Lessons From the Great Depression - Horwitz' Ideological Residue

This morning I was listening to a conference call held by a US Representative, generally taking credit, as they tend to do, for anything good and any new dollars that have come to our State, while generally dodging credit or blame for any failures or transgressions of the Congress. (Hence the 90%+ return rate for incumbents? – But, I digress)

Then a fellow named “Smith” asked a very well-phrased question about the concerns we should have about King Obama firing GM’s CEO and the government discussion of imposing even more onerous restrictions on the salaries of those who have the bad fortune to work for a company that took bailout money from the government. In response, this brilliant leader of the free world and peer of the “Clueless 435”, otherwise known as the House of Representatives, stated, and I will paraphrase, that “while he understands the concerns about government intrusion into the bailiwick of shareholders and corporate boards, he was more concerned about the ‘average citizen’s concern that the people who caused this mess and caused us to lose so much money in our savings plans’ should profit from these bailouts.” In other words, to hell with principle, we can forget the Constitution and limited powers doctrine if we are mad as hell and we want to punish the greedy. Of course, while these average citizens have been told repeatedly by Congress and the liberal media that it was those greedy so-and-so’s on Wall Street who caused this financial mess, many, if not most, have never been told who or what was the real culprit in the recent economic debacle.

So let us set the record straight – if you want to limit the salaries of those who were the principle cause of the recession, then Congressman, you should pass laws to limit the salaries and benefits of Congress and the Administration, in general, and Barney Frank and Chris Dodd, in particular. And yet, it is the inimitable Mr. Frank who is sponsoring this new legislation! The false assumption that it was Wall Street greed (which there is no lack of, to be sure) that caused this mess is not just wrong, it is illogical.

Economist Larry White noted recently that, if we saw a bunch of airplanes crash all on the same day, we wouldn’t blame gravity. Why, then, does it make sense to blame greed, which is always there and, like gravity, always has been, for this economic calamity? Logic would tell you that something else was at work. It is more likely that processes, policy and institutions, which can channel greed for good or evil, are more likely the cause.

It is just as illogical to believe the crisis was caused by the unrestrained free market strategy of Bush and his deregulation of the financial industry. Why? Well, the last deregulation in that industry was during the Clinton administration, so anyone arguing that point should point out just what deregulation they are talking about. There was a decision by the SEC to rely upon the modeling and servers developed by the huge financial players, rather than trying to regulate through an IT process that would merely slow the models and thwart the intent of protecting and hedging investments, but in truth the SEC was merely admitting that they did not have the capability of doing that level of regulation with their own servers and models. Anyone arguing that was “deregulation” should also point out what central planners could have done, other than grind the markets to a halt, that would have regulated this process so as to avoid the rather certain cyclic adjustment, and what the ameliorative impacts would have been. Besides, the Bush administration added hundreds of thousands of pages to the Federal Registry, and trillions to the deficit – not something a limited government, free market advocate is likely to do, so he doesn’t get a pass, either.

As I have stated in earlier posts (and perhaps hundreds of blog threads in the last several months), there are two primary causes to this crisis: the irresponsible and expansionist monetary policy of the Federal Reserve Board (the “Fed”), and a well-documented collection of regulatory and institutional interventions that created excess credit and expanded access to credit in the housing market, creating a housing boom that was destined to fail because it was built on sand, bad credit principles, and a flawed idea that real estate values would always go up. As stated by Steven Horwitz, Professor of Economics at St. Lawrence University: “In other words, the boom (and inevitable bust) are the product of misguided government policy, not unbridled capitalism. … The Fed drove up the money supply and drove down interest rates very consistently since 9/11 [,] mak[ing] long term investments relatively cheaper than short term ones, thus the excess funds flow[ed] toward such goods. …[I]n this particular case, a set of other government interventions and policies pushed those funds toward housing.”

The wrong-headed government interventions Horwitz is referring to include: ­ -The Fed expanding money supply and driving down interest rates consistently over a number of years; ­ -A strong governmental push for “affordable” housing in several administrations; ­ -The involvement of the GSE’s, Freddie Mac and Fannie Mae in the development of low down-payment mortgages and the packaging of those mortgages for sale as securities in the secondary mortgage market, with an implicit promise of government support; ­ -Government pressure on the GSE’s to make housing more affordable, and more accessible to certain favored groups of borrowers (the historically underserved); ­ -The Community Reinvestment Act; ­ -The impact of zoning laws, which crowded housing into limited areas in many cities; ­ -At least two presidents pressing for even more “affordable housing.”

