The Means of Production

On the subject of capital investment, and the taxation of capital gains, it seems to me that almost all of the media has missed an important point, and several lesser points that flow from that central point.

The Central Point: 

Capital investment pays for (or finances) what Karl Marx called “the means of production”.

  

Other Points:

In a free capitalistic market individual investors decide where they want to invest their money, how much risk to take with their money, and whether they are going to invest in, for instance, the manufacture of cell phones or the activities of grocery stores. Or, they can decide if they want to invest in solar panel manufacturers (like, Solendra?).

If individual investors are not incented to invest their capital in “the means of production” it seems the alternative is for government to use taxpayer funds for investment and use some form of ‘central planning’ to decide in which enterprises the taxpayers taxes will be invested.

It’s been pointed out by several in the media that capital investment actually produces taxable revenue when the enterprise must pay a tax on revenue. And, it’s been mentioned that the investor then pays another tax (the capital gains tax) - if the investor is fortunate, or smart, enough to make a capital gain.

However, I’ve not seen any media (or reporters) mention that there is usually another source of taxable revenue which flows from capital investment. Capital investment generally contributes to job creation. Most of the people who are employed in the investors’ enterprise will have an income – some of which is taxed. And another point, which also seems subtle to the press, the part of those workers’ income which is not taxed can be used by the workers to consume, save, or invest. These worker activities (consumption, saving and investing) all add value to the economy, and they produce jobs and more (downstream) revenues which are taxed.

I believe myriad individuals participating in a relatively free market, and making judgments about products to be offered while making judgments about demand levels for those products, and evaluating risk-and-reward payoffs, is a far more efficient, objective, and practical way to finance ‘the means of production’ than any central planning scheme.

 

Ron Paul's Chrystal Ball

Government Mortgage Schemes Distort the Housing Market

Congressman Ron Paul U.S. House of Representatives July 16, 2002*

Mr. Speaker, I rise to introduce the Free Housing Market Enhancement Act. This legislation restores a free market in housing by repealing special privileges for housing-related government sponsored enterprises (GSEs). These entities are the Federal National Mortgage Association (Fannie), the Federal Home Loan Mortgage Corporation (Freddie), and the National Home Loan Bank Board (HLBB). According to the Congressional Budget Office, the housing-related GSEs received $13.6 billion worth of indirect federal subsidies in fiscal year 2000 alone.

One of the major government privileges granted these GSEs is a line of credit to the United States Treasury. According to some estimates, the line of credit may be worth over $2 billion. This explicit promise by the Treasury to bail out these GSEs in times of economic difficulty helps them attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital. More importantly, the line of credit is a promise on behalf of the government to engage in a massive unconstitutional and immoral income transfer from working Americans to holders of GSE debt.

The Free Housing Market Enhancement Act also repeals the explicit grant of legal authority given to the Federal Reserve to purchase the debt of housing-related GSEs. GSEs are the only institutions besides the United States Treasury granted explicit statutory authority to monetize their debt through the Federal Reserve. This provision gives the GSEs a source of liquidity unavailable to their competitors.

Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges of Fannie, Freddie, and HLBB have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.

However, despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government’s policies of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.

Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.

No less an authority than Federal Reserve Chairman Alan Greenspan has expressed concern that government subsidies provided to the GSEs make investors underestimate the risk of investing in Fannie Mae and Freddie Mac.

Mr. Speaker, it is time for Congress to act to remove taxpayer support from the housing GSEs before the bubble bursts and taxpayers are once again forced to bail out investors misled by foolish government interference in the market. I therefore hope my colleagues will stand up for American taxpayers and investors by cosponsoring the Free Housing Market Enhancement Act.

See transcript at: http://paul.house.gov/index.php?option=com_content&task=view&id=323&Itemid=60

The Fannie and Freddie Hate Storm

Wall Street Journal Online ~ DECEMBER 27, 2011 OPINION

 

The Fannie and Freddie Hate Storm*

A dubious prosecution but it helps set the record straight.

