How the Government Caused the Financial Crisis

Are People Starting to Understand?

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Free Market Solutions

Mark Thornton writes:

People often ask me, "What do you think the government should do instead of QE inflation?" My stock answer is that the government should not try to fight the depression with government spending and cheap credit. Trying to stop the market from correcting the errors of the past only delays the consequences and makes them much worse.

Government should balance its budget. There should be no new credit expansion by the Federal Reserve. Most importantly, government should not meddle in markets to try to soften the consequences of the correction. Specifically, that means no bailouts, stimulus packages, or new public-works projects. Do not prop up wages. Allow competition to lower the prices of land, labor, and capital. The only positive steps for government to take are implementing tax cuts and spending cuts, eliminating regulations, and allowing free trade.

Now, I have a name for this policy. It's called the "Lehman Bros. plan," after Lehman Brothers, the large financial firm on Wall Street that was allowed to go bankrupt in September 2008. This plan relies on allowing big firms to fail. Had this policy been followed from the beginning, I have little doubt that the crisis would already be over and we would not have added to the debt problem.

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Myth of a Free Market

Joel Bowman writes:

One of the more pervasive myths, perpetuated – either ignorantly or maliciously – by the mainstream media, is that the market tumult witnessed over the past few years is somehow a result of the free market having “run wild.”

The argument, as you are surely familiar with it, goes something like this…

Until recent and heroic intervention by the Feds, the world had been aimlessly bobbing about on a sea of unregulated, laissez-faire capitalism. Adrift in the cold, harsh, dog-eat-dog seascape, where rules were callously discarded and government vigilance eschewed, we clueless individuals simply made our way as best we could. Of course, it wasn’t long before we lost sight of the horizon. Then, the clouds of capitalist deceit obscured our view of the stars, by which we had previously been navigating our way across the perilous oceans. Sensing our vulnerability, the greedy capitalists stealthily moved in under the cover of “free market anarchism” to rock the markets and capsize our tiny, unguarded vessel.

What followed – around 2007-08 – was the painful aftermath of a great era of free market irresponsibility. Lessons were to be learned. Regulators, it was said, had failed to protect us (mostly from ourselves). The markets had been allowed to “run wild,” fleecing all and sundry of their earthly wares. The whole system was in danger of collapsing under the weight of its own free reigns and pundits from every corner of the boat were soon crying out for some form of central guidance, some direction, some calm. This, we were told, and not without a wag of the finger, is what happens to modern, mixed-market economies when they become adulterated by the blinding whims of free market capitalism.

And it would be a nice story, with a presumably easy remedy…if only it were true. Alas…

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Less Government, Less Economic Trouble

Robert Higgs writes:

Though our current economic troubles are complex, many mainstream economists have endorsed the simplistic Keynesian theory that massive government spending will produce jobs and prosperity.

From such Keynesian thinking have flowed the "stimulus" and bailout measures that have increased the size and power of government and added trillions of dollars to the public debt...

Politicians, who are always looking for plausible rationales for their insatiable spending, borrowing, and power grabbing, had never abandoned Keynesianism, so they have been elated to find economic "experts" again confirming their self-interested inclinations...

But what does history teach?

History teaches that temporary surges in government spending give people money that, for the most part, they save or use to reduce debt, rather than setting in motion an upward spiral of income, expenditure, real output, and employment, as was envisioned by John Maynard Keynes, the British economist whose theory spurred massive government interventions in the economy from the 1930s onward.

History also teaches that government "emergency" spending tends to fatten the coffers of the politically connected. Thus, much of the so-called stimulus spending has served only to increase the pay and benefits of government employees, transferring income from the private sector to the government sector, and to reward groups, such as the United Auto Workers and low-income home buyers, for their support of the Obama administration...

Since the early 20th century, periods of national emergency — real and imagined — have triggered sharp increases in government power, scope, and cost.

The first five episodes were World War I, the Great Depression, World War II, the upheavals associated with the civil-rights revolution and the Vietnam War, and the post-9/11 events associated with the war on terror and U.S. engagements in Afghanistan and Iraq.

We are now in another such critical period, springing from the housing bust, financial debacle, and recession.

In their embrace of Keynesianism, many economists have concluded that even though the New Deal's hodgepodge of policies never brought about full recovery, World War II did, as the economy expanded to produce munitions and enlarge the armed forces. Huge, deficit-financed government spending, they argue, finally wiped out the lingering mass unemployment.

