The Main Causes of the Housing Crisis and the Financial Meltdown

Previous student question:
For years, I have always believed that some of the government regulation in place has not worked well and has distorted the economy and the financial market.

I also feel the problem of the current weak economy and the on-going housing troubles includes regulatory inadequacy. Is there no regulation in place when it comes to the mortgage industry? If there is, then why did the banking regulators in 2008 look the other way when mortgages were given to people who were unable to afford the loan or unable to understand the fine print? 

My response:

The politicians in charge of executing the banking regulations and in charge of the banking regulators were doing three things that interfered with their ability to enforce a reasonable rule-of-law. One does not find much mention of these activities in the left-leaning, economically-challenged mainstream media. Did you know that a significant number of new mortgages issued during the few years prior to the housing collapse were indirectly sponsored by the government?

1) Those same politicians were accepting political contributions (conflict-of-interest?) from the very mortgage-holding organizations, Fannie Mae and Freddie Mac, two Government-Sponsored Enterprises or GSEs, those politicians were supposed to be regulating. If one checks the facts and follows the money, they will notice that the prominent politicians Chris Dodd (Chairman of the Senate Banking Committee 2007- 2011), Barney Frank (Chairman of the House Financial Services Committee 2007 – 2011), and Barack Obama (Member of the Senate sub-committee on Federal Financial Management 2004 – 2008) were among large recipients of these monies in the mid-2000s.

2) Those same politicians were also insisting that American banks comply with banking laws that used skin color or last names or geographical locations as the criteria for banks to loan mortgage money instead of insisting banks ascertain whether or not these types of new clients were likely to be able to repay the mortgage loan.

3) You are correct that these politicians were looking the other way because they were worrying about whether they were pandering well enough (the real reason for passing ethnic-group membership banking laws) to earn re-election exactly when the voices of many were urging immediate action, because they could clearly see that Fannie Mae and Freddie Mac were near collapse. Do we need new and better banking regulations? Perhaps we do. Do we need better enforcement of the reasonable banking regulations already in place? Of course we do.


Passing new, tough legislation can be spun by a politician to show that the politician is doing something about an obvious problem. On the other hand, simple enforcement of reasonable regulations is not sexy, nor is it helpful to extracting maximum political contributions from those entities being regulated. (See numbers 1 and 2 above.)

The three political activities enumerated above contributed mightily to the financial crisis that we Americans are still mired in. Oh yes, there is always “greed” or the normal capitalistic draw of profit to be made (Adam Smith call this draw, “self-interest”), but that incentive is mostly a constant, while what I cited above is what I see as the primary reasons causing the housing and financial crisis. The notion of profit to be made did not change much and is what it always should be in a capitalistic society.

Making more profit is only a secondary cause of the current housing and financial crisis. But please notice who is mostly blamed — the secondary contributor, i.e., the banks seeking profit, when the primary culprits (greedy politicians) are let off the hook by the left-leaning, economically-challenged mainstream media.


The Wonder of The Free Market – 3

The Wonder of The Free Market – 3

Question from MBA Candidate  (student) – “But can citizens and the free market really fix themselves? A comment from the website of the Department of Justice (2011) states that the competitive process, which is found within free markets, only works when competitors set prices honestly and independently.”

I guess I’m partial because I work for a state agency, but they do have their benefits. True, when the government steps in, their intervention never seems to be truly successful, but we as humans are imperfect, therefore an imperfect market exists; when there are such practices as price-fixing and bid-rigging, then that tells me there are flaws everywhere.

(2011) Price fixing, bid rigging and market allocation schemes.  Retrieved from

PJU Response:

Basically, you are pointing out illegal ways that some people try to manipulate price, and just like you, I agree this illegal behavior calls for government action. But it does NOT call for government price intervention, rather 1) either putting people in jail or 2) heavily fining them for violating the rules of the game or 3) otherwise removing them from the marketplace. Just like you, I want and the free market needs, in fact demands, regular and reasonable enforcement of a reasonable rule-of-law that fosters competition.

