Blame Bernanke and Paulson
John Taylor has an interesting Op-Ed in the WSJ today purporting to have done the research and determined that letting Lehman fail was not the cause of the panic.
While interest rate spreads increased slightly on Monday, Sept. 15, they stayed in the range observed during the previous year, and remained in that range through the rest of the week. On Friday, Sept. 19, the Treasury announced a rescue package, though not its size or the details. Over the weekend the package was put together, and on Tuesday, Sept. 23, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson testified before the Senate Banking Committee. They introduced the Troubled Asset Relief Program (TARP), saying that it would be $700 billion in size. A short draft of legislation was provided, with no mention of oversight and few restrictions on the use of the funds.
The two men were questioned intensely and the reaction was quite negative, judging by the large volume of critical mail received by many members of Congress. It was following this testimony that one really begins to see the crisis deepening and interest rate spreads widening.
The realization by the public that the government’s intervention plan had not been fully thought through, and the official story that the economy was tanking, likely led to the panic seen in the next few weeks. And this was likely amplified by the ad hoc decisions to support some financial institutions and not others and unclear, seemingly fear-based explanations of programs to address the crisis. What was the rationale for intervening with Bear Stearns, then not with Lehman, and then again with AIG? What would guide the operations of the TARP?
The core of Taylor’s argument, beyond finding fault with Greenspan, Bernanke and Paulson, is that arbitrary action by the government causes panic and paralysis. There’s a compelling logic to what Taylor writes. But there’s also a nagging feeling that his research is biased toward his own intellectual assumptions.
Source:
How Government Created the Financial Crisis
by JOHN B. TAYLOR
Wall Street Journal; February 9, 2008
http://online.wsj.com/article/SB123414310280561945.html
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February 9th, 2009 at 1:48 pm
I also get the same nagging feeling about your intellectual assumptions.
http://www.campaignforliberty.com/article.php?view=10
One of the most pernicious misconceptions of our time is that the Bush administration represented an era of free-market capitalism. By wrongly blaming the financial crisis and economic woes associated with Bush on his alleged devotion to laissez-faire, many in the mainstream press, academia and political life are misdiagnosing the problem and prescribing the wrong solution: More government, which will in reality only make things worse.
Big-government Republicans like Bush have done more than their part to encourage the confusion. By branding themselves as friends of the free market, budget hawks, tax cutters, deregulators and champions of constitutionally limited government, all while pushing the opposite agenda, they have helped create the impression that the disasters resulting from their interventionist meddling are the consequence of free enterprise.
Even some officials whose entire public policy legacy was one contrary to free-market principles often convince the public that they are among the market’s great defenders. Alan Greenspan, longtime head of an agency inherently hostile to economic liberty — the Federal Reserve, which regulates credit and money itself — long professed to embrace free enterprise, only to say last October that he had been wrong in this judgment. “I made a mistake,” said Greenspan, “in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.” Despite having spearheaded major monetary interventions and disruptions into the economy for years, with a straight face he claimed he had been too loyal to the free market.
Meanwhile, liberals have mistakenly or disingenuously characterized every huge governmental catastrophe as the doings of a hands-off attitude, concluding that we must trust government to manage the economy. Bush responded to Katrina with federal intervention that obstructed relief efforts while trampling on civil liberties, but he was blamed mostly for not doing enough. His health care policy has been attacked for being too free-market, but it was his prescription drug plan, the largest welfare state program in 35 years, that has contributed to the spike in pharmaceutical prices.
Even on foreign policy issues, Bush spent hundreds of billions on and conducted central planning in Iraq, but Democrats have criticized him more for mismanaging the war than waging it in the first place. As for Afghanistan, he has always been accused of neglecting it rather than continuing the occupation for so many years.
