Unanticipating The Great Depression and the Great Recession
by Mike Kimel
In Response to Bryan Caplan et. al., Part 2 – Unanticipating The Great Depression and the Great Recession
Cross-posted at the Presimetrics blog.
Last week I noted that Bryan Caplan, like many libertarians (and conservative economists as well), operates under the assumption that the data doesn’t support the Keynesian view of the economy. I put up a few graphs showing he is in error, and that growth rates are, in fact, lower when libertarian and conservative economic prescriptions are followed. But the problem is worse than one of slightly slower growth – that would simply mean we’re all just a little poorer than we otherwise would be. The problem is that every so often, bad policies leads to an outcome worse than just slightly slower growth.
Consider something I wrote back in March of 2008:
Think back to January of 2001. Say you told any conservative or libertarian that there would be what the White House refers to as a “mild recession” later that year. Say you also told that conservative or libertarian that by the beginning of 2008, the economy would have enjoyed years of tax cuts, years of cheap money coupled with low inflation, years of reduced regulation, and a couple (semi-privatized) small wars. Would they have predicted that along the way, real growth would be sub-par, and right now we’d be facing the possibility of a major downturn? Could they have even accepted that combination of facts? Is what we’re seeing a feasible outcome of any conservative or libertarian model?
Sure, we’ve all heard the arguments that the Community Reinvestment Act went a long way toward causing the meltdown, but there are three problems with that. The first is that even if the CRA bore some responsibility, it was passed in 1977, and that wouldn’t change the paragraph above – CRA or no CRA, there were years of tax cuts, cheap money coupled with low inflation, reduced regulation and a couple of semi-privatized wars. If the CRA was the problem and not lack of oversight, presumably the Great Recession would have happened during an administration that, say, did a less thorough job of deregulating and tax cutting. A second problem with blaming the CRA is that the economic mess is due to banks loaning money to people who shouldn’t have borrowed or been allowed to borrow, and there was no policy or law that forced a single organization to make loans it shouldn’t have or any entity to borrow money it shouldn’t have. A third problem is that the Great Recession struck many other countries as hard or harder than the US. One thing that was common about many of the worst hit countries is that they were high on the list of recent (say, in the past ten years or so) success stories as told by the folks who like to blame the CRA for the mess.
In any case, what is interesting that the paragraph I wrote in March of 2008 could have been written in October 1929. Sure, the semi-privatized small wars from the 1920s were mostly in Guatemala, Honduras and Panama, and the eight years of tax cuts and deregulation saw two Republican Presidents rather than one (Harding & Coolidge v. a single Bush), but on the economic front, things were quite similar. Sure, the NIPA data doesn’t go back that far, and the 20s do have a sterling reputation when it comes to growth (the Roaring 20s, dontcha know) but that only goes to show that the folks who were doing well at the time were the ones to write the history books. For everyone else, the Roaring 20s was a period where the economy could barely stay out of recession, denoted by the gray bars below:
Data sources for the graph are described in the post where the graph originally appeared. And as I noted in that post:
in the 96 months between the end of the 1920 Depression and the start of Great Depression that followed this tax cutting bonanza, the economy was in recession 30% of the time
Incidentally, I can also think of one other period during the past 100 years which can also be described as several consecutive years of deregulation and tax cuts: the Reagan administration. That too ended poorly, though the price for the resulting S&L debacle was only paid during the administration of Bush the Elder, and it was spread over an extended period of malaise so nobody thinks of cause and effect.
All of which brings me back to where I started. The policies advocated by libertarians and economic conservatives not only tend to be accompanied by slower growth in general, as I noted last week, but also tend to precede economic meltdowns. All of which leads to a few possibilities:
1. Libertarians and economic conservatives are dead wrong; policies they advocate should tend to lead to worse outcomes than policies they are against
2. Libertarians and economics conservatives are mildly wrong; in general, whether the policies they advocate are adopted or not won’t have much of an effect on economic growth and its just a coincidence that in periods where their policies are adopted, outcomes tend to be worse
3. Libertarians and economics conservatives are right. As a result, the fact that outcomes tend to be worse in periods where their policies are adopted is just the result of a large number of very unlikely events.
