tag:www.invisibleheart.com,2011://1 2011-02-07T14:40:58Z Movable Type 3.34 tag:www.invisibleheart.com,2011://1.102 2011-02-07T14:38:36Z 2011-02-07T14:40:58Z

This article originally appeared in the Wall Street Journal on June 28, 2010. He was born in the 19th century, wrote his most influential book more than 65 years ago, and he's not quite as well known or beloved as...

Russ Roberts in the Wall Street Journal on June 28, 2010. He was born in the 19th century, wrote his most influential book more than 65 years ago, and he's not quite as well known or beloved as the sexy Mexican actress who shares his last name. Yet somehow, Friedrich Hayek is on the rise. When Glenn Beck recently explored Hayek's classic, "The Road to Serfdom," on his TV show, the book went to No. 1 on Amazon and remains in the top 10. Hayek's persona co-starred with his old sparring partner John Maynard Keynes in a rap video "Fear the Boom and Bust" that has been viewed over 1.4 million times on YouTube and subtitled in 10 languages. Why the sudden interest in the ideas of a Vienna-born, Nobel Prize-winning economist largely forgotten by mainstream economists?]]> Hayek is not the only dead economist to have garnered new attention. Most of the living ones lost credibility when the Great Recession ended the much-hyped Great Moderation. And fears of another Great Depression caused a natural look to the past. When Federal Reserve Chairman Ben Bernanke zealously expanded the Fed's balance sheet, he was surely remembering Milton Friedman's indictment of the Fed's inaction in the 1930s. On the fiscal side, Keynes was also suddenly in vogue again. The stimulus package was passed with much talk of Keynesian multipliers and boosting aggregate demand. But now that the stimulus has barely dented the unemployment rate, and with government spending and deficits soaring, it's natural to turn to Hayek. He championed four important ideas worth thinking about in these troubled times. First, he and fellow Austrian School economists such as Ludwig Von Mises argued that the economy is more complicated than the simple Keynesian story. Boosting aggregate demand by keeping school teachers employed will do little to help the construction workers and manufacturing workers who have borne the brunt of the current downturn. If those school teachers aren't buying more houses, construction workers are still going to take a while to find work. Keynesians like to claim that even digging holes and filling them is better than doing nothing because it gets money into the economy. But the main effect can be to raise the wages of ditch-diggers with limited effects outside that sector. Second, Hayek highlighted the Fed's role in the business cycle. Former Fed Chairman Alan Greenspan's artificially low rates of 2002-2004 played a crucial role in inflating the housing bubble and distorting other investment decisions. Current monetary policy postpones the adjustments needed to heal the housing market. Third, as Hayek contended in "The Road to Serfdom," political freedom and economic freedom are inextricably intertwined. In a centrally planned economy, the state inevitably infringes on what we do, what we enjoy, and where we live. When the state has the final say on the economy, the political opposition needs the permission of the state to act, speak and write. Economic control becomes political control. Even when the state tries to steer only part of the economy in the name of the "public good," the power of the state corrupts those who wield that power. Hayek pointed out that powerful bureaucracies don't attract angels—they attract people who enjoy running the lives of others. They tend to take care of their friends before taking care of others. And they find increasing that power attractive. Crony capitalism shouldn't be confused with the real thing. The fourth timely idea of Hayek's is that order can emerge not just from the top down but from the bottom up. The American people are suffering from top-down fatigue. President Obama has expanded federal control of health care. He'd like to do the same with the energy market. Through Fannie and Freddie, the government is running the mortgage market. It now also owns shares in flagship American companies. The president flouts the rule of law by extracting promises from BP rather than letting the courts do their job. By increasing the size of government, he has left fewer resources for the rest of us to direct through our own decisions. Hayek understood that the opposite of top-down collectivism was not selfishness and egotism. A free modern society is all about cooperation. We join with others to produce the goods and services we enjoy, all without top-down direction. The same is true in every sphere of activity that makes life meaningful—when we sing and when we dance, when we play and when we pray. Leaving us free to join with others as we see fit—in our work and in our play—is the road to true and lasting prosperity. Hayek gave us that map. Despite the caricatures of his critics, Hayek never said that totalitarianism was the inevitable result of expanding government's role in the economy. He simply warned us of the possibility and the costs of heading in that direction. We should heed his warning. I don't know if we're on the road to serfdom, but wherever we're headed, Hayek would certainly counsel us to turn around. tag:www.invisibleheart.com,2010://1.101 2010-02-27T17:42:21Z 2010-03-05T17:57:56Z

This article originally appeared in the Wall Street Journal on February 26, 2010 For an economist, these are the best of times and the worst of times. We live in the best of times because everyone wants to understand what...

Russ Roberts This article originally appeared in the Wall Street Journal on February 26, 2010 For an economist, these are the best of times and the worst of times. We live in the best of times because everyone wants to understand what happened to the economy and what's going to happen next. Is the mess we're in a market failure or a government failure? Is the stimulus plan working? Would tax cuts for small business spur employment? When will the job market improve? Is inflation coming? Do deficits matter? So many questions and so little in the way of answers. And so it is the worst of times for economists. There is no consensus on the cause of the crisis or the best way forward. There were Nobel Laureates who thought the original stimulus package should have been twice as big. And there are those who blame it for keeping unemployment high. Some economists warn of hyperinflation while others tell us not to worry. It makes you wonder why people call it the Nobel Prize in Economic Science. After all, most sciences make progress. Nobody in medicine wants to bring back lead goblets. Sir Isaac Newton understood a lot about gravity. But Albert Einstein taught us more.]]> But in economics, theories that were once discredited surge back into favor. John Maynard Keynes and the view that government spending can create prosperity seem immortal. I thought stagflation had put a stake in the heart of this idea back in the 1970s. Suddenly, he's a genius once again. F.A. Hayek, Keynes's more laissez-faire sparring partner, is drawing interest. There are various monetarists to choose from, too. Which paradigm is the "right" way to think about the boom and the bust? Or are they all wrong? I once thought econometrics—the application of statistics to economic questions—would settle these disputes and the truth would out. Econometrics is often used to measure the independent impact of one variable holding the rest of the relevant factors constant. But I've come to believe there are too many factors we don't have data on, too many connections between the variables we don't understand and can't model or identify. I've started asking economists if they can name a study that applied sophisticated econometrics to a controversial policy issue where the study was so well done that one side's proponents had to admit they were wrong. I don't know of any. One economist told me that in general my point was well taken, but that his own work (of course!) had been decisive in settling a particular dispute. Perhaps what we're really doing is confirming our biases. Ed Leamer, a professor of economics at UCLA, calls it "faith-based" econometrics. When the debate is over $2 trillion in additional government spending vs. zero, we've stopped being scientists and become philosophers. Do we want to be more like France with a bigger role for government, or less like France? Facts and evidence still matter. And economists have learned some things that have stood the test of time and that we almost all agree on—the general connection between the money supply and inflation, for example. But the arsenal of the modern econometrician is vastly overrated as a diviner of truth. Nearly all economists accept the fundamental principles of microeconomics—that incentives matter, that trade creates prosperity—even if we disagree on the implications for public policy. But the business cycle and the ability to steer the economy out of recession may be beyond us. The defenders of modern macroeconomics argue that if we just study the economy long enough, we'll soon be able to model it accurately and design better policy. Soon. That reminds me of the permanent sign in the bar: Free Beer Tomorrow. We should face the evidence that we are no better today at predicting tomorrow than we were yesterday. Eighty years after the Great Depression we still argue about what caused it and why it ended. If economics is a science, it is more like biology than physics. Biologists try to understand the relationships in a complex system. That's hard enough. But they can't tell you what will happen with any precision to the population of a particular species of frog if rainfall goes up this year in a particular rain forest. They might not even be able to count the number of frogs right now with any exactness. We have the same problems in economics. The economy is a complex system, our data are imperfect and our models inevitably fail to account for all the interactions. The bottom line is that we should expect less of economists. Economics is a powerful tool, a lens for organizing one's thinking about the complexity of the world around us. That should be enough. We should be honest about what we know, what we don't know and what we may never know. Admitting that publicly is the first step toward respectability. tag:www.invisibleheart.com,2010://1.100 2009-12-10T22:50:38Z 2010-02-17T23:01:13Z

