Did loose money regulations cause the Great Recession

[cegman]

http://www.freedomworks.org/blog/jborowski/debunking-myths-of-the-great-depression

There are links on the site used to back up the claims

The current economic crisis is often compared to the Great Depression which lasted from 1929 until the early 1940s. From the causes to the policy responses, there are striking similarities between the two economic meltdowns. Unfortunately, the typical high school history teacher continues to perpetuate myths about the Great Depression. Learning the real story of the worst economic crisis in U.S. history is important to stop it from happening again. Listed below are rebuttals to five common myths about the Great Depression.

1. Free Market Capitalism Caused the Great Depression.

Most of us probably learned that “unfettered” and “unregulated” capitalism in the 1920s led to the Great Depression. Some have similarly blamed capitalism for the current economic crisis. But just like today, there was not pure free market capitalism in the 1920s.

The Federal Reserve, the central bank of the United States, was created in 1913. Not only did the Federal Reserve fail to prevent the Great Depression but it was primarily responsible for its length and severity. The Federal Reserve controls the money supply and would never exist in a true free market economy.

As Murray Rothbard explains in America’s Great Depression, the Federal Reserve creates boom and bust cycles that destabilize the economy. The Federal Reserve created an unsustainable boom in the 1920s by lowering interest rates. Rothbard estimated that the money supply had increased by 61.8 percent between 1921 and 1929. The inevitable stock market crash was a symptom of the inflationary boom.

Economist Henry Hazlitt once wrote that “worse than the slump itself may be the public delusion that the slump has been caused, not by the previous inflation, but by the inherent defects of ‘capitalism.’” The blame for the Great Depression should be placed on the Federal Reserve, not free market capitalism.

2. Herbert Hoover Was a Laissez-Faire President.

Many history teachers claim that Herbert Hoover was a “do-nothing” passive president who allowed the Great Depression to happen. Quite the opposite is true. Far from being an advocate of laissez-faire, Hoover was an extremely interventionist president. Hoover actually intervened in the economy more than any prior president.

Herbert Hoover’s interventionist policies prolonged the Great Depression. He doubled federal spending in real terms in just four years. One of Hoover’s first acts as president was to prohibit business leaders from cutting wages. He also launched huge public works projects such as the San Francisco Bay Bridge, Los Angeles Aqueduct, and Hoover Dam. Hoover signed the Smoot-Hawley tariff into law in June 1930 which raised taxes on over 20,000 imported goods to record levels. He raised the top income tax rate from 25 percent to 63 percent and the lowest income tax rate from 1.1 percent to 4 percent in 1932. Despite what most of us have been taught, there was nothing laissez-faire about Hoover.

In the 1932 election, Franklin Delano Roosevelt (FDR) criticized his opponent Hoover of presiding over “the greatest spending administration in peacetime in all of history.”

His statements are seen as a bit hypocritical in hindsight since Roosevelt continued and expanded Hoover’s big government policies. Many of the New Deal programs were based on policies already enacted by the Hoover administration. It could be said that Hoover was the real father of the New Deal.

3. The Federal Reserve’s Tight Monetary Policy Caused the Great Depression.

Federal Reserve Chairman Ben Bernanke and the late Nobel Prize-winning economist Milton Friedman blame the Federal Reserve for the Great Depression. But they do so for the wrong reasons. While Milton Friedman was correct on many economic issues, he was wrong on monetary policy. He was a monetarist who incorrectly believed that the money supply determines the level of economic activity. In his view, an increase in the money supply will lead to more economic activity.

In A Monetary History of the United States, Friedman argued that the economy was strong in the 1920s until the year 1929 when a typical economic downturn occurred. He believed that the economic recession turned into a depression because the Federal Reserve did not print enough money between 1930 and 1933. Friedman and Ben Bernanke essentially blame the Great Depression on the Federal Reserve’s failure to inflate the money supply.

The real problem is that the Federal Reserve inflated the money supply in the 1920’s. Inflationary booms induce widespread malinvestment--bad investment decisions made under the influence of easy money and credit. Malinvestments inevitably lead to wasted capital and economic losses. An economic recession is actually necessary to correct all of the previous malinvestment.

At Milton Friedman’s ninetieth birthday party in 2002, Ben Bernanke even said “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” He spoke too soon. The current economic situation may not be as severe as the Great Depression—though economists such as Peter Schiff say it could get as bad. But it's clear that the central bank was the main culprit in both financial crises. The Federal Reserve’s expansionary monetary policy in the 1920’s caused the Great Depression, not the central bank’s “tight” monetary policy in the early 1930’s.