Assuming folks like Caplan actually know what the data says and aren’t advocating positions out of complete ignorance or worse, ill will, they seem to be arguing for position number 3. From a logical perspective, its far less likely to be true than the other two positions. Presumably that should put the onus on him (and those who agree with him) rather than those who advocate a position requiring much less heroic assumptions, such as position number 1.
I cannot find teh original Caplan post/story.
Greenspan’s Fed and its low interest rates had nothing to do with the housing and credit bubbles, I suppose?
Any ‘economic’ post which attempts to ignore the efforts of the Federal Government throughout the 1990’s and 2000’s to peddle home ownership by any means necessary is biased beyond belief.
And who cares what happened in Ireland? 20% down and proof of income would have stopped almost all the excess in the home lending market.
And it was the government that lead the charge to reduce those requirements. They were ‘unfair’.
How’s that working out for ya?
“Obama was an integral part of the far-left Congress that created the over-sized, welfare oriented government expansion that has led the Federal Reserve to an inflationary policy of credit expansion, resulting in the boom-bust economic cycle.”
The republican congress was far left during the Bush years. Well, they were big spenders using the ol credit card for sure, but your guy points to no numbers or dates of programs. It is hard to start with this premise using numbers and dates. It is also hard to take as serious when names are left out of the leaders of this far left Congress are ommitted, such as Boehner.
Purifying the far left Republican party appears to be the outlook, but please name names overall whi passed the legislation…wasn’t Barney Frank in the minority party??
Biased. Hmmm. Ignoring….the government forced 0% down payment contracts on the banks and mortgage industry. Please point out the legislation instead of stomping your feet.
And in the rush some big banks abrogated private property ownership title law all on their lonesome.
No one has ignored Greenspan here, but he was a darling of Wallstreet and D and R party for a long time…and the far left congress of the 2001-2008 was voted out, no?
The efforts to continue to goose the construction industry (favored beau of governments everywhere attempting to simulate/stimulate economic activity) were certainly the proximate cause of the first leg of the recession.
How much now are the tax cuts the cause of the second shoe dropping? Rainy day funds have been emptied in most of the country (in those places that even had them), public sector jobs are being slashed massively leading to flat at best employment while the private sector seemed to have been recovering. We had a credit based recession first, are we headed into a second consumer spending lead recession now?
Option 1. The conservative/libertarian economist is wrong. They are trying to apply rules that are good for one person to a complex economy. For a single person having excess wealth is a good thing. For an economy having a excess wealth is a bad thing because: 1) excess wealth leads to a) excessive speculation which causes boom and bust or b) loose lending rules since you have a surplus of money you are trying to lend. 2) The money tied up in this excess capital can’t be spend as quickly as money that the middle class and poor have. The velocity of money is an important factor in maintaining economical activity.
“The CRA caused the financial crisis” was debunked extensively back in October in 2008 – http://www.ritholtz.com/blog/2008/10/misunderstanding-credit-and-housing-crises-blaming-the-cra-gses/ . Can the defenders of this false meme get a new set of excuses for why Wall Street is not to blame, please? I, for one, am getting increadibly bored with this line.
Perhaps it’s just a misunderstanding of the term “Debunk”. To debunk a lie does not reduce it’s bunkiness unfortunately.
Dear CoRev: Retelling a debunked lie is still a lie.
Dan said: “… passed the legislation.” Piolicy is not only legislation. It can be Agency Director’s directions, congressional oversight pressure, Executive Orders, and finally regulations derived from legislation.
Legislation creates the hooks from which the executive branch hang the implementing regulations. It seldom is a policy scalpel. Changes in policy direction are relatively easy by emphasizing and de-emphasizing portions of the regulations. regulations can be re-drafted also to change direction.
But, in the housing bubble issue both parties were pushing getting more families into houses, with fewer and less stringent economic strings. Just bad policy.