This is the text of my testimony before the Joint Economic Commitee on December 10, 2009. It differs from the text in the Congressional Record that was submitted in advance. This is the actual text I delivered. Video of my...

Russ Roberts This is the text of my testimony before the Joint Economic Commitee on December 10, 2009. It differs from the text in the Congressional Record that was submitted in advance. This is the actual text I delivered. Video of my testimony (along with Joseph Stiglitz's testimony, opening statements by the committee members, and the Q and A) is available here. My testimony starts at 58:15. A man once asked his doctor how much weight he’d lose if he skipped his daily breakfast of a bagel with butter, about 350 calories. The doctor said if you can do that every day for a month, you’ll lose three pounds. After ten days of skipping breakfast, the man came in to see how he was doing. To the doctor’s surprise, the man’s weight was unchanged. The doctor said good thing you stopped eating breakfast. Otherwise you’d have gained a pound. When I made my prediction, I didn’t realize how bad your situation was. Unfortunately, the doctor’s analysis was flawed. He didn’t realize the man was eating a bigger lunch because he was hungry after skipping breakfast. I think about that doctor when I think about the CBO estimates of the impact of the American Recovery and Reinvestment Act of 2009, the stimulus package. The CBO estimates that there are between 600,000 and 1.6 million extra jobs in the economy compared to what would have happened in the absence of the stimulus. That’s an embarrassingly imprecise estimate. But it’s not really an estimate at all. It’s just a repeat of the forecast that the CBO made at the beginning of the process, like the doctor who predicts that skipping breakfast reduces your weight. We have no idea of how many jobs have been created or lost because of the stimulus. As the CBO admits, to know the real impact of the stimulus, we’d have to know the path of the economy in the absence of the stimulus. And that is unknown to the CBO just as the lunch habits and metabolism of the patient might be unknown to the doctor. What we do know is that since March, the economy has lost another 2.7 million jobs. When the stimulus was passed, we were told that without it, unemployment would reach 8.8%. Well, with the stimulus, unemployment went over 10%. ]]> There is no reliable way of knowing whether the stimulus has averted a worse situation or whether it’s part of the problem. There’s no consensus in the economics profession on this question and no empirical evidence to settle the dispute. But it wouldn’t be surprising to discover the stimulus has had little or no effect, or even made things worse. Of the $235 billion spent to date, more than a third of that has been a temporary tax rebate. Just as with the Bush Administration tax rebates in February 2008, most of the money was saved rather than spent and had little impact. The direct spending component has been $145 billion. Of that $145 billion, the four government agencies receiving the most money—the Departments of Health and Human Services, Department of Labor, Department of Education, and the Social Security Administration, account for over 80% of the spending. Those agencies don’t have many shovels. The money has gone to increase funding for Alzheimer’s research, to bolster the tax revenues of states so that teachers can continue to be paid, to digitize medical records and to continue paying unemployment benefits. Some of the money went to give raises to workers. Pleasant for them, but not so helpful for job creation. Roughly one half of the job losses since December of 2007 are in construction and manufacturing. A better understanding of Alzheimers and more efficient medical record-keeping are good things. But they do little or nothing for the bulk of the workers looking for work. Some argue that it doesn’t matter what we spend the money on. People will spend the money they receive which creates jobs and puts more money into people’s hands and so on. Ironically, this Keynesian story works best when the economy is healthy. But consumer spending is down because people are rightfully worried about the future. When people are scared, they’re going to save more and spend less compared to when they are optimistic about the future. So fiscal policy that counts on the multiplier doesn’t work any better than monetary policy in that famous liquidity trap. This is particularly true of temporary increases in income. So both fiscal and monetary policy are constrained by the anxiety people have about the future. Unfortunately, policy makers have been doing a lot to create anxiety rather than dispel it. The deficit last year was $1.4 trillion. People know that tax increases are coming but they do not know how big their share will be. The prospect of tax increases discourages spending and offsets some or all of the stimulus. The size of the debt is creating worries about default or inflation. The government continues to intervene in ad hoc ways in the auto industry and the financial sector. Major changes are on the table for how the government regulates health care and energy. We need new businesses to start and old businesses to expand. But if their owners can’t be sure of what the rules of the game are going to be—the tax rates they might face, the interest rates they might face, the inflation rate they might face, the health care mandates they might face, the emissions regulations they might face—then it’s not surprising that business are likely to sit on the sidelines to see how things will turn out. In a recent survey of employers released this week by Manpower, Inc., 73% said they plan no change in staffing for the first quarter of 2010. That is the highest level of “no change” since 1962. Employers are sitting on the sidelines waiting to see what the rules of the game are going to be. So what is to be done? Most people presume that there is something that can be done, something to get people back to work faster. That may not be possible. Government policy induced an unnatural expansion of the housing sector. We built way too many houses. That naturally drew a lot of people into construction. Fully 25% of the job losses have been in construction. The workers who no longer hold those jobs need to find other things to do. They will want to take time deciding what they should do instead. Unfortunately, it is natural that unemployment lingers. If you must do something, look for effective ways to spend money and reduce policy uncertainty. Stop giving away money to states with no strings attached. Why has a major goal of policy so far been to preserve state employment while the private sector takes a beating? Let the states deal with their past recklessness by cutting spending. Don’t treat any unspent TARP funds as free money. It isn’t. Don’t waste it the way the stimulus money was wasted. Instead of spending randomly, cut the payroll tax. Cutting the payroll tax makes workers less expensive, at least in the short run. Cut it by 25% for the next five years. That will reduce revenue by about $250 billion per year, but at least it has a chance to create jobs. To reduce uncertainty and fear, stop fiddling with every aspect of the economy. Maybe this is not the best time to be trying to radically change the health care system and the energy market while propping up banks and the auto industry and borrowing trillions of dollars. • Stop issuing short-term debt. That’s what got Wall Street in trouble. The government rescued Wall Street. There is no one to rescue us. • Reduce some aspect of government spending to show that the grown-ups are in charge. Get rid of corporate welfare. Cut tariffs and quotas which are a silent tax on the consumer. • Stop propping up losers. Let people who were reckless go out of business. Otherwise, we are throwing good money after bad and setting the stage for future recklessness. F. A. Hayek said that “the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” It would be good to recognize our limits about what we imagine we can design. We cannot steer the economy. Or the labor market. Recognizing our limitations is a step in the right direction. tag:www.invisibleheart.com,2009://1.99 2009-11-25T20:44:50Z 2009-11-25T20:48:12Z

What follows is my testimony before the House Committee on Oversight and Government Reform, delivered October 28, 2009. The topic was executive compensation and the Special Master for TARP Compensation, Kenneth Feinberg, who was determining compensation at the firms who...

