Reclining Right 10/20/2011

Today’s column is a response to a university student in Cairo, Egypt on what caused the economic collapse in 2008. The student had read a lengthy article I had written on the subject and asked for a shorter less complicated explanation. Below is what I wrote:

Government interference in the economy was the cause of almost every economic downturn in the 20^th century. It has been the cause of virtually all depressions.

My study of economic history has shown that if a government gives special favors in the form of low cost loans, subsidies and/or writes regulations that give advantages to a select few, it results in the misallocation of resources to less productive enterprises. As soon as a government no longer gives the special favors, the subsidized entities usually collapse causing great economic hardship with many people losing their jobs all at once.

In the case of the 2008 collapse of the US housing market and mortgages, the US government caused this by passing laws requiring banks to give home mortgages to people who did not have the means or inclination to pay back the loans. The Federal Reserve Bank (Central Bank) lowered interest rates to make it easier for just about anyone to borrow much more than they could pay back if rates or conditions changed.

The government-backed mortgage agencies, principally Fannie Mae and Freddie Mac, bought the loans from the private banks. They in turn sold the loans to mostly investment banks like Goldman Sachs, which are much more highly leveraged than commercial banks.

These investment banks sold the interest-bearing mortgage loans to mutual funds and other investors worldwide, guaranteeing the loans. Rather than building loan loss reserves with the profits obtained from their guaranteeing the loans, the investment banks paid select employees huge bonuses.

When the loans started to have heavy defaults in 2007, the investment banks did not have the reserves (money) to honor their guarantees. Most investment bankers then went to politicians and gave huge campaign contributions to those politicians.

These bankers expected that the politicians would have the government pay off their bad loans and guarantees with taxpayer provided funds. That is what essentially happened.

The banks and investors should have been allowed to take responsibility for their bad judgment investments and irresponsible behavior and taken the losses themselves. But instead, the politicians, principally Democrats, used the American taxpayers’ earnings to pay off the banks and their investors.

To compound the problem, elected representatives in the United States Congress have taken so much money from the American taxpayer that it has caused a massive decrease in American individuals’ purchasing power. When people have less money to spend, they buy less.

When manufacturers have fewer sales, they reduce their number of workers, thus causing more unemployment. Those people in turn then have less money to buy things and more unemployment occurs.

Thus, as usual in history, the unethical manipulations of governments have caused major unemployment. Only in a free market, where buyer and seller BOTH benefit, does the market readjust in a gradual way.

When someone comes up with a better technology or a less costly way of delivering a product do people improve their standard of living. Of course some may temporarily lose their jobs in the less productive enterprises until they are able to find work in an expanding efficient industry.

The two best books I have seen on the subject are: “The Housing Boom and Bust” by Thomas Sowell and “Meltdown” by Thomas E. Woods, Jr. If you Google them you may find summaries of their works.