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Ss Meltdown A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas E Woods Jr. As author of the New York Times bestseller The Politically Incorrect Guide to American History, you would expect Thomas E Woods to be controversial and his latest book to be a thought-provokingly good read. As Senior Fellow of the free-market, laissez-faire Ludwig von Mises Institute in Alabama, he is a natural candidate to go hard-knuckle against the grain of those who preach intervention as a solution to the 2008-9 global recession. Readers of Meltdown — at least those who know him — will be neither surprised nor disappointed at his challenging stance against bailouts, interest rate manipulation and just about every other weapon deployed so far in the battle to right the economy. His basic argument: Why should government intervene in this crisis when it's the very act of intervention that has brought the US — and thus the world — to its knees? His solution: Stop the bailouts, let banks and other firms go bust, get rid of the meddlesome Federal Reserve System, and let the free market sort things out. And if we don't do what he recommends, he warns that the recession will both be deeper and take longer to resolve than it would otherwise. "There is nothing the government or the Federal Reserve can do to improve the situation," he says, "and a great deal they can do to prolong it." As Woods would be the first to admit, though his ideas may seem revolutionary, there's nothing new about them. They stem from the early 20th century economic theories of what became known as the Austrian School, of which Ludwig Von Mises (and later, the influential economist F A Hayek) was a key proponent. A basic tenet of the Austrian School, as summarized by the author, is that government tinkering with the supply of money and credit starts the economy on an unsustainable boom that has to end in a bust. That's where we are now. Applying this, the "Austrians" saw the Great Depression (and its lesser-known but still painful precursor several years earlier) coming. What is more, says Woods, they foresaw the current economic disaster, but no one took any notice of their warnings. It's time, he says, that people started getting to know the Austrian school, so they can understand just how wildly we are heading off in the wrong direction — and hopefully do something about it in time to avoid more pain. 1 | The Business Source www.thebusinesssource.com All Rights Reserved Ss The Seeds of Destruction The author does not dispute the role of the housing market collapse in bringing about the recession but he vehemently disagrees with many on how this came about. He identifies six "culprits": 1. Fannie Mae and Freddie Mac (the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, respectively). These two government sponsored enterprises (GSEs) don't provide mortgages but buy loans from banks. In doing so, they free banks to lend yet more money, while often bundling their own holdings into mortgage-backed securities they sell to investors. Becoming involved in politically-instigated moves to lower lending requirements to help "disadvantaged" groups, and with an implicit bailout guarantee from the US Treasury, the two organizations built up ever-riskier debt obligations. 2. The Community Reinvestment Act (CRA) and affirmative action in lending. This is a Carter-era law that opened banks up to crushing discrimination suits if they did not lend to minorities in numbers high enough to satisfy the authorities. Naturally, the banks did what government regulators wanted. More importantly, "the same cavalier approach to risk assessment that informed the CRA pervaded the whole mortgage lending arena, thanks to other agencies that pushed the same destructive, loose-lending strategy on all American financial institutions." 3. The government's artificial stimulus to speculation. The push for easier mortgage access for low- and middle-income borrowers spilled over into the lending standards applied to higher income borrowers as well. Easier mortgages were available for everyone, including speculators, and when foreclosures began they occurred in both subprime and prime loans, not exclusively subprime, as has been supposed. "Foreclosures came about not because of subprime mortgages but because of adjustable-rate mortgages — the ones Alan Greenspan had once urged people to use," Woods says. 4. The "pro-ownership" tax code. Renters and people who own their homes outright don't get to write off their housing costs, but mortgage borrowers do. And the more they borrow, the more they can write off. In some places, like Washington DC, there are additional tax credits for home buyers. "This is not to suggest that any of these tax breaks are undesirable ..." the author argues. "Instead, they should be extended to as many other kinds of purchases as possible, in order not to provide artificial stimulus to any one sector of the economy." 2 | The Business Source www.thebusinesssource.com All Rights Reserved Ss 5. The Federal Reserve and artificially cheap credit. Woods describes the Fed as "the institution whose fingerprints are all over the current mess." The organization started the housing boom, he declares, by increasing the money supply, thereby pushing down interest rates. "This new money and credit overwhelmingly found its way into the housing market, where artificially lax lending standards made excessive home purchases and speculation in homes seem to many Americans like good financial moves," he notes. The frenzy was exacerbated by repeated Fed denials that the housing boom was a bubble. 6. The "too Big to Fail" mentality. Some players in the financial and manufacturing markets were able to operate in the knowledge that they would not be allowed to fail and that, one way or another, the American public would absorb their losses. Inevitably, Woods argues, this reassurance influenced the way they behaved. For a start, they were more inclined to take risks, knowing that they would be considered too big to be allowed to go under if their strategies failed. Letting a few major firms go bankrupt would "do more to jolt the financial sector into being sensible and cautious instead of reckless and irresponsible than all the regulatory tinkering in the world." Bailouts Under the Microscope Looking more closely at the build-up to the bailout fiasco, the author recalls the optimistic statements about the health of the economy made in 2008 by then Treasury Secretary Henry Paulson and Fed chairman Ben Bernanke. "You would think that anyone who fed the public such lines through the first eight months of 2008 would have lost all credibility — and probably his job," Woods remarks. "But not only did Bernanke and Paulson retain their positions as the stock market melted down in September, but these men, who were proven so wrong in their assessment of the situation, also demanded unprecedented new powers to fix it." Americans were told all kinds of horror stories about what would happen if Congress did not agree to the urgently demanded bailouts — decimation of retirement plans, the collapse of housing prices, the inability of businesses to be able to make payroll, and so on. But the bailouts didn't seem to save the economy at all, he suggests, and the fears were actually fulfilled regardless. The stock market continued to plunge, and in the ensuing weeks and months, the ongoing bailout mania struck an increasingly skeptical American public as little more than a giant black hole for 3 | The Business Source www.thebusinesssource.com All Rights Reserved Ss money and resources. "By the end of the year, everyone, from insurance companies to automakers, was lining up for a share of the loot," he adds. "The profit-and-loss system ... was beginning to mean guaranteed profits for business and losses for taxpayers and wage earners." The consequences were insidious. The handouts to the big three automakers sent the message that although mismanagement at an average size firm would be punished with losses, gross mismanagement on a gigantic scale would be rewarded with credit and funds purloined from innocent third parties. "People who are good stewards of wealth are thereby forced to subsidize people who are disastrously poor stewards of wealth," the author declares. When the bill comes due, the wealth-producing sector of the economy will be that much poorer and all the production and investment that those funds might have brought about will be lost forever in exchange for propping up firms that deserved to go bankrupt. Whatever the government chooses to do, Woods concludes, the result will be to divert resources away from wealth producers, dry up healthy economic activity and reduce the pool of resources from the private economy to use towards recovery. Government Intervention and the Boom-Bust Cycle Woods now puts the theories of the Austrian School in the spotlight, recalling that F A Hayek won the Nobel Prize for Economics in 1974 for his explanation of the boom-bust cycle. Hayek's ideas are based on the work of von Mises who held that central banks are the root cause of the cycle because they manipulate interest rates, putting them out of sync with what is really happening in the economy and what the free market would dictate. Woods delivers a simple lesson: Interest is the price people pay or the income they earn for borrowing or lending/saving money respectively. These two sides of the equation influence each other on the basis of the laws of supply and demand.

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