A different take from the DOJ website might be that free markets only work when government enforcement reasonably and regularly enforces a reasonable rule-of-law such that competitors firms feel free to set honest and independent prices.  A meaningful motto might be: Government price intervention – never! Government refereeing, of course!

However, perhaps you might read this DOJ comment more carefully. First of all, the only way free markets really work is that almost all firms are price-takers, not price-makers or price-setters. This observation does not include monopolies, which are almost all heavily regulated by local, state-wide or regional government regulatory bodies, like corporation commissions. Or cartels like OPEC, which manipulate supply, therefore manipulate price, and which entities are outside of the reach of US law enforcement.

Yes, I agree that someone in the firm sets a price for the firm’s product or service, then the consumers in the marketplace either buy the product or service, on not. But these type of ‘price-setters’ are really only gauging the market and mechanically setting a price at what they think the market will bear.

Take bread, for instance. If your grocery store started charging eight dollars a loaf for bread you could buy bread loaves at a dozen other nearby places for four dollars a loaf, how much of the eight dollar loaves would you buy? None, right? Why?

Because the free market, without government intervention, sets the price, based on supply and demand interaction and either your firm follows, or your firm might reap zero revenues. This is true with almost any product or service, as long as there is a free market. This price mechanism is called the “invisible hand” and is the hallmark of free markets.

Collectively, imperfect human beings DO NOT create imperfect markets very often, if the government wisely referees. Unless they are not truly free markets, of course, which is what happens when the government intervenes!!!


Will America or China dominate the 21st Century?

Will America or China dominate the 21st Century?

China’s per capita GDP today is close to $4,000, about 20 times more than in the 1970s, moving that country’s overall GDP directly behind America’s.[i] Teng Hsiaop’ing, Mao’s pragmatic successor, pushed wide open the spout of market forces flooding economic growth across China. Will China’s economy inevitably surpass America’s?

Teng Hsiaoping’s motto, “Socialism, with Chinese characteristics”[ii], granted a market economy to China, providing ordinary Chinese incentive to become wealthy. If you check the encyclopedia to see what the typical entrepreneurial risk-taker looks like, you see the picture of a regular Chinese citizen. But will economic freedom, without meaningful political freedom, be enough to sustain China in the future?

Milton Friedman states that “economic freedom [is a] necessary condition for political freedom” and that the relationship is “not unilateral”.[iii] Friedman insists on a bilateral relationship between economic freedom and political freedom. Therefore, until China provides its citizens political freedom, the seemingly boundless Chinese economic growth will someday screech to a halt, a prediction Gordon Chang made years ago.[iv]

Political freedom means government does at least these three things:

1) holds regular free elections,

2) enforces a reasonable rule-of-law, and

3) protects individual rights, including property rights.

Yet contrary to nurturing political freedom, the government of China has not seriously enforced trademarks and copyrights[v] and regularly turns political dissenters into political prisoners.[vi] Chinese governmental actions today are not expanding political freedom among Chinese citizens, nor are free elections an option yet.

Does the current authoritarian regime in Beijing represent the natural state of government Chinese citizens prefer? Ancient, influential Chinese philosophers like Laozi and Mencius both advised that the best government stays distant and doesn’t micromanage, definitely NOT the current nanny-state approach.[vii]

The bloody “Arab Spring” in progress substantiates George W. Bush’s once decried declaration that every human heart desires freedom and liberty[viii], as authoritarian and totalitarian regimes across the Middle East are challenged by ordinary citizens. Is China different?

The short answer is … no. Recently, Walter Russell Mead opined that the 21st

Century will belong to America. “… Pundits keep telling us it is … a time of America decline. … Crippled by debt at home, hammered by the aftermath of a financial crisis, bloodied by long wars in the Middle East, the American Atlas can no longer hold up the sky. … Geopolitically, the doomsayers tell us China will challenge America’s leadership throughout the world.” [ix]

Tellingly, Mead proclaims that America, NOT China, is best positioned to respond to the unpredictable, fast-paced technological challenges facing the world during the 21st century. As Milton Friedman might argue, the virtuous cycle of economic freedom begetting political freedom will allow Americans to prosper mightily in the future.