AS, Uh Huh!
I’m not sure you have the three choices right. I read a story once about the rector of the church at Princeton College in the 1890s (or so). He frequently preached against people taking innoculations for infectious diseases. He admitted that innoculations were effective. However, he believed that they thwarted the will of God. If God wanted you to be sick and die, then you should just accept it, sicken, and meet your maker. I don’t recall if he lived to a ripe old age or not. I suspect the fourth choice would be (4) Libertarians and Conservatives are dead wrong in terms of improving the economy, and they know it. However, they believe it would be somehow immoral or unethical to accept (choose one of: government intervention, increased taxes, smaller defence industry). Therefore, they are willing to accept a less capable and prosperous national economy for all, to maintain their sense of morality and ethics.
Also, there’s another (5) Libertarians and Conservatives are dead wrong in terms of improving the economy, but they don’t really give a damn about the economy, as long as they can make money from investing in the Federal government through the defence industry, or some other graft opportunity.
I don’t understand this at all. According to Wikipedia, Obama was a law professor from 1991 to 1992, and was a corporate lawyer until 1999. He was an Illinois state senator from 1997 to 2004. He was the Federal Senator from Illinois from 2004 to 2008, when he got his current job. How could he as a law professor, corporate lawyer and state senator have any effect on the CRA? I suppose that he could have used those four years between 2004 and 2008 to gang up on beefing up lending, but it’s hard to see how he could have had any effect before then.
Now, I suppose with Barney Frank or John Kerry you have more of a story. They’ve been around for a long time. But since you name Obama as one of the key co-conspiritors, and it’s hard to see how he could have had anything to do with it, it seems to me the rest of your argument has a dead-fish smell to it.
The explosion of imprudent (fraudulent, insane, criminal) loans did not occur until innovations in securitizing turned imprudent loans from a potential liability into a profitably sellable asset.
No act of of Congress did that. No government policy did that. That was financial industry ingenuity and greed at work.
Medicare and Medicaid reimbursments for a certain opthalmologist/libertarian comes to mind.
I think Bill White’s No. 5 deserves serios consideration. As to the ‘far left’ and home ownership who was it that was allus yatterin’ about the ‘Ownership Society’, eh?
In all fairness, it does seem to me that there’s a #4 option here, which is maybe a little better than #3 (but still wildly implausible.)
Liberal economics are a complete disaster, but their evil effects are worked only on the long term. Temporarily, liberal policies cause false prosperity. What keeps happening is that the political pendulum naturally swings away from lib-dems after they’ve had a kick at the can, whereupon wise farsighted economic conservatives are elected who do their best to stem the tide of economic disaster before we all go over a cliff. They succeed, but nonetheless are still hit with the (attenuated) consequences of liberal economic foolishness, and get blamed, whereupon a new Democratic administration is elected, which begins to reverse the wise farsighted Republican policies even as their positive impacts begin to be felt.
This is ridiculous, but at least not as bad as the “string of inexplicable coincidences” hypothesis, and it does bear a sort of shambolic semi-resemblance to some of the more extreme “Austrian Business Cycle” views (despite the manifest inadequacies of those theories and the fact that economically literate libertarians do not generally accept them.)
You don’t think tranched MBS, insured by CDS, and falsely rated as a result had anything to do with this? Where would the mortgages have gone if there was not a safe way to package them and sell shares of them to unknowing investors. In any case, the CRA had only a 20% hold in this debacle. Wall treet and the TBTF banks led the way in this deception.
Re: The government and the housing/MBS bubble, you should read this response by Prof. Raghu Rajan to Paul Krugman http://forums.chicagobooth.edu/faultlines?entry=24 The government played a key roll in creating the bubblicious conditions, and then private aggregators piled on (in an environment of cheap money and an implicit federal guarantee on the Fannie/Freddie purchased securities). And you cannot overlook the popping of the internet bubble as a cause in driving big investors to find “safe” AAA MBS assets (which just happened to be appreciating) in which to park their money. So you had a push and a pull, as it were, for the housing/mortgage bubble, and the government played a big part – but not the only part.
