The flaws behind John Howard’s defence of capitalism

John Howard, former Prime Minster of Australia, today writes a detailed defence of free market capitalism for Conservative Home defending, in the process, Conservative party economic policy, executive remuneration levels, and attacking US Government policy to encourage the provision of mortgage loans. Left Foot Forward fisks the five key points in the article.

John Howard, former Prime Minster of Australia, today writes a detailed defence of free market capitalism for Conservative Home defending, in the process, Conservative party economic policy, executive remuneration levels, and attacking US Government policy to encourage the provision of mortgage loans.

Left Foot Forward fisks the five key points in the article.

Point 1:

“Britain’s Conservative Opposition, eschewing the customary timidity of Oppositions which have big poll leads, showed much courage in spelling out in such detail, at its recent annual conference, proposed expenditure cutting plans, if it wins government.”

The Opposition has done no such thing. The detail was lacking at Conservative party while some measures, including savings from pensions reform, unraveled within a week. Meanwhile, George Osborne’s approach to economic policy has, in recent weeks, been criticised by central bankers, by the City and business leaders, by the leader writers of the Financial Times. and even today by  Simon Heffer who writes “Mr Osborne is set to become Chancellor of the Exchequer not because he is a great economic thinker or strategist, and not even because he understands economics, but because he is Mr Cameron’s chum”.

Point 2:

“Even more important, is the challenge to understand the reasons for the great financial meltdown of 2008, and not be seduced by the false argument that it was caused by a systemic failure of free market capitalism”

The systemic failure of free market capitalism has been noted by, among others, historian Niall Ferguson who wrote:

“As long as there have been banks, bond markets, and stock markets, there have been financial crises”;

Or Nobel Prize winner Joseph Stiglitz who wrote the day after the collapse of Lehman Brothers:

“America’s financial system failed in its two crucial responsibilities: managing risk and allocating capital. The industry as a whole has not been doing what it should be doing – for instance creating products that help Americans manage critical risks, such as staying in their homes when interest rates rise or house prices fall – and it must now face change in its regulatory structures”

Or perhaps Financial Times columnist Martin Wolf who wrote, “recognition of the systemic frailty of a complex financial system would be a good start.”

Point 3:

“The issue of executive remuneration is, for example, a complete distraction from the real issue. I hold the conventional market view that remuneration is something for owners or shareholders to decide.”

Mr Howard is at odds here with most international thinking on the issue. The G20 has agreed to “implement strong international compensation standards aimed at ending practices that lead to excessive risk-taking”. Meanwhile, the independent Federal Reserve Board unveiled rules last Thursday to “designed to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of their organizations.” CEO pay has continued to outstrip median earnings over the last decade.

Point 4:

“If one accepts that the origins of the meltdown lay in the state of the sub-prime lending market in the United States, then it is impossible to absolve government intervention, both through the Congress and otherwise, from a large share of the blame for the development of lending practices whereby loans were made to people who never had any real capacity to service the principal and interest payments on those loans.”

This argument has been continually peddled by right wing commentators in the US who lay blame for the crisis at the door of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). These organisations had been in place since 1968 and 1970 respectively. The financial crisis arose because of the securitisation of subprime mortgages which accelerated in the mid-1990s. According to research by New York University and the Federal Reserve of Cleveland, the total amount of mortgage-backed securities issued almost tripled between 1996 and 2007, to $7.3 trillion. Meanwhile, the securitized share of subprime mortgages increased from 54 per cent in 2001, to 75 per cent in 2006. Indeed, Business Week has written that “Fannie Mae and Freddie Mac were victims of the credit crisis, not culprits.”

Point 5:

“If I may be forgiven for saying so, the fact that Australia has performed rather better than most, experiencing only one quarter of negative growth, was due largely to the robust fiscal position of no net debt and a budget surplus, which the Government I led bequeathed to our successors, when we left office.  It was partly for these reasons that Australia ranked number one in the 2008 Prosperity Index.”

