<h3>Excerpt</h3> <div><div> <h2>CHAPTER 1</h2> <p><b>Fundamental Themes</b></p> <br> <p>There are six fundamental themes that reflect the basic causes, consequences, and cures of the financial crisis and the ensuing Great Recession. These themes outline the essential ideas that must be understood and that will be discussed in detail in the following chapters.</p> <p>1. <i>Government policy is the primary cause of the financial crisis.</i> We do not live in a free-market economy in the United States; we live in a mixed economy. The mixture varies significantly by industry.</p> <p>Technology is one of the least regulated industries in the United States. It should be noted that technology continued to perform well in the difficult economic environment.</p> <p>Financial services is a very highly regulated industry, probably the most regulated industry in the world. It is not surprising that a highly regulated industry is the source of many of our economic problems. By the way, if you do not believe that financial services is highly regulated, obtain a copy of the state banking, Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), Federal Reserve, Securities and Exchange Commission (SEC), or other agency regulations document that affects the industry. The claim that the financial industry was deregulated is a myth that will be discussed in <b>Chapter 13</b>.</p> <p>Not only did government policy create the financial environment for a significant economic correction, but government policy makers unnecessarily turned a challenging economic environment into a crisis.</p> <p>2. <i>Government policy created a bubble in residential real estate.</i> A bubble is an irrational, excessive investment of capital and human resources. The real estate bubble burst, as all bubbles do. The loss of wealth from the declining values in residential real estate was transmitted to the capital markets, destroying more wealth and leading to a significant reduction in economic activity, that is, to negative real growth and the destruction of millions of jobs.</p> <p>The recent roots of the government policy incentives that created the bubble in housing can be traced to Lyndon Johnson's "Great Society" of the late 1960s. The errors multiplied and went exponential over about a period of 10 years ending in 2007.</p> <p>Unfortunately, another of Johnson's Great Society programs, Medicare/Medicaid, will go exponential in less than 10 years and will be far more damaging than the housing bubble if the direction is not changed. (<i>Going exponential</i> means increasing at a mathematically accelerating pace.)</p> <p>3. <i>Individual financial institutions (Wall Street participants) made very serious mistakes that contributed to the crisis.</i> These institutions should have been allowed to fail. (In <b>Chapters 17</b> and <b>19</b>, we will discuss the consequences of not letting companies fail.) However, any errors by these institutions, individually and collectively, are far less important than government policy mistakes, and almost all the errors were the direct result of government policy incentives. It is important to note that many of the financial institutions that should have been allowed to fail had a history of being crony capitalists; that is, these companies did not advocate limited government but instead sought special favors for themselves. Goldman Sachs, Citigroup, and Countrywide are examples of crony capitalists. Crony socialist is probably a better name for these individuals and firms. If the United States had separation of "business and state" as it does separation of "church and state," crony capitalism (or crony socialism) could not exist.</p> <p>4. <i>Almost every governmental action taken since the crisis started, even those that may help in the short term, will reduce our standard of living in the long term.</i> If you misidentify the fundamental cause of a problem, you will almost certainly recommend the wrong solution. If your doctor treats you for cancer when you have heart disease, the outcome will not be good.</p> <p>In addition, some of the primary culprits who caused the financial crisis, such as Bernanke, Geithner, Frank, and Dodd, are the people who developed the "solution." How realistic is it to expect that they would identify the cause as their own actions and suggest cures accordingly?</p> <p>5. <i>The deeper causes of our financial challenges are philosophical, not economic.</i> All of the destructive government policies are based on philosophical ideas taught in our elite universities to future elitist leaders. These ideas are inconsistent with the founding principles that made America great. They are also inconsistent with individual rights, especially property rights. At a deeper level, these ideas are inconsistent with humans' fundamental nature as thinking beings who must make independent judgments that are based on the facts and that use their ability to reason.</p> <p>Academics purport to defend academic freedom. They are right to do so. However, when put in government policy positions, the same academics somehow believe that businesspeople can continue to innovate and create wealth despite the ball and chain of government regulations. In reality, government regulations prevent businesspeople from being innovative and from thinking creatively. In my career, I have seen a number of significant opportunities to add products and services that would unquestionably benefit our clients, and yet some law made this impossible. All human progress is, by definition, based on creativity, because anything that is better is different. Creativity is possible only for an independent thinker. Someone who is not creative, who cannot innovate, cannot contribute to human progress. Government policies often provide incentives for destructive activities and prevent productive innovations. In a broader context, our lives ultimately depend on our individual ability to make independent judgments based on our assessments of the consequences of our actions for us.</p> <p>These regulatory policies are typically based on a fundamental misunderstanding of human nature, the means of human survival, and the nature of the production process. Ideas have consequences. We need to ensure that our future leaders are taught ideas consistent with the laws of nature and human nature, which are the foundation for a successful society and individual happiness.