Leland Yeager on the Crisis

In the August 2009 edition of Liberty, the great monetary/macroeconomic thinker Leland Yeager has an important article discussing the financial crisis entitled "The Contagious Crisis."  You can get a copy now through university libraries and journal-finder.  And I think in a month or two you will be able to get it at the Liberty website.

Yeager starts his paper with this opening paragraph: "Libertarians face charges these days that capitalism has failed or at least that deregulation has invited our current economic troubles.  These charges are not persuasive.  A more realistic view is that a housing boom and bust happened to strike a fragile system whose fragility was worsened by ill-conceived government interventions."

Yeager goes through a variety of explanations for the crisis, and demonstrates the "perfect storm" that led to this crisis.  Housing policy (including tax laws); easy credit; distortions to the intricate multilateral interdependencies that led to unraveling damages to not only the financial system, but to production, employment and consumption; changes in accounting rules that impacted the short run balance sheets and exposed capital deficiencies; moral hazard as past rescues breed expectations of future bailouts; monetary policy that threatens inflation; fiscal policy that is ineffective and threatens to bankrupt the future; and burdensome financial regulations which strangle the economy and thwart economic innovation and wealth creation.

Among my favorite quotes are Yeager's argument that "The great potential for money-creation threatens inflation. Current worries about deflation are preposterous. If need be deflation is much easier to check than inflation; and anyway, not all downdrifts of prices are harmful."   Yeager follows up on this by suggesting that academic ideas of a "monetary constitution" and alternative monetary regimes, such as free-banking, have become relevant.  The fiscal recklessness that follows as the financial situation continues to spiral out of control leads Yeager to state that a "Form of Keynesianism crude enough to embarrass Keynes himself then appears relevant, especially in political circles. Measures to stimulate spending seem to promise relief, even though, a crisis like our current one originated in overborrowing and overspending, and although more of the same would risk long-run disaster."

And Yeager ends his discussion endorsing Thomas Sowell's dictum that: "The first law of economics is scarcity, and the first law of politics is to disregard the first law of economics."

Bottom line: Yeager's article is highly recommended.

Hat-tip to Larry Reed of FEE.

Comments

[Mario Rizzo]

I haven't seen Leland Yeager in years. But I always remember him as one of the most careful scholars around. No sloppy thinking in his world! I look forward to reading this.

[Richard Ebeling]

Another excellent analysis of the housing crisis can be found in Thomas Sowell's new book, "The Housing Boom and Bust" (Basic Books, 2009, $25).

In the April 6th issue of AIER's print publication, "Research Reports," I have a review of Sowell's book.

If I may be permitted to quote from my review:

"Sowell explains that the Federal government began a huge regulatory push to create 'affordable housing' in the 1990s, under the presumption that the cost of acquiring a home was out of reach for a growing number of American families.

"However, he shows that in general average American incomes were keeping up with or even exceeding the cost of buying a home in most of the U.S. The only problem areas were in places like California, where regulations on land development and home building were making land increasingly scarcer and more costly to buy.

"Prominent Democratic and Republican members of Congress and both President Clinton and Bush put pressure on lending institutions to lower their credit rating standards; reduce the minimum down payment requirements (in a growing number of cases, to zero); and introduce short-term flexible monthly payment methods that would only increase later on.

"Often under intimation of bank and mortgage market regulators, financial institutions greatly increased their lending to targeted socio-economic groups that were less credit worthy due to fears that they might otherwise be hit with anti-discrimination law suits. As Sowell points out, the tragedy of forcing banks to make home loans to people really not financially able to bear the costs of a house once times turned even moderately bad, is that foreclosure rates are highest for this segment of the population.

"Two major vehicles for the growth of this unsustainable housing bubble were the semi-governmental agencies, Fannie Mae and Freddie Mac. Congress and the White House pressured both agencies to extend loan guarantees or buy up the mortgages of these credits unworthy borrowers, until finally before the housing crash last year these two agencies held or guaranteed around fifty percent of all the home loans in America.

"The irresponsibility of Fannie Mae and Freddie Mac, and those in Congress who pressured them to go out on this limb has been shown by their formal take over by the government and the huge sums of taxpayer’s money that it has cost to maintain their solvency.

"What also fed this housing market frenzy, Sowell explains, was the monetary policy of the Federal Reserve. In 2003 and 2004, the central bank kept interest rates artificially at historically low levels. Indeed, when adjusted for inflation, for part of the time interest rates were zero or negative. Mortgage rates were pushed down to barely two or three percent in real terms.

"If there is a lesson to be learned from the facts of the housing crisis, it is that its cause has been misguided and intrusive regulations and political pressures, and not any inherent weakness or instability in the market."

Richard Ebeling

[LVDH]

Has anyone read any of the following books:

Dimitris Chorafas, Financial Boom and Gloom;

David Murphy, Unravelling the Credit Crunch;

?

[None]

"If need be deflation is much easier to check than inflation."

So is he denying the existence of the liquidity trap?

It amazes me that so many good economists suggest that deflation is not a concern and that we should be worried about long-term inflation. Look at the monetary aggregates M1 and M2, NOT the monetary base. Neither growth rate (in M1 or M2) is significantly higher than the past 30 years. Those are the monetary growth rates that determine long-term inflation.

[Lee Kelly]

To the anonymous commenter,

Although some regular commenters have reduced their names to initials, it is customry here to provide your full real name when commenting.

In any case, I think one reason many good economists fear long-term inflation, is because the government is projecting major long-term deficits. When massive government debt meets a fiat money supply, the temptation to inflate becomes very powerful. Once that kind of inflation gets started, it is extremely difficult to prevent from spiralling out of control.