Now that the election is over, the most important issue facing the new president and Congress is the economy. To deal with it effectively, they will have to understand its causes. Americans were doubly unlucky that the crisis broke in the last weeks of a heated presidential election — which guaranteed that it would be exploited for partisan purposes. The Democrats certainly made more hay than the Republicans, blaming it on core Republican ideals like free markets and deregulation. Yet liberals helped cause this problem; whether they are willing to admit this is a real test of whether we have actually entered a new kind of politics.
While Republicans must bear their share of the blame, the really inconvenient truth is that Democrats must also share that blame — from Bill Clinton to Barney Frank. If we are to find a way out of this crisis, we need to honestly appraise its causes. There is plenty of blame to go around. Here’s a partial list of culprits.
The Clinton administration: Beginning in the early 1990s, the Clinton administration pursued a superficially laudable policy of extending home ownership into the less advantaged sectors of society. In the name of racial and economic equality, banks and lenders were subjected to carrots and sticks to get them to offer more loans to people who would not traditionally qualify, with Fannie Mae and Freddie Mac backing up the policy. This helped weaken traditional underwriting disciplines. New products were invented, which quickly spread through the market and proved particularly attractive to property speculators. This is where the toxic assets at the base of the financial scandal originated.
The Bush administration and the Federal Reserve: Since the early 90s, the Fed has responded to financial crises by a series of interventions designed to lessen their effect. These mini-bailouts had all seemed to work. Faced with the collapse of the dot-com boom, not to mention the aftermath of 9/11, the Fed and the Bush administration collaborated to engineer another “soft landing” for the economy by promoting a sustained increase in housing values. Loose monetary policy and favorable tax treatment made real estate an extremely attractive investment vehicle. People were thus able to keep spending on the basis of credit guaranteed by their house values, kept up by government policies.
Fannie Mae and Freddie Mac: The Government Sponsored Entities (GSEs) known as Fannie Mae and Freddie Mac grew in strength and power in the early part of this decade. Although they did not invent subprime loans, they quickly became their biggest buyer, effectively guaranteeing a continued market even as house prices started falling. Without this market, the bad securities would not have spread throughout the global financial system. The GSEs lobbied Congress heavily to keep their powers and privileges. Their statutory regulator appeared not to notice.
Congress: In 2004, even as congressional Republicans were beginning to warn of the distortions of the mortgage market caused by government interference, congressional Democrats blocked reform. Senator Chris Dodd (D., Conn.) called the U.S. mortgage market “one of the great success stories of all time.” Unwilling to suggest that housing was a privilege to be paid for, rather than a right, Congress failed to restrain the GSEs or the subprime market when they got out of control.
Wall Street: While history and prudence both should have provided a lesson that house prices would not go on rising forever, Wall Street convinced itself that the finance houses’ mathematical models proved that they had successfully mitigated that risk. Directors and shareholders failed to exercise due diligence at least partly on the grounds that they thought regulators had given the seal of approval to credit ratings agencies, which also failed to analyze risk properly. On learning of their mistake, Wall Street financiers ran straight to government and the taxpayer to save their jobs — and preserve their massive bonuses — rather than accept the market discipline of creative destruction.
As this brief survey suggests, blaming the financial mess on “deregulation” is facile (just look at the similar problems in Britain where the financial regulator, the Financial Services Authority, is much more powerful than any previous financial regulator there.) Instead, what happened was that government — successive administrations, Congress, the Federal Reserve — sent bad signals to the market that severely distorted it. The market proceeded to make mistakes that were reinforced by government at every step of the way.
If we are to solve this problem, the American people must realize how deeply involved government was in creating it. If the new president and Congress fail to admit that, then the recession we are entering can only be prolonged. It is therefore in liberals’ political interest to recognize the real causes of the crisis and act accordingly. In that respect, this provides a great opportunity to demonstrate that Americans have indeed got the change they deserve.
– Iain Murray is director of projects and Analysis at the Competitive Enterprise Institute, and writes on this subject at www.beyondbailouts.org. He is author of The Really Inconvenient Truths: Seven Environmental Catastrophes Liberals Don’t Want You to Know About — Because They Helped Cause Them.