Learning the Wrong Lessons From the Financial Crisis

The rule of law has many enemies. One of them is bad law.

BY JR NYQUIST

In a book titled Theory and History, Ludwig von Mises wrote,

“Because history is not a useless pastime but a study of the utmost practical importance, people have been eager to falsify historical evidence and to misrepresent the course of events.” 

In recent history, the champions of regulation and state control of the economy would endeavor to depict the financial events of 2007-2008 as a failure of regulation. At least one historian is worried that we might have “learned” the wrong lessons if we suppose any such thing.

Historian Niall Ferguson of Harvard University says that insufficient regulation may not be at the heart of the financial crisis. Ferguson calls into question Princeton economist Paul Krugman’s assertion that Reagan era deregulation of financial institutions triggered the crisis. “For one thing,” wrote Ferguson in The Great Degeneration, “it is hard to think of a major event in the US crisis — beginning with the failures of Bear Stearns and Lehman Brothers — that could not equally well have happened with Glass-Steagall still in force.”

History teaches that rule of law plus economic freedom makes for prosperity, yet we are supposed to believe that restricting freedom — or eliminating vital aspects of freedom — will somehow prevent financial ills. According to Ferguson, 

“there is something especially implausible about the story that regulated financial markets were responsible for rapid growth, while deregulation caused crisis.” 

The fact that heavily regulated markets in the past have created less wealth than free markets under the rule of law must surely count for something. Furthermore, there is no progress without risk, no advances without partial setbacks. And what does the history of capitalism show if not the fact that the advances have far outweighed the setbacks. And if freedom means progress then we must accept the consequences of that progress instead of introducing regulations that will, in the end, choke off progress altogether.

Ludwig von Mises wrote: 

“To lie about historical facts and to destroy evidence has been in the opinion of hosts of statesmen, diplomats, politicians, and writers a legitimate part of the conduct of public affairs and of writing history. One of the main problems of historical research is to unmask such falsehoods.” 

Ferguson’s unmasking of falsehood reminds us that spectacular economic progress is not found in eras of complex or heavy-handed financial regulation. The sad truth is that regulation has far more to do with causing crises than deregulation. 

“The financial crisis that began in 2007 had its origins precisely in over-complex regulation,” wrote Ferguson. “A serious history of the crisis would need to have at least five chapters on its perverse consequences….”

Ferguson wrote up a brief overview of his proposed five chapters on the role of government interference in the financial crisis, which may be summarized as follows: 

(1) incentives were given to bank executives toward low risk assets;

(2) Risk was weighed on ratings given to securities; 

(3) monetary policy consisted of cutting interest rates at the abrupt fall of asset prices, but not if they rose rapidly (as in the housing bubble); 

(4) Congress passed legislation that effectively offered home loans to people who would not otherwise have qualified, inflating real estate prices with “unhedged and unidirectional bets on the US housing market”; 

(5) Chinese currency manipulation effectively and artificially provided the United States with “a vast credit line.”

Read more at:

http://www.financialsense.com/contributors/jr-nyquist/learning-wrong-lessons-from-financial-crisis