Bernie says it. Hillary says, even some Republicans say it. Sometimes you get people that seem to say that government was at fault… Only to find out that they incorrectly diagnose the problem to be “The government didn’t regulate enough.” Unfortunately for these mouthpieces of the state, “deregulation” did not cause the financial crisis in 2008 (nor did it cause the Great Depression”). Even today, in 2015, as we ready for the political troglodytes to tell us everything they promise to give us (for free of course), we hear the constant “truism” that deregulation is the problem. We need to intervene in the capitalist system in order to save capitalism from itself. The problem is that there are plenty of people out there willing to believe this nonsense. It’s easier to believe nice sounding rhetoric than hard truth. For the many that believe that government is their savior, the idea that government caused all of their pain is a hard truth.
What actually happened back in 2008? What was going on prior to this crisis? What was the Fed doing? What was the government doing? Even if you disagree with me, that the markets should be free from all regulations, you have to concede that these are important questions to ask. These questions can help to answer what exactly happened and how it can be prevented in the future.
What was the Government Doing?
This is an important question and can directly answer whether or not deregulation caused the financial crisis. If government regulations might have actually been a cause in the first place, then those that cry for more regulation need to stop and ponder the facts. The Free Market makes for a very convenient villain, especially after an economic down turn. But has the blame been put where it belongs? Rather than accept conventional wisdom (the same wisdom that said everything was fine prior to the crisis), let us think for ourselves and view the evidence with unbiased and fresh minds.
First let us talk about loans within the housing market. Let us also investigate banks as well. Prior to the crisis, there was the Community Reinvestment Act (CRA). This was a form of affirmative action within lending and it placed a lot of pressure on lenders to lower their standards. Why? Because if they did not lend to certain people, they could be open to law suits by those that felt they were “discriminated” against. Many lenders lowered their standards in order to become compliant with the new regulations the government was imposing.1 Notice I said “regulations”? That’s because that is what it was. This was all part of the government’s wonderful plan to have every American own a home. In order to do so, they had to lower the lending standards thus making people who previously could not purchase a home, eligible. This means that the market was about to be flooded with a many dangerous and risky loans. Many of which, the government knew would be defaulted on.
Due to this affirmative action and the lowering of banking standards brought about by government, the natural outcome was that people were buying houses that did not have the savings to afford it. You had people making $17,000 year, and no second income, becoming the brand new owners of a nice new house. The idea that any of this was sustainable shows the lack of foresight the government and their cronies had. This didn’t matter, the government was dead set on every American owning a home and the populace loved the idea. Think about it. If you were completely ignorant of economic theory, this sounded like it was too good to be true. Unfortunately it was.
Once the values of homes began to decline, foreclosures began to sky rocket. 2.5 Million foreclosures occurred by June, 2010.2 This should have been the first warning that something was wrong. Those with the economic power and control refused to acknowledge that something of a catastrophic nature was about to occur. The problem was that up until this point, the so called “experts”, were telling everyone that everything was ok. That there was nothing to worry about. In 2005, Ben Bernanke, the then chair of the Fed, said:
Well, unquestionably, housing prices are up quite a bit; I think it’s important to note that fundamentals are also very strong. We’ve got a growing economy, jobs, incomes. We’ve got very low mortgage rates. We’ve got demographics supporting housing growth. We’ve got restricted supply in some places. So it’s certainly understandable that prices would go up some. I don’t know whether prices are exactly where they should be, but I think it’s fair to say that much of what’s happened is supported by the strength of the economy.3
If only these people would have looked at what was in front of them. It was plain as day. Could they not understand the connection between lowering standards and a “strong” economy? None of this wealth was sustainable. There was also another insidious factor at work in the economy. This leads us to our next question.
What Was The Federal Reserve Doing?
