The Corner

How We Got Here

Economist Steven Horwitz on the current mess and the residue of the Great Depression. A very useful excerpt:

Before talking about how we did get here, let me say a quick word about what didn’t cause this mess.  Those who wish to blame greed for the crisis need to explain how and why it is that greed seems to causes crises only at specific times, despite the fact that it is omnipresent as a feature of human nature and market economies.  As the economist Larry White has noted, if we saw a bunch of planes crash all on the same day, we wouldn’t blame gravity.  It’s always there.  Something else must be at work.  I would argue that the key is the set of institutions through which greed or self-interest is channeled.  That is, good institutions can cause self-interest to generate desirable unintended consequences, and bad ones can cause undesirable ones.  So perhaps we should be looking at institutions and policy.

Those who wish to blame deregulation or the supposed “laissez-faire” philosophy of the Bush Administration are going to have to identify the deregulation in question, which will be a challenge given that the last deregulatory legislation in the financial industry was in 1999 under Clinton.  These folks will also have to explain how the enormous growth in the Federal Register and domestic spending over Bush’s two terms reconciles with his supposed belief in laissez-faire.  Answer: it doesn’t. 

The two key causes of this crisis are expansionary monetary policy on the part of the Fed and a series of regulatory and institutional interventions that channeled that excess credit into the housing market, creating a bubble that eventually had to burst.  In other words, the boom (and the inevitable bust) are the product of misguided government policy, not unbridled capitalism.

The Fed drove up the money supply and drove down interest rates very consistently since 9/11.  When central banks do so, they make long-term investments relatively cheaper than short-term ones, thus the excess funds flow toward such goods.  Historically, these were producer goods in capital industries, but in this particular case, a set of other government interventions and policies pushed those funds toward housing.

A state-sponsored push for more affordable housing has been a staple of several prior administrations.  Fannie Mae and Freddie Mac are key players here.  Although they did not orginate the questionable mortgages, they did develop a number of the low down-payment instruments that came into vogue during the boom.  More important, they were primarily responsible for the secondary mortgage market as they promoted the mortgage-backed securities that became the investment vehicle du jour during the boom.  Both Fannie and Freddie are, we must remember, not “free-market” firms.  They are “government-sponsored entities,” at one time nominally privately owned, but granted a number of government privileges, in addition to carrying an implicit promise of government support should they ever get into trouble.  With such a promise in place, the market for mortgage-backed securities was able to tolerate a level of risk that truly free markets would not.  As we now know, that turned out to be a big problem.

Read the whole thing.

Jonah Goldberg — Jonah Goldberg holds the Asness Chair in Applied Liberty at the American Enterprise Institute and is a senior editor of National Review. His new book, The Suicide of The West, is on sale now.

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