4. FDR’s New Deal Ended the Great Depression.

The New Deal is widely perceived to have ended the Great Depression but it actually made the economic situation worse. The series of economic packages implemented between in the 1930s hampered economic growth and prolonged the Great Depression. Roosevelt imposed excise taxes, harmful regulations on businesses, increased the top tax rate to 79 percent, doubled government spending between 1932 and 1940, and artificially raised wages and prices.

The New Deal created many public works projects. Contrary to what most of us were taught, public works projects do not boost the economy. It is the classic case of the seen versus the unseen—we can all visibly see the jobs created by New Deal spending, but it is more difficult to see the jobs destroyed by the high taxes needed to pay for the New Deal programs. Of course, taking money away from entrepreneurs in the private sector will only hurt economic growth.

In 1931, a year before FDR was elected president, the unemployment rate was an unprecedented 16.3 percent. By 1939, nearly two terms into the Roosevelt administration, the unemployment rate had risen to 17.2 percent. The New Deal clearly didn’t lower unemployment like most of us were taught.

In May 1939, Treasury Secretary Henry J. Morgenthau Jr. stated that, “we are spending more than we have ever spent before and it does not work… I say after eight years of this Administration we have just as much unemployment as when we started…And an enormous debt to boot.”

The depression would have been much shorter without the New Deal.

 

[Bootstoots]

I'm under some impression that the Great Recession would not have happened, or would not have been anywhere near as severe, if either 1) the Fed had raised interest rates to reasonable levels, or 2) banking regulations such as the Glass-Steagall Act had been left intact.

It seems to me that the combination of inappropriately low interest rates and low levels of regulation were largely to blame for both the Great Depression and the Great Recession, but I'd like to hear from people who know more.

 

[Monsterzuma]

In a nutshell:

http://www.ritholtz.com/blog/2011/12/nytimes-takes-on-the-big-lie/

 

[Integral]

Tight money caused the Depression and Great Recession, assertions to the contrary notwithstanding.

The story I see looks something like this.

Housing bubble and runup in housing construction from 2000-2006. Housing price bubble pops in 2007. From mid-2007 to mid-2008 we have a garden-variety recession. The relative price of housing falls, sectoral reallocation does its thing, and unemployment rises mildly.

From June to August 2008, a series of severe shocks hit the American economy.
(1) Continued fallout from the housing bubble which ripples through the financial sector. Nobody has any clear plan of what to do with very large problem banks. Consider this a "demand" shock to money velocity.
(2) The oil price spike in June 2008 was "exogenous" to the American economy and represented a mild supply shock.
(3) Contemporaneously, "confidence" falters as private expectations of future income fall dramatically. (source: U Michigan Survey of Consumers). A 'demand shock" to wealth.
(4) real interest rates soar upward (source: look at the yield on inflation-indexed bonds as a proxy for real interest rates). A "demand shock" to investment. (Strictly speaking this point is incoherent, as interest rates are endogenous, but I don't feel like going into the details at the moment.)

As a result of these shocks the demand for money (or, equivalently, safe assets like Treasury bills) increased.

However the Fed and Treasury did not act to meet that increased demand. Monetary policy loosened in absolute terms but not relative to where they needed to be.

The "crash" in October-November 2008 was precipitated by a contraction in aggregate demand caused by tight money, falling expectations of future income and soaring real interest rates.

Monetary policy continues to be tight relative to where it needs to be, even today. That's why unemployment is so high and output so low. We can also see this in tepid realized inflation, low inflation expectations and continued low asset prices.

In short: mild "real" recession from mid-2007 to mid-2008. Tight monetary policy (relative to where it needed to be) drove the economy off a cliff in June-August 2008. Large recession followed.

But again, this is a story that I piece together using evidence from the Great Depression and the 1987 stock market crash. The basic causality is "tight money in April-August 2008 -> financial crash -> recession." It's not the financial crash that caused the recession, it's tight money.

I also claim that Fed policy was largely to blame for the depth of the crisis, but with the opposite sign!

I am rather exhausted but will try to commit some time to addressing the Austrian "malinvestment hypothesis" in the near future.

 

[cegman]

Intergral don't rush yourself on my account I am going to be terribly busy today but I do want to debate you on whether or not it was the loose money policy causing bad investments before the tight policy came into effect. I am a bit of a history person so I always try to look further back to see if there were decisions there that people don't consider. Sometimes I look too far back and that is why I would love to hear your view.

Something I do want to talk about is the role of regulation. I am of the opinion that regulation is necessary but that we have some areas of over regulation. A lot of the "lack of regulation" issues were not the result of not having regulations against the actions but the lack of enforcement of regulations we currently have. I don't have any of the articles on this saved currently so I am looking for those now.

