The economic situation we're currently in is arguably the worst it's been since the Great Depression. Let's examine the causes of this crisis. First, who isn't responsible?
1) Liberals. It's become popular in right-wing circles to spread the notion that liberals are actually the ones responsible for the mortgage-crisis because of their policies forcing banks to make loans to lower-income and minority families. An interesting argument. Unfortunately, for them, it isn't true. Presumably the legislation they're referring to is the 1977 Community Reinvestment Act (CRA). As this article makes clear, there is no connection between the CRA and the current crisis. For those of you who don't want to read the whole article, let me summarize the main points. a) Only 25% of sub prime mortgages were made by banks that were even subject the the CRA. b) Even among those 25%, there's no evidence that the CRA loans have a higher default rate than the rest of their loans. c) The investment instruments that spread this bad mortgage debt around the whole economy had absolutely nothing to do with the CRA. d) The first sub prime mortgage was made 25 years after the CRA was first passed. Blaming the CRA is such a ridiculous argument that neither John McCain nor any bank executive has tried to make it, but never underestimate the power of the right-wing chatterboxes in convincing people that liberals are really responsible for all of their problems.
2) Wall Street Executives. This may seem counter intuitive to anyone listening to any politician talk about the meltdown lately, but Wall Street is not to blame. They were just doing what the rules of the game expected them to do. It's a classic prisoner's dilemma. For those of you not familiar, I'll fill you in. Two people are arrested. They each have to decide whether to stay silent or rat the other one out. If they both stay silent, they'll each get 6 months in prison. If they both rat each other out, they'll each get 30 years in prison. If one stays silent and the other rats him out, the ratter will go free, and the rattee will get life in prison. Assuming we are dealing with rational people who prefer less jail time to more, the only outcome we will ever get is that they'll both rat each other out and spend 30 years in jail. Even though they'd both be happier if they both stayed silent, absent any way to bind the other person to an agreement, there's no incentive for either one to remain silent. If I think you're going to remain silent, I should rat you out because free is better than 6 months. If I think you're going to rat me out, I should still rat you out, because 30 years is better than life. This is essentially how wall street works on a much bigger scale. It's the paradox of the free market. If you allow everyone maximum liberty to make the decision that most benefits him or her, you will almost inevitably wind up with an outcome where everyone winds up suffering. It's not fair to blame the people involved. True, they all would have been better off if they didn't make these risky investments, but if I choose unilaterally not to make these investments while everyone else still is, I'm just going to wind up in even worse shape. Another one of my favorite examples of this is the minimum wage. Every time congress raises the minimum wage, conservative economists start screaming about how it's going to put companies out of business and lead to huge unemployment, and yet this has never panned out. Why? Because even though minimum wages might drive up short term costs, in the long run they are good for the economy. When the people at the bottom, the people for whom every extra dollar translates to an increase in their quality of life, have more money, they spend more. They create more demand in the economy. Businesses sell more. Everyone benefits. However, one firm raising wages will never be sufficient to create that stimulus. Without the government mandating it, no company is going to unilaterally volunteer to increase their payroll costs. However, when the situation is required of everyone, everyone is better off.
So who is responsible for the current economic crisis? It should be obvious by now. It's not Wall Street and it's not liberal government policy. It's conservative government policy. I stress conservative and not Republican, because many of these conservative policies were passed with the full support of a large number of Democrats as well. It's the policies of deregulation that caused this mess. The false belief that the market will perform best if the government would just leave it alone. Adam Smith's contention that a completely unregulated market will work at maximum efficiency is true only in the highly idealized situation where competition is perfect, and no firm is large enough for their decisions to have an impact on any other firm. No real market actually works this way (and besides, efficiency doesn't necessarily equal fairness). If I had to put the blame on one person for the current economic mess, it would be Ronald Reagan. Not that I can point to any specific policy of his that caused it. However, he was the one who set the conservative trend in American economics in motion. He was the one who made deregulation the politically popular thing to do. If it weren't for Reagan, Bill Clinton never would have felt compelled to go along with deregulation to the extent he did, and George W. Bush never would have been able to muster the political will to push deregulation to new extremes.
So what's the solution to the crisis? Well, in the long run, the solution is liberalism. We need to reregulate the markets in a way that makes sense for the 21st century economy. Now, I'm not a socialist. I don't want to government running the entire economy. In general, I view competition as a good thing. It motivates innovation and can be of tremendous benefit to the consumer. In order for competition to work, companies do need the opportunity to make bad decisions and fail on account of them. However, the government needs to have an active role in preventing situations where the markets motivate everyone involved to act in destructive ways as it does now. I find it funny when Larry Kudlow on CNBC asks things like "Can the market survive the regulatory state of an Obama presidency?" He doesn't seem to get that the market can't survive without the regulatory state of an Obama presidency. A successful capitalist economy depends on liberal government policy. It shouldn't surprise anyone that historically, the market has performed considerably better under Democrats than Republicans. The Republicans like to frame it as class warfare, business versus the middle class. But the truth is when the middle class is doing well, businesses fare better also. Economic success percolates up, it doesn't trickle down.
What about in the short term? I think we have no choice but to go along with this bailout. It's not perfect, but we don't have time to work out something better. If we want capitalism to survive, the government needs to do something now to preventing the market from collapsing on itself. We should do it in a way that protects the investments of ordinary people and not just big business, but if we completely ignore business interests, ultimately the people will wind up suffering as well. The idea the House Republicans proposed of a government-run insurance company that banks could buy into to insure their mortgage debt, is not a bad idea in the long run. In fact, it's similar to the original function of Fannie Mae, in the days when it was a pure public utility, created as part of the New Deal. I hope they continue pushing the idea after the immediate crisis has subsided, because it's something I think we should very seriously consider. However, it's not a short term solution. Telling the banks to buy mortgage insurance after the debts have already gone bad is like telling the residents of New Orleans to buy flood insurance after Katrina has already hit. Insurance is a good way to prevent crisis, but not a good way to alleviate one already in progress. However, if we only remedy the short-term crisis, and not the long-term problems, that's a good recipe for another crisis in the not too distance future. The best hope we have left is to elect Barack Obama president with strong Democratic majorities in congress and pray that they live up to their mandate.
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