The truth, however, is really quite simple. In 1940, after eight years of New Deal pump priming, the unemployment rate remained about 10 percent even if, unlike the Bureau of Labor Statistics, we count people enrolled in federal emergency work-relief programs as employed. The gigantic buildup of the armed forces, primarily by conscription, then pulled the equivalent of 22 percent of the prewar labor force into the military. Voilà, unemployment disappeared, as it was bound to do regardless of any wartime Keynesian fiscal policies.

Looking to the World War II model of how to deal with today's economic crisis is nonsense. Whatever else the war might have accomplished, it did not produce conditions that we may properly describe as genuine prosperity.

Government spending — whether on our current armed forces and their more than 800 foreign bases or on "green" energy and other government-favored projects — does not produce prosperity. It only diverts resources, as it always has in the past, from the genuinely productive private economy and bulks up an already bloated government.

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Free Markets Create Jobs

Ron Paul writes:

In this struggling economy it is essential for politicians to take a step back and think about what government has been doing to business in this country. In less than 200 years, the free market, property rights, and respect for the rule of law took this nation from a rough frontier to a global economic superpower. Today, however, our nation and our economy clearly are headed in the wrong direction.

Of course, America has never enjoyed absolute free-market capitalism: creeping government intrusion and special interest political patronage have existed and increased since our founding. But America historically has permitted free markets to operate with less government interference than other nations, while showing greater respect for property rights and the rule of law. Less government, respect for private property, and a relatively stable legal environment allowed America to become the wealthiest nation on earth...

First and foremost, the role of government in business should be limited to resolving contractual disputes. As long as both parties of a contract enter into the arrangement willingly, without coercion, and with complete and accurate information, they should be expected to live up to their end of the deal. When a party cannot or will not honor the terms of a contract, it is acceptable for government to provide a court system to resolve disputes in a fair and impartial way.

Government should not dictate the terms of a contract to the parties involved. However, throughout the 20th century, our government became increasingly comfortable mandating terms that politicians find acceptable without regard to what businesses or their customers might want. This interference has had a chilling effect on the economy...

Freedom and a restrained government are what made us an economic power house. If we keep chasing businesses away with onerous taxes, mandates, and regulations, they will eventually leave. The best approach to our economic woes that will help the most people is simple: get back to the Constitution and demonstrate respect for free markets, private property, and the rule of law.

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How to" Fix" a Recession

What does Mises say should be done, say by government, once the depression arrives?

What is the governmental role in the cure of depression? In the first place, government must cease inflating as soon as possible. It is true that this will, inevitably, bring the inflationary boom abruptly to an end, and commence the inevitable recession or depression. But the longer the government waits for this, the worse the necessary readjustments will have to be. The sooner the depression-readjustment is gotten over with, the better. This means, also, that the government must never try to prop up unsound business situations; it must never bail out or lend money to business firms in trouble. Doing this will simply prolong the agony and convert a sharp and quick depression phase into a lingering and chronic disease.

The government must never try to prop up wage rates or prices of producers' goods; doing so will prolong and delay indefinitely the completion of the depression-adjustment process; it will cause indefinite and prolonged depression and mass unemployment in the vital capital goods industries.

The government must not try to inflate again, in order to get out of the depression. For even if this reinflation succeeds, it will only sow greater trouble later on.

The government must do nothing to encourage consumption, and it must not increase its own expenditures, for this will further increase the social consumption/investment ratio. In fact, cutting the government budget will improve the ratio.

What the economy needs is not more consumption spending but more saving, in order to validate some of the excessive investments of the boom. Thus, what the government should do, according to the Misesian analysis of the depression, is absolutely nothing. It should, from the point of view of economic health and ending the depression as quickly as possible, maintain a strict hands off, "laissez-faire" policy. Anything it does will delay and obstruct the adjustment process of the market; the less it does, the more rapidly will the market adjustment process do its work, and sound economic recovery ensue.

The Misesian prescription is thus the exact opposite of the Keynesian: It is for the government to keep absolute hands off the economy and to confine itself to stopping its own inflation and to cutting its own budget.

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Cartoon: Freedom v. the Nanny State

Business and Self-Regulation

Grass somehow manages to grow up through small cracks in the sidewalk. Similarly, the American private sector somehow seems to be exerting itself despite the vast expansion of government by the White House and Democratic Congress.

