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Who Caused the Financial Crisis?
Perspective on the News
Monday, September 24, 2012
Ed DeShields

Economists have had four years to examine the financial crisis that would become the Great Recession and the subsequent crisis that followed.   The evidence now suggests who and what caused it, why it was prolonged and why the crisis worsened dramatically a year after it began.

Signs of trouble were first noticed on Thursday, August 9, 2007 when traders in New York and London noticed a dramatic and sudden change in conditions in the money markets.  For years prior, the money markets had been calm, almost monotonous.  A sudden spike in interest rates on that morning alarmed traders, bankers and the central banks around the world.

We now know that these were signs of an emerging recession cycle and a collapsing housing bubble hiding behind it.  Recessions are normal occurrences and it isn’t unusual for them to occur.  They are cleansing tools that cool overheated economies; that is, unless the central planners decide they’re smarter than the free market.

According to many Fed watchers including John Taylor – a legendary Fed economist, it was the Federal Reserve’s prolonged low interest rate policy that drove demand for money, and mortgages that set the crisis in motion.  New, higher yield mortgages were naturally proliferated – that is, until the investment banks saw default rates soar on poor credit borrowers and real estate speculators.  They were loaning money to people who were encouraged to speculate on homes whose prices were inflating rapidly.  Everyone felt wealthy – on paper.  Homeowners used the equity in their homes like ATMs to buy second homes.  Greed fueled the entire system.

Cheap money creates more buyers that push prices higher.  During the entire build-up, the Federal Reserve fueled the fire and watched.  They commented occasionally but couldn’t say stop.  The Fed knew the market was going to correct itself but worried that intervention would be more dangerous than creating a policy response.  It could upset the global apple cart.

History will show that George W. Bush didn’t cause the crisis.  It was the Federal Reserve who will carry the burden of lax oversight and liberal monetary supply.  It was the Fed that left the cleanup to a new president who wasn’t particularly qualified to understand or manage it.

2008 was an election year.  The tension of this presidential election, in particular, presented a clear change in ideology (not seen since the late 1970’s) that would paralyze both incoming and outgoing government and those manning the duty stations that might have been able to act.  As it would turn out, a fundamental shift in ideology was emerging that would make government, for the first time in history, the arbiter of the free market.

On December 16, 2008, George W. Bush, while preparing to hand the keys over to a new government, reluctantly announced,

 “to make sure the economy doesn’t collapse, I’ve abandoned free market principles to save the free market system.”  

Bush had no options.  He had lost the election and the Obama policy team was already rearranging the furniture.

Three weeks later on January 8, 2009, incoming President Barak Obama let the markets in on his views by boldly proclaiming,

“Only government can break the vicious cycles that are crippling our economy.”

Barak Obama entered office believing that only government could fix the problem.   He was now the President of the United States.   But his early involvement proved to only prolong the crisis by misusing the rescue fund designed to secure the system.

Instead of moving troubled loans into a “bad bank” and using the Troubled Assets Relief Program (TARP) for what it was intended, he used the funds to wield new government influence onto to banks.  After all, his intentions were clear;  use the government where its power would influence the markets and use sweeping new regulation to fundamentally change the system of government.

This week General Motors desperately tried to convince the administration to sell the taxpayer’s interest in the company and release it back into the free market.   It’s major competitor, Ford for example, is doing well without a government bailout.

General Motors wants out because the government is making the management decisions for the company.  Even a mid-level manager cannot be hired with government approval.   Top talent fled the company and suppliers don’t like the terms they now have to accept.

The Obama administration didn’t save General Motors.  It destined it to the scrap heap of bureaucratic inefficiency and waste with unnecessary meddling.  It created no value, or jobs.   And, it wasted taxpayer money typical of government.  The value of the stock owned by the government is worth only one-half of it’s bail-out funds.

The Great Recession wasn’t caused by George W. Bush or by President Obama but it is Obama who prolongs the sinking economy preventing it from bouncing back – as it has historically through every prior recession.

U.S. economic policy from the early 80’s to around 2007 was much more stable than in other periods.  Not only were swings in inflation and interest rates tamed, economic expansions and contractions were mild, by comparison to other periods.   It was a record peacetime growth period now known as the Great Moderation.

However, the Great Moderation was not without its challenges.  Even though the excesses from the internet bubble in the late 90’s set up the recession of 2001, 2002, the economy didn’t collapse.   The Feds lowered interest rates and reduced taxes and the economy recovered quickly.

America was attacked on September 11, 2001 that pushed us into the war on terror.  Yet the economy didn’t collapse.

The fact is clear that the Fed kept interest rates too low for too long which caused the Great Recession.  And, last week they committed to repeating this mistake again until 2016.  The same conditions exist today.  They can’t raise rates because it will spawn the real crash, which is yet to come.

It is as if – at exactly the most inconvenient moment with only one foot in the canoe -- government has become the solution.

It is important, as history will eventually show, to see how this new governance managed a recession and how its views and policies would prolong and transform this recession cycle into a global crisis that could last a generation.

About Ed DeShields

Last article: Will Russia Side with Israel to Thwart Iran Attack?

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