Deregulation and the Crash of 2008: Was Greenspan right?

November 14, 2008

by SANDY IKEDA

When Alan Greenspan blamed deregulation for the Crash of 2008 many libertarians scrambled to denounce the former Fed chairman as a hypocrite or nuts or both. And in defense of the free market, some invoked “the dynamics of interventionism,” the popular interpretation of which is that the expansion of government control generates negative unintended consequences that tend in turn to provoke further government controls.

For what it’s worth, lately I’ve realized that these responses are probably wrong: What we’re going through right now is at least partly the result of deregulation – or to use my preferred clunky term “disintervention” – and less the result of the expansion of intervention. So how does that not make me a hypocrite or nuts or both?

Back in 1997 I published a book called The Dynamics of the Mixed Economy (pardon the self-promotion but it’s currently ranked 1,676,180th at Amazon.com), and in 2005 what is essentially a précis of that book came out in Advances in Austrian Economics called “The dynamics of interventionism.” I tried to integrate the implications of F.A. Hayek’s concept of “the knowledge problem” and Israel M. Kirzner’s “entrepreneurially competitive market process” into Ludwig von Mises’s “critique of interventionism.” One of the pattern predictions that I derive (it’s in Chapter 7 if anyone’s interested) is that really existing mixed economies will tend forever to cycle back-and-forth along the politico-economic spectrum.

(Bob Higgs, author of Crisis and Leviathan among other important books, has adopted my cycle concept. His own version can be found in the same volume in which my “Dynamics of interventionism” article appears.)

Banking and finance since 1980 seem to have been in the “dis-interventionist” rather than the expansionary phase of the interventionist dynamic.

In general if the public choosers decide, in the face of a systemic crisis, to disintervene, it has to be sweeping and radical to be effective. Half-hearted or piecemeal measures that leave significant sectors of the system still controlled will generate bottlenecks in the sectors where disintervention has gone further because that’s where entrepreneurial energies flow, and the resulting shortages, sharply rising prices, mal-investments, et al. will tend to frustrate the intentions of the supporters of disintervention.

So the more piecemeal and the less radical the disintervention, the more bottlenecks and disappointment that will arise. But these outcomes can cut both ways – public choosers can respond either by disintervening further or by turning to government. I think the strong empirical tendency in these circumstances is for public choosers to choose interventionism, for after years of internalizing the interventionist ideology they will have a proclivity to respond to the problems of partial de-control by returning to their comfort zone and re-intervening.

I think that’s what we’ve been experiencing in the present case – not the dynamics of intervention in the expansionary sense, but the dynamics of disintervention. Although the banking reforms of 1980 notably phased out the prohibitions on interest-bearing demand deposits, bank mergers, and branch banking – and Glass-Steagall was repealed in 1999 – it left in place a powerful Federal Reserve, as well as Fannie Mae and Freddie Mac, which enabled a series of presidents and congresses to apply political pressure to promote sub-prime and other kinds of risky lending beginning at least since 1992. (The role that the Fed, Fannie, Freddie and other GSEs played in the resulting housing bubble are well known by now, but here’s a guest blog I did for “Market Urbanism” recently, that gives a timeline.)

For me this helps to place in its proper context such things as the policy change in 1997 that cut the capital-gains tax to 0% on the sale of most primary homes, which is often given as a factor that contributed to the bubble. I think that’s right, even though I regard tax increases as interventions and tax reductions as disinterventions. In other words, this was just another piecemeal disintervention that interacted with the remaining interventionist institutions and policies in such a way that it probably caused more harm than good. One of the lessons of the dynamics of disintervention is that, if you’re going to free-up markets in small steps instead of making radical and sweeping changes, timing and sequencing become extremely critical. Indeed, successful piecemeal disintervention of heavily regulated sectors may be beyond abilities of even the most well-intentioned public choosers.

Anyway, we’ve seen the interventionist response by the Fed and the current Treasury, Congress, and President. Does anyone doubt that the in-coming one-party government will only hurry us along that road? Still, I think there’s time to get ready for the next systemic crisis when it comes.

10 Responses to “Deregulation and the Crash of 2008: Was Greenspan right?”

  1. Adam Martin Says:

    This is fascinating. I wonder if the same story could be told about the California energy “deregulation” of the 1990’s.

    Of course, this only makes Greenspan semantically correct. The substance of his arguments is nowhere near these ideas.


  2. Though I can’t now find the reference, I did recently read that some economists had criticized the repeal of Glass-Steagall not because they are opposed to deregulation in general — they are not — but because it was a possibly damaging move while we still have a fiat monetary system. They stressed that with a gold standard (or at least non-fiat currency) it would be a logical regulation to nix.


  3. I wrote specifically about the tax differential between capital gains realized on housing and other sorts of income in September, and tied it into an idea that Kevin Carson (reviled among many Austrians) about the difference between looking at policy from “atomistic” and “dialectic” perspectives. Looking at a single tax decrease and declaring that liberalization would be “atomistic,” but looking at the decrease compared to the lack of action on other taxes and realizing that what you’re really doing is favoring the less-taxed asset over the regularly-taxed asset, and that on the whole, the arrangement hasn’t made the overall system any more liberal. This is essentially the same idea that you’re arguing for here, but you can find Carson’s more theoretical treatment in an article in the Freeman here.

