Sunday, October 26, 2008

D.C. v. Heller Revisited

A friend of mine recently sent me this article from The New York Times:

The article presents arguments critical to Justice Scalia's majority opinion in D.C. v. Heller from the right.

The gist of the article is that the Justice Scalia's opinion in Heller is politically motivated and at odds with an originalist interpretation of the Constitution. It is an example of judicial activism on the right, the way Roe v. Wade is an example of judicial activism on the left. The argument runs that it makes a mockery of federalism by restricting the states ability to establish their own gun laws (as Roe restricts the states ability to have their own abortion laws).

Those that have read my post from April 26, 2008 ( will already know that I disagree with this view. I came to the same conclusion, by the same reasoning as Justice Scalia did.

Unlike Justice Scalia, who is an avid hunter (I think he's even survived hunting trips with the Vice President), I have never and will never own a gun. I don't hunt and I detest handguns. The only purpose of a handgun is to shoot a person, and I would agree no one needs one. I would favour the DC handgun ban, if I thought the Constitution allowed it. I came to the conclusion that it didn't independent of any political pro-gun agenda.

Justice Scalia's decision does not impair localities ability to regulate ownership - in the same way speech is still regulated (no profanity on publicly owned broadcasting venues, speech that incites violence isn't protected, speech that creates a danger (the old, "yelling fire in a crowded theatre,") isn't protected and slander isn't protected). In my view, there is nothing different about the right to keep and bear arms (which the framers clearly viewed as an individual right) and the right to free speech, free assembly, a free press, or freedom of religion. They are all quite explicit in the Bill of Rights. I agree with the point, later in the article, that comparing D.C. v. Heller with Roe is unfair because gun rights are explicitly mentioned in the Constitution and abortion rights are not.

I can see how some would view the decision (DC v. Heller) as activist. The idea that this decision is an assault on federalism is certainly a very originalist way of looking at the issue as the Bill of Rights was initially felt to apply only to federal law (and therefore the original interpretation to the 2nd Amendment is that the federal government shall not infringe the right to keep and bear arms - important because of the preceding clause that explains the reason: so that States will always have an armed citizenry to resist a federal standing army if necessary). Jefferson and the Democratic-Republicans viewed the Alien and Sedition Acts as unconstitutional, and they were, but after they were repealed there will still plenty of state sedition laws viewed completely acceptable under the Constitution that provided that only the federal government couldn't restrict speech or the press.

However, the 14th amendment changed all that. The equal protection clause mandates that those rights extend to everyone equally, in any state. So now state legislatures can't pass laws restricting free speech, free press, free assembly and so on. The argument from the right against Scalia's decision is an argument that they should be able to. In my view, if the 14th amendment extends all other rights guaranteed in the Constitution into every state and locality, it does so for second amendment rights as well, just as Scalia observed. We would not tolerate a different law with regard to free speech in New York city compared to Wichita Falls, Kansas would we? There are perhaps good reasons to have different gun laws in those two places, but the Constitution, extended to the states by the 14th amendment, forbids it.

I am not in favour of a national gun ban. I am, in priniciple, in favour of letting states and localities figure what gun laws work best for them as the critics of the Scalia decision suggest. I would be all for a constitutional amendment that restricted the second amendment to the federal government and allowed states and localities to be autonomous on this issue. But, I remain convinced that it takes an amendment to do that, and to do it without an amendment sets precedent that puts the remainder of the Bill of Rights at risk.

Tuesday, October 14, 2008

Anatomy of a Financial Crisis

Two weeks ago, Congress passed a $700 billion dollar spending bill to buy mortgage loans in danger of default. Doing so bailed out numerous lenders who made these risky loans and will require the federal government to figure out a way to realize payment on these loans. The purpose of bailout was to prevent the financial collapse of the nation’s mortgage companies and banks. The move comes after purchasing the failing AIG and was aimed at preventing a massive credit crunch as loans would default, banks would collapse and failing companies would send the stock market in a tail spin. There would be no money to lend, no loan that would be considered safe, stockholders (and people with a 401K) would see their savings evapourate and a run on banks could jeopardize cash savings as well. This crisis, we were told, had the potential to develop into the next Great Depression.

Our politicians have a penchant for labelling everything a “crisis.” Whether it is the tide of illegal immigration, or the number of Americans without health insurance; whether it is the war on drugs, or the war on poverty; whether it is the threat of WMD in Iraq or the threat of global climate change; we are always told by our leaders that the sky is falling and only decisive action by government can fix the problem. Although our political leadership has, “cried wolf,” on many occasions, it is easy to see how the current situation could degenerate into the misery described above. Whether or not the government’s action will stop this economic collapse is, of course, another story.