Case in point: The announcement last week by four oil companies - Chevron, ConocoPhillips, ExxonMobil and Shell - that they are setting up a $1 billion joint venture to design, build and operate a rapid-response system to contain spills as deep as and deeper than BP’s Deepwater Horizon disaster.

Their goal is a system that can start mobilizing within 24 hours of an oil spill. They hope to have it up and running within 18 months.

I suppose one might ask why oil companies didn’t do this before. But it seems a vivid contrast with the apparently hapless performance of the Minerals Management Service, recently renamed the Bureau of Ocean Energy Management, Regulation and Enforcement, which seems to have sat on out-of-date response plans for years and which was not able to call in equipment and personnel to respond to the April 20 BP spill for weeks or months...

Consider Underwriters Laboratories, founded in 1894, whose UL stickers come attached to regulator products. Or the Society of Automotive Engineers, founded in 1905, which sets standards for the automobile and other industries.

Government hasn’t had to step in because UL and SAE work well without them. Federal regulators couldn’t plug the BP well. The oil companies’ joint venture promises to be able to do so.

Another case in point, which is different and more diffuse: the “capital strike.” In the wake of the uncertainty raised by the Obama Democrats’ huge increase in regulations and pending increases in taxes, businesses are sitting on cash and not hiring, banks are buying Treasury bonds and not lending, investors are not investing and consumers aren’t buying. The economy languishes...

Two lessons seem apparent here. One is that private firms can do things government regulators can’t do. The other is that if you choke the golden goose enough, it stops producing eggs - and you have to get your hands off its neck.

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Economic Role of Government

Government’s role in an economy has never been properly explained. We will have a go at it ourselves. In a word, government betrays the future.

Government is a profoundly reactionary institution. It always favors its current clients – the present generation of taxpayers – over its clients of the future (who don’t pay taxes and don’t lobby). It provides protection against foreign invaders and domestic troublemakers. It also attempts to give its clients protection against the future.

Taxpayers want government to protect their existing assets…their businesses…their claims…their jobs…their franchises against all threats. In the modern world, most of those threats come in the form of economic and technological change. That’s why taxpayers demand subsidies and bailouts. It’s also why they like regulation. Anything that will keep change from diminishing what they’ve got.

A properly-functioning economy, as Schumpeter described it, is a process of incremental growth and also of creative destruction…in which old industries, old technologies and old institutions are blown up by change. This is what people pay their taxes to avoid. The present generation wants the government to “do something” to protect them from this process. It’s why they are perfectly happy to see the government take over the whole economy, if necessary, in order to prevent capitalism from happening.

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Cartoon: Government 101

“What were they thinking?”

Or more accurately, “What? Were they thinking?”

Cash for Clunkers: $24,000 per Car

A total of 690,000 new vehicles were sold under the Cash for Clunkers program last summer, but only 125,000 of those were vehicles that would not have been sold anyway, according to an analysis released Wednesday by the automotive Web site Edmunds.com.

Still, auto sales contributed heavily to the economy's expansion in the third quarter, adding 1.7 percentage points to the nation's gross domestic product growth...

The Cash for Clunkers program gave car buyers rebates of up to $4,500 if they traded in less fuel-efficient vehicles for new vehicles that met certain fuel economy requirements. A total of $3 billion was allotted for those rebates.

The average rebate was $4,000. But the overwhelming majority of sales would have taken place anyway at some time in the last half of 2009, according to Edmunds.com. That means the government ended up spending about $24,000 each for those 125,000 additional vehicle sales...

Emunds.com's projection indicates that, without Cash for Clunkers, October's sales increase would be even higher.

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Stimulus or Sowing the Seeds of Depression?

Government intervention, in all of its forms, distorts the market place; it directs scarce resources away from productive ventures to unproductive ventures. The measures, taxation, borrowing, and monetary inflation, which the government utilizes to pay for the extravagances of its various stimulus proposals and other constitutionally dubious programs, generate negative economic consequences. Economic prosperity is the product of innovative entrepreneurs who use capital, which is derived from real savings, to produce additional goods and services that market participants can purchase at lower prices. The government stimulus plans encourage capital consumption, which reduces the supply of goods available to consumers, and lays the foundation for an economic depression. The government’s response to the current economic crisis is the identical policies that contributed to the Great Depression. This is not the appropriate foundation for long term economic prosperity, but the inappropriate path to economic ruin.

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My thoughts: An outstanding essay.

