Published On:Wednesday, May 05, 2010

THANK you for allowing me, once again, to respond to Professor Horwitz's comments. This will be my last communication on this matter, which has now become an economic jousting match between the Nassau Institute and Dr Rodgers. Although arguing about economic theory and beliefs may be of interest to economists and students of economics, it is not a subject of great interest to most newspaper readers.

I have had an overwhelmingly positive response to my original article on reducing the cost of living in the Bahamas, primarily because this is an issue that impacts 90 per cent of the Bahamian population. The article was written in a format that the average person could understand and, more importantly, it made sense and could achieve the stated goal of reducing the cost of living in the Bahamas.

The opposing views [Nassau Institute versus Dr Rodgers] on my four-point plan for reducing the cost of living in the Bahamas are underpinned by a difference in opinion as regards the role of government intervention in the markets. The Nassau Institute believes in totally unfettered free markets, where the free hand of Adam Smith allows the markets to self-correct. As well, there should be minimal intervention by government in the markets. Furthermore, if there is a problem with the economy, the tendency is to blame government and not the markets.

The United States, until the recent financial crisis and the ensuing great recession, was regarded as the best example of a free market system, incorporating the most sophisticated capital markets in the world. Unfortunately, the system failed and there were many reasons for the failure, including failed economic theory (efficient market hypothesis), faulty derivative models, moral hazard issues, a failure of the rating agencies, excessive bank risk, a distorted incentive and compensation system, a lack of regulatory oversight, fraud and misrepresentation and, most important of all, the absolute unfettered greed of the Wall Street clan.

To quote from Professor Joseph Stiglitz's recent publication, entitled Freefall: "In short, America's financial markets had failed to perform their essential societal functions of managing risk, allocating capital and mobilising savings while keeping transaction costs low.

"Instead, they had created risk, misallocated capital and encouraged excessive indebtednes,s while imposing high transaction costs". The whole world watched as the financial crisis unfolded, and as time passed it became apparent that the crisis occurred because of the reasons cited above. We all now watch as governments in the G-20 countries try their best to put in place the appropriate framework, policies and regulations to lessen the chances of a reoccurrence. We are constantly amazed by the resistance being mounted by the Wall Street clan, through their lobbyists and the Republicans, to the introduction of new financial regulations, and the most recent allegations of fraud and misrepresentation on the part of Goldman Sachs.

I think it should be clear from all of this that the free hand of Adam Smith did not prevent the financial crisis, and that It was the American government's use of taxpayers' money that bailed out the financial institutions from the mess they themselves had created. Had there been no government intervention, then the entire financial system would have collapsed, and with it the free markets. Although the free market system is still currently the best economic model in the world, it is far from the perfect panacea. When it is controlled, manipulated and distorted by a clan of excessively greedy, heartless, immoral, unethical and disingenuous market makers, who have an inordinate influence over governments, along with the regulators, who have heretofore been in their back pockets, then this is a recipe for disaster, as we have just witnessed. Thus the need for better regulations.

Professor Horwitz claims that the current crisis was the "product of government interference with the market in the form of the US Federal Reserve policy, government-sponsored entities such as Fannie Mae and Freddie Mac and other elements of the housing policy. This was not a failure of the free markets".

I will contain my comments only to the above-mentioned entities. The Federal Reserve, contrary to popular belief, is a privately-owned entity. The name 'Federal' is totally misleading as it is not government owned. The Fed is actually owned by a consortium of 300 private shareholders, inclusive of Goldman Sachs, JP Morgan, the Bank of England, to name a few. As a matter of interest, former Fed chairman, Alan Greenspan, was formally employed by JP Morgan, and the present Secretary of the Treasury, Timothy Geithner, was formally head of the New York branch of the Fed.

The Fed has many responsibilities, one of which is oversight of the major banks, inclusive of Goldman Sachs and JP Morgan. The Fed is an autonomous body, solely responsible for monetary policy, whose main stated goals are the control of inflation and a monetary environment that fosters employment.

There is, however, an incestuous relationship between the Fed and the banks, because supposedly it is responsible for oversight of the same banks who actually own it. This is the reason why former Secretary of the Treasury, Hank Paulson, selectively gave so much of the TARP money to Goldman Sachs [where he was once the former chief executive], JP Morgan and AIG, which was an insurance company and not a bank, but was holding the other end of credit default swaps, primarily for Goldman Sachs. It was these same TARP dollars that ensured the rapid recovery of these two investment banks from the financial crisis, and their return to profitability far more rapidly than their competitors, which were not part of the Wall Street clan. Furthermore, former Fed chairman Greenspan admitted that he believed in free markets, but that the financial models he relied on during the housing bubble were faulty. He was also one of the main supporters of ARM [adjustable rate mortgages0, which contributed in a big way to the housing bubble and its eventual collapse.

Professor Horwitz's claim that government intervention (in the form of the Community Reinvestment Act [CRA]), which was passed to increase household ownership by the poor through increased lending to the same, and the involvement of Fannie Mae and Freddie Mac, were implicit it the financial crisis. In fact, both Fannie Mae and Freddie Mac are privately-held entities, and whose mandate, according to Professor Joseph Stiglitz, was for "conforming loans" to the middle class.

"The banks jumped into subprime mortagages -an area where, at the time, Freddie Mae and Freddie Mac were not making loans - without any incentives from government. Moreover, default rates on the CRA lending were actually comparable to other areas of lending, showing that such lending, if done well, does not pose greater risks," Professor Stiglitz said.

Perhaps the following will clarify our differences of opinion on the velocity of money and the money supply. My point is simply this: In the Bahamas today we have what I refer to as structural inflation, which means that the prices of all goods and services are much higher than they should be because of our tax structure (import duties), the monopolies of the retail banks (the high cost of money), the utility companies (the high cost of electricity and telephone services), and exchange controls (which limit Bahamians' fundamental right to the mobility and most efficient use of their financial resources).

If we eliminate import duties, the cost of local products and services would be reduced and there would be more demand for the same. This would increase demand (consumption) with a corresponding increase in GDP. Also, by reducing the cost of electricity through the use of nuclear power, not only would the cost of living be reduced, but overnight our tourism product would become far more competitive, while any industrial production that is highly reliant on electrical power would become more feasible.

In terms of the money supply, the entire credit or availability of Bahamian dollars are dependent on the US dollar reserves in the Central Bank of the Bahamas. With the present exchange control system, if the supply of these reserves begins to fall, then the Central Bank inevitably applies moral suasion to the retail banks in order to curtail credit and in so doing decrease imports and thus the demand for US dollars. Therefore, the more people shop at home, the less of a drain there will be on our foreign reserves, both at the retail and wholesale level. In other words, there would be less drain on our US dollar reserves or US money supply.

My final point is that there are far more rules and regulations in the US compared to the Bahamas, even though, over the past 30 years, there has been selective deregulation in the financial services sector. There are still some essential financial regulatory laws that are in place in developed countries, yet still lacking in the Bahamas. The two most important are truth in lending laws and antitrust laws. The former ensures that the banks truthfully inform the customers of the correct interest rates on loans, and the latter helps to ensure there is competition in all sectors, so that the consumer receives the best product at the lowest price. One can always argue about the effectiveness of any law or regulation with regard to the purpose for which it was created, but without laws and regulations the free hand of Adam Smith will be overshadowed by the greedy and manipulative hand of the financial corporatocracy.