What has been missing, however, from the rhetoric of both the President and the Congress and from most politicians on both sides of the aisle, is a frank discussion about how we got to this point in the first place. Politicians on the left have, predictably, laid the blame on greedy predatory lenders who took advantage of folks to make a quick buck. They argue that this is what naturally follows from too little regulation of the economy and that if only the government had regulated the mortgage industry more tightly then all of this could have been avoided. The current situation is a failure of deregulation. Even the Republican candidate for Vice President railed against the, “greed and corruption on Wall Street,” during the Vice Presidential debate. Almost no one has the political courage to assign any blame to the borrowers that took out mortgage loans that were beyond their means.

Although both lenders and borrowers are clearly at fault here, the notion that this crisis was created by a lack of government influence in the market place could not be further from true. Our government actively fostered the economic climate that created this housing bubble. Far from being a failure of deregulation, government intervention in the market place had a hand in creating this financial crisis.

The first piece of the puzzle is the Community Reinvestment Act. First passed in 1977 and then modified in 1995 and 2005, this act was passed with the goal of increasing home ownership among the working poor. It requires lenders in impoverished areas to maintain a quota of loans (often subprime loans) to underprivileged individuals. In other words, a percentage of the subprime loans contributing to this crisis were specifically mandated by the federal government. The act requires federally regulated banks to meet the credit needs of the community in which it is chartered by offering mortgage loans to low income families.(1) Although the act specifically states that banks are not required to make high risk loans to meet community needs, a study by the Federal Reserve Bank of Cleveland in 2000 of 143 of the 500 largest CRA-regulated banks revealed that the security of such loans is variable from loan to loan and institution to institution and that, on average, such loans are more likely to default or be unprofitable than other loans.(2) The same study estimated that 25% of CRA loans were, “unprofitable or marginally unprofitable.”(2) The CRA encourages predatory lending in two ways. First, some CRA banks will issue subprime loans to low income families directly because they would still get CRA credit for these loans and improve their CRA rating. Secondly, banks can get CRA credit by securitizing predatory subprime loan, buying them with federally guaranteed letters of credit.(3) Banks can even get credit for making subprime loans to low or middle income individuals that qualify for prime rates.(3) New federal regulations in 1995 and 2002 expanded the CRA, making it easier for smaller banks to participate by focusing on just lending.(4) In 2002, when several states, including Georgia(5), tried to limit credit for subprime lending, federal regulators blocked those efforts.(6)

In addition to the CRA, a 1992 federal law required Fannie Mae and Freddie Mac to devote a percentage of their activities to meeting affordable housing goals(4) and at the height of the housing bubble in 2003-2004 the federal government was directly securitizing nearly half of the nation’s subprime loans through Fannie Mae and Freddie Mac (government subsidized corporations).(7) In 1999, Fannie Mae was pressured by the Clinton administration to securitize more high risk loans, in an effort to expand home ownership among low and middle income Americans.(8) The Clinton administration also moved, in 1995, to allow Fannie Mae and Freddie Mac to count subprime mortgage securities toward their affordable housing goal.(9) Although this directive was later rescinded in 2001, in 2004 the Bush administration raised the affordable housing goal from 50% to 56% and again allowed Fannie and Freddie to count securitized subprime mortgages toward this goal, further encouraging predatory lending. Although some, such as University of Michigan Law Professor Michael Barr would call easing these restrictions on Fannie and Freddie, “an abject failure to regulate,”(9)nothing could be further from the truth. This was no failure to regulate. This was a specific government tampering with market forces to encourage subprime lending as a mechanism for increasing home ownership. President Bush bragged about the success of this policy in his 2004 State of the Union address noting that new home construction was the highest in twenty years and home ownership at its highest levels ever in the U.S.(10) He was, of course, describing the housing bubble that has now burst. Far from being created by an unfettered free market, this bubble was created, intentionally, by government policies aimed at loosening credit to expand home ownership.