Russ Roberts What follows is my testimony before the House Committee on Oversight and Government Reform, delivered October 28, 2009. The topic was executive compensation and the Special Master for TARP Compensation, Kenneth Feinberg, who was determining compensation at the firms who had not repaid their TARP funds. Chairman Towns, Ranking Member Issa, and Distinguished Members of the Committee: Americans are angry about executive compensation. Rightfully so. The executives at General Motors and Chrysler don’t deserve to make a lot of money. They made bad products that people didn’t want to buy. The executives on Wall Street don’t deserve to make a lot of money. They were reckless. They borrowed huge sums to make bets that didn’t pay off. And they wasted trillions of dollars of precious capital, funneling it into housing instead of health innovation or high mileage cars or a thousand investments more productive than more and bigger houses. Everyday folks who are out of work through no fault of their own want to know why people who made bad decisions not only have a job but a big salary to go with it. No wonder they’re angry at Wall Street, But if we keep getting angry at Wall Street, we’ll miss the real source of the problem. It’s right here. In Washington. We are what we do. Not what we wish to be. Not what we say we are. But what we do. And what we do here in Washington is rescue big companies and rich people from the consequences of their mistakes. When mistakes don’t cost you anything, you do more of them. When your teenager drives drunk and wrecks the car, and you keep give him a do-over—repairing the car and handing him back the keys—he’s going to keep driving drunk. Washington keeps giving bad banks and Wall Street firms a do-over. Here are the keys. Keep driving. The story always ends with a crash. Capitalism is a profit and loss system. The profits encourage risk-taking. The losses encourage prudence. Is it a surprise that when the government takes the losses, instead of the investors, that investing gets less prudent? If you always bail out lenders, is it surprising that firms can borrow enormous amounts of money living on the edge of insolvency? I’m mad at Wall Street. But I’m a lot madder at the people who gave them the keys to drive our economy off a cliff. I’m mad at the people who have taken hundreds of billions of taxpayer money and given it to some of the richest people in human history. I’m mad at President Bush and President Obama and Secretary Paulson and Secretary Geithner and Chairman Bernanake. And I’m mad at Congress. You helped risk-takers continue to expect that the rules that apply to the rest of us don’t apply to people with the right connections. You have saved the system, but it’s not a system worth saving. It’s not capitalism but crony capitalism. Using a Special Master for Compensation to get our money back is too little, too late. Many people argue that because the government handed out the money, the government has a right to dictate how it is spent. It’s a reasonable thought in personal relations. If I offer you money, I have a right to attach strings to my generosity. But in a constitutional democracy like ours, it is not the government that has rights. We, the people, have rights. The Constitution exists to restrain government, not to empower it. Whether government has the right to limit pay isn’t the question. The question is whether it’s a good idea for the government to have the power to set compensation. Despite our anger, the answer is no. F. A. Hayek, the Nobel Laureate economist, said: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” The Special Master imagines he can design compensation packages that “align incentives” while “retaining key talent.” But it is impossible for any one person—no matter how wise—to anticipate the consequences of such decisions. Certainly the Special Master does not possess that knowledge. The Special Master doesn’t even know who is key and who is not. Some of that talent should leave and some of those firms need to disappear. But he does not know enough to decide correctly. Nor does he have any incentive to acquire that knowledge. He has no skin in the game. A single individual has been given enormous arbitrary power with insufficient accountability or transparency. This is not good for the rule of law, democracy or capitalism. By focusing on those who owe the government TARP money, the Special Master distracts us from other firms that benefited from government rescue such as Goldman Sachs and JP Morgan Chase. The comfort we receive from seeing compensation reduced distracts us from the policies that created the problem in the first place—the rescue of Wall Street from its own recklessness. It is a charade of political window dressing to make crony capitalism look respectable. I want my country back. Let’s get the government out of the auto business, out of the banking business and out of the compensation design business. We need explicit timetables to disengage from government ownership including a plan for how the Federal Reserve will draw down its balance sheet. Most of all, we need to stop trying to imagine we can design housing markets and mortgage markets and financial markets and compensation. I want my country back. I want a country where responsibility still means something. Where rich and poor, Main Street and Wall Street live by the same rules. We don’t need a Special Master to level the playing field. We just need to take the crony out of crony capitalism so we can get back to the real thing. ]]> tag:www.invisibleheart.com,2009://1.98 2009-11-24T05:49:13Z 2009-11-24T05:54:36Z

Here is my take on financial reform from the latest issue of The Economists' Voice. Download file...

Russ Roberts Download file ]]> tag:www.invisibleheart.com,2009://1.97 2009-08-25T14:57:09Z 2009-11-17T15:20:23Z

(This piece appeared on NPR.org on 8/25/09) President Obama has reappointed Federal Reserve Chairman Ben Bernanke, praising his creativity in preventing another Great Depression. Talk about damning with faint praise. It's true that we appear to have avoided the worst-case...

Russ Roberts on NPR.org on 8/25/09) President Obama has reappointed Federal Reserve Chairman Ben Bernanke, praising his creativity in preventing another Great Depression. Talk about damning with faint praise. It's true that we appear to have avoided the worst-case scenarios of the last year, but at what price? Back in March of 2008, Bernanke and Treasury Secretary Henry Paulson engineered a rescue of Bear Stearns. A single suitor, JP Morgan Chase, was chosen to receive a sweetheart deal in the name of avoiding a credit freeze. The freeze came anyway. The Bear Stearns rescue was the beginning of an unprecedented expansion of power in the hands of the Fed and the Treasury with a level of opaque decision-making that is not appropriate for a democracy. Even today we have heard little justification for the expansion of the Fed's power and the Fed's balance sheet. Yes, we have avoided a depression. But let us count the costs. Financial firms that made irresponsible and imprudent decisions have been rescued, propped up and bailed out. AIG has received about $180 billion. That is almost $2,000 for every American household. That money has gone to sustain the bonuses of AIG and the financial health of its counterparties, such as Goldman Sachs. This is an obscene travesty. The Fed currently holds $600 billion worth of Fannie, Freddie and Ginnie mortgage-backed securities. I am not optimistic about how that will turn out. The Fed has injected hundreds of billions of reserves into member banks. This will fuel future inflation unless Bernanke is willing to raise interest rates when the recovery begins. There will be tremendous political pressure on him not to do so. So inflation is likely to come along with any recovery. Worst of all, Bernanke, Paulson and Timothy Geithner have continued the disastrous policy of sustaining bondholders and creditors of reckless financial institutions. Capitalism is a profit-and-loss system. The profits encourage risk-taking. The losses encourage prudence. The bondholders and creditors are the single most important check on imprudence. They care only about one thing: solvency. By making them whole, their incentive to restrain recklessness has been greatly weakened. This sows the seeds of the next financial crisis. I feel sorry for Bernanke. In one sense, as the world's greatest living authority on the Great Depression, he is the best man for the job. But because he is the world's greatest living authority on the Great Depression, another catastrophic economic debacle of a similar magnitude would be particularly embarrassing were it to occur on his watch. I believe he has gone too far in the other direction. The Great Depression was caused, or at least greatly worsened, by too little liquidity. Bernanke has avoided that mistake. He has instead committed the opposite mistake of too much liquidity and too few failures. Obama has praised him. How history judges him will be the real test.]]> tag:www.invisibleheart.com,2009://1.96 2009-03-02T22:52:28Z 2009-03-02T22:54:20Z

