Probably the three people I listen to most in the world when it comes to economics are Russ Roberts, Megan McArdle, and Arnold Kling. And here I get a chance to combine their wisdom in one post.
First up, Megan McArdle (channeling Tyler Cowen a bit) gives an excellent concise summary in her post, "How did it all happen". For the interesting and accessible details, read the whole thing. Here is her conclusion:
Over the past few weeks, much has been made of the various regulatory actions that enabled this mess. Though some are wrong, two are not: the Democrats protected OFHEO's shockingly loose regulation of Fannie and Freddie against the White House's attempt to toughen it; and the Republican-appointed SEC loosened the capital requirements for the five largest banks.
But why did they do this? Democrats seem to believe that the Republicans and the SEC simply did this out of wanton greed and a blind faith in markets; Republicans seem to believe that OFHEO, the Democrats, and Fannie/Freddie did this because of political corruption and a blind belief in homeownership for poor people. But neither side was simply accepting the risk that the whole thing might come crashing down leaving the economy in tatters and the taxpayers on the hook...
What we need, fundamentally, is not simply stricter regulation or less greedy bankers. What we need is better economic theory of how these things play out, so that the regulators have better tools to assess and prevent systemic risk. But that's not how we're thinking right now. What we're looking for is not better tools, but someone to blame.
To understand one of the key pieces in this puzzle, you need to know how Fannie Mae and Freddie Mac work and their history related to all this. As it happens, Arnold Kling used to work there, and he gives a very easy to understand description of these matters in an interview with Russ Roberts. You can listen to the interview on that page and read the highlights or download the podcast.
Finally, there is Russ Roberts himself, who gave an excellent interview to the Pittsburgh Tribune-Review. Definitely read this one too. Some excerpts:
The question I've gotten recently is, "Does this remind you of 1929?" -- which is a reference to the stock market crash. But what this reminds me of is 1932. In 1932 we had the feeling that we had to do something. The myth of 1932 is that Herbert Hoover did nothing but fortunately FDR realized that something had to be done because otherwise we'd wallow in crisis forever. That's a myth.
Herbert Hoover actually was quite an activist in trying to turn the economy around. He failed, which is why he wasn't re-elected. He ran large deficits. Then he tried a tax increase to get rid of the tax deficits. He signed a large tariff. And his Federal Reserve chair under him was aggressively contracting the money supply, which most people feel is the opposite of what he should have been doing....
You could debate for a hundred years as to what would have happened had they done nothing and we'll never know. What we do know is that FDR came in and tried lots and lots of things. Most of them didn't work. There was some improvement in the economy and then it started to fall off the table again. Unemployment began rising dramatically until 1938 and then started to go back down again, but it wasn't like the New Deal was a magic charm. It did not work. But he did something...
I find it remarkably bizarre that we have given an immense amount of arbitrary power to the Treasury, the secretary (Henry Paulson) and his department on the grounds that otherwise we will have a disaster. We continue to have a disaster. There is no evidence as to the scope of the disaster that made this intervention necessary, just merely the claim that we're about to have a disaster -- sort of as if the experts don't have the time or patience to explain to us mere mortals what the state of affairs is.
I find that extremely frightening, to be honest, not just depressing and disturbing and damaging to economic activity in the future, but frightening. $700 billion? Even for the United States, that's real money...
I mean, nationalizing the banks? It didn't work if the goal was to stop the stock market decline. You have to be careful: the stock market and the economy are not the same thing. The fact that the stock market's gone down is not proof that it's not working. But again, I don't have any data. You got any data? Does anybody have any data? How we're doing? Is it working? It's a war mentality. You have the president and his cabinet members stand up and say things like, "We're working on this. We're fixing this. We have to take dramatic steps, don't worry the economy will be stabilized." We've got to have some data...
There are a lot of people who say this is proof once and for all that markets don't work. Of course, those of us who like the free market can always argue that it's not a free market, and of course it's not. The other side can always say, "Well, these are the kind of excesses you get when you don't regulate and especially when you don't regulate well." It's a very, very difficult situation for the average person to make an independent assessment of what really happened. My worry is that this is going to be a watershed event like the Great Depression was in condemning markets -- fairly or unfairly, and I think unfairly. But it's certainly going to be the people who are opposed to markets who will want top-down centralized control of things in the hands of experts as opposed to decentralized, emergent decision-making...
In terms of true silver linings, the only real silver lining will be if we learn the appropriate lesson, which is the risk of trying to manage the housing market from the top down. I would love if the people would realize that Fannie and Freddie were intellectually bankrupt as entities and that it was impossible to create a schizophrenic entity that pursued profit and was backed by the government and that we could manage it in a way that would make sure it turned out all right. I hope we've learned the lesson that that is a bad idea.
Related to the discussion of Hoover, FDR, and all that -- over the past year or so I've heard various rumblings about economists researching the Depression era and coming up with surprising facts that counter some myths we all hold pretty strongly. So I'm very much looking forward to listening to the audiobook of Amity Shlaes's revisionist history of economic policy during those times (and hopefully not our times!), The Forgotten Man: A New History of the Great Depression. I will probably have more to say after I listen to it, and I'll gather comments from others in a post. If you can't wait, check out the book reviews on that Amazon page...