    @Jeremy: I believe that article was on the Mises Institute’s website, but I can’t for the life of me find it right now. But I remember at the time not being totally in agreement with it…it didn’t really take into account the fact that unified banks didn’t fail at rates worse than non-unified banks, either in the current crisis or during the Great Depression.

  4. RickC Says:

    I may be off subject here but isn’t this dynamic at play in every action taken by government planners in our type of democracy. By that I mean every policy will be piecemeal by the time it comes into effect and hence will cause more harm than good, or at least as much harm as good?

    For example, coming up with a policy on the issue of illegal immigration. Most libertarian websites I visit argue for open borders, at least that seems to be their stance to me. And I would agree with the concept if we lived in a “free” system. However, we don’t really live in that system. As long as there is a welfare state in existence the addition of millions of non-taxpaying people places a huge financial burden on already heavily burdened medical, law enforcement, prison, education and about every other system I can think of. All this paid for of course by taxpayers or by increasing the national debt.

    Now, what with various interests groups involved (Hispanics swung enmasse to the Democrats this election, for instance, influenced greatly by some Republicans’ stance on the issue) trying to enact any comprehensive policy is an impossibility. So what we will get, if anything, will be peicemeal and probably just exacerbate the problems or even bring new problems into existence.

    This same argument could be leveled on any issue; energy, education, foreign policy, defense, etc., where a centralized power extends its control over such a vast nation with so many varying issues. This leads the libertarian in me to think that the only answers rest in decentralization of control. Surely, smaller, more localized control centers would encounter problems too, but would be able to meet the smaller challenges more satisfactorily.

    Sorry if I went off subject. Maybe the connection I made is tenuous. In response to your closing paragraph – the interventionists just can’t help themselves. And, aren’t we still in this crises? I haven’t seen any “cure” yet and believe that everything being done could make things worse: that is if you happen to believe in individual liberty. A friend just told me that AIG owns or has controlling interests in most of the public transportation companies in the U.S. So now our public transportion is nationalized?


  5. My difficulty with Sandy’s analysis is that there has been no deregulation of the financial markets since 1999 (Gramm-Bliley Leach). And that act did not repeal the Glass Steagall Act of 1933, as he states, but amended it (Sections 20 and 32 of GS being repealed), and some other banking statutes. Mostly the act legitimized financial market developments already in place, and provided a new regulatory structure (so much for deregulation).

    I recognize that policy lags are long and variable, but Sandy cites events from 1992, 1997 and 1999. He can’t cite any later because there weren’t any. Affordable housing goals go back to the 1930s and, in contemporary form to 1968-70. Again, those are really long policy lags.

    Nor was the capital gains rate put at 0% on the sale of primary residences. Rather there was a lifetime $250K per person exclusion ($500K for a couple) put in place. It was put in place because there there were almost capital gains collected from taxing the sale of primary residences, because people avoided it by trading up. (The tax was recognized as distortionary.)

    Finanical services remains one of the most highly regulated indsutries, perhaps second only to health care. Non-existent deregulation can’t explain the current crisis.

    The policy change that occurred in the relevant time frame was the easing of monetary policy by the Greenspan Fed. From a high of 6.5% in May 2000, the Fed Funds rate was cut down to 2% in Nov. 2001 and remained there or below for 3 years. For one full year, it was at 1%. The real rate was negative for approx. 3 years. Negative real interest rates are inevitably inflationary, often causing asset bubbles.

    I’ll be talking about this at the Cato monetary conference (11/19) and the SEA/SDAE meetings (11/21).

  6. Tim Says:

    Sandy’s exposition has real value, even though I must say I find Jerry O’Driscoll’s counter-arguments compelling. The value of Sandy’s “disinterventionist” ideas are that they help us reframe the current debate in a thought provoking new way. When they say ‘deregulation’, we can say ‘disintervention’. This puts the focus squarely on “what is to be done next”.

    The idea of piecemeal versus radical reform is fascinating too, however I am not sure how politically realistic it is. You have to run before you can walk. It sort of reminds me of a similar problem on the socialist left. Revolution or reform. The ultra-revolutionaries see all reform as a ‘sell out’. This is of course not what Sandy is focusing on but it shows the political action dilemma the analysis provokes. I suppose however even in a real world where piecemeal reform of the interventionist state is the only option, Sandy’s idea has value. Piecemeal reformers need to be careful how they sell and justify their ‘disinterventions’, not selling them as the triumph of the market, so much as just one more small step on shakey ground.


  7. For a couple weeks now I have been searching for some kind of analogy similar to Sandy’s disinterventionism argument. I haven’t been able to come up with a clear one yet, but I’m optimistic.

    Having said that, I think Jerry does pose an important challenge. It is one thing to make general intervention/disintervention stories, but in this current and quite complicated situation, the details have to developed and clearly interpreted.

  8. Tim Says:

    The following ‘National Post’ article entitled “What Deregulation?” may be of interest to readers of this thread.
    See here.


  9. […] Ferguson joins Charles Calorimis, Jerry O’Driscoll, Arnold Kling, and many others in questioning the supposed link between “deregulation” […]


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