(This piece appeared on NPR.org on 2/25/09) In his first address to a joint session of Congress, President Obama pledged to cut the federal budget deficit in half in four years. Keeping that pledge won't be easy. The Congressional Budget...

Russ Roberts on NPR.org on 2/25/09) In his first address to a joint session of Congress, President Obama pledged to cut the federal budget deficit in half in four years. Keeping that pledge won't be easy. The Congressional Budget Office is forecasting a deficit for this year of $1.2 trillion. That forecast does not include the spending package Congress just passed and Obama signed that will add hundreds of billions of dollars to the deficit over the next four years. And that doesn't include unforeseen spending increases in further bailouts for Fannie and Freddie or AIG or Bank of America or GM or the state of California or whoever else shows up in Washington with a hand out. So Obama probably needs to cut spending or raise taxes by at least $700 billion a year. To give you an idea of how much money that is, that's about the amount the payroll tax currently collects. The payroll tax is about 15 percent, shared between employer and employee. Doubling that rate to 30 percent would add an extra $700 billion if — and it's an impossible if — if a tax rate of 30 percent didn't lead employers to reduce their number of employees or force workers to reduce their hours.]]> Besides, Obama also promised Tuesday night that 98 percent of American families, those earning less than $250,000, would not pay an extra dime in taxes. So to cut the deficit in half, he needs to raise taxes on the richest Americans and look for spending cuts. He claims to have found $200 billion per year in spending we can do without. Assuming those spending cuts actually materialize, that still leaves $500 billion in higher taxes for the richest Americans. In 2006, the latest year we have data for, the top 2 percent of tax returns yielded around $500 billion in revenue. So to cut the deficit in half, Obama will have to roughly double the tax rates on the top 2 percent. I don't think that strategy will be politically viable or economically productive. What I think will happen instead, is that he will simply settle for running larger deficits for a while, continuing to borrow money from our fellow citizens and from foreigners, and hoping that the interest rates we offer on those loans don't start to rise because people start to realize that no asset, even treasuries, is risk-free. The cheery scenario is the economy grows like gangbusters and tax revenues surge without increases in rates. Could happen, but I am not optimistic. Too many unknowns lie ahead. Every president who inherits a deficit promises to cut it somewhere down the road. Only one president in recent years has kept that promise — Bill Clinton. But he was helped by six years of Republicans in the House and Senate. When the White House and the Congress are from the same party, it's very hard to say no to key constituencies that expect rewards for past support. If Obama is really serious about cutting the deficit down the road, he will almost certainly have to fight with his own party. Russell Roberts is an economics professor at George Mason University, a distinguished scholar in the Mercatus Center and a research fellow at Stanford University's Hoover Institution. He is the host of the weekly podcast, EconTalk. His latest book is The Price of Everything: A Parable of Possibility and Prosperity. tag:www.invisibleheart.com,2009://1.95 2009-03-02T22:48:28Z 2009-03-02T22:51:17Z

(This piece appeared on the Boston Globe website on 2/2/09) The House has passed an $819 billion spending package. Soon the Senate will vote. Will government spending get the economy going or slow it down? How long will it take...

Russ Roberts on the Boston Globe website on 2/2/09) The House has passed an $819 billion spending package. Soon the Senate will vote. Will government spending get the economy going or slow it down? How long will it take to have an impact? How many jobs will it create? Can we afford it? You would think economists could answer these questions. Since at least the Great Depression, economists have theorized about what causes the economy to slow down or speed up. We've theorized about unemployment and inflation and whether they're connected. We've theorized about monetary policy, tax policy, and the role of government spending. And economists have tried to find evidence to settle these fundamental questions. And yet there is little or no consensus for what we should do right now to get the economy going and prevent it from getting worse. I wish it were otherwise. People expect us to know the answers. And plenty of economists claim to have the answers. Yet some of the finest economists in the country, including Nobel laureates, are on opposite sides of the current debate. And each side can cherry-pick data or historical anecdotes in support of its position. I think the real divide between economists isn't over different macroeconomic theories but over underlying differences in philosophy and ideology. So where does that leave you, the curious, intelligent, non-economist citizen?]]> You could try to master the empirical evidence of each side. Perhaps one side is more persuasive than the other. Let me suggest a simpler strategy that gets at the underlying philosophic disagreement that I suspect is the heart of the matter. Consider two different government programs for stimulating the economy. The first program borrows $819 billion and hires and pays groups of workers $819 billion to dig a bunch of holes and then fill them in. The second program spends $819 billion to repair a bunch of bridges on the verge of collapse, repair a bunch of sewers about to go bad, and revolutionize the energy and health sectors. I think most economists would argue that the first program would be a bad use of federal money at a time when we're already running a growing budget deficit. Yes, it would put money in the hands of workers but the effect on the non-hole-digging part of the economy would be insufficient to justify increasing the future taxes necessary to repay the borrowing that financed the program. Most economists would also agree that the second program would be a bargain that would yield benefits well beyond the money put in the hands of those executing the project. I think the disagreement among economists is really over which of these two scenarios is closest to reality. The federal budget is about $3 trillion. Is the next $500 billion or so money well spent or money squandered? I think it will be mostly squandered, so I'm against the stimulus. Plenty of people think it would be money well spent. Many people want a role for government closer to that of Europe's. Most of us against increased government spending want to move in the other direction. There is an underlying presumption in this debate that if the spending package doesn't stimulate the economy, then tax cuts or monetary policy are better. But maybe we simply don't have the knowledge to repair the economy from Washington. The economy is complex and the interaction between the financial sector and the real economy - between Wall Street and Main Street - is not well understood. Rather than spending money we don't have, I wish Obama would use his political capital to change the parts of our political system that are dysfunctional - our entitlement programs that are demographically bankrupt, our broken budget system, our Byzantine tax system, our financial system that is in disarray. These changes would be more likely to create the confidence and trust in the future that our economy needs to get healthy again rather than borrowing and spending. Borrowing and spending is how we got into this mess. Let's look in a different direction. Russell Roberts is professor of economics at George Mason University and a research fellow at Stanford's Hoover Institution. He is the host of the weekly podcast EconTalk. tag:www.invisibleheart.com,2009://1.94 2009-03-02T22:24:41Z 2009-03-02T22:47:29Z

(This piece appeared on Forbes.com on 1/23/09) President Obama is eager to attack the economic crisis. Here is the speech I'd like to hear from him. My fellow Americans, these are fearful times. Through a set of public and private...

