Demolishing the “Deregulation Caused the Financial Crisis” Myth

Hindsight is supposed to be 20-20, but for some people it seems like it’s blind.

We’re approaching a decade since the housing bubble burst, plunging the US economy into the worst crisis since the great depression. Still, defenders of big government and central planning continue efforts to sell the myth that the meltdown was caused by “deregulation” and insufficient government oversight of greedy Wall Street types. This includes a lot of people who should know better, including New York Times columnist Paul Krugman.

In a recent column, Krugman once again dragged out the deregulation myth, claiming “the bubble whose existence they denied really was inflated largely via opaque financial schemes that in many cases amounted to outright fraud — and it is an outrage that basically nobody ended up being punished for those sins aside from innocent bystanders, namely the millions of workers who lost their jobs and the millions of families that lost their homes.”

Tom Woods and Bob Murphy dismantle Krugman’s column in a recent episode of their podcast Contra Krugman. As they put it on their website:

Krugman called for low interest rates in 2001 precisely to stimulate housing, even calling for a housing bubble (this was ‘a joke,’ he later claimed) in 2002. Now he says the artificial stimulus to housing had to do with crooked Wall Street shenanigans, and had nothing to do with the Fed or government policy at all. We ain’t having it.”

Woods and Murphy convincingly demonstrate the real causes of the housing bubble and ensuing financial meltdown – a Federal Reserve policy of low interest rates pumping money into the economy, coupled with government policy directing this instant cash into housing.

At the heart of the crisis, we find government policies that both expanded the number of loans made and mitigated the risk of extending credit to shaky borrowers. Woods summed it up this way:

It turns out a lot of loans became non-performing loans. So, a lot of loans turned sour. These were loans, in retrospect, that shouldn’t have been made in the first place, and we can see that now, but we could not, or chose not to see that at the time. So it was the making of bad loans. That’s a traditional function of banks. It was not that banks were engaged in all kinds of new-fangled activities that so-called deregulation allowed them to do. No, it was in their traditional activities – the extension of loans – they did a really bad job.”

Murphy and Woods then detail the actual deregulation that occurred in the late 1990s, showing it had zero to do with the housing bubble or the evolution of mortgage backed investments. They go on to expose the role of Freddie and Fannie in the whole scenario, explaining how these quasi-government-private institutions took on the risk of making bad loans, leaving banks with only the upside. Finally, Woods nails the biggest factor in the whole mess:

We would place emphasis, of course, on the activity of the Federal Reserve, and then supplement that with government policy, because government policy was making housing an artificially attractive outlet for your money. So, if you have the Federal Reserve engaging in expansionary monetary policy, there’s a particular reason that it might go into the housing channel. It’s being directed there – it’s being lured there – by various levels of government policy.”

No wonder Ron Paul recently asked the question: do we even need the Fed?

All of this is important today because like Krugman, the Fed didn’t learn its lesson. The solution to the problem was essentially more of the problem – expansionary monetary policy inflating bubbles. It’s only a matter of time before the next one bursts.

You can listen to the whole Contra Krugman episode HERE.

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