</p> <p>Intentions that are called "good" often do not produce favorable outcomes. This is particularly true when these good intentions are based on false premises and a lack of understanding of what motivates human actions. Sometimes, unfortunately, the so-called good intentions actually reflect a lust for power, the desire to control others, and the belief that you are smarter than the people you are going to "save." <b>Chapters 21</b> through <b>25</b> are the most important in the book because they deal with the philosophical issues. However, the preceding chapters make concrete the effect of the philosophical ideas expressed in these chapters and therefore are very helpful to an understanding of these concepts.</p> <p>6. <i>If we do not change direction soon, the United States will be in very serious financial trouble in 20 to 25 years.</i> The economic forces that have now been set in motion are laying the foundation for a long-term disaster. Social Security deficits, Medicare deficits, unfunded state and local pension liabilities, government operating deficits, retirement of the baby boomers, and a failed K–12 education system are huge issues.</p> <p>Countries do not go bankrupt the way businesses do. They typically hyperinflate—that is, print valueless money—and move to some form of authoritarian government. In 1920, the United States and Argentina had the same standard of living. Argentina, through authoritarian government policies, has made itself into a third-world country despite having vast natural resources. The United States will be the next Argentina if it does not change direction soon. It is not too late for us to deal with our fundamental problems, but time is running out.</p> <p><b>Chapters 17</b> through <b>20</b> will clearly outline the fundamental economic solutions to our financial problems consistent with the philosophical principles covered in <b>Chapters 21</b> and <b>22</b>.</p> <h2>CHAPTER 2</h2> <p><b>What Happened?</b></p> <br> <p>The primary cause of the great recession was a massive mis investment in residential real estate. We built too many houses, too large houses, and houses in the wrong places. The overinvestment in residential real estate was more than $3 trillion (and possibly as much as $8 trillion, based on the decline that has occurred since the bubble burst).</p> <p>Underlying this massive misallocation of capital to residential real estate was a belief that home prices appreciate forever and that housing is a great investment. This false belief was based on a long-term trend of home appreciation that was driven by a long history of government policies supporting investment in the housing market, which we discuss in future chapters.</p> <p>In economic terms, spending on housing is consumption, not investment. We live in a house, and therefore we consume the house. Houses are not used to produce other goods. A manufacturing plant that makes computer parts is a production investment. Thus, the misinvestment in housing shifted resources from production to consumption. You can spend your money only once. If you spend it on houses, you cannot spend it on manufacturing plants. While houses create jobs while they are being built, once they are built, they do not create jobs going forward. A manufacturing plant creates jobs when it is being built, but, more important, it continues to create jobs as long as it operates. In fact, it is jobs that create houses, not houses that create jobs.</p> <p>When you shift capital (money) from production to consumption, you reduce your future standard of living. This may be a good decision for an individual (or an economic system) because we may want to or need to consume today. However, if artificial incentives cause this redistribution from production to consumption, our future standard of living will be permanently reduced. In other words, by investing too much in housing, we invested too little in manufacturing capacity, technology, education, agriculture, and other such areas. Also, we saved too little and borrowed too much from foreigners, which will have to be repaid. This is analogous to having partied for years in the Caribbean and now finding that we have a really bad "hangover" and a giant credit card bill.</p> <p>This type of misinvestment has many destructive effects. For example, numerous workers developed skills in building houses, but these skills are no longer needed or valuable. The workers could have been developing skills in running machines that manufacture advanced medical products. These construction workers will need to be retrained to do useful work. Retraining is expensive, and some older workers may not be retrainable.</p> <p>However, there is a bigger problem. Since we did not build the manufacturing plants, the jobs do not exist even if the worker is retrained. Also, construction jobs are competitive with manufacturing jobs, and so as the excessive construction of houses continued, construction wages rose rapidly and created upward pressure on manufacturing wages. As these manufacturing wages rose in the United States, jobs were driven overseas because U.S. manufacturers could not be competitive. At first, the workers in India and China were not skilled. However, the Indians and Chinese have become skilled and are highly productive at relatively low wages, making it difficult for us to get the jobs back.</p> <p>We cannot afford to build the manufacturing plants now because we wasted our capital building houses that we did not need. In addition, the government is taking the capital that we do have and spending it on pork barrel projects or projects that are not economically justified (clean energy), so these good jobs may never be created. Also, these former construction workers are accustomed to being paid a healthy wage rate because of their construction skills, but the new manufacturing plants cannot afford to pay that high a wage because the workers, even after being retrained, still have a great deal to learn. Unemployment insurance provides an incentive for workers not to take a lower-paying job. Also, the minimum wage law keeps small businesses from hiring low-skilled workers at a wage rate that would allow their businesses to be profitable, so entry-level workers cannot gain the skills to become more productive and thereby paid at a higher level.