The View From 1776

The House of Representatives has just passed a bill, primarily the brain child of Congressman Barney Frank, that expands the scope and detailed depth of financial markets’ regulation. 

For public consumption, Congressman Frank’s legislation aims to prevent future financial meltdowns.  This it will fail to do.  It will, however, continue the long standing animosity between Democrat/Socialists and Wall Street and the business community. 

Accepting the Democrat/Socialist Party’s nomination for the presidency in 1936, Franklin Roosevelt railed against the “economic royalists” who were allegedly seeking a “new industrial dictatorship.” Privately, he opined that businessmen as a class were stupid, that newspapers were just as bad.  During the election campaign of 1936, in an address at Madison Square Garden, he fulminated against the magnates of “organized money.” To uprorious applause, he threatened: “I should like to have it said of my second Administration that in it these forces met their master.”

Since 1929, the generally accepted remedy has been strict, even punitive, additional regulation of banks and financial markets.  But this is analogous to dealing with building collapses by regulating paint jobs and exterior trim. 

It has failed to work for two reasons.

First, the fundamental difficulty with the Democrat/Socialist approach is that dealing only with manifestations of a problem fails to deal with the source of the problem. 

Second, no matter how severely circumscribing new Federal regulations may be, we can depend upon Wall Street bankers, lawyers, and accountants, in very short order, to devise ways to get around them and to continue doing business as usual.  That is what has always occurred.

What then ought Congress to do?

Popular mythology, continually preached by liberal-progressives, is that economic crashes, from the 1929 to 2008 , were caused by wild speculation in the financial markets.  In fact, the underlying cause in both cases, as well as in the 1921 recession, was the same: excessive expansion of the money supply by the Federal Reserve.  Without excessive amounts of money, it’s impossible for Wall Street, certainly not the entire nation, to plunge into speculation.

Prevention of future destructive booms and busts can come only from curtailing the Fed’s power to expand the money supply limitlessly.  That means removing the Fed’s mandate to attempt managing the entire economy, with full employment as its main target.

Students in the 1950s and 60s were taught that President Franklin Roosevelt’s Keynesian economic policies adopted under the New Deal would prevent future depressions and that financial market aberrations had been prevented by creation of the Securities and Exchange Commission and the Federal Deposit Insurance Corporation.

Experience has revealed this to be malarkey.  Today’s disaster was preceded by the 1990s massive dot-com boom and bust, and by the 1980s collapse of the savings and loans caused by the run-away inflation induced by President Johnson’s Great Society welfare-state entitlements spending.  This recurrent pattern can be observed all the way back to the 1920s, following creation of the Federal Reserve System in 1913. 

Everyone of these was preceded by the Fed’s excessive expansion of the money supply, evidenced by unduly low interest rates that made marginal investments and speculations profitable.  When interest rates are not kept artificially low by the Fed’s printing presses, the spread between the cost of borrowed funds and the prospective return on speculation is too low to warrant the risk.  Banks tend to stick to sounder loans and investments.

Nonetheless, heedless of reality, retrospective sets of regulations were imposed after each bust on the assumption that the next financial bubble would be a repeat of the preceding one.  Unsurprisingly to anyone other than liberal-progressives, the boom-and-bust phenomenon keeps coming back, always in a different manifestation not anticipated by the latest set of regulations.  Tulip bulb mania in the 17th century, the “new era” economy of the 1920s, dot.com startups in the 1990s, and our recent can’t-miss mortgage-funded housing boom.

Human beings, from wage-earners to Wall Street tycoons, will always find ways to lend and spend when the economy is awash in liquidity, at lower-than-free-market interest rates, created by the Fed’s deliberate policies.  Fed chairman Bernanke called this money-supply inundation “a worldwide glut of savings,” because in Keynesian economic theory government’s deficit spending funded by the Fed’s fiat money is said to be the same thing as savings.

The Fed’s rampant expansion of the money supply since 1987 gave false signals to the entire economy, leading individuals to go on a spending binge, buying automobiles, gizmos, and homes on credit.  To keep the good times rolling, financial institutions did everything imaginable to encourage and facilitate consumer borrowing.

Bottom line: the crash of the housing industry, the subprime mortgage meltdown, and the securitized debt disintegration originated with the Federal Reserve.  In the extended period during the 1990s and into recent times, Fed Chairman Alan Greenspan kept interest rates artificially low by flooding the market with excess money.  Chairman Bernanke, who believes that the Depression was caused by the government’s failure to spend enough, is carrying on that destructive policy.

By all means, let’s prosecute people in the financial community who engaged in fraud or other crimes.  But it’s time to forget punishing the entire financial community with new sets of rigid regulations.  It’s time to move on and deal with the real source of the problem.  It’s time to remove the Fed’s money printing press, and, with that, to remove the wherewithal for Wall Street to indulge extensively in highly imprudent lending and investment activity.