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New Lessons from the "Rescue" and the Failed Stimulus

Tags The FedInterventionismMonetary Theory

09/30/2013John P. Cochran

The Wall Street Journal printed a major story on the aftermath of the financial crisis and the great recession and the lessons supposedly learned. In “Lessons of the Rescue: A Drama in Five Acts” author David Wessell claims, “[f]ive years after the financial crisis, enough time has passed to identify key moments in the war to save the world economy — and to derive lessons from the scramble.” (emphasis added) Wessell also claimed that “[f]ive years after the near-collapse of the global financial system, Americans could justifiably celebrate victory.” Wessel presents some limited criticism from the mainstream of Fed and Treasury mondustrial policy during the fall 2008 “crisis,” 2009’s failed fiscal stimulus, and the nearly continuous rounds of quantitative easing during this period of slow recovery. But Wessel overall presents a picture in which, absent those mondustrial policies, things would have been much worse and the major error in the policies was a matter of them being too little too late.

Wessel appears totally oblivious to the fact that absent the Fed as an enabler with its overly expansionary credit creation policy, first in the 1990s, and then in the mid-2000s, neither the dot-com boom-bust with its unfinished recession, nor the housing bubble, general boom and subsequent bust, which precipitated the financial crisis, would have happened. Roger Garrison sums it up succinctly:

Artificial booms entail a turbocharging of whatever else is going on at the time. The dot-com crisis of the 1990s occurred because a credit expansion took place during a time when technological innovations associated with the digital revolutions created a strong demand for investment funds in that sector. The housing crisis in 2008 occurred because a credit expansion took place during a time when the federal government was pushing hard for increased home ownership for low-income families. We understandably identify these different cyclical episodes (the dot-com crisis, the housing crisis) with “what was going on at the time.” The common denominator, however, is the Fed’s propensity to expand credit. (emphasis added)

The “war to save the economy” was unnecessary since it was a crisis wholly the result of previous actions by one of the supposed saviors of the economy.

Wessel does reference John Taylor who argues that while some of the deer in the headlights response during the fall 2008 crisis might have been necessary to forestall financial collapse, “Government policy has been the cause of the problem,” but ultimately, Wessell sides with the things-would-have-been-worse crowd:

The policy makers who led the response to the crisis argue that the economy would have been even worse if not for the stimulus. And there is substantial support for that view among private-sector economists.

Recovery most likely would have come quicker, with less long–run harm, if policy had been less active, even, perhaps if nothing had been done. As pointed out in the Wall Street Journal “Review and Outlook” of March 6, 2009, “Recessions don't last forever, but bad policies can prolong the pain.” By 2010, the Journal asked a highly relevant question in “A Tale of Two Recoveries” (September 21, 2010, p. A20): Did Keynesian policies do more harm than good? The Journal, sounding much like Robert Higgs, answers in the affirmative. “Our view is that hyperkinetic government policies have done more harm than good, leading to uncertainty and higher costs that have undermined business and consumer confidence and slowed the economy’s otherwise natural recuperative powers.” Little has changed since then.

Wessel is wrong about the bailouts as well. A better picture of the bailouts is provided by Vern McKinley in Financing Failure: A Century of Bailouts. McKinley documents how counter-productive and unnecessary much of the Fed and Treasury actions were. McKinley describes much of what was done as “seat-of-the-pants decision-making” (pp. 305-306):

“Seat of the pants” is not a flattering description of the methods of the regulators, but its use is justified to describe the panic-driven actions during the 2000s crisis. It is only natural that under the deadline of time pressure judgment will be flawed, mistakes will be made and taxpayer exposure will be magnified, and that has clearly been the case. With the possible exception of the Lehman Brothers decision ... all of the major bailout decisions during the 2000s crisis were made under duress of panic over a very short period of time with very limited information at hand and with input of a limited number of objective parties involved in the decision making. Not surprisingly, these seat-of–the-pants responses did not instill confidence, and there was no clear evidence collected that the expected negative fallout would truly have occurred.

Building on a quote from a key player in the bailouts and subsequent stimulus, Timothy Geithner, who stated that “[f]inancial crises require government,” McKinley sums up his analysis of the failed bailouts (pp. 311-312):

Based on the context in this case, Geithner appears to have meant that government action is essential as a response to a financial crisis, but again he does not make clear at all why government action bailing out financial institutions is the preferable approach over just closing them down. Based on history of crises, a meaning differing from Geithner’s intention is actually closer to the mark. It is clear that financial crises require government in the sense that it is government that is responsible for bringing on the crisis.

McKinley then correctly attributes the 1930s depression to monetary policy, the 1980s economy to problems created by overly inflationary monetary policy in the late 1960s and 1970s (here), and “In the 2000s, it was the broad push to homeownership through government policy that led to a bubble in prices facilitated by accommodative monetary policy, and the circumstances where exacerbated by regulatory breakdowns.” He summarizes:

So based on the historical evidence, it can be clearly articulated that it is government that is at the core of the initiation and worsening of financial crises and should be at the core response to the extent of taking swift action to shut down failing institutions.

If one just reads Wessell, one is very likely to learn the wrong lessons. Peter Lemieux’s Somebody in Charge: A Solution to Recessions? (reviewed here), Vern McKinley in Financing Failure: A Century of Bailouts, or Kevin Dowd and Martin Hutchinson’s Alchemists of Loss: How Modern Finance and Government Regulation Crashed the Financial System (reviewed here), are much better guides to what actually happened, what caused it, and why the numerous “policies” most likely made things worse not better.

The financial crisis and the Great Recession were consequences of monetary central planning writ large that twice created bubbles, booms, and subsequent busts by turbocharging first the dot-com-driven productivity growth, and then simultaneously using an easy money and credit policy to impede necessary re-structuring of the economy. Following the dot-com bust, these policies led to an “unfinished recession” while new credit creation began a new round of misdirection of production igniting the housing bubble, general boom, and subsequent bust. My assessment that an Austrian path to sustainable prosperity in 2010 holds up fairly well:

End government intervention in the economy and return to a sound money policy. Such a policy has been dubbed as harsh or too draconian; but the pain of a short, severe recession followed by renewed, sustainable growth and prosperity may actually be “comfortable and moderate compared to the economic hell of permanent inflation, stagnation, high unemployment, and inflationary depression” that is the likely outcome of a continuation of our current policy.

We already are in a Japanese-style stagnation or a semi-permanent Eurosclerosis. The central bank and high-finance driven “war to save the world economy” was, if not totally unnecessary, mostly unnecessary. To best avoid future crises, one failing institution that should be shuttered is the Fed.


Contact John P. Cochran

John P. Cochran (1949-2015) was emeritus dean of the Business School and emeritus professor of economics at Metropolitan State University of Denver and coauthor with Fred R. Glahe of The Hayek-Keynes Debate: Lessons for Current Business Cycle Research. He was also a senior fellow of the Mises Institute and served on the editorial board of the Quarterly Journal of Austrian Economics.