</p> <p>The ripple effect continues. Manufacturing is a primary industry. The manufacturing workers, if they had jobs, would be able to buy more food, clothes, and other things, creating other jobs in other industries. (By the way, this is not an argument for manufacturing vs. service jobs; it is just easier to understand the manufacturing example.)</p> <p>Of course, the impact of this overbuilding is not limited to construction workers. Real estate agents, attorneys, mortgage lenders, and other such groups also developed skills that are no longer needed. They will have to be retrained and will be less productive for years than they would have been had they not participated in the residential construction industry.</p> <p>Commercial real estate tends to follow residential real estate, especially shopping centers, retail stores, office buildings, and even hotels. After all, if there are many new houses being built, and numerous consumers are expected to be living in these homes, will there not be a need for a shopping center? This secondary misinvestment has the same ripple effect on commercial construction workers, commercial real estate brokers, and other such groups that we discussed earlier for residential real estate. It should be noted that the bubble was at least 10 years in the making, which means that millions of workers in multiple industries learned the wrong skills.</p> <p>There is another important consideration. When many (or most) individuals started viewing homes as investments, instead of as consumption, and also believed that these investments would continue to appreciate indefinitely in the future, they adjusted down their savings because they thought that "investing" in a house was a form of saving (when in reality it is consumption). People today are coming to realize that housing is consumption, not investing, which encourages them to save more in other areas. This is likely to have a permanent impact on housing consumption.</p> <p>Why did so many people make such bad financial decisions? The press likes to indicate that it was greed. Well, there certainly were some people who were greedy (that is, who made irrational, risky financial decisions). However, this group was relatively small. Many honest, intelligent people were simply mistaken, primarily because of the misinformation provided by government policy actions. After all, the government (both Democrats and Republicans) has been supporting housing for many years, and home prices have had a steady upward trend for many years. Every time prices started to decline, the government, in one way or another, stepped in to protect home values. Housing was an "investment" with upside potential and no downside risk.</p> <p>Residential developers and contractors were also misled by the same policies. Assume that it is the spring of 2005, and you are in the business of buying land, converting it into lots, and constructing residential buildings. Your business is excellent, and has been for many years. The economic forecasters, including the Federal Reserve economists, are projecting good times ahead. You are worried about running out of building lots several years in the future. Unfortunately for you, your business is in a market where the local government zoning laws make it very difficult to get land zoned for residential development. Because of the long time frame involved, you have to buy the lots many years in advance to get them approved for zoning. In addition, land values have skyrocketed because the county will approve only a few lots per year, less than the market demand. You know you may have to make some significant contributions to local politicians if your lots are have a chance of being considered, and maybe be "generous" to the local building inspectors once you start development. You go ahead and purchase the lots long before you need them and at a higher price than you feel comfortable paying, because if you do not buy those lots and get them zoned by the spring of 2007, you will be out of business. Also, after all, the government always supports the housing market. It will not let prices fall.</p> <p>How about bankers? Let me share with you my personal experience. Among BB&T's core businesses are residential construction and development lending and home mortgage finance. BB&T is organized conceptually as a group of community banks, and our focus is on local small and midsize businesses. Residential builders and developers fit into this category. We have been in this business for many years, with outstanding results—low loan losses and excellent economic returns. The bank even weathered the significant real estate corrections in the early 1990s.</p> <p>Even with this very positive historical pattern, in the summer of 2005, our management team was becoming concerned about the residential real estate market. House prices were rising too rapidly. It was obvious that "get rich quick" speculators were taking a bigger role in the market. In some communities, home prices had gone above affordability. What should we do? Would it be fair to our builder customers to just stop providing financing, which would put them out of business? If their business was doing well, how could we convince them that times might get tough? How about our residential lenders who work for the bank? They do not want to make their builder clients unhappy. In many cases, the clients are also friends, as BB&T is a local institution for which personal relationships matter. Also, of course, our lenders' performance evaluations are partially based on production goals. Were the bank's lenders going to be unfairly evaluated? A lender could easily leave BB&T and go to work for a competitor bank that had not tightened its standards and potentially move our clients' business to that competitor bank. </div></div><br/> <i>(Continues...)</i> <!-- Copyright Notice --> <div><blockquote><hr noshade size="1"><font size="-2">Excerpted from <b>The Financial Crisis and the Free Market Cure</b> by <b>John A. Allison</b>. Copyright © 2013 by John A. Allison. Excerpted by permission of The McGraw-Hill Companies, Inc..<br/>All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.<br/>Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.</font><hr noshade size="1"></blockquote></div>