Russ Roberts on Forbes.com on 1/23/09) President Obama is eager to attack the economic crisis. Here is the speech I'd like to hear from him. My fellow Americans, these are fearful times. Through a set of public and private mistakes, our financial system is in disarray. The problems of Wall Street have spread to Main Street. Unemployment is on the rise. Key sectors of our economy face unparalleled challenges. The auto industry is reeling. Housing and construction are in deep trouble. The financial sector has been hit with bankruptcy and layoffs. The retail sector is struggling. Workers, investors, managers and entrepreneurs face a fog of doubt and uncertainty. When will the economy rebound? Will I lose my job? Will my products sell as they once did and at what price? Investors and employers, consumers and entrepreneurs are sitting on the sidelines. Such caution is understandable. Until people are confident of the future, our economy is going to struggle. What can the federal government do to unleash the forces of recovery? Many are urging a massive increase in government spending coupled with tax rebates as a way to jump start the economy. But the economy is not stagnant because of a lack of spending. The economy is stagnant because of a lack of confidence in the future. Government spending on bridges, roads and new schools will stimulate the construction industry. But without confidence, the benefits will not spread to the rest of the economy. ]]> The argument for a massive spending increase presumes that spending is the source of our prosperity. But it is the combination of prudent spending and prudent investment that creates prosperity. I would like to guarantee that we in Washington would spend an additional trillion dollars or so wisely. I would like to guarantee that such spending would be free of pork and the influence of the powerful. But those guarantees would be empty promises. As a former senator, I know the temptations of power and influence that are unleashed when a trillion dollars are slopping around in the government trough. And would a trillion-dollar increase in the federal budget deficit enhance investor or consumer confidence? What costs will a spending increase of that magnitude impose on not just future generations but on this generation next year and the year after? Trillions of dollars of annual red ink puts at risk the government's ability to keep its promises. That will discourage private investment and private spending, imperiling any recovery that might take place based on private initiative. Finally, adding a trillion dollars to an already bloated federal budget is another sign that we in Washington are irresponsible and unable to live within our means. It is that failure of will and discipline that helped create the current situation--a belief that we could have cheap credit and ever-expanding home ownership without any consequences. A massive increase in spending on hurried projects of uncertain value, financed by borrowing, is a promise to raise taxes in the future and to squander resources in the meanwhile. That is not the road to recovery. That is not the road to prosperity. What is needed instead is a set of steps to stimulate the productive side of our economy. A tax rebate of either the payroll tax or the income does not stimulate investment. There is no evidence that rebates even stimulate spending. Rebates do not change the incentives of consumers to spend or savers to invest. Past rebates have consistently failed to encourage economic activity. Instead, I'm proposing today a radical re-imagining of our tax system. I am recommending the elimination of the payroll tax. The payroll tax is a regressive tax that falls harshly on the poor. And it is deceptive, an unacceptable characteristic of a tax in a democracy. Half of the payroll tax appears to be paid by employers. In fact, studies of the payroll tax show that the employer merely lowers worker compensation in response to the tax burden. So workers pay virtually the entire 15%. Worse, the payroll tax gives the illusion that taxes are "contributions" toward future social security payments. In fact, the payroll tax is used to finance current recipients of Social Security and Medicare along with other government spending such as the war on Iraq and welfare for wealth farmers. This fools workers into thinking such programs are cheaper than they actually are. This artificially encourages the demand for such programs. Unlike a temporary rebate of payroll taxes, eliminating the payroll tax will change incentives facing firms and workers. The result will be job creation and increased worker compensation. The permanence of the change raises the effectiveness of that encouragement, again in contrast to a temporary rebate. But eliminating the payroll tax without reforming the budget and entitlement programs would be irresponsible and would rob the tax cut of much of its kick. The payroll tax currently generates about $700 billion. We will pay for that reduction with three other changes: --Eliminating all corporate welfare. Corporate welfare rewards those corporations that excel at lobbying rather than serving their customers. Eliminating it will save $100 billion annually. --Implementing spending reductions in all departments of 10%, saving over $250 billion. Such cuts in a federal budget heading toward $3 trillion are hardly draconian. They merely return spending to the level of a year or two ago. --Making small across-the-board increases in the income tax rate, yielding $350 billion. The poorest workers will in fact see a significant improvement in their after-tax income because the elimination of the payroll tax will overwhelm the increase in income taxes. The richest Americans will see a slightly larger increase because their payroll tax contributions are currently capped. At the same time, I will appoint two bipartisan commissions to reform the budget process itself and the Social Security and Medicare programs. The budget process is out of control. Signaling to the private sector that the public sector will live within its means and avoid the erratic behavior of the past year will go a long way toward rejuvenating the economy. So will reform of Social Security and Medicare. Social Security and Medicare are not viable in their current form given our demographics. For 70 years we have pretended that they are insurance programs. In fact, they are welfare programs that also help the rich in the name of generating support for the system. It is absurd for wealthy Americans to be part of a retirement and health system when they have the wherewithal to take care of themselves without government help. The system isn't financially bankrupt--yet. But it is intellectually bankrupt. Why should today's workers pay for today's retirees in the expectation that future workers will do the same for them? Why should a poor worker of today send money to a wealthy retiree? There is a name for such schemes and it is not a pretty one. It would be far better to let those who are capable of taking care of themselves do so, while putting aside money for those unable to take care of themselves. In short, I propose that Social Security and Medicare become means-tested safety nets for the truly needy, rather than a fake pension and insurance program with a hidden welfare component. The commission I appoint will design a gradual transition over time to such a transparent system, allowing today's workers to plan honestly for the future. One method of transforming Social Security and Medicare will be to make them means-tested and make the welfare components explicit rather than buried and opaque as they are now. Ultimately, this will allow for lower tax rates. Those expected lower tax rates will help encourage current spending because consumers will not have to worry about future tax increases. If we have the courage to implement this plan of fiscal responsibility and a more transparent tax system with improved incentives, it will let the private sector know that the grown-ups are in charge and that the government can be trusted to act responsibly. This will in turn encourage the risk taking and investment that must take place before our economy can recover. And most importantly, we will set the stage for future prosperity. Thank you and God bless America. Russ Roberts is a research fellow at the Hoover Institution, a professor of economics at George Mason University, and the host of a weekly podcast, EconTalk. His latest book is The Price of Everything: A Parable of Possibility and Prosperity. tag:www.invisibleheart.com,2008://1.93 2008-11-20T05:12:10Z 2008-11-20T05:17:14Z

(This piece appeared on Forbes.com on 11/20/08) President-elect Obama announced the other day that the government would do "whatever it takes" to revive the economy. I suppose that made some people feel good. After all, who wouldn't want tireless effort...

