People of all political persuasions have been asking why the American economy sank to such depths in 2008 and 2009. Some blame the deregulation of the Bush years. Thomas Woods, senior fellow at the Ludwig von Mises Institute, offers a different perspective. The author of the book Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse discussed the economy with Mitch Kokai for Carolina Journal Radio. (Click here to find a station near you or to learn about the weekly CJ Radio podcast.)
Kokai: What’s the one thing about the economic collapse that people should know but don’t know?
Woods: Well, the main thing they should know is that conventional wisdom they’ve been told about is just all wrong. It’s really a comic-book version of events in which greedy people with white mustaches carrying sacks of money with dollar signs on them just took all our money. It’s almost laughable what people are being told, that all of a sudden everybody got greedy spontaneously and for no institutional reason. And so in writing Meltdown, my aim was to suggest to people there is an alternative way to look at this that suggests that — to the contrary — what happened was that the government itself plus the Federal Reserve System created incentives in the system for people to behave in perverse ways.
But also, they in effect acted in ways that misled people into doing things that they wouldn’t have done otherwise if they hadn’t been misled. So that is to say, for example, when the Federal Reserve System pushes interest rates extremely low, that makes certain types of consumption decisions and investment decisions seem profitable that wouldn’t otherwise be profitable. And the reason it wouldn’t otherwise be profitable is that the free market would be trying to tell you, “Hey, don’t do this.” And so what we’ve had for years, ever since Alan Greenspan at the Fed around 2001 started attacking the recession of 2000-01 by just lowering interest rates super low, is that people have been under the impression that housing can never go down. House prices never fall. The best investment you can make is a house.
And this is because when Greenspan did this, he did this in a time when there was a mild recession going on. He thought the way to get out of it was to keep interest rates super low. But what that did was it encouraged people to just keep on doing what they’ve been doing. So here we had the only recession we’ve ever had where housing starts went up. Housing prices are going up, and so people think, “Wow, even in a recession, housing is the best thing you can do.” So now when the bust comes it’s all the worse because now everybody’s invested in housing. So by trying to ease the pain years ago, he just made the pain much worse today.
Kokai: What you’re saying sounds completely opposite from those who blame deregulation.
Woods: Oh, yeah. It is completely opposite. If you ask those people, “Name me a repealed regulation that would have prevented this crisis,” they cannot do it. The brighter ones will try to reach for the partial repeal of the Glass-Steagall Act, but even that, when you actually look at what was repealed, it’s so trivial that there’s no conceivable way this could be the explanation for what happened. What happened was that banks wound up making loans they shouldn’t have made.
So in other words, banks were engaged in traditional banking activities and just made a lot of losses on those activities. They had always been allowed to buy, as assets to hold, mortgage-backed securities. That had always been allowed to banks. The securitization process whereby you bundle a bunch of mortgages, chop them up, and sell them as investment vehicles, there was no repealed regulation that allowed that. That had always been allowed. So deregulation is a complete red herring.
What in fact we have is an institutional structure that gives rise to precisely this sort of outcome because of the implicit — or sometimes explicit — too-big-to-fail guarantees. You have the fact that you have a Federal Reserve System that stands ready and had the physical ability to create all the money it would need to bail anybody out. There’s no physical restraint on it. So every market actor now knows that the only limit on bailouts that might be forthcoming is one of political will, which, as we’ve seen, is a pretty thin reed.
Kokai: Do people listen now to what you’re saying?
Woods: Some do. Some don’t. But more people seem to understand it than I think we had reason to expect a couple years ago. The conventional wisdom certainly has wrought a terrible toll because the natural consequence of believing in the conventional wisdom is: we need bailouts; we need massive changes. We do need changes, but all in the [other] direction from the ones that are being proposed.
But thanks to the Internet, frankly, and to programs like this one, people are able to get access to unconventional ways of thinking that turn out to be correct. Just because you happen to be the conventional way of thinking doesn’t make you right. To the contrary, it made almost everybody spectacularly wrong for years. But now people have access to points of view that are usually excluded from debate. Now people are much more critical about the Federal Reserve. They’re much more critical about the government. And they’re starting to ask the right questions. Instead of just saying “Gee, we’re in a bust, what do we do now?” they want to know “How did we get here?” And they don’t just want some gobbledygook about deregulation. They want specifics. …
If we hadn’t had all this government ginning of the free market on mortgages and artificially encouraging lending and lending at particularly low standards and all that, and if we hadn’t had a Federal Reserve pumping all this money in, forcing interest rates down, what would have happened to us? What would have happened if everybody, let’s say, just suddenly decided we all wanted to buy houses? The way the free market would deal with that is that instead of a housing bubble being created, house prices would shoot up because we’re all buying houses.
Well, that’s what happened in our case, but the difference would be if we hadn’t had the Federal Reserve pumping all this money in, is that interest rates would also have shot up. The banks would have started to run low on funds to lend, and the signals of that would have been high interest rates. And the high interest rates would have been the economy’s way of saying, “Whoa, whoa, whoa. Hey, everybody, stop. Stop what you’re doing. You’re getting out of control.” That’s what F.A. Hayek meant when he said, “The interest rate is like a brake on the economy, a stop.” But instead of getting these red lights, stop, we had an institution that could push interest rates back down again so all the lights were green. “Go, go, go.”
These are the sorts of questions that were not being asked in the early ’90s. They were not being asked in the ’80s. They haven’t been asked. By and large, we get the same explanation that, you know, when we leave you people to your own devices, you screw everything up. So it’s time for you to give more power to your overlords. There’s a lot more skeptical eye being cast on that sort of explanation than I think we’ve seen in any recession prior to this one.
Kokai: Are the current economic woes going to teach us any lessons?
Woods: People always say we ought to learn from history, and yet a lot of these people learn exactly the wrong lessons from history. I’ve focused a lot on the Depression of 1920-21 that most people have never heard of. The reason they’ve never heard of it is because the government didn’t try to fix it. One of my friends says that a depression is a recession the government tried to fix. So in 1920-21, you had double-digit unemployment, all the economic factors looking downward.
And what did the government do? Well, instead of a fiscal stimulus in the form of increased government spending, they cut the government budget roughly in half from ’20 to ’22. The Federal Reserve System didn’t really do anything in terms of increasing the monetary base until 1922. But the National Bureau of Economic Research tells us the depression was over in ’21. So we got through this thing with no emergency loans, no bailouts, no fiscal stimulus, at least in the form of government spending, no monetary stimulus. All the stuff that we’re told that without it the earth would break free of its axis and go spinning toward the sun, none of that was done, and the economy returns to a robust performance. We have tremendous economic performance after that.
I would say follow that model. In fact, pretty much whatever you hear coming out of the White House, whatever they’re recommending, a very good rule of thumb is do the exact opposite. Instead of the fiscal stimulus, cut the spending. Instead of creating all this additional money, no, that was what got us in this situation in the first place.