A Conservative Economic Narrative

At City Journal, The Free Marketeers Strike Back. It is a long and probing look from the perspective of conservative economists at free markets, regulation, and the origins of our current fiscal crisis. I highly recommend the entire article. To summarize the conclusions:

- Keynes was demonstrably wrong.

- Rising costs of energy were implicated in our economic meltdown and are the looming challenge for our future economy. Our government is not moving to meet this challenge, it is moving in the opposite direction.

- Don't underestimate the importance of monetary policy. Keep interests rates high enough so that prices remain stable but sufficient currency and credit are available to finance steady growth. Interest rates set too low for too long are a major factor in causing spectacular bubbles. That is what happened with Greenspan and the housing bubble.

- Market bubbles are an inevitable part of capitalism. You can't kill bubbles without killing capitalism. It is only when bubbles are combined with a very cheap money supply that they become truly dangerous in size.

- Recessions, as a part of the business cycle, are an intregal part of capitalism. Recessions are necessary for our system to correct market imbalances. You can't stop recessions without killing capitalism.

- The much maligned derivative market brought tremendous financial benefit, particularly to the world's poor. They allow for the efficient allocation of risk, thus increasing the availability of cheap credit. Some have recommended greater transparency for the market by funneling them through a clearing house that would create a record of the swaps.

- Big banks do not bring any economy of scale and, therefore, we should consider limiting the ability of banks becoming "too big to fail."

- Big banks should not enjoy taxpayer protection because that harms free competition, putting smaller banks at a disadvantage

- Reasonable regulations are necessary to efficient markets, and that includes requiring sufficient reserves. Banks become far too overleveraged, leaving them vulnerable during the economic downturn.

- Republicans need to stand up more forcefully for markets.

- Ballooning American and European debt poses a huge threat to long-term prosperity.

- By increasing taxes and imposing the wrong regulations, Western governments are hindering entrepreneurship and hence growth, that is the path to long-term prosperity.

The one thing Guy Sorman touches upon in his article does not go into any great detail about is the dismantleing of traditional lending standards. It is critical to note that Democrats dismantled our lending standards in the 1990's on a now discredited assertion that racism was endemic in the mortgage and loan industries. Even though now fully discredited, the race based standards remain in our laws and have actually been strengthened by Obama as part of the financial regulatory overhall recently passed into law.

Sorman does make one interesting point in addressing this issue. That is that, in comparing U.S. to Canadian home ownership, the Canadians fared better because of higher down payment requirements, yet the overall home ownership percentage between the U.S. and Canada are the same, suggesting the final irony, that Democrats destroyed our credit system for nothing. Here is how Sorman addressed the issue:

. . . [E]asy money helped expand a massive credit bubble. And that credit helped fund a wild proliferation of risky subprime mortgages, often issued with little or no money down, thanks to relaxed mortgage-lending laws and to Fannie Mae and Freddie Mac, the now-infamous “government-sponsored enterprises” that busily bought mortgages from lenders to keep homeownership expanding. The bursting of the bubble in 2008 brought the U.S. banking system, which had invested extensively in the subprime mortgages, to its knees. Given the enormous scale of the crisis, Taylor says, it’s clear that the private sector could not have caused it on its own. “Distorted incentives encouraged private speculation,” he says. “Central banks should return to their former global targets against inflation and be less erratic and more predictable.”

Taylor’s analysis draws support from a comparison of the financial crisis in the U.S. and Canada. Canadian banks, it turns out, weathered the financial storm much more effectively than American banks did. The reason: Canadian mortgages, unlike American ones, legally required robust guarantees, usually a 20 percent down payment. That helped keep homeowners from running away from their mortgage payments when things turned south, as happened in the United States. Canada and the U.S., it’s worth noting, still have the same percentage of homeowners—roughly 67 percent—meaning that the American incentives that favored risky bank behavior failed to increase ownership levels.