Robert Murphy – September 20, 2018
This week marks the 10th anniversary of the collapse of Lehman Brothers, the pivotal event that serves as the official starting point of the financial panic of 2008. Officials in both the George W. Bush administration and Ben Bernanke’s Federal Reserve did not let that particular crisis go to waste, but instead rescued Wall Street from its reckless behavior as the U.S. Treasury Department infused equity capital into major banks and the Fed began its “Quantitative Easing” programs, whereby it bought trillions of dollars worth of “toxic” mortgage-backed securities.
In the wake of Lehman’s collapse, a familiar refrain from government officials, academics, the news media, and even Hollywood served to cement the “lessons” that deregulation and greed were the main causes of the financial crisis, while bold political intervention spared Americans from another Great Depression (the last time policymakers allegedly stood back and did nothing).
There’s just one problem with this narrative: Every single element of it is false. “Deregulation” had nothing to do with the housing bubble and subsequent crash, which actually resulted from government programs that intentionally reduced mortgage lending standards, as well as Fed monetary policies that prominent Keynesian pundits advocated in order to fuel a housing boom in the early 2000s. Furthermore, the world financial system did not need the bailouts of 2008 and beyond — these measures only postponed the needed economy-wide readjustments. (If anything, the interventions have set us up for an even worse day of reckoning still to come.) Finally, the Keynesians’ frequent allusions to Herbert Hoover and the early 1930s are also misleading. Far from heeding the advice of Treasury Secretary Andrew Mellon to “liquidate stocks” and everything else, Hoover took the opposite tack. He was, in fact, the most interventionist peacetime president in U.S. history to that point, implementing several policies that anticipated the New Deal.
“Deregulation” Didn’t Cause the Housing Bubble
Advocates of government intervention point to the alleged “repeal of Glass-Steagall” regulations in 1999 as the mechanism by which the free market caused the subsequent housing bubble. It’s a bit awkward that the change in the Depression-era legislation occurred during the Clinton administration (rather than under one of the Bush presidents), but there is a superficial plausibility to the claim. After all, there was some tinkering with the firewall separating investment and commercial banking in the late 1990s, and then almost a decade later the financial crisis occurred.
In reality, the rollback of Glass-Steagall regulations is a red herring. The bulk of the lending activities that fueled the 2000s’ housing bubble would have been perfectly permissible before the change to Glass-Steagall; it’s not as if this loosening of the separation between different financial institutions allowed them to dabble in activities that they couldn’t do already. (For what it’s worth, PolitiFact “mostly” agreed with Bill Clinton that the Glass-Steagall repeal legislation he signed didn’t contribute to the housing mess.)
Uncle Sam and the Fed Pumped Up the Housing Bubble
Numerous government programs encouraged banks to issue mortgage loans to borrowers who otherwise would not have received them. Lawrence J. White has explained the major role that Fannie Mae and Freddie Mac played, while Peter Boettke and Steven Horwitz have given a longer history of government and central bank intervention. In this short clip from the early 2000s, President George W. Bush proudly pledged that his administration would increase homeownership.
It is understandably a bit difficult for Federal Reserve apologists to admit to the origins of the housing bubble. After all, Alan Greenspan, Fed chair from 1986 to 2006, was dubbed “The Maestro” in the early 2000s partly for his ability to engineer rising home prices amidst an economic recession and the dot-com crash. Indeed, Paul Krugman in a 2002 New York Times column infamously echoed PIMCO’s chief economist, who said Greenspan “needs to create a housing bubble to replace the Nasdaq bubble.”
The World Was Not Going to End with the Fall of Lehman
Despite the claims of Greenspan’s successor Ben Bernanke and Bush’s Treasury Secretary Hank Paulson, the global financial system was not poised for collapse when Lehman Brothers went down. As David Stockman points out, “AIG’s $800 billion globe spanning balance sheet at the time [of the Lehman collapse] was perfectly solvent at the subsidiary level. Not a single life insurance contract, P&C [property and casualty] cover or retirement annuity anywhere in the world was in jeopardy on the morning of September 16th.” In his book The Great Deformation, Stockman gives exhaustive statistics and arguments to show that ATMs were not in jeopardy, either. Claims that they were at risk amounted to scare tactics to get Americans to accept the financial bailouts.