Now if you follow this blog, you probably know a thing or two about the Federal Reserve. It is a “private” bank that acts as a “lender of last resort”. It keeps the economy “strong” and they keep interest rates at the optimal level that the economy needs… Or so you are told. One has to ask, “does artificially and and arbitrarily manipulating interest rates produce beneficial outcomes?” I would posit that it does not. To understand this assertion, we have to understand what interest rates do.
Interest rates act as indicators for when it is a good time to save and a good time to spend. Low interest rates mean that speculators and entrepreneurs may want to consider investing in long term projects. It means that people are supposedly not spending and are saving their money for future consumption. When interest rates are high, it means people are spending. The common wisdom says the following:
This interpretation basically says that it is the interest rate that determines savings and investment. And so the policy conclusion is that the higher the interest rate is, the higher will be savings and the smaller will be investment. And because investment — rather than savings — is nowadays seen as being conducive for growth, the lowering of the interest rate is perceived as advancing economic prosperity.4
Within a free market, interest rates are allowed to move with consumer demand. They accurately reflect the consumption habits of consumers. But if the Federal Reserve decides to push interest rates artificially low, this sends a false signal. The are telling businesses and entrepreneurs that right now is great time to invest in long term projects. Unfortunately, this is actually not the case. These business begin their projects only to find out that resources are not as plentiful as they originally thought.
Think of it like this (this is my favorite analogy that Mises used):
The distortion in the market caused by the Federal Reserve is like a man building a house who over estimates how many bricks he has by 20%. At which point is it better for the man to find out he will not have enough bricks? Before he begins building? In the middle of construction? Or at the very end? Of course it is better for him to find out before he begins. If he knows the true amount of bricks available to him, he has the chance to redesign his house to fit within his means. The Federal Reserve is not this prudent. They allow people to continue to build only to find out that resources are not as readily available or that they are too expensive. This causes the bust. Now this is where the Fed did the unthinkable. They continue to do everything mentioned above that causes this distortion and bust in the first place. They do it, because as stated above, they assume that low interest rates bring about economic prosperity. What they are really doing is subsisting off of the hair of the dog. They hope that they can live in a permanent boom when all they are really doing is keeping zombified businesses alive at the expense of businesses that were actually good stewards of their resources. This diverts capital from actual producers in order to keep businesses and corporations on life support. Since the producers are not getting the flow of capital they could be getting for the sake of these zombie businesses, society as a whole is poorer.
Did Deregulation Cause the Crisis?
I think the answer is a resounding no. Lending standards were lowered as a result of government edicts and regulations. The Government and the Fed’s monetary policy of chasing after a never ending boom (that’s like chasing a unicorn) also contributed to the economy’s downfall. It should be quite clear that the freemarket should be pardoned of it’s supposed crimes. The blame should be squarely laid on government and and economic intervention on it’s behalf.
1. Holmes, Steven A. “Fannie Mae Eases Credit To Aid Mortgage Lending.” The New York Times. The New York Times, 29 Sept. 1999. Web. 16 Oct. 2015. <http://www.nytimes.com/1999/09/30/business/fannie-mae-eases-credit-to-aid-mortgage-lending.html>.
2. Gruenstein Bocian, Debbie, Wei Li, and Keith S. Ernst. “Lola, Race, and Ethnicity.” Women, Pleasure, Film (2010): n. pag. Http://www.responsiblelending.org/mortgage-lending/research-analysis/foreclosures-by-race-and-ethnicity.pdf. Center For Responsible Lending, 18 June 2010. Web. 16 Oct. 2015. <http://www.responsiblelending.org/>.
3. Sanchez, Daniel J. “Ben Bernanke Was Incredibly, Uncannily Wrong.” Mises Institute. Mises Institute, 28 July 2009. Web. 16 Oct. 2015. <https://mises.org/library/ben-bernanke-was-incredibly-uncannily-wrong>.
4. Polliet, Thorsten. “The Cure (Low Interest Rates) Is the Disease.” Mises Institute. Mises Institute, 11 Apr. 2011. Web. 16 Oct. 2015. <https://mises.org/library/cure-low-interest-rates-disease>.