Don't Bail Them Out
It was the singular achievement of Murray Rothbard's America's Great Depression to have demonstrated that the Great Depression was a crisis manufactured and prolonged by the attempts to stop an inevitable downturn. The policy response — creating more money, propping up prices, ginning up employment, and a host of other devices — took a stock-market price collapse and a banking liquidation and spread the mess throughout every sector of the economy. What might have lasted a year to 18 months instead lasted 16 years.
At the time, Ludwig von Mises tried to warn against intervention. See his Causes of the Economic Crisis. So did F.A. Hayek. See his Prices and Production. So did Lord Robbins. See his book The Great Depression.
And yet, that is not the conventional wisdom. The conventional wisdom is that the Depression was a natural disaster, a hurricane that swept through society that had to be fixed by the government. Another view, found in the work of the monetarists, is that it was caused by the failure of the government to create oceans of paper. This seems to be the view of Bernanke.
America is now imprisoned by these fallacious views of cause and effect. For this reason, we see virtual unanimity that the bailout (call it want you want: conservatorship, nationalization, socialization, whatever) of Freddie and Fannie must take place.
On the day following the nationalization, a day that will live in infamy, the Wall Street Journal editorialized against the Democrats and their reform efforts, but didn't actually oppose the bailout; instead it observed that we are all somehow "on the hook." The paper also published a piece by McCain/Palin which said that the bailout is "sadly necessary."
The New York Times called it "a reasonable and reassuring move." The Los Angeles Times wrote that the bailout was "inevitable," and complained that Freddie and Fannie should only help 20% and not half of borrowers. Steve Forbes in his magazine wrote that "drastic action" had to be taken because a default would "have triggered the worst financial meltdown since the Great Depression."
It's interesting, isn't it, that all these people believe that waving the magic money wand can make reality just go away. That incredible superstition seems to be the official position of the entire US establishment. And we like to flatter ourselves into believing that we live in an age without illusions!
As for those who should know better, Greg Mankiw, author of the leading economics textbook, writes that because "it was likely to happen eventually" it is "better to get on with it." The supposedly free-market economics blog Marginal Revolution warns that without the bailout, "most of the U.S. banking system would be insolvent," failing to point out that a system that needs a bailout with fiat money is already insolvent.
The Cato Institute agrees that the Treasury had to bail out the mortgage industry because it "was forced to do so," and since Fannie and Freddie are indeed "too big to fail." The Heritage Foundation agrees that it was a "necessary step" and a "vital move toward reform."
Sure, these people have plenty of recommendations about what should have been done in the past, and lots of ideas about what should be done in the future. As for the present, they are ready to propagandize for the largest socialist operation in American history. In all of these latter cases, we are looking not at a problem of economic education, but rather the lack of courage to stand up to the state when it is needed most.
Pretty much alone in both predicting the calamity and actually opposing the bailout are those who have learned from the Misesian tradition, people such as Nouriel Roubini of the RGE Monitor, investor Jim Rogers, and of course our own scholars such as Mark Thornton, George Reisman, Robert Blumen, and pretty much all of our adjunct scholars, who have said plainly and clearly that this is a dreadful error, one that will worsen the present meltdown. Of course Ron Paul was right all along, as the evidence proves.
Let us address this claim that not bailing out the system and not nationalizing the mortgage market would lead to a financial meltdown on the level of the Great Depression. It makes no sense to warn that we will repeat the past if we fail to do the things that actually made the past as bad as it was. The truth is exactly the opposite: to avoid another Depression-length downturn, we need to avoid the mistakes of the past, among which were the policies that attempted to keep failing firms and industries afloat in difficult economic times.
What should have happened in 1929 is precisely what should happen now. Let the price system prevail! The government should completely remove itself from the course of action and let the market reevaluate resource values. That means bankruptcies, yes. That means bank closures, yes. But these are part of the capitalistic system. They are part of the free-market economy. What is regrettable is not the readjustment process, but that the process was ever made necessary by the preceding interventions.
Let me state this very plainly: I do not believe for one second that if the government fails to nationalize Freddie and Fannie, the world as we know it will come to an end. Those who are saying so are trying to scare the population, the same as with every other major demand by the regime. It was the same with NAFTA, the WTO, the war on terror, the war on bird flu, the nationalization of airport security, and everything else.
If the government did nothing but sell off the assets of the mortgage giants, we do not know for sure what would happen, but the market has a way of finding value and readjusting. I would expect about 18 months of difficulties. Banks would fail just as many businesses in the free market fail every day. Housing prices would fall more, just as all market prices are subject to change. But the process of readjustment would be smooth and rational. Most importantly, we would all stop living a lie and believing an illusion.
Contrary to what the blogging heads say, there is nothing that makes this nationalization inevitable. We need to let the market handle the entire process, come what may. I guarantee that this solution is a better one than creating another trillion or so to bail out failing enterprises.
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.