how the government created a financial

8/12/2019 How the Government Created a Financial

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How The Government

Created A Financial CrisisComment Now Follow Comments

Facing double digit inflation, double digitinterest rates and soon to be double digitunemployment, President Reagan came intooffice with a four point economic program on which he had e plicitly campaigned,fundamentally changing the course of Americaneconomic policy! As discussed in my recent op"ed, #Reaganomics vs! $bamanomics% Facts andFigures ,& those four points were%

'! Reduce ta rates sharply to improve incentives forsavings, investment, (ob creation, business start"ups ande pansion, entrepreneurship and wor)!

*! Cut unnecessary government spending!
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+! Pursue anti"inflationary monetary policy to maintain astable dollar!

! -eregulation to reduce costs for business andconsumers and to increase efficiency!

As . discussed in that article, this was the mostsuccessful economic e periment in worldhistory! .nflation was tamed by '/0+, never to be heard from again 1 until recently! Theeconomy too) off on a *2"year boom, #thegreatest period of wealth creation in the historyof the planet,& as recounted by Art 3affer and4teve 5oore, and &an economic Golden Age,& asrightly labeled by 4teve Forbes!

6hy did it end with the *770"*77/ financialcrisis, from which we have not yet fullyrecovered8 9y *770, as shown below, Americaneconomic policy had departed from every one of

the four plan)s of Reaganomics! Two of those blunders were especially salient% '! the 9ushcheap dollar monetary policy and *! the Clintonre"regulation to force the financial communityinto the subprime mortgage fiasco!

Federal Reserve 9oard Chairman AlanGreenspan and other governors at the Fedeventually departed from Reagan:s in(unctionthat monetary policy focus on maintainingstable prices, and started trying to stimulate theeconomy through old ;eynesian policies of easymoney! The 9ush Treasury supported that,


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favoring a cheap dollar in response toubiohn Taylorin his timely boo), Getting Off Track ! Taylor begins%

The classic e planation of financial crises, going bac) hundreds of years, is that they are caused bye cesses 1 fre


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mortgages! 9ecause real estate is an especiallylong"lived asset, its mar)et value is especially boosted by low interest rates!

4ustained below"mar)et interest rates distorthuge flows of investment into housing inparticular because the lower rates most favor thelongest term investments!

9ut low interest rates by themselves do notmean monetary policy is e cessively loose! Thatdepends on what mar)et prices are saying, asreflected by the dollar, gold and inflation! TheFed:s loose monetary policies during the 9ush Administration, however, also generated sharpdeclines in the dollar! The dollar was worth '!'2euros near the start of *77*, but it declined byclose to 27 near to 7!D =uros by the start of*770! The price of gold soared from +27 near

the end of *77* to almost ',777 by the start of*770! =ven inflation, defeated *2 yearspreviously, started to come bac), increasingfrom '!22 at the end of *77', to as high as2!D in >uly *770!

The cheap dollar monetary policy furtherinflated the housing bubble because it generatedflight into real assets to escape the depreciatinggreenbac)! This also e plains why the housingcrisis showed up virtually worldwide! The Fedmanaging the world:s reserve currencyeffectively e ported its wea) currency policy


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globally! $ther countries loosen their monetarypolicies to avoid the negative short term tradeimplications of appreciating currencies relative

to the dollar! 5oreover, the dollar:s wea)nessmas)s the looseness of their monetary policies,misleading them into even looser policies!

6hen the Fed finally reali ed it had to rein in itsloose monetary policy, soaring housing pricesslowed, flattened out and then tipped intodeclines! The steep decline in housing prices

produced chaos throughout the financialindustry in the ?!4!, and ultimately the world, as widespread financial assets based on housingcollapsed in value! As Taylor concluded, #ITheJe tra"easy IFed monetaryJ policy accelerated thehousing boom and thereby ultimately led to thehousing bust!&

9ut that is not the whole story! Chapter * of thestory is the #affordable housing& policies going bac) many years, spawned by liberals andprogressives! These increasingly e treme andunbalanced policies began the housing bubbleeven before the Fed:s miscalculations starting in*77'! 5oreover, because of these affordable

housing policies, when the bubble burst, andhousing prices stopped rising and started deepdeclines, the resulting damage was far worse!


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.n the early '//7s, these liberalKleft activists began using the Community Reinvestment Actand anti"discrimination housing laws to allege

discrimination against housing lenders whomaintained traditional lending standards thate cluded borrowers who were not creditworthy!Their demands reached the point of insistingthat lenders discount bad credit history, nocredit history, no savings, lac) of steadyemployment, a high ratio of mortgageobligations to income, undocumented incomeand inability to finance downpayment andclosing costs, while counting welfare and evenunemployment benefits as income in ustice beganthreatening and even following through on

discrimination suits, and ban) regulators begandowngrading institutions that refused to)nuc)le under!

9ut the big brea)through came when PresidentClinton got on board with what was effectivelyan official national policy of looting the ban)s! As 4tanley ;urt e plained for National Review %#Finally, in >une of '//2, President Clinton, Lice"President Gore and 4ecretary Cisnerosannounced the administration:s comprehensivenew strategy for raising home"ownership in America to an all"time home high!


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Representatives from AC$RM were guests ofhonor at the ceremony! .n his remar)s, Clintonemphasi ed that% #$ur homeownership strategy

will not cost the ta payers one e tra cent! .t willnot re


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vulnerabilities for the financial system, and vastly pumped up the housing bubble far more!

$ther regulatory blunders further contributed tothe damage caused by the ultimately inevitablecollapse of the artificial housing bubble! Theseincluded ill"considered #mar)"to"mar)et&accounting re


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side rate cuts to restart growth, President 9ushcut a deal with the -emocratic Congress inFebruary, *770 for a thoroughly forgettable

;eynesian stimulus pac)age, which predictablyfailed to produce any positive effect! 6orse,it provided the foundation for President$bama:s far more egregious ;eynesiantravesties, which have also thoroughly failed yetagain!

How then to restore booming growth should be

obvious! Restore each of the four plan)s ofReaganomics! How to do that will be discussedin my column for ne t wee)!

Peter Ferrara is Director of Policy for theCarleson Center for Public Policy and Senior Fellow for ntitle!ent and "udget Policy at the #eartland $nstitute% #e served in the &hite #ouse Office of Policy Develo'!ent under President Reagan( and as )ssociate De'uty )ttorney General of the *nited States under the first President "ush% #e is the authorof America:s Tic)ing 9an)ruptcy 9omb ( forthco!ing fro! #ar'erCollins( whichdiscusses the causes of the financial crisis and

how to restore boo!ing growth in !ore detail%

how the government created a financial

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