Contributing to China’s boom are infrastructure and construction projects presently underway. Less obvious, but accompanying, is the existing process of capital allocation in China. In America, private markets allocate capital based on the marketplace evaluating feasible projects, whereas the autocrats in Beijing, employing the best principles of crony capitalism, usually make that decision.

Plus, 30 years of unintentional technology transfers[x] and a recurring reluctance by China to enforce intellectual copyrights and trade secrets[xi], has unwittingly caused the West to contribute significantly to China’s macroeconomic growth the last three decades. Yet China’s booming economy has not produced greater political freedom for the Chinese citizen, once a hoped-for consequence of economic growth.[xii] Moreover, in 2010, America imported $365 billion of goods from China, about 8% of China’s GDP, and 2011 imports are running 15% ahead of 2010’s.[xiii]

Today finds many billions of dollars of uncollectable state-owned enterprise debt on Chinese banks’ balance sheets.[xiv] Instead of “creative destruction”[xv] going on in China, we have speculative buildings built, torn down, then different buildings built on the same property, one sure way to boost GDP figures.[xvi]

Milton Friedman points out “economic growth has become [an] … excuse for widening government intervention in economic affairs.”[xvii] History tells us government picking marketplace winners and losers causes economic stagnation over time, not robust economic growth.

Americans for 235 years have risen to meet all the challenges that have come our way.  As long as both political and economic freedoms remain honored here, America will stay on top.




3 Capitalism and Freedom by Milton Friedman, 1962, p4 & p10.

4 The Coming Collapse of China by Gordon Chang, 2001.

5 Fraud Magazine, January/February 2011, Volume 26, p32, “Countering Corruption in Intellectual Property Cases.

6 See Liu Xiaobo and Ai Weiwei, adfinitum. Wall Street Journal, June 23, 2011, “The House Prisons of Beijing.”

7 Wall Street Journal, July, 6, 2011 The Ancient Roots of Chinese Liberalism





12 Talk by Clark Dewaal given c. 2007 in Mesa, AZ. Dewaal was a former BYU Professor who spoke fluent Mandarin and served as a banker in China during the 1980s and 1990s.


14 Fraud Magazine, January/February 2011, Volume 26, p32, “Countering Corruption in Intellectual Property Cases.

15 UOP ECO 360 Lecture 1 by Paul Updike, 2001.


17 Capitalism and Freedom by Milton Friedman, 1962, p37

Milton Friedman Freedom Essay July, 15, 2011, by Paul J. Updike


Theory or Practice, Which Matters?

Theory or Practice, Which Matters?
STUDENT QUESTION:  I do understand that there is something special you get from experience that you cannot get from a book or class, but with classes having more hands on approaches can you think of something specific experience can give a person that pure education cannot?

MY RESPONSE: That’s an easy question. If one looks at the textbook, they will find that the textbook writer, a highly educated Ivy League Professor, David Colander, talks about economic theories as if they are all created approximately equal, except Keynesian Theory, which theory he really likes. Colander has probably forgotten more about various economic theories than most regular people have learned. And in my opinion, he is one of the best textbook writers I have ever read.

But here is the difference. I have found myself in the trenches with companies actually executing according to a  forecast that did not fit reality. When one is in the middle of a turbulent stream paddling for dear life, one does not worry about whether a theory may or may not apply, but whether you are paddling hard enough. When death and destruction try to muscle into your space, then you adapt to reality in ways that theory never prepared for or even contemplated.