Russ Roberts Forbes.com on 11/20/08) President-elect Obama announced the other day that the government would do "whatever it takes" to revive the economy. I suppose that made some people feel good. After all, who wouldn't want tireless effort in the face of a crucial problem? Unfortunately, the problem with the economy isn't insufficient effort or focus. The problem is that no one knows what to do next. Hank Paulson already looks like a man who's not sleeping enough. His problem isn't insufficient effort. It's too much effort. If reviving the economy were like reviving a patient whose heart has stopped, then relentless effort would be the key. Get out those paddles and keep stimulating the guy until he comes back to life. Never give up. Whatever it takes.]]> But reviving an economy is more like parenting. There's no manual. If there were a parenting manual, every hospital would hand one out with every newborn. But there isn't a manual because each kid is different. And parents come to learn that they aren't really in charge. There's too much of the process they can't control. So great parenting isn't about doing whatever it takes. It's an art. It's about a set of principles and knowing which principle to apply in which situation. When to be tough. When to be soft. When to give a kid a do-over. Even the most skilled parents make mistakes. Not because they don't understand what it takes to be a good parent. Not because they aren't committed to doing the job as well as it can humanly be done. But simply because there's no way of knowing what to do next. Often what's called for in parenting is the exact opposite of whatever it takes--what's called for is doing nothing. Welcome to the world of macroeconomics. Even the wisest president and most skilled secretary of the Treasury doing whatever it takes isn't enough if you don't know what it takes. And there's no way of knowing. Look at poor Henry Paulson. He can't figure out what to do. But you think it's easy? To revive financial markets, he just has to create confidence and a desire to invest. Piece of cake. Alas, no one knows how to do it. And it isn't from lack of trying. Or desire. Paulson's successor will have one advantage Paulson doesn't have. He'll know something about what not to do. But unfortunately, that isn't enough. After all the changes in policy and the uses of the TARP that have been announced in the last six weeks, I suspect that confidence and a desire to invest are no longer under the control of the Treasury secretary or the president. If anything, many of Paulson's relentless efforts to move markets forward have made the situation worse. Obama may promise whatever it takes, but the unfortunate reality is that he faces the same situation that Bush and Paulson have been facing. We need confidence and optimism, but there's no way of knowing how to get there from here. Obama's only practical suggestion has been to support the idea floating around Congress for a stimulus package of $100 billion or more. That doesn't exactly meet expectations of doing whatever it takes. That's doing what we've already done. We tried a $160 billion stimulus package last spring. That accomplished very little. What's the argument for spending $100 billion to revive a $14 trillion economy? A $14 trillion economy where the government has just spent a few hundred billion and counting on financial bailouts and capital injections. To no avail. Does anyone really think that we haven't spent enough? Somehow, I don't think an extra $100 billion or even $300 billion is going to get the job done, even if it goes toward infrastructure as some are suggesting. What if markets are spooked by the specter of government spending without any constraints? What if doing whatever it takes means doing less, rather than more? That is the conundrum for Obama and the successor to Paulson. The more options there are, the harder it is to know which one is the right one. The more options you try, the more uncertainty is injected into the economy, and the more cautious are investors and employers and consumers. Nobody knows what it takes to move the economy forward right now. tag:www.invisibleheart.com,2008://1.92 2008-11-14T15:00:00Z 2008-11-16T15:19:58Z

(This article appeared on NPR.org on 11/14/08) Secretary Paulson might be the only person in America who worries that consumers haven't borrowed enough money. He says the consumer credit market has "ground to a halt." He wants to get it...

Russ Roberts NPR.org on 11/14/08) Secretary Paulson might be the only person in America who worries that consumers haven't borrowed enough money. He says the consumer credit market has "ground to a halt." He wants to get it going again — maybe if we all just buy enough cars and use our credit cards, the economy will come back to life. Paulson is also upset that banks aren't doing enough. He's given them all this money and they're sitting on it. He doesn't seem to realize that these two phenomena are really one and the same. He can inject all the money he wants into the consumer credit market and it isn't going to make us want to buy cars or use our credit cards.]]> We did enough of that for a while. More than enough. Too much. And right now, before we spend, spend, spend, we're going to wait and see if we keep our jobs. But we're also going to wait and see what the government's going to do next. Nobody knows, and that evidently includes the secretary of the treasury. When no one knows how the rules of the game are going to change — and they seem to change from week to week — who wants to take a risk? Who wants to borrow money? Who wants to invest? Business and consumers are hunkering down, waiting for the storm of change to pass. The problem isn't liquidity. It's uncertainty. Paulson doesn't realize that his erratic attempts at creating liquidity are creating the uncertainty that makes liquidity meaningless. And his erratic moves elsewhere just add to the uncertainty. A few days ago, he announced that he was "exploring strategies" to use the TARP (the Troubled Asset Relief Program) for "foreclosure mitigation." Then came the news that, no, the FDIC would have to go it alone in helping mortgage workouts. No TARP for them. I guess he's done exploring. At least until tomorrow. As the TARP spreads, the cost will keep rising. Remember the talk about how the government might even profit from its $700 billion "investment?" (Insert hollow laugh here.) I'd feel better if the money spent so far was helping. But there's no evidence that it is achieving what Paulson intends. And who's going to pay for all of this? Those who lived within their means, who went with the smaller house, who waited a few more years to get that new car, who took a part-time job rather than borrowing even more money to pay for college. Suckers. You missed out on the thrills and now you're going to be paying the bills. The prudent will be paying for the imprudent for a long time. The great economist F.A. Hayek wrote that "the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design." With each improvisation, Secretary Paulson is proving how little he knows about what he imagines he can design. Russell Roberts is professor of economics at George Mason University and a research fellow at Stanford's Hoover Institution. His latest book is The Price of Everything: A Parable of Possibility and Prosperity. tag:www.invisibleheart.com,2008://1.91 2008-10-31T14:57:19Z 2008-11-16T14:59:41Z

(This article appeared in the Wall Street Journal on 10/31/08) People ask me if the current mess feels like 1929. But the right comparison is 1932, when Herbert Hoover was desperately trying anything, anything at all, to get the economy...