However, Professor Barr pointed out that about half of the subprime mortgages were made by lenders not under the CRA’s jurisdiction and another 20-25% were made by small lenders and only later securitized under the CRA (although we have seen how this is a direct result of government policy and encourages predatory lending), leaving only 25-30% if subprime loans made by CRA institutions.(11) Robert Gordon, senior fellow at the Center for American Progress, offers as proof that the mortgage crisis was caused by a lack of regulation a statistic provided by Janet Yellen of the San Francisco Federal Reserve, “Independent mortgage companies, which are not covered by CRA, made high-priced loans at more than twice the rate of the banks and thrifts.”(12),(13) However, this does not negate the fact that CRA lending is responsible for thousands of subprime and high risk loans. In communities where CRA institutions were conservative in lending, there was demand for other institutions to offer higher risk loans.(3),(4) This was also encouraged, actively, by the federal government as we have seen through its mandate to Freddie and Fannie to increase the percentage of their business that is directed to affordable housing goals and by giving other banks incentives to securitize these mortgages by guaranteeing their investments or allowing these banks to claim that activity as CRA credit. Therefore, many of these loans made by independent mortgage companies ultimately do fall under the CRA.(14) But even the subprime lending completely outside the CRA was encouraged by federal government policies. From 2003-2005, the Federal Reserve held interests low, below the expected level of inflation.(15) This reduced the cost of borrowing money dramatically and allowed lenders to offer subprime mortgages with very low introductory, but variable, rates easily. It was a policy that changed market dynamics from encouraging people to save to encourage them to borrow. Furthermore, the Fed lowers interest rates by buying bonds from banks and thereby injecting more cash into the economy. The increased supply in money reduces the “cost,” of borrowing it, or the interest rate. The increased supply in money also devalues the dollar, and we have seen the U.S. dollar plummet in value over the past few years (yet few talk about the fact that it is the policies of our federal government that are responsible for its devaluation). Oil is sold on the world market in U.S. dollars, therefore, even without the increased demand for oil from India and China, the rise in oil prices is directly linked to the falling value of the dollar. The Feds’ inflationary policies have not only encouraged the exuberant lending that is at the root of this financial crisis, but they have also contributed to rising energy and food prices, putting an economic pinch on those low income homeowners that the government wanted to have mortgages. When these people can no longer afford to pay their mortgage, put food on the table, heat their homes, or put gas in their car to get to work, all at the same time, they then default or are at risk for defaulting on that loan, and hence the bursting of the bubble and the beginning of the financial crisis. Because many U.S. securities are owned by foreign lenders, this has become an international credit crunch. Another mechanism by which government policy helped create the crisis are government regulations that limit assessment of credit risk to a handful of credit agencies, who inaccurately assessed the risk of these loans, leading to, ironically, the most regulated banks making some of the worst mortgage investments.(15)

In summary, the federal government set a goal of increasing home ownership among low and middle-income families, an ostensibly laudable goal. The government employed several mechanisms to achieve this goal. First, it mandated lending to lower income families through the Community Reinvestment Act. Sometimes this was done responsibly, and sometimes not. Secondly it put pressure on lenders to increase their CRA activity and allowed smaller lenders to participate in the CRA. Third, it subsidized subprime lending, both directly by ordering Fannie Mae and Freddie Mac to securitize more of these loans to increase its activity to meet affordable housing goals, and indirectly by allowing secondary mortgage market banks to count securitized subprime loans towards their CRA ratings. Fourth, it encouraged non-CRA lenders to join the party by keeping interest rates artificially low and fifth, it pumped capital into the economy to lower the interest rates, thereby devaluing the dollar and putting an economic pinch on the lower income families that made the loans. Those that argue that this crisis was caused by a failure to regulate the financial industry are simply wrong. Ironically, those on the left who are blaming the, “deregulatory policies of the Bush administration,” actually opposed Bush administration plans in 2003 to increase oversight of Fannie and Freddie (Barney Frank (D-MA) argued that Fannie and Freddie were not, “facing any kind of financial crisis,” and that, “The more people exaggerate these problems, the more pressure we see on these companies, the less we will see in terms of affordable housing.”)(16) This crisis was not caused by a lack of government oversight. It was caused by government policies specifically designed to create a housing bubble (to increase home construction and home ownership). Alan Greenspan cheered it on,(12) Barney Frank made sure no one put on the brakes,(16) and President Bush bragged about its success.(10) Certainly in a free market, at times, individuals or groups will act irrationally. But, a correction will occur and those who acted imprudently will pay the price, often with minimal effect on the economy as a whole. In the current situation, however, our government encouraged exuberant borrowing and lending, through a combination of mandates and incentives, creating a national economic mess. The lemmings didn’t jump off the cliff, they were pushed. These actions were taken for a good cause, affordable housing, but illustrate clearly the principle that government intervention in the market place often has unforeseen, unintended, negative consequences. This isn’t what happens when the government keeps its hands off the market, this is what happens when your government fights for you.

