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Guy Sorman
The Free-Marketeers Strike Back « Back to Story

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Great simplification: "Why, then, after the 2001 recession, did the Fed let the interest rate fall beneath what the rule suggested and keep it extremely low even after 2003, when the economy was clearly growing again? Greenspan wanted to do better than the Great Moderation, Taylor guesses. The quest for perfection became the enemy of the gooda case of hubris.

In my opinion, that was only ONE of the interacting factors that led to the exponential growth in price of houses from 2003 to 2006.

The other in my opinion was the increase in allowable leverage in big banks, treating them as "exceptions" to low leverage rules.

Another was the deregulation of energy industry (badly executed, but also infected with new commodities exchange rules that allowed the big investment banks to change the old rules about only 20% non-supply-chain hedging on that exchange. Quickly, the big banks became majority gambler on the exchange. Enron, which hired Wendy Gramm, the author of the new rules, and the rest is history.

There will always be bubbles and banking crises, but allowing leverage in key financial institutions to go from 10 percent to 40 percent is certainly a major interacting factor, as recognized by new higher capital requirements (one small step).

The perfect storm of killing off the Glass Steigel Act, giving special leverage rules and commodities exchange rules to biggest 5 banks, and of course using ratings agencies instead of due-diligence and transparency rules, led to a debacle...with another one coming soon if regulators and public do not understand these interacting factors.
"........the recession triggered the financial crisis, not the other way around."

Perhaps, but the financial crisis would not have been so severe or need a massive government bailout if the financial sector had been healthier, like it should have been.

It 's like what Warren Buffet said: "When the tide goes out you see who is naked. Well, the recession made the economic tide to go out and that exposed all the weaknesses and unhealthiness in the financial sector, hence the financial crisis.
Mr. Denmore wrote: 'Nowhere in their (the free-market) robotic worldview is there a recognition of the importance of human agency and the rights of people to make decisions about their welfare'.

Isn't it the Keynesians who build deterministic models based off of their assumptions that people impusively 'run with the crowd' and are guided by 'animal spirits'? Isn't it government intervention and the welfare apparatus that interfere with 'the rights of people to make decisions about their welfare'? Actually, the Austrian economic model starts from the (apparent) axioms that people have free will ('agency') and that they pursue their values ('make decisions about their welfare')---perhaps you should look into Murray Rothbard or F.A. Hayek for a new free-market perspective.
Every one of the free-market economists quoted or mentioned in the article belongs to the 'Chicago', 'monetarist', or 'neoclassical' schools. Where are the Austrians? They actually have a model of business cycles that predicted the crash and recession---why not ask their opinions? Also, the reasoning stated in the two-sentence paragraph in favour of more regulation isn't good reasoning at all: bankers do have 'a vested interest in going for the highest risks'; they also have a vested interest in not keeping their companies solvent, if their corporate government doesn't obstruct share-holder wishes. Perhaps the limited liability laws pertaining to corporations are to blame for excessive risk-taking. Also, what is the 'right' capitalisation ratio or reserve requirement ratio? Regulators, over time, tend to grant the wishes of the regulated, which in this case would mean the relaxing of any regulations of financial activities by entrenched corporations. But lax regulation is worse than no regulation at all, because everyone in the country not privy to the actual policies of the regulatory agencies will have expected them to make financial markets 'safe' and 'free of excessive risk'---while banks will be able to take bigger risks (and feel safe doing so due to government's habit of bailing out systemically important businesses on the verge of failure), everyone else will be assuming that financial markets are stable. This divergence of expectation from fact will lead to an inevitable market correction, i.e., a crash and recession.
The writer also cites mandatory deposit insurance as a hedge against risk in the financial markets. It actually encourages risk, because it protects depositors to a large degree from the depository institution's failure, which leads them to stick their money in whichever bank promises the highest interest rate and lowest fees, since the risks each bank takes is of little financial concern to them. It think it's generally accepted that advertisements reflect what consumers value in a product---so take a look at bank advertisements some time and see how many mention the bank's recent record of risk exposure---perhaps two or three that proudly mention that they've never been 'bailed out', and that's it. Between 1990 or so and 2008 the answer would probably be none, and that's because people weren't worried about their bank failing because their money was safe regardless. People should worry. If someone's got a hundred thousand dollars in a savings account and he's not worried about how safe it is, something's up---and what's up is that the money's insured against the bank failing, so the bank can afford to take more risks, especially since it's only point of competition for customers is its rate of return, or interest rate.
Why is none of this mentioned in the article? Failure to go along with the line of 'we need more regulation' is not 'extremism', it's a different theory of regulation's effects on markets. Those economists don't favour regulation in other markets; why do they favour it in financial markets? The case in favour of more regulation isn't open and shut, and if it were, one can at least make the case instead of acting as if only an 'extremist' could possibly reject it. The 'free-market' explanation posited above seeks to correct the problem with controls---how is this a free-market position? Doesn't this position imply that the reason the crisis happened was because we didn't have those controls---in other words, that the free market is to blame for the crisis? There is a free-market explanation of the crisis---it is the Austrian explanation, and the explanation offered above is the unsupported stance taken by the main-stream of the profession.
Conservatives Grover Norquist (Americans for Tax Reform) and Milton Friedman (economist) have both advocated tax cuts to bankrupt America in order to keep down government spending beneficial to the lower economic classes – who make up the bulk of American military personal.

A 12/28/04 libertarian Cato Institute article ( defines the crux of Norquist’s idea of purposely creating deficits when it stated: “Tax hawks like Grover Norquist, of Americans for Tax Reform, maintain that we should "starve the beast": create pressure on Congress to reduce spending by cutting the government's intake of taxes and running up deficits. This is the approach prescribed last year by Milton Friedman and Gary Becker, both Nobel Prize-winning free-market economists, in separate Wall Street Journal op-eds.”

