Politics & Policy

Who’s to Blame for the Sub-Prime Problem?

I'm looking in the direction of the 2003 Fed -- and the doomsayers at the New York Times.


In 2003, many supply-siders found themselves in a debate with the American economic Left, most especially the New York Times. Larry Kudlow, Don Luskin, Art Laffer, Steve Forbes, and I all said the economy was better than reported, and that because of the full implementation of the president’s tax cuts that spring, the economy had begun to take off. Some of us even dared to call it a boom.

Meanwhile, the New York Times and its lead economist-turned-polemicist Paul Krugman said the tax cuts would not work. They continually downplayed the strength of the economy, with the Times arguing that a looser Federal Reserve policy was a better solution than tax cuts. Cut interest rates, not tax rates. That was the thinking. And the Fed did its part to comply: It opened the money spigots wide.

In retrospect, that action marked the beginning of the sub-prime mortgage bubble. And if you don’t believe me, just look at the chart at the top of the page.

When the Fed pumps money into the economy, it does so through the banks. The Fed buys bonds from banks using money created from thin air. Yes, the money ends up flowing throughout the whole economy, but it hits the banks first. And flush with this excess cash, the bankers make loans, including loans to homeowners. And when they run out of reasonably good credit risks, they start lending to bad credit risks — such as all those sub-prime mortgage holders you’re now reading about.

In the year of the great money flood, sub-prime lending went from 4 percent of total lending to more than 10 percent. That’s in one year!

Many supply-siders believed the Fed was loose a few years back and they (your humble correspondent included) issued their warnings. Economist Larry Kudlow and I discussed this on his WABC radio program this past Saturday, and he made the point that the Bush tax cuts protected the Fed from itself — causing enough growth to absorb the effect of all that extra money. Interesting point.

But here’s what I think: The executive and legislative branches went the way of the supply-siders, cutting taxes on income and capital. These results are reflected in the growth-sensitive areas of the economy: GDP, unemployment, and stock market valuations. The Fed, however, didn’t believe the tax cuts would do the job, and turned on the money pumps. The results showed up in monetary phenomena such as inflation, loss of dollar value, and the sub-prime bubble.

Supply-side tax cuts and global capitalism kept inflation from getting out of control, but that money had to go somewhere, and some of it went to people who really couldn’t afford the houses they were buying.

Had the Federal Reserve, and its prompters at the New York Times, put a little more faith in the power of broad-based tax cuts, we might have skipped this messy sub-prime episode altogether.


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