 

[warpus]

I'm really glad our banks and mortgages are regulated properly up here in the great white north - Our banks are fine and are doing very well - no bailouts.. our real estate market is doing pretty good as well, even the bubbly Toronto and Vancouver markets.

 

[Tahuti]

1) the Fed had raised interest rates to reasonable levels

The sudden increase of interest rates actually - in part - led to the financial crisis as many individuals and corporations became unable to repay their debts, leading the collapse of several major American Banks and firing the opening shots of the Great Recession.

 

[Bootstoots]

But what about the period from 2002-2005? Although I could be wrong, I'm under the impression that the rates were far lower than they should have been during that period, fueling unsustainable growth of the real estate bubble.

 

[Cutlass]

Intergral don't rush yourself on my account I am going to be terribly busy today but I do want to debate you on whether or not it was the loose money policy causing bad investments before the tight policy came into effect. I am a bit of a history person so I always try to look further back to see if there were decisions there that people don't consider. Sometimes I look too far back and that is why I would love to hear your view.

Something I do want to talk about is the role of regulation. I am of the opinion that regulation is necessary but that we have some areas of over regulation. A lot of the "lack of regulation" issues were not the result of not having regulations against the actions but the lack of enforcement of regulations we currently have. I don't have any of the articles on this saved currently so I am looking for those now.

Monetary policy hasn't got the slightest connection to whether investments are good or bad. Investments are good because investor are smart and careful. Investments are bad because investors are stupid and careless. No monetary policy can change those facts in any way.

The financial crisis happened because the banks, investment banks, Wall St in general, and investors were stupid and careless. And they lobbied Congress for decades for the right to be stupid and careless. So it wasn't chance that they were stupid and careless, but rather a deliberate decision.

 

[Cutlass]

I'm under some impression that the Great Recession would not have happened, or would not have been anywhere near as severe, if either 1) the Fed had raised interest rates to reasonable levels, or 2) banking regulations such as the Glass-Steagall Act had been left intact.

It seems to me that the combination of inappropriately low interest rates and low levels of regulation were largely to blame for both the Great Depression and the Great Recession, but I'd like to hear from people who know more.

Repealing Glass-Steagall was monumentally stupid and destructive. But wasn't the whole of the story. The problems had been building a bit at a time for a long time. A fight for deregulation here. A stupid deregulation there. Reckless business practices everywhere growing worse and worse year by year.

The problem with monetary policy is that it is a marco tool that doesn't really fit for dealing with many micro problems. Once banks started stupidly and recklessly selling adjustable rate mortgages broadly, rather than just to the most sophisticated customers, and then eliminated the down payments and all owner equity through aggressively pushing refinancing, home equity loans, home upgrading, and other advanced products, the Fed's hands were tied. Any rise in interest rates was certain to cause an avalanche of mortgage defaults.

Normally monetary policy tightening is only in response to inflationary pressures. And there was none. Monetary policy is an extremely crap response to a bubble economy. It is essentially certain to cause a recession before the bubble is affected. It cannot be targeted at the actual problem.

So you had no inflation, and monetary policy was certainly the wrong tool to deal with the growing housing bubble, which only a minority of economists believed in before 2006 in any case.

But that's only part of the story. Then you have Wall St. And Wall St had built a doomsday device, several of them actually, into the economy. At that point nothing could have prevented a financial crisis.

Now while I think that Integral is right that monetary policy was too tight as the system started coming apart at the seems, I don't agree that any possible monetary policy at that point would have prevented the financial meltdown. Only moderated its effects.

I'm not entirely following his argument. But it seems to me an argument to prevent the financial crisis by preventing the bubble from bursting. And I don't see that as possible. As I see it, a bubble bursting may be delayed, but can never be prevented.

 

[Trev]

Although there were a lot of contributing issues to the crisis in US, a lot comes back to a lack of accountability for bad decisions.
Banks could write bad loans and then securitize or insure the probable losses away. The people and institutions who make bad decisions in loans/investments etc must in future bear some of the pain when things go wrong with those decisions. The habit of insuring for all losses, or securitizing mortgages so the pain is switched to other people caused lax lending and investment practices.
A return to basics of people/institutiions suffering the consequences of their decisions is the only way major problems like this can be avoided in future. The ability to insure/securitize away all risks must be ended, or lax practices will quickly return.
The majority of the worlds economies avoided US and Europes problems because they either did not allow or it had yet permeated throughout their institutions the irresponsible lending that happened in US and Europe, in US the irresponsible lending was largely to individuals, in Europe a lot of it was directed to governments running big deficits.
If banks etc know they will bear the pain of bad loans, that will help deter that sort of behaviour in teh future