With these steps and many more, government intervention provided all the ingredients of a credit-fueled and regulatory-directed housing boom and bust. Of course, none of it would have happened without inspired assistance from those in the private sector who profited from the boom, but was it their greed or the finagling of the government that started the boom?

Professor Horwitz discusses this in detail in a speech, comparing this “Great Recession” to the Great Depression, to be found at – http://myslu.stlawu.edu/%7Eshorwitz/gsutalk.htm To summarize his points: ­ -The stimulus won’t stimulate much, and the bailouts so far have not, and may not, be effective. ­ -The original TARP plan has not done much good – and the prices of these inflated assets need to fall before the economy will correct. ­ -The stimulus legislation was premised on government spending bolstering demand for labor and reducing unemployment, but how government spending can add to growth, when government can only get resources through a reduction of private spending, remains unanswered. ­ -Focus on macroeconomics (money supply, interest rates, etc.) ignores the microeconomic adjustments that are necessary, so the focus is not just as retrenchment from inflation, but a sectoral reallocation of resources away from the artificially large longer-term asset sectors, to where real consumer demands lie. ­ -Obama’s proposed budget is based, apparently, on the presumption that we spent too much on housing, the financial sector, and debt in general, and not enough on the core issues of the environment, health care, and education. “For the life of me,” says Horwitz, “I cannot see how such a theory can explain anything of what’s happened the last six months, but it does serve to create a rationale for a budget that contains a whole bunch of new initiatives … [and] taken on a whole bunch of new debt.” ­ -Institutions created in the Great Depression are operating in and relevant to our current mess: the Banking Act of 1935 gave the Fed the power to adjust the money supply more directly, and to buy and sell government securities to adjust the money supply and interest rates; the Fed also has the power, and used it, to create the credit expansion of the post 9/11 period that caused the boom that has ended in the current bust; Fannie Mae was chartered in 1938, to address a rise in foreclosures and a problem of unaffordable homes – and its use, through the application of systematic policy to artificially support the housing market, was central to the current mess, and is an unintended consequence of the Great Depression’s institutional legacy; the SEC was created in 1933-34, and its role in the current crisis, though limited, was in creating a cartel of bond rating agencies that serve issuers rather than investors, hence the fox was guarding the hen house. ­ -If the period preceding the Great Depression (or this recession) was all about greed and laissez-faire economics/banking as urged by the media and the President, both then and now, why is it that Canada, which had far fewer limits on banks in the 20s than the US, had only one bank failure in the 20s, and none after 1929? ­ -The kind of meddling we now see from this Administration is very similar to that of FDR’s “brain trust”, which had many of its efforts declared unconstitutional, and by consensus, most were judged to have actually exacerbated the distortions of the 1920s and prevented necessary corrections, thus prolonging the debacle.

To put all this in perspective, economist Bryan Caplan asks: “do you suppose that if Bush and Obama had simply relied upon free market, laissez-faire principles to respond to this crisis, and the market had dropped by 4000 points and unemployment increased by 2 or 3% (now 5% or more?), the media would not have savaged them for their stupidity?” Well, why aren’t they questioning these effects from central planners who now have their fingers in everything, and if the G20 reports are accurate, are now going to mess with things on a global scale, inventing new currencies that devalue the current ones and reflating asset values. Their track record doesn’t give me much confidence. TARP has done basically nothing except prolong the agony of certain market failures -- yet the market would say that we need to let inflated housing prices fall to proper levels. These interventions are attempting to prevent that from happening, again, prolonging and exacerbating the misery.

In short, as Horwitz urges, we need to learn the lessons of the Great Depression, not mimic their failures. Short term bear market rallies may buoy spirits, but they will not last, and the inflation that must result from all these government trillions being thrown about in a panic will certainly end up hurting, rather than helping, any recovery. The programs that Obama is instituting in the name of recovery have nothing to do with recovery, and everything to do with his, and the left-leaning members of his party’s, long term programmatic and policy goals. Social democracy is a political movement advocating a gradual and peaceful transition from capitalism to socialism – a democratic welfare state that still incorporates some capitalist practices with its primarily socialist practices. But the goal is clear – a transition to socialism. If Obama is indeed a social democrat, and his statements and policy decisions all suggest strongly that he is, then his goal is clear as well – an economic and political system which includes collective or governmental ownership and administration (like hiring and firing?) of the means of production and distribution of goods (like car companies?). There are pundits who say we are wrong, and silly, to call Obama a socialist. I wonder. At least he is a statist, as were many Progressives in history, including FDR and Wilson. Because they all lead to the same place, it matters little what we call him, as long as we limit his powers as much as we can, beginning in the 2010 elections.