What a mess

The Constitutionality of the recent actions taken by the Federal Reserve and subsequently the Federal Government comes into serious question when things are looked at objectively. Many of you may know that I have been a staunch supporter of Ron Paul ever since I first heard about him about a year ago. His strong belief in the US Constitution and the limits it imposes on the Federal Government is unmatched, and thus some of his ideas come across as radical and have been portrayed as unpatriotic. However, years ago he correctly predicted that a financial bubble was forming and that action was needed to keep it from getting to the point of implosion, which we are seeing today.

However, this isn’t a political ad. Rather, I wanted to highlight what it is exactly that the Federal Government has done recently, and whether or not these actions are supported by the document on which this country was founded.

Since its founding in 1913 Federal Reserve, through the FOMC (Federal Open Market Committee), has regulated interest rates through the buying and selling of US Treasury notes to and from its member banks. For more on how this works see this page.

One can argue that the presence of a Monetary Policy system where government controls the amount of money in the economy is by definition unconstitutional. But, there are many positives to having such a system, so that debate will be left for another time.

However, it is much easier to see that in the past decade, the Federal Reserve has acted irresponsibly in the interest of Wall Street by setting rates low, providing for the easy borrowing of money. While this was good for corporate America (capital projects become cheaper, investment banks have access to cheap money for creating lucrative investment products, etc), it painted an unrealistic picture for prospective homeowners. People bought homes that they could just barely afford (if they could at all) under the assumption that mortgage rates would remain low. Well, we all know what happened here. The low interest rates also weakened the US Dollar in terms of Foreign Exchange, the long-term affects of which can be extreme political instability. Finally, low interest rates hurts everyone with a savings account – I’ve seen my rate drop 50% since opening my “High Yield Investor Checking” at Schwab.

With the recent actions by the Federal Government to not allow Bear Stearns, Freddie Mac, Fannie Mae, and AIG to fail, we have entered a historical turning point. While one should be cautious with throwing around the word ‘socialist’, that is becoming a more and more accurate description of actions taken in 2008 by the government in response to the financial meltdown in this country.
Let’s look at what has transpired:
Most recently, with the AIG bailout: (taken from a lawsuit filed September 18, 2008 by a New York resident against the the Fed)

• On Tuesday, September 16, 2008, Defendants agreed to an $85 billion bailout that would give the Defendants control of the troubled insurance company American International Group, a private corporation.
• Under the Agreement, Defendants will make a two-year loan to A.I.G. of $85 billion and, in return, will receive warrants that can be converted into common stock giving the United States about 79.9 percent ownership of A.I.G., if the existing shareholders agree.
• In effect, the agreement puts billions of dollars of taxpayer money at risk to protect bad investments made by A.I.G. and other private institutions it does business with as providers of esoteric (unregulated) financial insurance contracts to private investors who bought privately held debt securities. The agreement requires the United States taxpayers, in effect, to cover losses suffered by the buyers in the event the securities default. It means the taxpayers are on the hook for billions of dollars’ worth of private securities.
• On information and belief, Defendant Treasury Department sold $40 billion of special supplementary Treasury bills on Wednesday, September 17, 2008 and will sell $60 billion more today, Thursday, September 18, 2008.
• Defendants are set to give or lend public money and public credit to A.I.G.

These are the legal Facts presented in the case, and I think they speak for themselves. Cliff’s Notes: the US Government is using taxpayer money to buy a private company and assume its risks.

The (lack of) constitutionality of this seems obvious. As taxpayers, we vote for representatives to choose how to spend our money, and we surely have never approved of our money going to buy a private company. Congress simply doesn’t have this authority.

We’ve seen this before though. As James K. Hickel, of the Heritage Foundation so accurately pointed out in 1983: "In the case of the Chrysler bail-out, a big chunk of taxpayer money was committed to a shaky and inappropriate venture. Every American became an involuntary and uncompensated partner in a company whose future is still in doubt. On top of this, the bail-out even failed in its purpose. The precedent established is extremely dangerous."

So now here we are, our government has bailed out four giant financial companies, and now they’re talking about something that would dwarf their actions to date. $700,000,000,000 of taxpayer money may be used to purchase the toxic mortgage assets that US financial institutions have accumulated over the past decade.
One Jim Cramer has come out in support of the plan, and he makes some…interesting points. He thinks that once this legislation has passed, housing prices will stop declining and the foreclosures will stop. I disagree:

• Let’s say that I am on the brink of defaulting on my mortgage, currently owned by Merrill Lynch. Now the Federal Government comes in and purchases that mortgage and tells me to ‘pay what I can, when I can’ and not to worry about the possibility of moving out. First of all, what about all of the people that have already had to foreclose on their homes? This surely isn’t fair to them. But that’s not the main issue. The issue is that the government has effectively written a blank check to distressed homeowners. This may stop the foreclosures, but it also means that the government’s return on their investment (remember, $700,000,000,000) becomes miniscule with no definite term of repayment. To deal with this (fund itself), the government will be forced to increase the money supply, thus increasing inflation, and thus creating additional hardships for Americans. Buying a new home will be the last thing any average American will want to do when they are worried about $7 gas and $5 bread. Proponents will argue that the bailout will restore health to credit markets, giving homebuyers access to low-rate mortgages with which they can go out and buy up existing housing inventory on the cheap. Haven’t we seen this before?

But, the point of this is not Mike’s opinion on whether or not it will work. The point is that the Federal Government has absolutely no authority to do this. Show me where the Constitution gives government the authority to use taxpayer money to buy companies or their assets. Our money is supposed to be going to programs that give us citizens a return – whether it be Education, National Parks, national defense, etc.

NPR has a great article on the subject of constitutionality. Here are a couple main points:

• Checks and Balances - The language in the measure sent to Congress would make the Treasury secretary's decisions "non-reviewable" — including by "any court of law or any administrative agency." That would give the Treasury secretary powers that are not only extraordinary but, some would say, also unconstitutional because of the lack of accountability.
• Public Losses – the point of a free market is that private companies take risks and either see rewards or losses. This bailout makes the resulting losses the responsibility of taxpayers.

Here is what Ron Paul has to say about the whole deal. I would summarize it, but every word of the article is worth reading.

So we have the unchecked power of Treasury and the use of taxpayer money to bail out private companies and homeowners. Constitution be damned.