Russ Roberts Wall Street Journal on 10/31/08) People ask me if the current mess feels like 1929. But the right comparison is 1932, when Herbert Hoover was desperately trying anything, anything at all, to get the economy going. The stock market had crashed. The economy was starting to follow it down. So what did Hoover and his fellow policy makers do? In 1930, Congress passed a massive tariff increase, in hopes of protecting American jobs. Hoover signed it. But it simply accelerated the economy's slide. The Federal Reserve contracted the money supply, taking a recession and making it into a depression. By 1932, real GDP was 25% lower than three years earlier. Hoover increased federal spending steadily, including an increase in real terms of about 40% in 1932. At the same time, fearful that deficits were harmful, Hoover raised income taxes. Nothing worked. So Franklin Roosevelt came into office pledging stronger medicine. Enter even bigger increases in government spending. Government nationalization. Bigger deficits. Destruction of crops and livestock in the name of raising prices. Government-organized cartels. A greater empowerment of unions. It was a whirlwind of activity without any real plan. It worked for a while, but then, in 1938, the economy turned sour again. Unemployment, which had been falling, spiked again, reaching 19%. Consumption didn't recover to its prewar levels until 1945. Today, President George W. Bush plays the role of Hoover, the so-called free market ideologue who is trying anything to avert disaster. He signs a $700 billion bill putting Treasury in charge of buying troubled assets. A week later, the money is used to partially nationalize the banks. Some companies, like Bear Stearns, are bailed out. Others, like Lehman Brothers, are not. Some companies are sold. Some are allowed to fail. There is no plan, no rules, nothing to count on. ]]> It's just like the New Deal: a massive accumulation of power in Washington justified by the need to do something. There is every reason to think this trend will accelerate regardless of whether Barack Obama or John McCain wins the election. Back in March, Henry Paulson, Ben Bernanke and the experts assured us that Bear Stearns had to be propped up. If not, the whole system could come crashing down. It is crashing down anyway. Just as in the 1930s, there is no evidence that the policy makers have any understanding of what they are doing. They need to make way for the natural forces of repair. They need to let housing prices fall. They need to let firms go bankrupt. They need to let firms that are healthy thrive. They need to let healthy firms buy the sick firms. It is time to let the imprudent fail and the prudent pick up the bargains. A recession is coming (or has already arrived) no matter what happens in Washington. The question is whether the attempt to forestall it is going to make it worse and turn it into another Great Depression. By acting without rhyme or reason, politicians have destroyed the rules of the game. There is no reason to invest, no reason to take risk, no reason to be prudent, no reason to look for buyers if your firm is failing. Everything is up in the air and as a result, the only prudent policy is to wait and see what the government will do next. The frenetic efforts of FDR had the same impact: Net investment was negative through much of the 1930s. The next administration is unlikely to do any better. Mr. Bernanke is perhaps the greatest living authority on the Great Depression, yet he has failed to stem the damage. Messrs. Paulson and Bernanke are confronted with a sick patient. They have antibiotics. They have a scalpel. But is there any evidence from the last seven months that they understand the underlying cause of the illness, or how to cure it? Worst of all are the political incentives that are unleashed when Washington promises to spend a trillion dollars (and counting). No one can spend such money wisely even if they want to. The information about who needs to be bailed out and who needs to fail is too complicated. Inevitably, such decisions will begin to be more about politics than economics. The banks were first. Then the insurance companies. The car makers are getting a cut. Who's next? The governors, probably. Homeowners are waiting. Then there will be the hedge funds. Once the line forms, companies will stop trying to save themselves and focus on being saved by Washington. The resulting spiral will be devastating. Unfortunately, there is no consensus about a preferable alternative. The economists are almost as clueless as the politicians. At such a time, inaction may be the wisest course of action. Mr. Roberts is a professor of economics at George Mason University and a research fellow at Stanford University's Hoover Institution. His latest book is "The Price of Everything: A Parable of Possibility and Prosperity" (Princeton University Press, 2008). tag:www.invisibleheart.com,2008://1.90 2008-10-03T14:49:42Z 2008-11-16T14:54:45Z

(This article appeared in the Wall Street Journal on October 3, 2008) Many believe that wild greed and market failure led us into this sorry mess. According to that narrative, investors in search of higher yields bought novel securities that...

Russ Roberts Wall Street Journal on October 3, 2008) Many believe that wild greed and market failure led us into this sorry mess. According to that narrative, investors in search of higher yields bought novel securities that bundled loans made to high-risk borrowers. Banks issued these loans because they could sell them to hungry investors. It was a giant Ponzi scheme that only worked as long as housing prices were on the rise. But housing prices were the result of a speculative mania. Once the bubble burst, too many borrowers had negative equity, and the system collapsed. [How the Government Stoked the Mania] David Klein Part of this story is true. The fall in housing prices did lead to a sudden increase in defaults that reduced the value of mortgage-backed securities. What's missing is the role politicians and policy makers played in creating artificially high housing prices, and artificially reducing the danger of extremely risky assets.]]> Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate income borrowers. For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005. For 1996, HUD required that 12% of all mortgage purchases by Fannie and Freddie be "special affordable" loans, typically to borrowers with income less than 60% of their area's median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was to be 28%. Between 2000 and 2005, Fannie and Freddie met those goals every year, funding hundreds of billions of dollars worth of loans, many of them subprime and adjustable-rate loans, and made to borrowers who bought houses with less than 10% down. Hear No Evil What some Congresspeople said about Fannie and Freddie. Fannie and Freddie also purchased hundreds of billions of subprime securities for their own portfolios to make money and to help satisfy HUD affordable housing goals. Fannie and Freddie were important contributors to the demand for subprime securities. Congress designed Fannie and Freddie to serve both their investors and the political class. Demanding that Fannie and Freddie do more to increase home ownership among poor people allowed Congress and the White House to subsidize low-income housing outside of the budget, at least in the short run. It was a political free lunch. The Community Reinvestment Act (CRA) did the same thing with traditional banks. It encouraged banks to serve two masters -- their bottom line and the so-called common good. First passed in 1977, the CRA was "strengthened" in 1995, causing an increase of 80% in the number of bank loans going to low- and moderate-income families. Fannie and Freddie were part of the CRA story, too. In 1997, Bear Stearns did the first securitization of CRA loans, a $384 million offering guaranteed by Freddie Mac. Over the next 10 months, Bear Stearns issued $1.9 billion of CRA mortgages backed by Fannie or Freddie. Between 2000 and 2002 Fannie Mae securitized $394 billion in CRA loans with $20 billion going to securitized mortgages. By pressuring banks to serve poor borrowers and poor regions of the country, politicians could push for increases in home ownership and urban development without having to commit budgetary dollars. Another political free lunch. Fannie and Freddie and the banks opposed these policy changes at first through both lobbying and intransigence. But when they found out that following these policies could be profitable -- which they were as long as rising housing prices kept default rates unusually low -- their complaints disappeared. Maybe they could serve two masters. They turned out to be wrong. And when Fannie and Freddie went into conservatorship, politicians found out that budgetary dollars were on the line after all. While Fannie and Freddie and the CRA were pushing up the demand for relatively low-priced property, the Taxpayer Relief Act of 1997 increased the demand for higher valued property by expanding the availability and size of the capital-gains exclusion to $500,000 from $125,000. It also made it easier to exclude capital gains from rental property, further pushing up the demand for housing. The Fed did its part, too. In 2003, the federal-funds rate hit 40-year lows of 1.25%. That pushed the rates on adjustable loans to historic lows as well, helping to fuel the housing boom. The Taxpayer Relief Act of 1997 and low interest rates -- along with the regulatory push for more low-income homeowners -- dramatically increased the demand for housing. Between 1997 and 2005, the average price of a house in the U.S. more than doubled. It wasn't simply a speculative bubble. Much of the rise in housing prices was the result of public policies that increased the demand for housing. Without the surge in housing prices, the subprime market would have never taken off. Fannie and Freddie played a significant role in the explosion of subprime mortgages and subprime mortgage-backed securities. Without Fannie and Freddie's implicit guarantee of government support (which turned out to be all too real), would the mortgage-backed securities market and the subprime part of it have expanded the way they did? Perhaps. But before we conclude that markets failed, we need a careful analysis of public policy's role in creating this mess. Greedy investors obviously played a part, but investors have always been greedy, and some inevitably overreach and destroy themselves. Why did they take so many down with them this time? Part of the answer is a political class greedy to push home-ownership rates to historic highs -- from 64% in 1994 to 69% in 2004. This was mostly the result of loans to low-income, higher-risk borrowers. Both Bill Clinton and George W. Bush, abetted by Congress, trumpeted that rise as it occurred. The consequence? On top of putting the entire financial system at risk, the hidden cost has been hundreds of billions of dollars funneled into the housing market instead of more productive assets. Beware of trying to do good with other people's money. Unfortunately, that strategy remains at the heart of the political process, and of proposed solutions to this crisis. Mr. Roberts is a professor of economics at George Mason University and a scholar at the Mercatus Center. His latest book is a novel on how markets work, "The Price of Everything: A Parable of Possibility and Prosperity" (Princeton University Press, 2008). tag:www.invisibleheart.com,2008://1.89 2008-09-18T14:43:27Z 2008-11-16T14:55:51Z