Keynesian Economic Theory
Let’s apply this to reality. In the last 75 years the main concepts of Keynesian Economic Theory have been applied over and over again in the American economy starting with the Great Depression. Politicians who enjoy spending taxpayer’s money really like that Keynesian Economic Theory justifies big government and more or less unlimited  government spending. Yet an honest analysis of the last 75 years shows that Keynesian Theory does not work as advertised, has never worked in America, and therefore, to my small mind, will not work.

The latest example is the $800 billion stimulus bill advocated by President Obama which made it through Congress in early 2009. We were assured by the theory experts that passing the bill and thus applying economic theory would cause the unemployment rate to rapidly fall. Surprise, government spending did not work the way we were promised. Yet one prominent economist, Paul Krugman, (another highly-educated Ivy League Professor) called for a do-over, and said the reason it  did not work was that the package was too small and needed to be twice as large!

But who looks at history? No other economic theory justifies government spending like Keynesian Economic Theory and tenured professors in academia do not worry about their jobs or whether the theories work in reality, just that those theories work on paper. You know, econometrics, elegant curves, regression analysis,  and all that. And Keynesian Theory works quite well on paper.

It is just weird human behavior that we need to adjust, because IT IS NOT cooperating! So the next generation of students will learn Keynesian theory too, I suppose, and the madness continues!

Static Scoring versus Dynamic Scoring
That reminds me of another economic reality. If you want to increase economic activity, then lower tax rates. 100% of my students get that. But the government politicians refuse to study history and do not believe that an increase in economic activity is quickly followed by more government revenues, at lower tax rates. Four times out of four, (it has only been tried in America four times over the last 90 years) or 100% of the time, government revenues have grown with lower tax rates.

Works like a charm in practice, but not on paper. Why does it not work on paper? It is that pesky human behavior again, always changing by adjusting to new tax rates. This is because when we use paper, we use “static” scoring, but with lower tax rates, human behavior changes, so to capture this we must use “dynamic” scoring, which is lots harder and which thing the CBO (Congressional Budget Office) refuses to do.

Bottom line is that though there often is a wide gap between theory and practice, especially as regards economic theory, but unless one is motivated by results, one does not have to be concerned by whether the theory actually works in reality.



Energy Policy, Global Warming and Economics

One of my economic students wondered what all the ruckus was about “Global Warming” and how its might be related to the recent bankruptcy of Solyndra. We had the following conversation.

We can talk about Global Warming, or whatever that notion might be called today, but that is not the point. The point is money, or in the language of economics — supply and demand interaction, specifically.

Alternative fuels like solar, or wind, or thermal, or wave power, are not cost efficient at this time. Production costs are high, demand is low and therefore the price willingly paid by consumers is also low.  That is why Solyndra asked for and got over $500,000,000 in government loan guarantees, then filed for bankruptcy a few years later, because their product was not selling. These alternative fuels mostly exist today because of government subsidy — not because entrepreneurs are getting rich producing them.

Why does the government subsidize alternative fuels?

Good question. Perhaps it is because burning oil and natural gas produce carbon dioxide (CO2) emissions that ends up in the atmosphere, which is bad. Don’t forget, coal fuel burns carbon too, producing more CO2 emissions, so more bad, because when CO2 gets into the atmosphere, climate changes occur, according to many scientists.

BTW – If you are concerned about the approximate doubling in gasoline prices during Obama’s four years in office, you may not want to raise those gasoline price increase issues with Obama’s Secretary of Energy, because he (Steven Chu) likes the price increases as government subsidies for alternative fuels paid for with taxpayer dollars are more effective today than they were four years ago.

But science is untainted by money or politics, so we can believe scientists, can’t we?

Of course we can, therefore, we MUST use alternative fuels immediately, or disaster lurks. Or does it?

Is there a  mostly cost efficient,”clean” fuel whose burning does not produce CO2 emissions?

Yes, there is – nuclear power, and France produces 70% of their energy using nuclear plants, but that is another story.

Wait, nuclear power  is dangerous, so claimed the movie China Syndrome – and movies only tell the truth, right? Stop please, you are confusing me. What is exhaled by humans when we breathe oxygen?

