Government intervention, not market failure, explains crisis

Jason Clemens and Robert Murphy are the authors of this guest commentary. Jason Clemens is the director of research and Robert Murphy, Ph.D., is a senior fellow at the Pacific Research Institute (

A financial crisis is gripping the nation and the global economy. This crisis, according to a growing consensus, is the result of market failures coupled with Wall Street greed and corruption. This false assessment of the cause will lead to costly “solutions” that will only make things worse.

Almost unanimously, national leaders criticized Wall Street, deregulation, and lax oversight. House Speaker Nancy Pelosi indicted almost everyone in her recent speech: “budgetary recklessness, on an anything-goes mentality, with no regulation, no supervision, and no discipline in the system.” President-elect Barack Obama has repeatedly blamed “deregulation” for the crisis.

The Republicans have chimed in too. During the presidential campaign, both John McCain and his running mate chastised Wall Street for greed and corruption and Washington for slack oversight.

This bipartisan windstorm ignores an awkward fact–government policies sowed the seeds of both the housing bubble and the ensuing financial crisis.

In an effort to jumpstart the economy after the dot-com crash, Alan Greenspan cut rates from 6.5 percent in 2001 down to one percent by 2003, and then held them at that incredibly low level for an entire year. At the same time, the government-sponsored Fannie Mae and Freddie Mac did everything they could to extend homeownership to applicants who would likely not have qualified in a normal market.

Other government culprits include Jimmy Carter’s Community Reinvestment Act, which was beefed up under President Clinton in order to further “encourage” banks to lend to traditionally unqualified applicants, and activist groups such as ACORN that intimidated local banks into loosening their lending standards. But the story doesn’t end there.

Government policies to save institutions saddled with mortgage-backed assets have contributed to the crisis in credit markets. Since September 2007, the Fed and Treasury have offered greater and greater assistance to troubled firms. This paradoxically has given an incentive for banks to hold on stubbornly to their overvalued assets, hoping for a government bailout.

Perhaps more disruptive have been the government seizures of firms such as AIG. By bypassing traditional bankruptcy proceedings, the government shortchanged senior debt-holders in these companies. These heavy-handed actions–not to mention the ban on short-selling–have scared investors away from the very financial institutions that stand in dire need of new capital.

Despite the evidence of government culpability, critics of the market argue that it takes two to tango. After all, nobody forced banks to make loans to unqualified applicants, and the investment banks on Wall Street were only too happy to securitize dodgy mortgages into exotic new instruments, which the ratings agencies happily stamped with their approval. None of these fat cats complained about government intervention during the few years when they made out like bandits.

Although there is some truth to this, the irony is that it was liberal Democrats who resisted the urge to regulate the mortgage giants amidst the housing boom. The reason Fannie and Freddie dominated the market was their implicit government backing. And even after the discovery of accounting scandals that would have spelled ruin–not to mention jail sentences–for any private-sector firms, Fannie and Freddie stayed in business because of support from politicians such as Senator Christopher Dodd and Representative Barney Frank. Indeed, a quick YouTube search of “Barney Frank Freddie” reveals some worrying clips, such as his statement in July 2008 that the firms were “fundamentally sound.”

Identifying the cause of a problem is a necessary step to determine the appropriate solution. Government interference with the market caused nearly every aspect of the financial mess. The current financial crisis is the result of years of systematic government policies that flooded the markets with cheap credit, promoted mortgages for unqualified applicants, and then bailed out firms when their leveraged bets turned sour.

There are many terms one could use to describe this history, but “market failure” is not one of them.

*This article was also printed in the following publications. Article title may vary.

Sandoval Signpost (Placitas, NM), December 1, 2008
Souderton Independent (Souderton, PA), November 19, 2008
The Leader (Lyndhurst, NJ), November 13, 2008
Prince George’s Post (Upper Marlboro, MD), November 13, 2008
Tinytown Gazette (Cohasset, MA), November 12, 2008
Cranford Chronicle (NJ), November 8, 2008
Daily Messenger (Canandaigua, NY), November 6, 2008

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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