Unfortunately, understanding how the crisis occurred is not the same as knowing what to do about it. Much like the invasion of Iraq, the mess was caused by misguided policies but how to clean it up isn’t as obvious. Personally, I am inclined to be distrustful of government action to, “fix,” the problem, since it was government action that created it in the first place. I am distrustful of this government when it tells me there is a crisis that requires immediate governmental action, for history shows that usually politicians call something a crisis that isn’t simply to expand the government’s (and therefore their own) power. Certainly many on the left are taking just that opportunity right now, using the current situation as an excuse to expand the government’s influence in the market place (so we can have more crises like this in future). And of course it really irritates me that the solution proposed is to bailout all those greedy lenders (who, yes, do share responsibility with the federal government) who made risky loans and now don’t have to pay the price for taking a risk (which will encourage similar risky economic behaviour in the future because it is without consequence). Where is this $700 billion dollars coming from? Our Treasury certainly doesn’t have this money as our federal government is in debt. I suspect the Federal Reserve will simply print it, further devaluing the dollar and causing greater inflation (the value of the dollar compared the British Pound and the euro has increased over the last week because national banks in Europe have already pumped large amounts of capital into their economies and devalued their currencies). And, as I write this, President Bush is proposing another cash injection to capitalize banks by having the government buy ownership shares in the nation’s major banks (alas, we are back to the 200-year-old Hamilton-Jefferson debate about whether or not there should be a national bank…). Those of the Austrian school of Economics, such as Loyola College (Maryland) economics professor Thomas DiLorenzo and Congressman Ron Paul (R-TX) would argue that this bailout only has the effect of prolonging economic misery by attempting to stop, but only delaying, a necessary correction in the market (in his book, How Capitalism Saved America, Professor DiLorenzo argues that the market interventionism of both Presidents Hoover and Roosevelt extended the duration of the Great Depression, whereas previous economic crises had been much briefer).(17),(18) While I am convinced that this is true and that allowing the market to correct would be quicker, the real question is, at what cost? Would the losers be only those who acted irresponsibly, or does the crunch in credit have the ability to affect those who did the right thing, as illustrated in the opening paragraph. If the savings of those who were fiscally responsible are at risk in the correction, then that, in my view, is market failure and I would be willing to sacrifice my laissez-faire principles if it would prevent another Great Depression. But how can we trust that our leaders will do the right thing (even if the right thing is doing nothing) when they are always telling us of crises government needs to address, demonstrate so little understanding of how this crisis was created, and use the crisis to advance a pro-regulatory political agenda? Understanding the genesis of the crisis may not help us determine the best course of action (or inaction) to take going forward, but it does tell us something useful about future policy. The lesson to learn here is that this kind of government interventionism in the market place that creates artificial incentives to promote certain economic behaviour and devalues our currency, leading to boom and bust business cycles, has got to stop.

See also: for another nice summary of how government policies helped create the housing bubble.(19)
(1)Full text of Community Reinvestment Act available at:
(2)Avery RB, Bostic RW, and Canner GB, “The Performance and Profitability of CRA Regulated Lending,” Economic Commentary, Federal Reserve Bank of Cleveland [November 2000]. Available at:
(3)Engel KC and McCoy PA, “The CRA Implications of Predatory Lending,” Fordham Urban Law Journal, Vol. XXIX, April 2002. Available at:
(4)Bernanke BS, “The Community Reinvestment Act: It’s Evolution and New Challenges.” Speech at the Community Affairs Research Conference in Washington, D.C., on March 30, 2007. Available at:
(5)Georgia Fair Lending Act.
(6)Bagley N, “Crashing the Subprime Party: How the Feds Stopped the States from Averting the Lending Mess,” Slate, January 24, 2008. Available at:
(8)Holmes SA, “Fannie Mae Eases Credit to Aid Mortgage Lending,” The New York Times, September 30, 1999. Available at:
(9)Leonnig CD, “How HUD Mortgage Policy Fed the Crisis,” The Washington Post, June 10, 2008, p. A01.
Available at:
(10)Bush GW, State of the Union Address to Congress at the Capitol in Washington D.C. on January 20, 2004. Available at:
(11)Barr MS, “The Community Reinvestment Act: Thirty Years of Accomplishments, but Challenges Remain,” Testimony before the Committee on Financial Services, U.S. House of Representatives on February 13, 2008. Available at:
(12)Gordon R, “Did Liberals Cause the Sub-Prime Crisis?” The American Prospect (on-line), April 7, 2008. Available at:
(13)Yellen JL, Opening Remarks to the 2008 National Interagency Community Reinvestment Conference. San Francisco, California. March 31, 2008. Available at: (statistic referenced in the Gordon article is actually in footnote 16, not the text of the speech).
(14)DiLorenzo TJ, “The CRA Scam and It’s Defenders,” Ludwig von Mises Institute, Daily Article for April 30, 2008. Available at:
(15)“A Mortgage Fable,” The Wall Street Journal, September 22, 2008. Available at:
(16)Labaton S, “New Agency Proposed to Oversee Freddie Mac and Fannie Mae,” The New York Times, September 11, 2003. Available at:
(17)Paul R, “Bailouts Will Lead to Rough Economic Ride,” CNN Commentary (online), September 23, 2008. Available at:
(18)DiLorenzo TJ. How Capitalism Saved America. Crown Forum 2004.
(19)Roberts R, “How Government Stoked the Mania,” The Wall Street Journal, October 3, 2008.