The loose credit policies of the Greenspan years have led to consequences that fit in well with the Austrian view. During Alan Greenspan’s reign as chairman of the Fed, he maintained a loose monetary policy punctuated with
generous injections of extra cash in times of crisis, such as the Asian financial crisis of 1997 and the collapse of the hedge fund
Long Term Capital Management. This easy credit fed into the excesses of the dot-com era, which led directly to a stock market crash and recession in 2001.
Federal Reserve policy was also instrumental in inflating the housing bubble and creating the current recession. As the economist
Mark Thornton points out, Alan Greenspan pushed interest rates down to unprecedented levels in the wake of the 9/11 attacks, which resulted in historically low mortgage rates. The fallout of the dot-com collapse led to massive losses, but the recession was mild, as the Fed’s easy money pumped up a real estate bubble just as the NASDAQ bubble unwound. The low rates led to increased borrowing for homes on a massive scale. House prices soared, but when reality eventually reasserted itself, they fell sharply, a process which culminated in last fall’s financial crisis.
Freddie Mac and Fannie Mae, which bought mortgages and resold them as securities under an implicit government guarantee, certainly abetted the housing bubble, as did the Community Reinvestment Act, which pressured banks into increased lending to disadvantaged groups at the cost of loosened lending standards. Perhaps these mechanisms helped to funnel cheap credit into the housing sector which would otherwise have created mal-investment elsewhere in the economy. But blame for the industry-wide decline in lending standards cannot be placed solely with the CRA: Lax credit standards are virtually inevitable when a massive amount of cheap money is looking for something to do.
Bolstering the Austrians’ credibility is the fact that Austrian school economists such as Mark Thornton, Frank Shostak, and Christopher Meyer warned of the housing bubble relatively early on in the process (in 2003-04). Likewise, Ludwig von Mises, the originator of Austrian business cycle theory, and his student friend. A. Hayek warned of a coming depression during the boom years of the 1920s. Unfortunately, the parallels between the Great Depression and today’s troubles do not end there.
The Great Depression is often trotted out as an example of the failure of unfettered markets and the need for governmental regulation of the economy, and the same argument is being rehashed regarding today’s crisis. But like our housing bubble, the boom years of the 1920s were fueled with inflationary monetary policy. And just as in the 1920s, the current downturn is being exacerbated by misguided policy designed to alleviate the crisis.
The severity of recessions is determined by the heights reached in the boom period, but in the absence of government intervention, the adjustment process is relatively quick, and the economy can soon return to growth. As the economist Murray Rothbard taught, a serious recession in 1920–21 was met with a generally laissez-faire government response, the economy quickly returned to health, and it is now a historical footnote. The same can be said of the various panics and depressions of the 19th century.
But after the inflation-fueled boom of the 1920s, Herbert Hoover’s response to the 1929 stock market crash was aggressively interventionist from the start, as is documented exhaustively in Rothbard’s book
America’s Great Depression. Hoover has been painted by historians as sitting impotently on the sidelines amid the deepening crisis, but in fact, the exact opposite is true: He had an expansive understanding of the role of government during a crisis, and he quickly set about to take aggressive action to rescue the economy.
What he actually did, though, was to take measures that seem expressly designed to thwart recovery by interfering with the economy’s ability to reallocate its resources to serve productive ends. Moreover, some of Hoover’s interventions in the wake of the 1929 crash show ominous parallels with policies being enacted to deal with the current crisis. Hoover initiated a program that kept failing businesses, including banks, afloat through emergency loans. Sickly banks on life support were pressured to expand lending despite a shortage of savings and viable projects. Measures were taken to save mortgaged property from foreclosure. Massive public works projects such as the Hoover Dam were initiated while large companies were pressured to retain staff at above-market wages. Such employment-boosting measures only served to divert capital and labor that could have been used productively by private industry into wealth-destroying make-work projects. Repeated bailouts of industry, moreover, forestalled the market’s correction process by propping up failed companies, rewarding poor decision-making, and keeping additional resources tied up unproductively.
Such measures were expanded upon by Franklin D. Roosevelt’s New Deal, and the depression predictably ground on. Like Obama, and despite the vaunted “brain trust” of policy intellectuals serving in his administration, Roosevelt entered office without any coherent economic philosophy, and experimentally created a hodgepodge of interventions in an effort to gain some kind of traction on the economy.
In recent years academics have come to acknowledge the ineffectiveness of New Deal programs, but have largely failed to come to terms with the New Deal’s role in extending and deepening the downturn
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for a piece of the American Pie.....
