Government Caused the Meltdown

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A Free-Market Look at Why the Stock Market Collapsed, the Economy
Tanked, and Government Bailouts Will Make Things Worse

by Thomas E. Woods (Regnery, 2009); 194 pages.

Thomas Woods’s
Meltdown is a truly radical book.

That is to
say, it probes to the root of America’s persistent boom-and-bust
economic cycles. Not only has the most recent episode, beginning
in 2007 with the rapid collapse of inflated housing prices, brought
about widespread economic pain as unemployment rises, foreclosures
increase, and bankruptcies mount, but it has also brought us to
the brink of a sea change in the United States. For decades, the
United States has been sliding into the quicksand pit of federal
domination of the economy (and also most other facets of life).
Now the politicians responsible for the current economic debacle
are determined to use it as the leverage they need to force changes
that will greatly increase Washington’s grip on the populace.
They want to push us past the point of no return.

The country
is in such grave danger because few people understand the real causes
of our troubles. Overwhelmingly, politicians, opinion leaders, and
academicians have pinned the blame for the current crisis on capitalism.
They maintain that we can regain prosperity only if the federal
government spends money like never before, bails out failing companies,
and exerts far more regulatory control over what’s left of
free enterprise.

Are we doomed?
Is it inevitable that the United States will become a thoroughly
politicized dystopia with so little freedom left that it would be
unrecognizable to people who lived as recently as the middle of
the 20th century?

It all depends
on the ideas that Americans believe. Most have been taught to accept
the pro-state version of events – that the free market has
failed and we must turn to governmental power for salvation. A few
writers, however, have been trying to get across the opposite message.
The current economic crisis (and in fact, all of our previous economic
crises) is a result of governmental meddling with the economy; the
only path to take if we want liberty and prosperity is to undo the
government’s net of controls, starting with its control over
money and credit.

how people think

One of those
writers is Thomas E. Woods, a senior fellow at the Ludwig von Mises
Institute. In Meltdown, Woods explains the truth: government
blundering got us into the current recession and if we allow the
politicians to exploit it to increase their power, we will have
made a gigantic, perhaps fatal mistake. The book gives the reader
an excellent, clear discussion of the causes and consequences of
the housing bubble, but goes further to provide a convincing explanation
of the Austrian theory of the business cycle. After reading the
book, readers will be familiar with the names von Mises and Hayek;
they will understand why it is impossible for the government to
make a nation wealthy by inflating the supply of money; they will
know why we would be much better off if we took control of money
and credit entirely out of government hands.

Put it this
way: Woods is attempting to get people who have mostly been steeped
in Keynesian/socialistic ideas favorable to omnipotent government
to renounce those ideas in favor of a vision of the state that would
have been congenial to, oh, Patrick Henry.

I don’t
know whether that’s possible, but this is no time for temporizing
or advocating measures that are “moderate” and “politically
realistic.” Woods realizes that we can’t fight the socialist
juggernaut with mild “that’s going too far” rhetoric.
We need strong arguments that enlighten people about the root of
our troubles. That is just what Meltdown gives us.

Woods has
two main objectives, first to set the record straight regarding
the housing bubble and the frantic governmental efforts to deal
with its aftereffects, and second to explain what policy changes
are necessary to prevent future bubbles. He succeeds admirably in

Fearing that
they would be blamed for the economic turmoil, leading politicians
(including both the Democratic and the Republican presidential candidates
in 2008) proclaimed that it was not due to government meddling,
but instead had been caused by “laissez-faire philosophy”
and greed. And intellectuals, eager to protect their stake in the
alleged benevolence and wisdom of federal economic regulation –
people such as Paul Krugman – leaped up to say that the crisis
couldn’t be blamed on the government. Woods clears away the
fog of self-serving falsehoods, showing that the collapse of the
housing market was the entirely predictable result of federal policies
for which the politicians and intellectuals were happy to take credit
as long as they seemed to be “working.” He writes, “Following
a familiar pattern, government failure has been blamed on anyone
and everyone but the government itself. And of course, the same
government failure is being used to justify further increases in
government power.”

The home-loan

The first
part of the book examines the government’s policy blunders,
beginning with the very notion of federal housing policy. The Constitution
says nothing about housing, but in 1938 Congress and President Roosevelt
created the Federal National Mortgage Association, usually called
“Fannie Mae.” They did so because they thought it was
a good idea to promote home ownership and figured that establishing
a “government sponsored entity” to buy mortgages from
lenders would do that. Of course, there were millions of Americans
who owned houses prior to the creation of Fannie. There was no problem
that needed to be solved, but the politicians thought it would be
a popular move, so they went ahead, never contemplating that getting
the government into the home-financing business would one day lead
to disaster.

mortgage-backed securities were sold to investors worldwide, most
of whom assumed that the paper was sound, backed by the U.S. government.
Woods writes, “Everybody knew that if the GSEs [Fannie and
its younger sibling, the Federal Home Loan Mortgage Corporation
or “Freddie Mac,” are known as government-sponsored enterprises
– GSEs] ran into trouble, they would be bailed out at taxpayer
expense.” They ran into enormous trouble and were bailed out,
but hardly anyone has had the guts to blame these political pets
and call for their abolition.

