Lest we forget

Most of the time, I preach the virtues of markets and the vices of government. For good reason.  But every now and then (meaning a few times per century), the US government is the world’s last, best, and even only hope.

The crisis of 2008 was one of those times, as this somewhat cheesy piece by Warren Buffett reminds us.

Something to be thankful for in this season of thanksgiving.


6 thoughts on “Lest we forget

  1. If only we had a parallel universe to see what would have happened had the government taken no action. I suspect the consequences would have been a rapid repricing of assets – housing and other articifically, bubble inflated assets – and a quick recovery. Instead, we’ve had a serious of government interventions, bailouts, and stimuli that will likely be a drag on economic growth for decades. I don’t give thanks when government builds onto our house of cards.

    1. Counterfactuals are always tough, but don’t link the stimulus package (or even much of the TARP spending) to the governments infusion of liquidity into the financial markets. They aren’t related.

      We did have a “rapid repricing” of assets–but a repricing that was completely unreasonable, given the assets underlying values. Market adjustments can leave vast destruction in their wake. It is quite likely (though certainly not assured) that had the markets continued to tumble, we would have seen utter collapse of much of the economy, unemployment rates in the 20-50% range, similar declines in GDP, failures of constitutional governments all over the world including, perhaps, even the US–in short, utter calamity. The systemic risks were so deep and so vast (perhaps they still are?) that the markets had no ability to self-correct in this case in any fashion that would have been socially acceptable.

      We avoided this calamity at relatively little cost because we had people at the helm who believed in markets, but also had common sense to avoid a calamity that was becoming more and more apparent.

  2. Sven, you choose an appropriate title to your post, Lest we Forget. What we shouldn’t forget is government’s primary role in causing the financial meltdown in the first place. A new study from Peter Wallison in AEI’s October-November 2010 issue of Financial Services Outlook offers a strong and empirically based explanation for the financial meltdown.

    This from a recent column by Richard Rahn:

    Mr. Wallison argues that the housing bubble, driven by U.S. government policy to increase homeownership, is the primary cause of the financial crisis. He notes: “The most recent bubble involved increases in real (not nominal) home prices of 80 percent over 10 years, while the earlier ones involved increases of about 10 percent before they deflated.” Starting in the late 1990s, the government, as a social policy to boost homeownership, required Fannie Mae and Freddie Mac to acquire increasing numbers of “affordable” housing loans. (An “affordable loan” is made to people who normally would not qualify.) By 2007, 55 percent of all loans made by Fannie and Freddie had to be “affordable.” By June 2008, there were 27 million subprime housing loans outstanding (19.2 million of them directly owed by government or government-sponsored agencies), with an unpaid principal amount of $4.6 trillion. By the middle of this year, foreclosure starts jumped to a record 5 percent, four times higher than any previous housing bubble.

    Mr. Wallison concludes his argument: “What we know is that almost 50 percent of all mortgages outstanding in the United States in 2008 were subprime or otherwise deficient and high-risk loans. The fact that two-thirds of these mortgages were on the balance sheets of government agencies, or firms required to buy them by government regulations, is irrefutable evidence that the government’s housing policies were responsible for most of the weak mortgages that became delinquent and defaulted in unprecedented numbers when the housing bubble collapsed.” The tragedy is that the financial crisis continues because Congress misdiagnosed the problem and came up with a 2,000-page “solution” that will only make matters worse.

    1. I can believe that most of the bad loans were, at least partly, the result of government policies. But that is not the same thing as saying that government caused the financial crises.

      The financial crisis was not caused by the housing crisis. It came about because those bad loans were wrapped together in nontransparent securities that the market could not price appropriately and were held by institutions in ways that overexposed institutions to the risks. As loans started to go bad after the prices on homes declined sharply, the market valuations of those securities dropped to near zero (rather than, say, 80 or 60 cents on the dollar where they should have gone). Thus we had a clear and massive financial market failure, whose effects were rippling through the economy. And because so many firms rely on capital flows to do business, those ripple effects were severe, indeed. And when there started to be a run on money market funds, decisive actions by the feds (decisive meaning actions within a few hours, not months), saved the system from collapse.

  3. Has anyone mentioned the role of mark-to-market laws in creating the liquidity crisis? Not to question Warren Buffet’s nostalgic patriotism, but if not for a bunch of government do-gooders, a correction of asset prices in the real estate market would have remained just that: a price correction. Instead, investment firms were forced to write down illiquid assets that had significant underlying value to almost zero, which magnified the crisis and crashed the market. So, yes. TARP helped alleviate some of the downward price pressure by propping up illiquid assets (months too late). But thanking the government is like thanking a bully for handing you a band-aid after he busts your eye.

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