Yes, there were major imbalances in the system, but the bankruptcy of even major investment banks doesn’t necessarily make humanity poorer. Rather than bailing out the financial institutions that had helped inflate the housing bubble, regulatory authorities in the fall of 2008 should have stayed out of the mess. Normal bankruptcy rules would have moved net assets into the hands of those parties who had behaved more responsibly during the giddy days of the bubble. Instead, the authorities rewarded the profligate players and taught everyone that political pull, not prudence, was the name of the game.
True, a bad recession would have occurred in 2008-09 even if the authorities hadn’t intervened. But that’s the unavoidable consequence of an inflationary boom; the “correction” isn’t a euphemism but an accurate designation for the necessary and (under market conditions) naturally occurring reallocation of resources to more appropriate uses once interest rates and other market prices are allowed to do their job. I lay out the general Austrian theory of the business cycle in my book Choice: Cooperation, Enterprise, and Human Action. The theory applies very well to the 2000s’ housing bubble and bust.
The Great Depression Wasn’t Due to Laissez-Faire, Either
As for the last leg holding up the false lessons about Lehman and the 2008 financial panic, we must explode the myth that the Great Depression itself was due to laissez-faire economic policy. Princeton University scholar Harold James reminds us of this erroneous historical link (without himself endorsing the claims), when he relays a popular narrative that says:
…Lehman’s failure had made the Wall Street crash of 1929 and the Great Depression newly relevant. Policymakers drew lessons from the interwar years, and successfully avoided a full repeat of that period. During the Great Depression, especially in Germany and the US, the prevailing attitude was that of then-US Secretary of the Treasury Andrew Mellon: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” By contrast, the response during the Great Recession was to use public debt to replace insecure private debt – an intervention that would prove sustainable only as long as interest rates remained low.
To repeat, Harold James recognizes the problems with the above narrative, but he is definitely right that many pundits (and even academic economists) did their best to ingratiate these ideas in the minds of the public.
In reality, the Hoover administration was not laissez-faire. Indeed, the only reason we know that Treasury Secretary Andrew Mellon recommended liquidation after the 1929 stock market crash, is that Hoover himself reported this in his Memoirs — in order to assure readers that he rejected Mellon’s advice! In fact, Hoover initially raised federal spending despite plunging tax revenues, leading to a sharp increase in the federal budget deficit. (It’s true that he agreed to massive tax hikes in 1932, but this is hardly laissez-faire.) Hoover also authorized bank bailouts and infrastructure projects; later one of the lieutenants in the New Deal admitted that President Franklin D. Roosevelt’s policies had merely elaborated on what Hoover had started.
Keynesians can argue that Hoover’s deficit spending, bank recapitalization, interference with the labor market (urging businesses to avoid a vicious downward spiral in wages and prices), farm subsidies, and other proto-New Deal policies were too little. But it makes no sense to blame the Great Depression on Hoover’s (alleged) unwillingness to tinker with the economy, for he was the most interventionist (peacetime) president in U.S. history to that point. To blame the Depression on Hoover’s relative support for laissez-faire would be akin to blaming a plane crash on gravity.
The 10th anniversary of the collapse of Lehman Brothers allows us to revisit critically some of the false “lessons” that have emerged since the crisis. Americans have been assured that financial deregulation caused the housing bubble and that bold government and central-bank action was necessary in the fall of 2008 to prevent another Great Depression—which itself supposedly had been due to inadequate political intervention. Yet as I’ve demonstrated in this article, every element of this narrative is false. The U.S. government and Federal Reserve caused the crisis, and since 2008 their actions have set us up for an even bigger calamity.
This article was originally published at the Independent Institute. Robert P. Murphy is a Research Assistant Professor with the Free Market Institute at Texas Tech University and a Research Fellow with the Independent Institute. He is author of Choice: Cooperation, Enterprise, and Human Action (Independent Institute 2015).