Lemmings in suits

The political class is running us over a cliff

By Steven Miller
  • Wednesday, February 11, 2009

Let's recall how Nevada got into this economic mess, OK?

It was the loving gift of your federal government.

In the second half of the 1990s, the Federal Reserve System found multiple excuses to pleasure its primary political constituency, Wall Street, by pumping out dollars at an ever-accelerating rate.

Predictably, virtually all that money went directly into asset inflation—in that particular instance, the binge now known as the Tech Bubble.

When that Fed-induced euphoria among investors started dissipating in 2001 and the bubble began to deflate, our deeply politicized Federal Reserve was unwilling to let credit rates adjust to market realities. After all, that would have entailed 1) actually standing up to ignorant and demagogic politicians while markets and the economy went through withdrawal from their addiction to artificial Fed credit and 2) abandoning the Fed's foundational fiction that it can actually ensure economic "stability" and "prosperity"—a claim the carnage around us reveals to be a complete joke.

So the American central bank rushed in again to administer another "fix," injecting liquidity (dollars) at an even greater pace and pushing nominal interest levels down to 40-year lows. However, as before, these interest rates were essentially bogus: They did not represent an abundance of genuine investment capital in the economy, built up out of real savings. Instead, they merely reflected the Fed's most recent fiddling with the road signs.

This new wave of artificial Fed credit now flowed into housing assets. Given the Tech Bubble's collapse, real estate appeared to millions of investors the most reasonable place to leverage the exceedingly cheap dollars offered to them through the Federal Reserve System banks and the federal mortgage-incitement agencies, Fannie Mae and Freddie Mac.

Incitement is indeed the correct word here. Both agencies, in response to corrupt and benighted political pressures from Congress, promoted ridiculously loose and risky lending standards by favored lenders. The No. 1 favorite of Fannie and Freddie was Countrywide Financial—which, not coincidentally, was giving cut-rate mortgages to powerful senators, representatives and congressional staffers to curry their favor.

Thus, given the Fed's continuing sabotage of normal market disciplines and the illicit relationships between Congress, Fannie-Freddie and their private-sector favorites, it was all predictable. Large amounts of investors' money would end up in unsound mortgages and mortgage-based financial instruments—producing, yet again, another bubble and another crash.

Nevada's huge glut of homes for sale, for example, stems directly from these short-sighted, politicized government interventions in the marketplace. The Fed's artificially low interest rates and the flimsy Fannie-Freddie mortgage requirements made it appear to buyers and builders alike that the real-estate risks were much lower than they actually were. This is the deception that government intervention always perpetrates, as it substitutes the self-interested choices of politicians and bureaucrats for the intelligence of millions of individuals operating in a dynamic marketplace, all attending to their best estimates of how best to meet their own individual needs.

So, as regularly occurs in Nevada, the Fed's fraudulent credit manipulations again produced massive and widespread mal-investment—people taking on debt for projects that won't repay them later. Soon following inexorably were the bankruptcies as the debt-repayment deadlines arrived, but the income that was expected did not.

These losses are Nevada's basic problem today: The state—meaning everyone who resides here—is simply much poorer in reality than most members of our political class can either understand or bring themselves to accept. Their political brethren at the federal level have, over the last 20 years, repeatedly seduced Americans into deeper and deeper levels of debt, waving the bait of easy (if ultimately phony) credit. One important—if unpublicized—result has been multitudes of incidents of micro-economic loss among the Silver State's small businesses. At the same time, Nevadans' purchasing power has taken serious, long-term hits from the Fed's obsessive attacks on the value of the dollar, as the agency seeks to bail out the insolvent financial institutions it generated.

Remarkably, today this model is what Washington is once again offering as the solution to America's economic woes.

Insanity has been defined as continuing to do what you've been doing, while expecting a different result. By that definition, our political class is truly certifiable.

Nevada's legislative leaders—for all their posturing regarding today's difficult times—do not appear to actually grasp the seriousness of the situation. Most major American banks are today essentially insolvent, according to various widely accepted metrics of valuation. It is because bankers know this that they have been so reluctant to lend to other banks or to loan-applicants generally, and that the Treasury and Fed have felt compelled to attempt to step into the breach. Yet the Fed, itself, today, is only 2 percent solvent—meaning that America's entire financial structure is tottering, while Washington continues business as usual, slinging pork and calling it "stimulus."

This strongly suggests that Nevada's economy has little chance of genuine recovery for years to come. Because the capital structure of the U.S. economy largely reflects the massive, yet unsustainable, credit expansion perpetrated by the Fed, that capital structure itself is unsustainable. That shake-out, that restructuring, must most likely occur before the Silver State economy can recover. But that market clearing almost certainly will not arrive until Washington's pretend solutions have been abandoned—a distinctly unlikely prospect at present, given current disrespect for reality.

Here in Nevada, too, elected politicians continue to presume that they—and their pet, government-employee interest groups—can blithely continue their tax-increases-as-usual approach to governance. Rational individuals would recognize that the collapse of the state's current biennial revenues so far below 2007's projections clearly signals that we have entered a radically different economic environment.

Leaders of the current legislative majority, however, keep running toward the cliff. They presume that because their sponsoring special-interest groups have for so many years been able to live beyond Silver State taxpayers' means, all the current budget shortfall really signifies is that Nevadans must be strapped down and bled even more.

We're going to see how angry Nevadans can get.

Steven Miller is vice president for policy at the Nevada Policy Research Institute.

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