The Great Recession Revisited

Livin' the dream.
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The long term impact of economic recessions is more clear today, massive amounts of research and data prove the Great Recession is correlated with significant spikes in drug abuse and domestic violence due to unemployment, which eventually molds itself into a loss of pride that can break the human spirit, while intoxication and frustration are just a reaction to the realization of shortcoming. Further, a significant decrease in charitable contributions, especially effecting non-profits, even food security for some states have been in the red-zone and still have not achieved near pre-recession levels. In addition, it created a new class of welfare recipients that seem discouraged to take on low-wage meager jobs.

When President Bush took office in 2001, there were 17.3 million people on food stamps. During his last full year in office, 2008, there were 28.2 million on food stamps — an increase of 10.9 million – or a 63 percent increase over an 8-year period. But from the last full year of Bush’s presidency (2008) through 2011, just three years into the Great Recession, the number of people on food stamps increased 16.5 million — going from 28.2 million to 44.7 million — an increase of 59 percent in just a 3-year period. That’s an increase of 4 times on an annual basis. So to whom, after all the information gathered on the who’s, how’s, and why’s of the financial crisis, deserves the blame?

The contemporary rhetoric spewing from our presidential candidates reveals a divergence in who ought to bite the bullet. Bernie Sanders points the finger at the big banks, while Hillary points to the F.I.R.E. industry, or Finance, Insurance, and Real Estate, aka the ‘shadow banking’ sector. However, the State, as it has always managed to do when scrutiny is being dealt, observes the catastrophe it caused from the sidelines. And although the size of the banks are heavily emphasized, especially by Senators Sanders, it had little to do with the catalyst of the Great Recession, and more to do with policymaking. Tom Woods connects the root of the problem in Meltdown, stating the government’s first attempts to regulate the mortgage market through the creation of the Community Reinvestment Act passed in 1977, which prohibited the indiscrimination of borrowers according to their income level. Furthermore, the Housing and Community Development Act passed in 1992, ordered Fannie Mae and Freddie Mac (Government Sponsored Enterprises, GSEs) to direct a substantial portion of their financing to the lower middle-income and poor households. Also, the American Dream Down Payment Assistance Act passed in 2003 provided the low-income communities down payments and closing cost assistance. Moreover, in 1999 the Financial Services Modernization Act (FSMA) effectively overturned Glass-Steagall, allowing large financial companies to engage in commercial and investment banking as well as insurance. This act, perhaps more than any other piece of legislation, contributed to the increase in the number of “megabanks,” notable among them being Citigroup, the largest financial company in the world.

The Fed incentivized banks to increase their leverage by herding into mortgages, mortgage backed securities and government debt, while pushing banks to reduce the quality of those mortgages, and also further exacerbating the problem by promising to bailout any company that labels itself as a ‘bank holding’ company, even if done over a 24 hour period (such was the case with Goldman Sachs), therefore providing the environment for banks to engage in risky behavior. If any parents can relate, it’s similar to telling your teenage child that you will bail them out of any mischief they get into, no matter what- obviously, the end result is they will be much more less risk adverse when you strip the fear of punishment away. Fortunately, one of the repercussions of the Great Recession and bank bailouts is the realization of the bankocracy in America, as well as a widening distrust for government intervention, and not just in the market, but almost all activities it slithers its way into, the senses of the American people are more keen to spotting suspicious activity from the Nanny State.

As Murray Rothbard noted, that bank runs happen, and when they do, the best solution is to let them dissolve. When you bail them out, they develop the same attitude as the welfare state, they become much too reliant on it. Such was the case with Iceland, refusing to bail its zombie banks out, what ended up happening was a robust and fast recovery, along with indictments carried out among suspect bank managers. But in the first place, if banks were allowed to dissolve knowing that taxpayers will not come to their rescue, then managers have little reason to take on risks. Finland had a major banking crisis in the beginning of the 1990s, which led to the collapse of one of her major banks. During the crisis of 2007-2008, Finnish banks had very little problems, because they did not own any exotic assets. Lastly, the role of credit rating agencies is despicably undermined for contributing to the crisis. As Bob Murphy rightfuly noted, if credit agencies were not in some shape or form a GSE like Fannie or Freddie, then they’d be weeded out and replaced by more efficient companies whom have a reputation of scoring bonds accurately, rather than giving junk rated bonds the highest rating, camouflaging the true value of a borrower’s ability to service a loan.

The underlying question is, just as banks use collateral for borrowers, shouldn’t taxpayers have gotten their debts written down after the TBTF banks were bailed out? Why didn’t homeowners catch a break, instead of paramilitary state police raiding homes for those whose jobs and industries were a victim of creditor’s reckless behavior induced by government meddling?

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Read Scott Horton's new book Fool's Errand: Time to End the War in Afghanistan