The Depression of 1920-21

It is a cliché that if we do not study the past we are condemned to repeat it. Almost equally certain, however, is that if there are lessons to be learned from an historical episode, the political class will draw all the wrong ones—and often deliberately so. Far from viewing the past as a potential source of wisdom and insight, political regimes have a habit of employing history as an ideological weapon, to be distorted and manipulated in the service of present-day ambitions. That’s what Winston Churchill meant when he described the history of the Soviet Union as “unpredictable.”...

If the Austrian view is correct—and I believe the theoretical and empirical evidence strongly indicates that it is—then the best approach to recovery would be close to the opposite of these Keynesian strategies. The government budget should be cut, not increased, thereby releasing resources that private actors can use to realign the capital structure. The money supply should not be increased. Bailouts merely freeze entrepreneurial error in place, instead of allowing the redistribution of resources into the hands of parties better able to provide for consumer demands in light of entrepreneurs’ new understanding of real conditions. Emergency lending to troubled firms perpetuates the misallocation of resources and extends favoritism to firms engaged in unsustainable activities at the expense of sound firms prepared to put those resources to more appropriate use....

The experience of 1920–21 reinforces the contention of genuine free-market economists that government intervention is a hindrance to economic recovery. It is not in spite of the absence of fiscal and monetary stimulus that the economy recovered from the 1920–21 depression. It is because those things were avoided that recovery came. The next time we are solemnly warned to recall the lessons of history lest our economy deteriorate still further, we ought to refer to this episode—and observe how hastily our interrogators try to change the subject.

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Health Care Solution: Do Nothing

The second-best solution for the health-care crisis? Do nothing.

Of course, that drives the interventionists crazy. “Do nothing?” they cry! “Don’t you realize that we’re in a crisis? We can’t afford to do nothing!”

What they fail to realize is a fundamental principle about interventionism: It produces more crises. Therefore, any new health-care intervention, whether termed “reform” or “modification” or “improvement” is only going to make things worse than they already are. New interventions will produce new and bigger crises, thereby producing calls for more “reform” in the future.

What ultimately happens is that as the crises and interventions grow in number and intensity, people get so frustrated that they end up supporting a complete government takeover of that particular segment of society. In fact, that’s already happening in the health-care debate...

That, of course, leads us to an opposing diagnosis — that it’s not freedom and free enterprise that have caused America’s health-care crisis but instead the socialism and interventionism that have infected every aspect of the health-care field...

Thus, the prescription is obvious: radical surgery by removing all of this cancerous material from the body politic. No reform. Simply an immediately repeal of Medicare, Medicaid, health-care and insurance regulations, and medical licensure. End all government involvement in health care. Given the positive power of the free market and the enormous resiliency of human beings, the body politic will immediately begin recovering.

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Economic Contractions in the United States: A Failure of Government

Seeking 'not to let a crisis go to waste', left-leaning politicians and old-style Keynesian economists want to remedy the alleged failure of capitalism with a rising tide of big government. Let the budget deficits rip, empower the unions, socialise healthcare, increase trade protection, go green, and socialise the financial and industrial base.

The irony, as Charles Rowley and Nathanael Smith show in this timely monograph, is that the Keynesian policy prescriptions that are serving as the pretext for this programme have already been tried. Expansionary fiscal and monetary policies by the Bush administration and the Greenspan Fed were implemented to deal with the recession of 2001, and are precisely what caused the current crisis.

Applying sound economic reasoning and cutting-edge public choice theory, Rowley and Smith show that both the Great Depression and the current economic contraction were caused by failures not of capitalism, but of government. While monetary policy was the primary culprit in the 1930s, the interventionist policies of the Hoover and Roosevelt administrations exacerbated the downturn and stifled recovery. Fortunately, the monetary policy of the independent Fed is much better now (thought the Fed has unduly widened its role), but elected politicians are pursuing problems of intervention and re-regulation similar to those pursued in the 1930s. If these adverse trends are not reversed, the dynamic laissez-faire capitalism of the United States will be assimilated to the state capitalism and economic stagnation of Western Europe.

The authors outline a radical free-market approach to policy reform, designed to restore the United States economy to its stellar performance during the final fifteen years of the 20th century.