In fact, the advoidance of a sustained recession was due, according to economists, to Australia recording its biggest ever trade surplus in the final quarter of 2008. A press release accompanying the 2008 Legatum Prosperity Index noted that “[Australia] has reinvented itself as a wealthy, service-oriented economy with good scores on liveability indicators, including health, charitable giving and effective governance.” Neither the budget surplus nor debt levels were mentioned.

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6 Responses to “The flaws behind John Howard’s defence of capitalism”

  1. Will Straw

    Fisk on @leftfootfwd @timmontgomerie: ConHome is honoured to have ex-Australian PM John Howard writing for us

  2. Rory

    So basically, because lots of people, including Simon Heffer, disagree with him, that means John Howard is wrong? This does not strike me as a very sophisticated method of argument.

  3. Howard Reed

    Howard’s point 3 – “leave it to the owners/shareholders” – is precisely what got us into the economic meltdown for 70 years. He’s talking as if the Credit Crunch never happened – which makes sense of course, because in his worldview, it wasn’t meant to happen. Australia’s economy and its trade balance has benefited massively from large reserves of raw materials, huge demand from China for those raw materials and high commodity prices – all of which had nothing to do with John Howard and everything to do with being in the right place at the right time with the right commodities.

  4. Dan_Humphreys

    Got to love this especially the 'even' Simon Heffer bit, because we all know how much he loves George Osborne! Fail!

  5. David Cameron

    George moping about today. His feelings still smarting from this (especially the part about being my chump)

  6. Niklas Smith

    Just a quick point on Point 4: Much as I dislike the man in general, Mr Howard is actually right on this.

    a) Fannie Mae (founded in 1938 – it was privatised in 1968) and Freddie Mac actually constituted the entire secondary mortgage market until securitisation took off. They were always in the business of buying mortgages off originators and often selling them on. They used to make their big profits from guaranteeing these packages of loans that they sold on and charging a fee for this.

    b) They both distorted the market because of their government guarantee, which made their guarantees on mortgages essentially a federal government guarantee and allowed them to borrow cheaper than any bank or savings and loan cooperative could. This guarantee and some juicy tax exemptions allowed their private shareholders to make a mint despite putting up too little capital, leaving a lot of risk in the hands of the American taxpayers.

    c) Under the Clinton administration, the Housing Department began to draw up targets for Fannie Mae’s and Freddie Mac’s mortgage portfolio in 1995. In 1999 then Housing Secretary Andrew Cuomo raised the target for lending to people of below median income for their area from 42% to 50% of Fannie and Freddie’s operations, with the share going to very low income households up from 14% to 20%. In order to achieve this target, Fannie Mae set up a subprime mortgage programme with 24 banks to roll out mortgages to people who would not usually qualify. (This was certainly not the first instance of subprime lending in the USA, but it market a departure from the standards that Fannie and Freddie had previously followed.)

    d) By 2007 Fannie and Freddie were trying to redefine the term “subprime” so that previously subprime loans were classified as prime. The chief risk officer of Countrywide told analysts in a conference call that his company was selling mortgages to Fannie Mae that were “far below” even generous limits for subprime but were considered “prime” by Fannie.

    e) Business Week is not really correct: Fannie and Freddie owned junk loans and securities based on them (anyone remember those lovely CDOs?) worth over $1 trillion – more than a fifth of their portfolio. Without greed and short-sightedness on the part of their shareholders and idiotic pressure to lend from both Republicans and (especially) Democrats they would not have had to hold any of these.

    f) A similar organisation in Sweden has also contributed to loosening lending standards. The state-owned mortgage lender SBAB was the first in Sweden to introduce 95% mortgages and has started lending people their deposit as well. As with Fannie and Freddie, its implicit government guarantee gives it cheaper funding than its competitors, and its capital base is worryingly thin.

    New ideas for regulation of finance are certainly needed, but we must start with getting rid of distorting government guarantees – especially when they benefit shareholders rather than consumers. A highly developed financial system such as ours, America’s or indeed Sweden’s has no need of a government-backed mortgage company (let alone two!). Surely the lesson of this whole debacle has been that we need to have better lending standards, not looser ones?

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