By Holman W. Jenkins, Jr.

As I read Mr. Jenkins’ article I was impressed by many of his points, but not his conclusion. Then, after some thought, I remembered the article is published in the OPINION section, not in the FACT section.

Q. What does CMO stand for? A. Collateralized Mortgage Obligation. What caused the COLLATERAL in CMO to become price inflated?

In my opinion, The Housing Bubble and the ensuing financial crisis were caused by several factors which played-out in concert. Political pressure for every person to receive a home loan was one principle cause. The Greenspan Federal Reserve's manipulation of interest rates, and the Fed’s long low interest rate policies, in order to avoid any-and-every anticipated economic slowdown was another. The irrational levels of leverage used by large financial institutions (including Fannie and Freddie) was another factor in the formation of the bubble. The unregulated and irrational use of mortgage derivatives was another contributor (adding another layer of leverage). Serial reductions in mortgage loan qualification standards, the move to low-down payment or no down payment mortgages, and exotic mortgages with deferred payment options, also contributed.1 These were just a few of the ‘moving parts’ which contributed to the home price bubble.

Then, when a few people began to look at the home price inflation - late in the bubble - those few people began to analyze the economics of home prices - it became clear to them that the 'house-of-cards' was dependent on infinitely increasing home prices and infinitely available financing for those infinitely higher home prices. That's when the music began to slow-down, and all the dancers began to head for that small exit.2

Watch this video-clip in which Warren Buffett tries to explain the dynamics of bubble formation and bubble bursting to the Financial Crisis Inquiry Committee (FCIC) at:

Note: Late in the bubble the impending implementation-date for the requirement that banks and other investors use mark-to-market3accounting for valuing ‘infrequently traded assets’ (way back in history mortgage backed securities were infrequently traded) might have also created a more sober attitude toward the volatility and risks involved in holding, leveraging and trading CMO’s 4

* On December 16, 2011 The SEC filed lawsuits - charging fraud- against former senior executives of Fannie Mae and Freddie Mac. The filings provide interesting information and evidence which might force retraction and republication of past financial disclosures made by Fannie and Freddie, and which might also force significant revisions to volumes of analysis and statements about the safety and soundness of the two Government Sponsored Enterprises. [See SEC Filings at:  http://www.sec.gov/news/press/2011/2011-267.htm ]

Footnotes:
1. See, SEC filing against former executives of Fannie Mae: page 9 para. 32 “Desktop Underwriter” and page 10 para. 35 “Fast and Easy” and “Clues” at: http://www.sec.gov/litigation/complaints/2011/comp-pr2011-267-fanniemae.pdf
2. From, Inside Trillionaires’ Club of BlackRock By Shawn Tulley - Fortune Magazine - pub. August 18, 2009: “In late 2006 the company developed a model that put a lower, more realistic number on the incomes subprime borrowers were claiming on their "no doc" loans. The projections were shocking: BlackRock figured that when the loans reset to their new, higher rates in a couple of years, most borrowers would be spending more than half their real incomes on mortgage payments. Foreseeing an avalanche of defaults, BlackRock dumped subprime bonds in early 2007 when the prices were still lofty.” see complete article at: http://money.cnn.com/2009/08/12/news/companies/blackrock_trillionaires_club.fortune/index.htm
and see, Former Countrywide #2 Sees Opportunities in Troubled Mortgages By Matthew Padilla - Orange County Register pub. June 10, 2008 at: http://mortgage.ocregister.com/2008/06/10/former-countrywide-no-2-sees-opportunities-in-troubled-mortgages/ and see, Betting on The Blind Side By Michael Lewis - Vanity Fair – pub. April 10, 2011 at: http://www.vanityfair.com/business/features/2010/04/wall-street-excerpt-201004
4. see, Congress Helped Banks Defang Key Rule By Susan Pulliam and Tom McGinty – WSJ, June 3, 2009 at: http://online.wsj.com/article/SB124396078596677535.html ).