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Cartoon: Socialized Medicine

My thoughts: This is the problem of the slippery slope. There is no logical stopping point once you accept government intervention in an industry or the economy. Proponents of the health care plan like to claim opposition is to the plan is hypocrisy. In some cases it is. However many who oppose government health care also oppose Medicare, Social Security, and all other government intervention in the economy. Then there is the practical reality of the federal budget. It is Medicare and Medicaid that are currently projected to be the programs that bankrupt the government. An additional government health care program will likely accelerate the process. This issue should be aaddressed by the proponents of the health care plan.

The Right to Medical Care

The idea of a right to medical care is so blithely tossed around that most people never take time to ponder the rather serious consequences that would flow from it. It is a classic pseudo-right. A pseudo-right is any claim expressed in rights language that would expand the power of the state at the expense of genuine rights...

Let’s start with something basic: for a right to be genuine, it has to be capable of being exercised without anyone’s affirmative cooperation. The full exercise of my right of self-ownership requires you to do nothing except refrain from killing or assaulting me. The full exercise of my property rights requires you to do nothing except refrain from taking what is mine. You have no positive, enforceable obligations to me, apart from any you accept through contract...

Here is the crux of the issue. The right to medical care must mean—no exceptions—the power of government, in principle, to determine who gets what. It may not exercise that power immediately. But given the economics of the matter, it will, sooner or later. I submit that this has nothing to do with rights and everything to do with control, literally, of people’s lives...

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Sheldon Richman on Health Care Reform

The effort to reinvent medical care is so full of fallacies and bad logic that it would take volumes to properly expose them. Nevertheless, in this short space, let’s take a crack atsome of the problems.

To begin, the “reformers” want to compel insurers to cover people who are already sick for the same price healthy people pay. But if someone is already sick, no government plan to pay his medical bills can be accurately called “insurance.” Insurance is a voluntary way to spread risk. Risk comes from uncertainty. But someone already sick doesn’t face a risk that he might need medical attention for his ailment. He is certain to require the attention. There’s a reason you can’t buy homeowner’s insurance after your house has burned down or life insurance for a deceased person. Why should one expect to be able to buy insurance to cover medical treatment for a disease one already has contracted? When private donors voluntarily pay the bills, we call it charity or philanthropy or benevolence. When government pays them after extracting money by force from taxpayers or by requiring insurance companies to overcharge healthy people who are compelled to buy coverage, we should call it (at the very least) welfare.

If someone wants to defend medical welfare, let him do so. But don’t let him get away with calling it insurance. He not only does violence to the language; he also clouds the discussion. This is another application of the tacit premise that no one should have to pay for his own medical care. Bastiat’s line about the state being the means by which we all try to live at everyone else’s expense comes to mind...

Finally, the way to rig a debate over public policy is to never acknowledge the only genuine alternative to your proposal. Obama says, “I’m confident that when people look at the costs of doing nothing they’re going to say, we can make this happen.” Why is “doing nothing” the alternative to a conscious attempt to reinvent the healthcare industry? While it is true that doing nothing would be preferable to what Obama and his congressional allies want to do, it is not the best alternative. The best alternative is the free market. But have you ever heard the advocates of government control offer an argument against the free market? The answer is no, and the reason is that to argue against it would be to acknowledge it as an alternative. And that they cannot afford to do. Better to have the people think we already have a free market in medicine and that it has failed. That way they will be more likely to win support for government control. The “reformers’” task would be more difficult if people understood that what has created the problems is government, not the free market.

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A Free Market in Health Care

There is one reason why there is a health-care crisis in America: socialism and interventionism, both at the federal level and the state level. On the demand side, there are Medicare and Medicaid. On the supply side, there are regulations and occupational licensure of physicians and other health-care providers.

Yet, virtually all of the discussion about how to solve the health-care crisis takes place within well-defined parameters in which Medicare, Medicaid, regulation, and licensure are the given. The discussion then focuses on how to resolve the crisis within those parameters...

Socialism and interventionism are inherently incapable of working. No matter how much time and energy are put into solving the health care crisis, it won’t matter one iota as long as the reformers are operating within the parameters of socialism and interventionism. The results will be same, no matter what the reform: chaos and crisis, which will only produce the need for more reforms down the road...

The freer an economy, the wealthier the society will be, and the better off the poor will be. Conversely, the more socialistic and interventionist an economy, the poorer society will be, and the worse off the people at the bottom of the economic ladder will be...

There is but one solution to the health care crisis — the free market, which would entail a complete separation of health care and the state, in the same way that our ancestors separated church and state.

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