Although Bush did perhaps administer the government less adroitly than other politicians might, his record was overall the reverse of what is often claimed. He made government much bigger and increased spending on virtually every program more rapidly than Bill Clinton did. He responded to Enron with Sarbanes Oxley, a significant aggrandizement of the regulatory state, bragging in March 2004 that “[w]e passed the strongest corporate reforms since Franklin Roosevelt, and made it clear we will not tolerate dishonesty in the boardrooms of America.”
The financial crisis is blamed on an “atmosphere of deregulation” even though it came after years of intervention, specifically easy credit and big-government promotion of homeownership. A growing literature makes the case that intervention, not free markets, was the culprit behind the current economic troubles. For a book-length treatment, see Tom Woods’s new contribution, Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Despite such evidence, the market gets the blame.
Historically, government interventions in the market have caused disruptions often wrongly blamed on economic freedom. Progressives blamed the ungainly growth of big business in the late 19th and early 20th centuries on laissez-faire. As leftist historian Gabriel Kolko and others showed, however, this was an incorrect reading. In The Triumph of Conservatism: A Reinterpretation of American History, 1900-1916, Kolko documented how the relative free market of the late nineteenth century allowed for robust and increasing competition. Big businesses were losing their market share to smaller ones and prices were plummeting. The wealthiest players from the railroad, coal, meatpacking, communications, finance, insurance and other industries were watching their profits dwindle, so they called upon government to enact regulations to entrench and preserve their economic power. The most significant Progressive reforms — the Pure Food and Drug Act, the Meat Inspection Act, the Clayton Antitrust Act, the Federal Reserve Act — were all championed by the exact big business interests that they were charged to regulate. To this day, big business interests have often favored a robust regulatory state, despite the common assumption that the free market is the rich man’s best friend.
The clearest historical parallel to the Bush laissez-faire myth is the case of President Herbert Hoover. The media have been calling Bush the new Hoover for months. The idea is that just as Hoover’s policies of laissez-faire left President Franklin Roosevelt with a Depression that only the New Deal could remedy, Bush’s laissez-faire governance brought on a financial crisis that demands a second New Deal under President Barack Obama.
But this historical narrative is backwards. As economist and historian Murray Rothbard showed in America’s Great Depression, not only did the crash result from a 1920s interventionist monetary policy rather than the free market, but Herbert Hoover’s response to it was one of the most interventionist programs in American history. Rothbard writes,
Before the great depression struck, Hoover vowed that in any such economic crisis, he would immediately deploy the massive powers of government to end it. He put that vow into effect as soon as the stock market crashed in October 1929, and he invoked every measure that would become even more visible in the New Deal: propped-up wage rates, massive public works, heavy federal deficits, huge federal loans to shaky businesses, unemployment relief, inflationary monetary policies, etc. There was no need for FDR to install a farm price support program to combat the Depression; Hoover had already carried out his pledge to the farm bloc to establish one as a permanent fixture of the economic scene, a fixture that would generate huge and unusable food surpluses in the midst of starvation.
Hoover also signed off on the Reconstruction Finance Corporation, the Federal Home Lone Bank Act and Smoot-Hawley Tariff; attempted to shut down the banks; and signed one of the biggest tax increases in U.S. history, raising the top income tax rate from 25% to 63%, doubling the estate tax and increasing corporate taxes by about 15%. In fact, it is uncommonly known that FDR loudly attacked Hoover for spending too much and ran against him on a small-government platform, promising to cut government, taxes and tariffs, preserve sound money, and allow for the liquidation of bad assets.
Once in power, FDR broke his campaign vows and instead continued and expanded upon Hoover’s interventionist policies, just as Obama is expected to do with Bush’s interventionist response to the financial crisis. And despite the conventional wisdom, Bush, like Hoover, did not warm up to intervention late after events compelled him. Bush did not “abandon. . . free-market principles to save the free-market system,” as he claimed in December. Rather, he was always a big-government president whose policies helped bring about the crisis.
