Figuring out how we've reached this point is not easy. One choice is to blame laissez-faire policies, an argument that's been invoked by everyone from notoriously pessimistic economist Nouriel Roubini and reporters at the New York Times to French President Nicolas Sarkozy.
On the other hand, the number of pages of federal regulations has swelled, not shrunk, over the last decade. The number of employees at the relevant agencies (SEC, FDIC, FINRA, OCC, NCUA, FFIEC, OTS, FHRA, and the FRB) has continued to grow. It was regulatory failure, not market failure, that gave us the spectacles of Darrel Dochow, Bernie Madoff, and taxpayer-funded bonuses at AIG.
Another explanation is that unfettered greed, especially on the part of Wall Street and mortgage lenders, is the culprit. But human greed and avarice are not unique to the last decade, when beyond what fundamentals permit, making that explanation less satisfying than it should be.
A new book by Thomas Woods called Meltdown (Regnery Publishing, 2009) provides a more fulfilling account of what went wrong, why it happened, and who's to blame. Woods holds a doctorate in history from Columbia University and is the author of the bestselling, iconoclastic The Politically Incorrect Guide to American History.
Woods' latest book makes a strong argument for laying the blame squarely on the shoulders of Washington politicians and regulators. One chapter is titled "How Government Created the Housing Bubble," and points to special privileges granted to Fannie Mae and Freddie Mac, a federal law allowing tax-free capital gains, and the Community Reinvestment Act's incentives for banks to make bad loans.
The ultimate culprit, in Woods' view, is the Federal Reserve. In 2001, he writes, "Fed chairman Alan Greenspan sought to reignite the economy through a series of rate cuts... the 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."
This is not a unique criticism. Many economists, including Stanford University's John Taylor, have charged that the Federal Reserve kept interest rates artificially low and that the housing boom and bust could have been avoided with more prudent government policies. At a congressional hearing last fall, some Democratic politicians made similar allegations.
(For his part, former Fed Chairman Alan Greenspan responded in a Wall Street Journal op-ed article last week titled "The Fed Didn't Cause the Housing Bubble.")
Woods is a senior fellow at the Mises Institute in Auburn, Ala., a non-profit group devoted to libertarian scholarship and championing what's known as Austrian business cycle theory. The idea is that a central bank's low interest rates expand the money supply, therefore creating malinvestments (because, say, real estate or dot-com entrepreneurs believe there's immense demand for what they have to offer), an unsustainable boom, and an eventual correction. Nobel laureate F.A. Hayek, a leading proponent of that theory, was a founding board member of the institute.
The Austrian explanation remains a minority one among economists -- Times columnist Paul Krugman likened it to the "phlogiston theory of fire," and the late Milton Friedman claimed it has done "a great deal of harm." Woods' solutions to today's economic woes are the opposite of the U.S. government's (or Krugman's) approach: he would let firms go bankrupt, ditch Fannie and Freddie, halt bailouts, and question whether the Federal Reserve even needs to exist.
Woods says Austrian theory is worth studying because it correctly predicted what's happening today. "It's about time we listened instead to people who have a coherent theory to explain why these crises occur, saw this crisis coming, and have something to suggest other than juvenile fantasies about spending and inflating our way to prosperity," he writes, perhaps a little too optimistically given the in Washington.
Woods' work -- the complete title is Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse -- is in the vanguard of the first wave of books dissecting the Crash of 2008. (Rep. Ron Paul, the Texas Republican and former presidential candidate, said in a foreword that "there is no better book to read on the present crisis than this one.")
Other volumes include Taylor's Getting Off Track, Richard Posner's forthcoming A Failure of Capitalism, NYU's forthcoming Restoring Financial Stability, and William Cohan's House of Cards.
Meltdown will not be the last word on the slow-motion crash we've been waking up to every morning. But it has the virtue of being published early enough, and written accessibly enough, to make a difference. Assuming, that is, anyone in Washington besides Ron Paul reads it.
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Declan McCullagh is the chief political correspondent for CNET and an EconWatch contributor. Previously, he was Wired's Washington bureau chief and a reporter for Time.com and Time magazine in Washington, D.C. He has taught journalism, public policy, and First Amendment law. He is an occasional programmer, avid analog and digital photographer, and lives with his wife in the San Francisco Bay area.
By Delcan McCullagh