Smith Faculty Opinion Article
The 30 Seconds Outlook
October 15, 2010
“The conventional wisdom is that . . . free-market economists failed
most of all, and that market fundamentalism bears grave responsibility for
the economic crisis. But, talk to the free-marketeers themselves and a
different picture emerges. Disagreeing vehemently . . . they argue that we
need to learn from the crisis without disrupting the free-market model that
has served the world so well.”
— Guy Sorman, City Journal, Summer 2010
Democrats “discovered” early on that the financial crisis was born of George
Bush and his support of “free markets.” Yes, free markets created the chaos.
What else would liberal spokesmen say when government, financial market
regulators, and monetary policy all contributed to the crisis?
Well, now its time for “free marketeers” to respond, and Guy Sorman leads the
charge. So what do leading free market economists have to say?
Charles Calomiris of Columbia says “. . . the current banking crisis fits
into the pattern of all banking crises that we have known since about the
fifteenth century”---excessive leverage and belief in ever-rising prices
followed by collapse of trust in banks. The problem is that contemporary
economists and the public have short memories. Long periods of time without a
panic can make it easier to forget.
Eugene Fama of Chicago says the same forgetfulness applies to recessions. It
was only with the 2008 recession that the Great Depression became an issue of
public debate. Subsequent recessions were all too short to leave deep
impressions on the collective mind, no less to develop a predictive model.
John Cochrane of Chicago says “[w]hen major recessions don’t appear over
three generations, one tends to think that they belong to the past, and will
never happen again.” Until 2008, free market economists saw the world following
their model of the early eighties that produced the Great Moderation.
What the professors appear to be saying is that failure to remember the
history of crises leads to the same mistakes. But then how does Bernanke explain
his failure to read his own research on monetary policy and the Great
Depression? His continuation of Greenspan’s loose money policy appears to say
something about “Fed independence.”
What makes the nature of recessions important is the surprising contention by
free-market economists that recession triggered the financial panic, the
opposite of the usual explanation.
Eugene Fama of Chicago says the recession began in 2007 with less consumer
spending, more delinquent loans, and housing prices with negative owner equity.
The complex derivatives at the center of the meltdown were not its cause, but
its victim. Derivatives had successfully lowered the cost of capital for over 25
years.
Fama argues he learned much about government overreaction and less about
recessions. When economic downturns occur, governments face political pressure
to act. The stimulus spending and other interventions in the economy appear to
be the right things to do, but the history of past crises suggests otherwise.
The subsequent growth in public debt and regulations impede recovery. The
correct course was mostly to let markets clean up the mess, reestablish true
prices, and determine firms to survive.
John A. Haslem