Although Bush’s mythical laissez-faire agenda did not cause the crisis, true laissez-faire is the best response. In 1921 to 1922, after years of President Woodrow Wilson’s expensive World War I disruptions of the free market, America suffered a Depression as sharp as the one after the 1929 crash. President Warren G. Harding did not respond with new public works programs or regulation or an expensive “stimulus” spending bill, though he did significantly cut taxes under the advice of Treasury Secretary Andrew Mellon. The Depression was painful, as all corrections to a government-created bubble and bust must be, but it ended quickly. Hoover and FDR’s New Deal, in contrast, prevented a quick recovery and prolonged the Great Depression for more than a decade, by keeping prices high, discouraging investors with over-regulation, interfering with the labor market and forcing the cartelization of businesses. In 1946, although politicians debated about how to deal with the millions of Americans coming back from World War II, they failed to conjure up any grand plan. Instead, their loosening of the strangling wartime economic controls allowed for a quick adjustment, and finally, seventeen years later, the economy was on the path of steady civilian economic growth that it had followed until 1929. For more on this, see the work of economist Robert Higgs, especially his book Depression, War and Cold War.
For Americans to resist the temptation of more spending, inflation, regulation and costly “stimulus” packages, they need to understand what caused our current financial collapse and what the best remedy is. They must learn the right lessons from our history to avoid repeating it. Yes, Bush is a lot like Hoover in terms of economic policy. But the idea that the economic trouble they caused was a consequence of not enough government is a dangerous myth, the exact opposite of the truth.
February 9th, 2009 at 2:34 pm
On Tuesday September 16 the money market funds Reserve Primary Fund and Reserve International Liquidity Fund LTD, managed by Reserve Management Corporation, broke the buck. Was that an unintended consequence of Lehman’s failure? Word is that this event was used by Paulson and co. to scare the hell out of the Congressional leaders. And then came TARP. (The money markets are also affected AIG).
February 9th, 2009 at 5:41 pm
The WSJ article reminds me of a lot of things that were written after Katrina in this regard; specific people were incompetent and took specific wrong actions, but people with an emotional investment generalized this to “government actions.” What happened to the party of personal responsibility?
For instance the WSJ article mentions that “The Fed held its target interest rate, especially in 2003-2005, well below known monetary guidelines that say what good policy should be based on historical experience.” They are right, but who did that and why? Alan Greenspan did that because he was invested in supply-side theory. There had just been a massive, budget-busting round of tax cuts. According to supply-side “theory” this was supposed to generate growth which would help make up some of the lost revenue. The growth was not happening. There were only two options: 1) Double-down and inflate a housing bubble by keeping rates low or 2) Admit that that supply-side tax cuts are hogwash. Greenspan has since admitted that his “model for reality was flawed” but most of the tax-cut cheerleaders are not so intellectually honest.
Similarly the WSJ article talks about the disjointed and haphazard actions taken by the Fed and the Treasury. Right again but missing the point. Why were Bernanke and Paulson blindsided? Why wasn’t there any transparency into the problems? Why was there no plan? Because there were eight years of people in charge of these things who were simply not doing their jobs.
I notice that this guy works for the very aptly named Hoover Institution. ‘Nuff said.
February 9th, 2009 at 8:41 pm
We are so not being given the whole story, but left to conjure up our own rationalization. Is is that we can’t upset the Saudi princedom? Or the Chinese? Something requires propping these banks up. What is it really?
Furthermore, slightly off topic but not. Has anyone definitively answered the question whether any foreign banks have received TARP money? In particular Credit Suisse? That question during the hearings still sticks in my craw. Did Bernanke ever answer that in public as he was supposedly going to? Or did he cancel?
February 9th, 2009 at 8:56 pm
what’s worse is the way Paulson et all threatened Congress with something akin to “IF YOU DON”T PASS THIS BILL YOU”LL ALL GO DOWN IN A FIERY BLAZE OF ANARCHISTIC GLORY!” it was legislation by intimidation.
the scary thing is, the current plan is so bad that Obama has to take to the ignorant American public to convince them that the bailout is good for them. similar tactics: legislation by intimidation “we NEED to do this or face a CATASTROPHE”