Financial Crisis Roots Unearthed

Critics of free market economics have conveniently blamed “laissez-faire” policies for causing the current worldwide recession. On September 2, 2009, the CATO Institute held a briefing on Capitol Hill to discuss the causes of the financial crisis and evaluate whether deregulation should be blamed for the economic downturn.

Johan Norberg, Senior Fellow at the Cato Institute and author of the new book Financial Fiasco: How America’s Infatuation with Home Ownership and Easy Money Created the Economic Crisis, argued that many factors causing the crisis were “global” in nature but that America’s policies played a central role.

“Many countries and many economies tried to create a global financial fiasco, but only America had the size and the wealth to really do it,” he said.

Norenberg described current Federal Reserve policies as “how to ruin the economy in seven easy steps.” The crisis started, according to Norenberg, through an influx of “easy money” into the American economy.

“We…look[ed] to the [Federal Reserve for] more liquidity and lower interest rates and that is what happened in 2001, after the ‘dot-com bubble’ and after the 9-11 terrorist attacks,” he said.

Federal Reserve Chairman Alan Greenspan and Board of Governors Chairman Ben Bernanke lowered interest rates dramatically in the aftermath of September 11, 2001, from 6.75% to 1.75%. By 2003, the interest rate was merely one percent.

Norenberg argued that this policy was not simply a “temporary response,” but a “discretionary” policy for the Federal Reserve’s long-term economic agenda. As a result, more “easy money” flowed into the market, turning into more mortgages and generating an increase in housing prices.

“In 2002, a year of ‘recession,’ we could still see an increase in housing prices. In 2003, it climbed further and we could see an increase by ten to fifteen percent every year in the American cities,” he said. “If [people]…are afraid of the stock market after the ‘dot-com bubble,’ if they are not interested in bonds and savings, well then they might be interested in putting [their money] in the house where it seems very, very safe,” he said.

According to Norenberg, Americans spent $269 billion dollars to fund mortgage debt on their old houses in 2002. Norenberg described this phenomenon as “see[ing] your house as the new ATM machine,” for Americans who were looking into “refinancing, building bigger and buying something even larger.”

Then there was Fannie Mae and Freddie Mac. Norenberg argued that both organizations had one “political purpose,” namely to ensure that more mortgages were being made available to those who could not afford them.

Norenberg described how Fannie Mae and Freddie Mac had to “buy more sub-prime mortgages” to the tune of $175 million in 2004. This resulted in a “deterioration of the loans,” particularly “stated income loans” where the buyer does not have to prove their actual income but can self-certify their income levels.

There were also what Norenberg referred to as the “NINA” (no income, no assets) loans and the “NINJA” (no income, no job or assets—no problem!) loans, which essentially took considering the long-term earning prospects for applicants completely out of the picture. The risk, Norenberg argued, had to be “passed onto someone else,” (i.e., usually the taxpayer) and all the while credit agencies constantly reassured the American public that “this was a great idea.”

Mark A. Calabria, Director of Financial Regulation Studies at the Cato Institute has numerous concerns about President Obama’s plan to use the Federal Reserve as a systemic risk regulator.

“One of the consistencies we’ve seen with the previous administration with Secretary Paulson and Secretary Geithner now is a commitment that debt holders and creditors will not take losses,” Calabria said.

Calabria added that the Obama administration “greatly expands” the number of institutions that could be bailed out. These institutions, such as insurance companies and various banks, would be fighting for a place at the government trough to gain an edge over their competitors.

Calabria is also not convinced that the Obama administration simply wants to give the Federal Reserve “more discretion” to handle a future crisis.

“The [Federal Reserve] had this same ability over [Citibank] and had it over [Bank of America], yet the last time I checked [Citibank and Bank of America] were in bad shape,” he noted.

He also argued that the Obama administration should be more transparent about increased capital standards. CNN reported on September 14, 2009 that Obama has proposed a “resolution authority” (another czar?) for the economy to maintain stability amid the possible collapsing of more financial institutions deemed “too big to fail.”

“If [the Obama administration] truly believe[s] that [their policies eliminate] the need for bailouts then why don’t we eliminate the ability to bail out?” he asked. “The administration plan would retain the [Federal Reserve’s] ability to bail out these institutions. That would not go away. I would more accurately characterize their proposal as not ending bailouts, it is institutionalizing bailouts.”

Norenberg said that he fears an “encore” of the crisis because the crisis was a result of too much credit and indebtedness combined with a policy of bailing out bad investments. He added that he is not optimistic about policies that substitute the “invisible hand” of the free market for the “invisible wallet” of the American taxpayer.

“Some people say that it will get worse before it gets better, I think personally that the risk is that it will get better before it gets worse again,” he said.

Brittany Fortier is an intern at the American Journalism Center, a training program run by Accuracy in Media and Accuracy in Academia.