Dr. Russ Roberts looked slightly amused as he likened the worst economic upset since the Great Depression to a game of poker. A Distinguished Scholar from George Mason University’s Mercatus Center and Research Fellow from Stanford University’s Hoover Institution, Dr. Roberts was invited to speak at Christopher Newport University’s Center for American Studies 2010 Annual Conference. His lecture, “Capitalism After the Crisis,” began by explaining how exactly the United States stumbled into the crisis in the first place.

“We built too many houses,” he said. “We stupidly, wastefully channeled trillions of precious capital into something that was not worthwhile. Having everyone own their own house is not the American Dream.” He lamented the possible ways our money might have been spent: innovation, better cars, better fuel, or green technology. Instead, large private companies, such as Bear Sterns and Lehman Brothers, as well as public mortgage companies such as Freddie Mac and Fannie Mae, were “greedy and stupid” with other people’s money.

“Did you know you were sitting at the poker table with Bear Stearns?” His frustration was palpable.

According to Dr. Roberts, capitalism is economic freedom: the freedom to exchange freely, to buy and sell to whomever one chooses at prices that are voluntarily agreed upon rather than distorted by government policy. “I am not talking about anarchy,” he explained, but simply the freedom to buy and sell with anyone.

Profits and losses are what make capitalism work. Without profits, there would be no incentive to take risks, and without loss, there would be no prudence in the risk-taking. Both are required under capitalism to foster competition, which in turn, sets prices. Leading up to the housing market crisis, the government significantly reduced the role of loss, causing corporations to make riskier and riskier decisions.

When playing poker, people are much more likely to bet differently if $97 of their $100 is not their own. If they’re only betting three of their own dollars, and $120 is earned, the $97 that was lent is paid back and the $20 earned goes to someone who only really played with three dollars of their own. If the money is lost and there are no earnings, however, money will be owed. As a lender, then, it would make sense to only lend $97 to good poker players who will make good on their money and come away from the table with more money than from when they started.

Using this poker scenario, Dr. Roberts launched into the housing market. Around 1998, a lot of people borrowed money to bought houses. Banks were obviously hesitant to loan $97,000 to a household only putting $3,000 down for a house; it was a risky investment for the bank and that money may not be paid off.

So Freddie Mac and Fannie Mae came along.

These mortgage giants were part of the federal governments’ attempt to help more Americans own homes. Freddie Mac and Fannie Mae bought these risky mortgages from the banks; these loans were then taken off the banks’ books and paid for by Freddie Mac and Fannie Mae. Households could then go to these public mortgage companies and take out a loan for a house. Usually, the loan was required to be at least 20% down, or in proportion with income so it was not high-risk, but around 1993, The U.S. Department of Housing and Urban Development (HUD) wanted home ownership to increase among the lower-income bracket. Loans were made by these mortgage giants to riskier and riskier households, and by 2001, 51% of loans made by Freddie Mac and Fannie Mae were to low-income households. By 2007, that number had climbed to 56%. This was, by the way, “a bi-partisan mess-up;” it began with the Clinton administration and was continued by the Bush administration.

So Freddie Mac and Fannie Mae have purchased all these mortgages from the banks to make loans to high-risk, low-income households. If more people are going to buy houses, then more money is going to be poured into developing homes and areas where people choose to live. Houses became more expensive and property values increased. Private mortgage companies, including Bear Stearns, Lehman Brothers, and Merrill Lynch got in on the scheme and gave loans to low income households as well. Which begs the question: where was all the money to make these loans coming from? If people had actually be paying back loans, then understandably there would have been more incentive to give lend, but the money was not being returned. More money was being funneled into bad loans: money borrowed from foreign governments or from people who bought bonds.

Why would anyone give such risky loans in the first place and play with money that did not really exist?

“It’s simple,” said Roberts, “At the end of the day, everyone knew that the government would bail them out.” Roberts, passionate about the American economy, sounded a little angry at this point. “It’s like having a high-reward investment without the risk. If you take away the losses from capitalism, take away the prudence, you’re left with reckless risk-taking.”

Did those companies think they’d get bailed out? No one knows, but capitalism, in Roberts’ view, was distorted. “We like a free lunch, but growing up is about realizing there isn’t a free lunch. We merely tried to pretend that there is.”