Government, with its immense coercive and regulatory powers, can (and does force) anyone to act against his self-interest. This is exactly what triggered the lingering economic downturn we have been suffering through since 2008 and the onset of the Great Recession. So unlike what most media outlets parrot, it wasn’t caused by deregulation and unfettered capitalism.
John Allison — chief executive of the Cato Institute and former chief of BB&T Bank — is more than familiar with financial regulations and saw this crisis coming during his BB&T tenure. Like many others in the industry, he had to make subprime loans to could avoid stiff fines from government regulators. Now, in his book — The Financial Crisis and the Free Market Cure — he talks about the causes of the 2008 financial and housing crisis and proposes solutions to avoid another one.
The trigger of this crisis was the housing bubble that inflated during the early and mid 2000s and then popped in 2008. Like the Great Depression of the 1930s, the 2008 crisis can be linked to government intervention, namely an “easy-money policy,” with abnormally low interest rates.
This money was mainly channeled into the housing industry, which, according to Allison, represents the most heavily subsidized domain since the New Deal of the 1930s. These policies include tax credits for low-income housing, that benefit crony developers, and vast, crime-ridden public housing projects paid for by the federal government.
These funds are meant to help every family live in a house, in spite of the fact that this type of acquisition is not for everyone, especially for people who move frequently. Also, officials forget that a house is not necessarily an investment in the economic sense of the term — a good that will be used to produce other goods.
Once the construction is finished, housing can become a consumption good, just like a bag of carrots. In fact, too many houses are a diversion of resources away from more productive allocations and can hinder economic growth in the long run. Further, many jobs directly involved in construction become obsolete during the correction period, once the bubble has popped.
The End of Rule of Law
Beyond housing regulations, Allison shows how regulation in general affects the actions of business leaders — given its arbitrariness — wherever they may work. Some banks, for example, received bailouts while other did not.
Normally, a business that is badly managed will fail in the free market, and more competent competitors buy off the assets. But when government pitches in, it can decide to bail out a bankrupted company by using “too big to fail” reasoning, as though the whole system would fall apart. Instead, they just delay and impede the market correction.
For example, former Secretary of Treasury Hank Paulson had a substantial investment in Goldman Sachs when it failed. He did everything he could to save his money while letting Lehman Brothers fail. The simple fact that one, though, compounds the problem, since it encourages others to take greater risks, since they may be rewarded for doing so.
Aggressive but Necessary Solutions
In order to avoid another crisis like the one we are still experiencing — Allison believes another major crisis looms in the next 10-15 years if nothing changes — radical-but-necessary solutions will be necessary. He contends that the majority of banking regulations, especially the Dodd-Frank Act, adopted in the midst of the crisis, must be abolished. Similarly, Fannie Mae and Freddie Mac must be liquidated and/or privatized.
He also suggests, like every person knowledgeable of human action and incentives, to lower taxes in order to boost production. Indeed, when taxes are high, people spend more time and money on avoiding them rather than on innovation, keeping us from increasing our standards of living.
Most important, though, Allison wants to attack the root of economic crises, which is philosophical and not economic — and he is well-placed to do so with the Cato Institute.
Get Yourself a Copy!
The Free Market Cure should be a part of anyone’s book collection. The author offers detailed information that explains the crisis from the point of view of the “culprits” and shows that their actions were rational in their context. Some parts become hard to follow — probably because the regulations themselves are impossible to understand — but, given that content, the book is still relatively accessible to the layman.