argued in a previous article, "Dave Ramsey, Cato Institute's 6.2% Plan, and Transforming Social Security," paying off debt, including home mortgages is the foundation for retirement. Hence, whenever possible, home ownership, not private investment accounts, should be the first step in privatizing social security. The benefit to home owners over the course of a decade would so greatly reduce wage earners dependency on the banking system that bank regulation would simply be redundant. Lenders would need to present themselves as much more reputable and much more realistic or their offers of "easy money" would be indeed be laughed to scorn.
Lastly, if previous experience is of any value in judging the economic future of the United States, a PRSST is needed now as a hedge against the devaluation of the American dollar, run away inflation, higher interest rates, AND greatly increased levels of unemployment. The devaluation of American currency can easily result in higher interest rates on federal bonds in order to service the national debt. The increased inflation will result in home prices that will be even more difficult for future generations to afford, and the Obama tax hikes on the greedy rich will result in increasing unemployment. A PRSST will allow lower relative wages to have greater purchasing power and this decreased dependency on banks will keep interest rates more reasonable. However, until such a time as a PRSST would have sufficient time to take effect, regulations would be essential. Certainly, the temptation of the mortgage industry will be to raise interest rates and to front load (paragraph 2) their loans more than ever. PRSST will not work at interest rates that exceed 8%. No PRSST loans should be given as jumbo loans, and no PRSST loans should be permitted with less that 3% down on the home. PRSST loans should not be ARMs nor any of the other nonconforming, financial instruments that are based on housing market speculation.
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