W/r/t the CRA, it was passed in 1977, but then Clinton started using it to pressure the banks w/r/t origination in the 90s.
One thing missing in the discussion of the cra is there is a difference between lending money to good credit risks in formerly “redlined” neighborhoods and lending willy-nilly to anyone with a pulse. No one made the banks give “no doc” loans and subprime loans to bad credit risks. It’s bigoted assumptions that lead one to treat entire neighborhoods as one. Additionally, the crisis was not only in subprime, not by a longshot. And let’s please dispnse with “helpless banks” defense. They made billions originating and securitizing any loan they could get their grubby hands on. Then they blew up the economy andgot a full bailout from the govt. Now your telling us the gov made them do anything? It looks like they make the gov do things they want, so stop. Please already. You are wrong. Have some character and own up to it.
You are right. And they won’t.
The CRA had very low default rates, and to qualify you had to have good credit, enough resources, etc. Very few of the loans that went bad at the start of this were CRA–no-doc and all the rest were *illegal* under CRA. The bad loans did not qualify for CRA. CRA had nothing to do with condos in Miami and hotels in Vegas. This canard is pure obfuscation and a waste of time.
Greenspan signaled to the world he ws not going to raise Fed Rates. The influx of dollars to Wall Street looking for safe investments certainly aggravated the situation. Wall Street and private originators met the demand created long before the CRA ever became a part of this tar pit from which there ws no escape. When they ran out of safe investments, private business created more investments which when squinted at appeared to be safe. The government duplicity is Gramm, Weil, Greenspan, Summers, etc. Financial Services Modification Act of 2001 and signed into law by Clinton.
I think this is it:
The real problem was the fed did not do it’s job. Preditory Loans were out lawed in legistation in 1994. With Bush all regulators looked the other way, as well as the SC.
Mike Kimel’s narrow focus on U.S. deregulation and tax cuts doesn’t answer the mail. The recent global economic collapse involved more than that.
Explaining the key factors behind the latest financial crisis involves a timeline analysis of decisions and activities that occurred in the financial/housing market, government, households, and global imbalances over an extended period of time. My short list includes 12 key factors that led to the global economic collapse. Trade policy sits at the top of that list, though it is seldom if ever cited as a cause of the financial crisis.
Economists and others who act as though the financial crisis couldn’t be anticipated are not on my short list of those I recommend as valued sources of information on this subject. Many of these people also didn’t anticipate the impact of global trade balances and hollowing out of the U.S. economy that unfolded over the last fifteen years. It’s hardly a surprise that they don’t list trade policy changes as a key factor behind the latest economic crisis.
It’s foolish to focus solely or primarily on U.S. deregulation and tax cuts as the causes of the recent global economic crisis.
I think you are forgetting the “Ownership Society” under GWB. Since you are naming names, you ought to include the ones we all know. You say this fraud was going since the early 90’s, yet no mention of GWB and his cronies in that list of yours? Your perspective seems very skewed. That alone gives you no credibility in my book.
On top of that, you’re just wrong, but you don’t seem to be open to that idea.
CPA never gave anyone the right to create fraud. Those who commit fraud, do so at their own will. Demand does not mandate supply if supply means breaking the law.
That’s like saying: My neighbors makes the most incredible pie. The more enticing they make the pie, the more they “make me want to steal” my neighbor’s pie.
No, that’s all wrong. That can be the best pie the world has ever known, I am not gonna commit a crime to get it. Meaning people are expected to abide the law, even when tempted by high profits (or delicious pie).
I hope you can see that this is really about more important than partisan politics.
“It’s foolish to focus solely or primarily on U.S. deregulation and tax cuts as the causes of the recent global economic crisis.”
Our policies fueled the global economic crisis. We have a responsibility, being the worlds superpower. Our shenanigans was replicated and sold around the world. That 70 trillion market is now worth what?