That is an easy question, CO2. Oops, we humans are bad too, I guess.

But wait, what do plants breathe?

Oh, yeah, CO2. And guess what plants give off during photosynthesis — oxygen, which humans breathe!

Hold on, I am really confused — is there a hoax going on here, or something?  All we need to do is plant more trees and we should be fine? Is this a joke? What about the money trail?

As I said earlier, the entire matter is really related to economics. Billions and billions of dollars are at stake, even trillions of dollars, over whether the taxpayers support alternative fuels as the main energy source to be tapped in the future such that coal, oil and natural gas are supplanted around the world.

Power and control and money are all bound up together with energy policy. If politicians successfully change the energy policy to one they can tax and control, then they can easily find the money for their re-election campaigns. Finding money for election campaigns is a hard and arduous task. President Obama went to over 140 campaign fund-raisers this election cycle. Much easier to change the energy policy and create an endless supply of new energy money by rewarding special interests with political favors you can control.

If you ask the question “who benefits?” when you hear government officials and people like Al Gore demonizing natural gas, oil, and coal, then your picture of what is happening grows clearer. If one follows the money and asks reasonable questions, then the game is up. Look at recent history. Over the last 12 years or so, the temperature of the earth has cooled a bit. In response, the wordsmiths changed the name from “global warming” (since it was no longer happening) to ‘climate change’.

Hold on, how can ‘climate change’ not happen?

Of course climate change happens, but it is just natural and not necessarily harmful.

Are you suggesting that scientists are not telling the whole story? Are you saying that in order to obtain funding (billions of dollars a year) there is a conclusion your research into so-called “scientific climate studies” must draw to be eligible for funding?

Hmm. Drawing a conclusion, before you do the study and amass data to test your hypothesis, is not science. It seems science has been politicized and money is really at the heart of the notion of “Climate Change”.

So what is going on, really?

Another good question. Anyway, is there really such a thing as man-caused climate change? I see too much money and too much power being chased by people who want to influence policy issues to come to that ballyhoo-ed conclusion.

Practical Economics: Squishy Numbers, Economic Indicators & the Mainstream Media

Practical Economics:  Squishy Numbers, Economic Indicators & the Mainstream Media 

Previous Student: 

Actually, I suspect the biggest unknown variable in every model of the dynamic economic forces at work that does not lend itself well to hard data measurement is – Consumer Confidence. We try to put a number on that every month, but is assigning a number truly reflective of reality?

Comments Regarding Soft Data

I wholeheartedly agree. We try to take all sorts of measurements to predict the economy, but I really think Consumer Confidence might be the most important. If people are confident that they will stay employed, that they will have steady income, then they will be more likely to spend or invest money. Yet measuring this confidence is difficult at best.

One important piece of the puzzle, as far as making meaningful economic predictions, is knowing something about consumer sentiment or Consumer Confidence. But Consumer Confidence cannot be measured objectively, period.

What we use is something the University of Michigan has developed called the Consumer Confidence Index. Every month, a certain number of consumers are surveyed and asked similar questions. Their answers are tallied and the end result compared to a base of 100 developed in 1982 or thereabouts. However, no matter how much mathematical care we exert, the monthly Consumer Confidence number is still soft data.

Squishy Numbers

The Consumer Confidence numbers are ‘squishy’ because they are subjective. But Consumer Confidence numbers are measured every month. That allows for some good comparisons, month to month, which removes some of their squishy nature stiffening up those numbers. However, there are also wide swings (cause unknown) from month to month that are more related to ‘mood swings’, than anything else. Remember though, one’s current mood has much to do with one’s current purchases.

The Consumer Confidence number is soft data, while many of the other economic indicators are hard data. The difference is that hard data numbers are counted, like totaling out-of-pocket dollars used or noting the time spent, while soft data numbers are completely subjective, that is, estimated by each person, subjectively, one-by-one.