(This article appeared on Forbes.com on 9/18/08) The collapse of Bear Stearns and Lehman Brothers, and the bailouts of Fannie Mae, Freddie Mac and AIG, have led to an inevitable call for more regulation. Obama promises "real" regulation. McCain will...

Russ Roberts Forbes.com on 9/18/08) The collapse of Bear Stearns and Lehman Brothers, and the bailouts of Fannie Mae, Freddie Mac and AIG, have led to an inevitable call for more regulation. Obama promises "real" regulation. McCain will "reform Wall Street." The consensus is that Something Must Be Done to rein in financial markets. This consensus is part of a general theme among some pundits and economists that it's time to give up the naïve faith that markets can solve every problem. We are told that markets have failed. Yet much of the current chaos is the result of attempts to steer or control markets rather than let them be. Much of the chaos is the result of political failure.]]> In the wake of Hurricane Ike, customers wait in line for hours to buy gasoline, the inevitable result of anti-gouging ordinances that discourage retailers from raising prices and letting markets clear. Ethanol mandates and subsidies try to create less carbon in the atmosphere than the market would create on its own. The result has been a worldwide increase in the price of corn that has hurt poor people around the world. The environmental benefits are negligible. The turmoil in the housing market and the resulting financial crisis is just the latest example of political failure. Politicians wanted more home ownership than the market produces on its own, especially among low-income families. To encourage this politically popular goal, Fannie Mae (nyse: FNM - news - people ) and Freddie Mac (nyse: FRE - news - people ) were allowed to privatize their profits and socialize their losses. At the same time, Housing and Urban Development (HUD) required them to expand their commitment to affordable housing. Freddie and Fannie achieved this goal by buying bundles of subprime mortgages. Now taxpayers are on the hook for at least $200 billion, and the dominoes are still falling. The real cost of this failure is that the return to housing was artificially inflated, funneling billions of dollars of capital into housing instead of more productive assets. Politicians and policy makers ignored the essentially organic nature of market forces and assumed that one piece of the market could be altered while everything else remained unchanged. But politicians always think they can design a market from the top down as long as just the right regulations are put in place. And they will tell us that the right regulations can be put into place to patch things up. Color me skeptical. Going forward, the first order of business is the same as a doctor's obligation when dealing with the complexity of the human body--to do no harm. Unfortunately, the most recent actions of policy makers have already done immense harm. By not providing the data or information or decision rules that cause one company to be bailed out and another to go bankrupt, they have weakened the faith of the American people in the fairness of the financial system. By sparing some reckless investors but not others, they have signaled that risk-taking results in arbitrary rewards and prudence will be punished. By failing to highlight the role of government in creating the current crisis, they have encouraged citizens to believe that markets have failed. Both presidential candidates will promise a risk-free world with high returns. But peddling that fantasy is the cause of the current crisis. We treat our children this way--we do our best to insulate them from harm and still allow them to grow. I'd like politicians to treat me as an adult, paying the price for my recklessness and reaping a reward when I am prudent. Returning to that world, the world of markets, is the beginning of a return to stability. Russ Roberts is a research fellow at the Hoover Institution and a professor of economics at George Mason University. His latest book, a novel on the organic nature of markets, is The Price of Everything: A Parable of Possibility and Prosperity. tag:www.invisibleheart.com,2008://1.88 2008-03-26T16:02:31Z 2008-11-16T14:56:35Z

This commentary aired on National Public Radio's All Things Considered on March 25, 2008. Audio is here. Wall Street is all about profit. All about the bottom line. And profit does play a major role in making our world go...

Russ Roberts This commentary aired on National Public Radio's All Things Considered on March 25, 2008. Audio is here. Wall Street is all about profit. All about the bottom line. And profit does play a major role in making our world go round. Without profit, there's no point in taking risks. Without risk-taking, there's no investment. Without investment, there's no growth. Profits are the cornerstone of our economy and our way of life. But as Milton Friedman liked to point out, our economic system isn't just based on profit. It's a profit and loss system. It's the combination that sustains and enhances our standard of living. Yes, the potential for profit encourages people to take risks. But without the potential for loss, you have reckless risk-taking. You have risk-taking without prudence. Without the potential for loss, irresponsibility goes unpunished. The Federal Reserve and the Treasury Department have orchestrated the rescue of Bear Stearns. The defenders of that maneuver argue that if Bear Stearns had failed it would have created a lot of collateral damage, so much collateral damage, that you and I, normal folk who don't know anything about high-falutin' financial instruments like "collateralized debt obligations" would have been engulfed as well. If Bear Stearns had gone bankrupt, Lehman Brothers might have been next. Some say that if Bear Stearns had failed, the entire banking system was at risk. Maybe. It seems awfully hard to know for sure. But what I do know for sure is that by subsidizing the marriage of Bear Stearns and JP Morgan, the government has removed some of the loss from the profit and loss system. Oh, they tried to make Bear Stearns suffer by demanding a price of $2 a share. But now the deal has been renegotiated—ta-da!—to $10 a share, a mere five-fold readjustment. What's going on here? What's going on here is that we're in uncharted territory, a world where the Fed and the Treasury are making up the rules as they go along, where accountability is being ignored and a world where the government bails out Bear Stearns and its creditors rather than letting those who have been reckless learn a lesson for the next time. Yes, letting Bear Stearns go under would have been dangerous. But helping JP Morgan devour Bear Stearns is dangerous, too. Where does the government stop in protecting people from irresponsibility? Home owners and lenders are next. The political pressure is inexorable for some sort of bail out. And then comes more regulation of investment banks. In a world where people who make bad decisions are spared the full consequences, only one thing is certain. We've encouraged more people to make more bad decisions in the future. The real price to be paid isn't the dollar costs of any bail out, but the encouragement of recklessness and irresponsibility. That will make all of us poorer down the road. ]]>