Is more federal regulation the answer to the credit crisis?

Steven Christopher, for the laissez-faire approach:

In the wake of a historic downgrade of the United States credit rating, Federal Reserve chairman Ben Bernanke has vowed to keep interest rates at near zero for another two years. Some of us would like to think that in a market economy, prices, such as interest rates, would be determined by supply and demand.

No matter, Bernanke is confident that he and his team of technocrats are so much smarter than you and I that they know what level interest rates should be, and therefore they will take it upon themselves to buy up as much government debt as is necessary to lower interest rates to their liking.

In effect, price fixing is just fine in their book as long as overly-educated central bank oracles are pulling the levers.

The idea behind Bernanke’s lowering of interest rates is that lower rates of interest are supposed to induce businesses to borrow and invest, thereby raising what economists call aggregate demand and cushioning the blow of the recent recession. Forgive me for stating the obvious, but clearly that hasn’t happened. The problem is that the initial bust itself was the result of this exact same process, and economic actors are beginning to see the writing on the wall long before the Federal Reserve’s newly created paper money floods the market.

After a decade of experimentation with a free-floating fiat currency that was no longer pegged to gold, the ability of our central bank to contain runaway consumer price inflation in the mid-1980s made its leaders ever more emboldened to continue their manipulation of the nation’s monetary system, thinking that they could perfect their art and lead us into a new economy — one that is in a state of perpetual boom.

Former Federal Reserve chairman Alan Greenspan, just as infinitely wise as Bernanke, pursued the same policy of lowering interest rates in the wake of the dot-com bust in 2001. Brand-new money was created, rates were driven downward, and the boom was perpetuated a little while longer. Tragically, the wide-open credit spigot fueled a housing bubble which was aided by politicians in Washington. Bernanke’s solution when that blew up in 2008: an even bigger hit of monetary heroin. No wonder the economy is stuck on skid row.

These actions taken by the Fed have simultaneously increased the federal government’s appetite for borrowing and debt, fueling the exponential growth in government we have witnessed over the past decade and playing no small part in the run-up to the debt ceiling debacle and ensuing downgrade of the US credit rating.

In the absence of healthy business and consumer spending, the National Treasury has continued its spree of paying off old debt with new debt, as Congress and the president desperately try to prop up the economy by regurgitating cash here, there and everywhere. Meanwhile, the Federal Reserve continues to subsidize Congress’ irresponsibility by lowering the cost of doing so.

What is to be understood here is that in a market economy, prices convey information about the availability of real savings and resources in the economy. When government bodies like the Federal Reserve manipulate these prices, this information becomes a lie. Like all lies, it has to come crashing down eventually. It is folly to believe that “the Fed,” that arbitrary authority vested with the monopoly power of paper money creation, will be able to manipulate us back to prosperity, regardless of how much it toys with interest rates and the money supply.

The rate of interest most conducive to real economic growth is the market rate of interest, one that is unhindered by the manipulations of presumptuous central planners like Ben Bernanke.

Steven Christopher is a graduate finance student in the C.T. Bauer College of Business and may be reached at [email protected].

Emily Brooks, for federal regulation:

Regardless of the implications of the downgrade of America’s credit rating by Standard & Poor’s, the reasoning behind their decision to downgrade is quite disturbing.

“The downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenge,” S&P said in a press release about the downgrade.

Fellow agencies Moody’s and Fitch have declined to follow suit, but reflected the same concerns regarding ineffectual American policy-making. The credibility of S&P and the other ratings agencies has been a matter of concern since their wildly optimistic ratings of assets turned toxic in the 2008 crisis. So why should we heed S&P? What, if any, conclusions can we draw from the downgrade? We still haven’t learned our lesson, and now it is time to cram for the test.

In a climate of deregulation, the repeal of the Glass-Steagall Act, which had separated commercial banks from investment banks since 1933, led to behemoth financial institutions that became too big to fail. Economic wisdom told us that enlightened self-interest would prevent the kind of over-leveraging that was rampant leading up to the crisis.

“All of the sophisticated mathematics and computer wizardry essentially rested on one central premise: that enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency,” former Fed chairman Alan Greenspan said in The Economist.

He was “deeply dismayed” by the failure of this premise. Many economists believe that people are always rational, and that markets always work. We learned the hard way in 2008 that this is not the case.

In recent years it has become fashionable in the GOP to decry the Federal Reserve, and the climate in the wake of the crisis doesn’t make that difficult. The Fed has become the right-wing’s scapegoat.

The current Fed chairman, Ben Bernanke, has been juggling the shrapnel of the crisis with minimal success for the past three years. The Fed has held interest rates down in an attempt to stimulate borrowing, but in a crisis caused largely by the insolvency of major financial institutions, a liquidity trap has resulted — interests rates are near zero, but banks still aren’t lending. After two rounds of quantitative easing — a process of buying up assets with the Fed’s reserves in an attempt to increase the money supply and stimulate private consumption and investment, our economy is just above water.

The Fed has reached, and even exceeded, the limits of monetary policy. It is clear that the cult of deregulation and enlightened self interest has failed. The free market is a very efficient system and the best we have available, but it is naïve to assume that it is perfect. The 2008 crisis reaffirmed that even in the aftermath of the Great Moderation, markets can and do still fail.

It is past time we accepted the failure of militant laissez-faire and turned to fiscal policy and to Congress, but in a political climate where even basic housekeeping measures are held hostage by ideologues more concerned with a political agenda than the welfare of our nation, how can we dare hope for unified legislation.

If we are going to pull our economy out of this crisis we need to heed S&P. Political and ideological vitriol caused S&P to downgrade America’s credit. It made economists blind to the coming storm and now threatens to derail our efforts at recovery.

America was built on innovation and unity. Isn’t it time to put ideology and broken systems aside so that we can find a new solution that will work for Americans and put Americans back to work?

Emily Brooks is a senior economics major and may be reached at [email protected].

Leave a Comment