For instance, soft data numbers are student survey numbers generated at the end of each university class. If you are asked, “on a scale of 0 to 5, zero being ‘never’, 5 being ‘always’, how do you feel about this?”, then the response you give is soft dataSoft data is an attempt to measure feelings or happiness or satisfaction or subjective value, etc.

Measuring feelings correctly is hard to do, but not impossible. At least few in our society thinks such measurement is impossible. However, and this is the critical issue, measuring feelings can be done well or be done poorly. Usually, it is not immediately obvious if the feeling measurement has been done well or not.

‘Hard Data’ and ‘Soft Data’ are NOT similar

Whereas the number of Americans unemployed at a given time can be counted (then estimated, but we assume the approximation is close and statistics tell us it is) by anyone because hard data is not feeling, but something that is counted, with all the attendant problems of counting. Soft data is never really counted per se as it is non-tangible by definition. Instead, because soft data is an attempt to measure feelings, we first try to identify which feelings we want to measure, then we put a number on those feelings, and then those numbers are tabulated.

There is a huge difference between hard data and soft data. I contend that soft data is almost always more important, but always much more difficult to measure. The reason the University of Michigan survey on Consumer Confidence is important is because the survey is done carefully and the same questions are asked over and over again, every month and every year.

The rich irony is often soft data is more important to business success than hard data. We recognize that fact when we say a person’s gut instinct is great. Or we identify that her intuition is almost always right on. Do employees happily anticipate going to work every day or do they dread it? Do you enjoy talking to your boss or do you try to avoid that person whenever possible? Examples of soft data in the workplace abound.

Yet actual difference between hard data and soft data illustrates one of my complaints with the academic study of economics. Some economists pretend that since economics can be subject to rigorous mathematical and statistical analysis, therefore, if we always follow the MC = MR rule (or some other economic principle) under every circumstance, then we will never be wrong. If only life were so simple.

One of the main reasons that economists have many different opinions while using the same information is because many crucial measurements in economics stem from soft data, like Consumer Confidence, which is decidedly NOT hard data.

Mainstream Media Problem

The worst part of this issue is how the mainstream media treats economic soft data and thus amplifies the reality problem. On a non-stop, 24/7 basis, the economically-challenged mainstream media inundates Americans with soft data masquerading as hard data. In fact, I am sure that most people in the economically-challenged mainstream media have little idea there is a difference. And perhaps those that do know better choose to bask in the power of broadcasting misinformation.

For instance, on a daily basis, the value of the overall stock market moves up or down based on the new information coming forward that day. Truly the stock market considers  many squishy numbers and issues daily, then the stock market translates both the soft data and the hard data into only hard data — reflected by a new stock price. But no one besides Warren Buffett seems to have a clue what the exact relationship is. And there are thousands of public companies trading millions of shares every day.

No one has ever been able to discern exactly why stock values move up and down. Yet often a single slice of the daily news (soft data – e.g. the Greek debt situation worsened) is identified by this or that analyst, then that analyst’ opinion is picked up by the economically-challenged mainstream media and confidently deemed the sole culprit causing the up or down movement in the stock price (hard data). This economically unreasonable scenario happens every day.

Likewise, we are constantly bombarded by the economically-challenged mainstream media claiming this soft data poll (usually ignoring relevant statistical issues) to be hard facts or that soft data survey to represent reality, whereas the truth is that what we are being given is tabulated feelings dressed up as hard data. Most people recognize the difference between soft data and hard data, the importance of soft data and the difficulty measuring soft data, but the mainstream media sometimes seems clueless.


May I conclude with a soft data analysis of my own? “On a scale of 0 to 5, zero being ‘not at all’, 5 being ‘perfectly’, how well do you feel the mainstream media is doing at disseminating meaningful information? A generous score from me on this scale would be 0.5, or perhaps 10% of the time, a scarcity largely caused by mainstream media confusion between soft data and hard data.