Another of
the culprits Woods identifies is the Community Reinvestment Act
(CRA), which used political leverage to compel banks to make more
loans “in their communities.” This law (again, outside
the constitutional authority of Congress but enacted anyway) was
a power play to force banks to make loans they would not otherwise
choose to, directing capital in ways that please the activists and
politicians. Under the Clinton administration, this statute was
used to compel banks to meet quotas of home loans to high-risk people.
At the same time, Clinton forced Fannie and Freddie to purchase
high-risk mortgages. Woods shows, in short, that political pressure
was used to undermine the traditionally cautious lending standards
in the mortgage industry.

in both parties took delight in crowing that home ownership was
increasing, especially among minority voting groups, without realizing
that home ownership is not necessarily good for everyone. For persons
with low and unsteady incomes, home ownership can be a costly mistake,
as later proved to be the case for millions who had taken out loans
they couldn’t repay.

The main

By themselves,
however, Fannie, Freddie, and the CRA could have done only minor
economic damage. Woods identifies the main villain in this drama
as the Federal Reserve System. For years, the Fed under long-time
chairman Alan Greenspan pumped up the money supply so as to drive
interest rates down to artificially low levels. Artificially low
interest rates tricked people into acting differently than they
otherwise would have. Home ownership and housing construction looked
like great investments during the years 2002 to 2006 because of
the outpouring of credit from the Fed, steered by politicians toward
the housing market. If interest rates had remained at market levels,
the housing bubble could not have grown to the enormous size it

When the Fed
finally stopped its wildly expansionary policy and interest rates
began rising, many borrowers found that they couldn’t afford
to keep the homes they had been lured into buying, and many builders
found that projects they had started couldn’t be completed
because of insufficient demand. Institutions that had invested heavily
in mortgage-backed securities discovered that their portfolios were
nearly worthless. Firms collapsed and the stock market plunged.

Woods makes
it clear that the government’s desperate moves to shore up
unsound investments through bailouts are exactly the wrong policy.
All the politicians are doing is taking resources from the healthy
sectors of the economy to prop up the unhealthy, thus obstructing
the efficient use of resources and rapid recovery from its cheap
credit binge. Instead of getting the government out of the mortgage
market, repealing the foolish CRA, and abolishing the Federal Reserve,
the politicians are taking us further into the interventionist swamp
with massive increases in government borrowing, spending, and economic

Who would
ever have thought that a consequence of federal interference in
the housing market would be that the president of the United States
could order the ouster of the CEO of General Motors?!

The business

The latter
part of the book is devoted to explaining the Austrian theory of
the business cycle so that readers can grasp the key point that
government tampering with money and credit always has bad
economic results. Woods wants people to understand that the United
States (or any other country for that matter) does not need a central
bank and has only been harmed by the existence of the Fed.

That point
leads Woods into a discussion of alternatives to government-controlled
fiat money systems, particularly the gold standard. Statist politicians
and economists have worked hard ever since the late 19th century
to discredit the idea that an advanced, industrial nation could
function with an allegedly antiquated monetary system based on precious
metal. Woods demonstrates that the objections to gold (or other
market-based monetary systems) are groundless. The objection to
our current, governmentally controlled monetary system, however,
is gigantic and looms right before our eyes: it leads to massive
economic dislocations and enables the government to spend almost

I can think
of nothing more important at this moment in history than to get
people thinking about the undesirability of allowing the government
to continue to control our monetary system. With Meltdown,
Woods is trying to steer our attention to that critical issue. Back
in the 1990s, Bill Clinton said that we needed a “national
conversation on race.” That was just political hucksterism,
but today we badly need a “national conversation on money.”
If enough Americans read this book and come to see how damaging
it is for the federal government to run our monetary system, it
might be possible to extract the nation from the horrible blunder
of the Federal Reserve and economic interventionism. That unjustly
maligned “laissez-faire philosophy” is in truth our only
way back to liberty and prosperity.

We are at
what educators call a “teachable moment.” The advocates
of omnipotent government are trying to capitalize on the economic
crisis they have caused to further expand their power. Advocates
of liberty must work harder than ever to convince people that inappropriate
government power is not the solution to our economic troubles, but
their very cause. That is why you should read Meltdown and
then spread its message as widely as possible.

27, 2010

C. Leef [send him mail]
is the director of the Pope Center for Higher Education Policy in
Raleigh, North Carolina, and book review editor of The

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