And the wealthy have certainly got much wealthier as a result of free market

And “free market” economics has worked quite well in ‘trickling up” wealth. . See “Wealth Disparities in U.S. Approaching 1920s Levels,” And IRS data, “The 400 Individual Income Tax Returns Reporting Highest AGI… 1992-2007,””

It feels like we have witnessed the transition of the US economy from one historical position to another, rather less pre-eminent one. It is like it is entering what the British called in their case, the "orderly decline ...."

Did you really just write an article on the free-market perspective on the crisis and not manage to include the actual free-market perspective - as opposed to the pseudo-market Chicago-school impostors?

The Austrian School economists PREDICTED this financial crisis would happen because their Austrian Business Cycle Theory describes the real world. Central banks push new money in, and it drives a wedge between savings and investment.

It's not that hard. Just say the Keynesians and Monetarists were wrong, and the Austrians got it right.

Somebody needs to admit it.
I am stunned at the unerring capacity of free market ideologues to interpret every development as supporting their corrupt and self-reinforcing assumptions.

Nowhere does there seem to be a willingness to admit that maybe, just maybe, their blind faith in self-correcting "markets" is what got us into this mess.

If the market succeeds, it's testament to its wisdom; if it fails it's because of meddling governments.

Nowhere in their robotic worldview is there a recognition of the importance of human agency and the rights of people to make decisions about their welfare.

Their ideology is broken and defunct, yet like door-knocking Mormons they just cannot get the message they are a pest on the body politic.on
Basing a nation's economy on inflation and speculation while encouraging the export of it's manufacturing infrastructure is insane.
I know a lot of people had their hands in on this, but if I had to name one person to put the blame on it would be, Barney Frank. And yet there he is still being paid by us tax payers. What happened to my country?
"Spontaneous order" says Hayak, "invisible hand" says Adam Smith. We know that in our personal lives this occurs. Please forgive me, I have an unfashionable view, but some of us attribute good fortune that results from the orderliness, creativity and timing of events to the hand and spontaneous order of God. Economists might give a respectful nod to the notion.
If Mr. Krugman feels that the economic multiplier of a dollar of government stimulus spending is $1.50--or for that matter anything greater than 1--then why doesn't he advocate printing 10 trillion dollars and injecting them into the economy via 'stimulus' programs? We'd have a $1.5T benefit! He'd be elected president-for-life!
To malalex : I did not "miss Mises" ( or Hayek ). They happened not to be around any more.And where did you read that I ignore the Austrian school ? I do not.
It's a shame you missed Mises. It's a bigger shame none of these eminent economists have read Mises. Human Action, chapter xx. QED.
Too bad the 'intelligensia' in the U.S. are so uneducated (thanks to several generations of government-run schools) that they don't even understand basic economics.

Until we require voters have to a) be off entitlements (moocher welfare, union benefits, or professional licensure), and have to understand basic 'Austrian' economics, we're doomed to becoming a socialist police-state.
You admit capitalism caused the melt down. Therefore, get rid of capitalism! Problem solved.
Reasons for economic collapse, almost all generated by big government
1. Housing bubble
- Fed creating oceans of easy money, low interest rates
- Suspending normal mortgage lending requirements: job, income, credit score, big down payment, credit history, etc.
- Four biggest banks pledging $6 trillion in low-moderate income mortgages, in order to get permission to expand
- HUD setting low-income mortgage quotas, most notably on Fannie & Freddie
- Fannie & Freddie competing with banks to write no-doc loans
- 7 layers of fake federal regulators who cannot find first base
- Democrats in Congress defeating Republican reform efforts by Bush and McCain to fix Fannie & Freddie
- 30:1 leverage granted by SEC to financial firms

2. High energy prices $147 per barrel - the energy policy of the US is to prohibit the production of cheap energy
3. Food inflation of 10% - ethanol subsidy drives up food prices, with a tripling of this awful program scheduled to phase in over the next 12 years.

Besides all those precarious conditions, we now have governments (federal, state, local) which spend 44% of GDP, plus another 15% of GDP in regulation costs. The business of the US is now government. In addition, governments are borrowing about 12% of GDP every year. Another bubble.

Now we have a bond bubble, and the collapse of that will mean massive destruction of wealth, and defaults by governments which will not be able to pay soaring interest rates.

We must rein in government by cutting them all in half. We must absolutely prohibit government borrowing. We must prohibit government from guaranteeing mortgages, big banks, pensions, insurance, loans, etc. so they cannot obligate us for their socialist insanity.

By cutting government in half we can nearly double the income of the private sector. We could and should achieve 5% annual economic growth, doubling national income in 15 years. The prosperity will allow all workers to easily save and invest enough to become multimillionaires at retirement.

Or we can keep pretending we're socialists.
Your column was picked up by Boortz in his Reading Assignments section, but I have since added City to my browser favorites list in anticipation of additional lucid economic explanations. I had just heard someone ranting on a talk show recently that the Keynesian Multiplier was an unimpeachable fact, which I found hard to believe. Your article confirms my belief and also the corollary (or anti-corollary) of the broken window theorem of spending.

Well written and well done.
Some free-market economists with credibility and the capacity to communicate with average citizens do exist. I have even seen them talk about complicated economic problems at Tea Party rallies. Problem is, however, it is in the interest of the gatekeepers in the institutions of economics, who either lack these skills or are not really free-market in their orientation, to make sure that journalists and the public never hear from these guys and gals and keep hearing instead from the gatekeepers and their anointed acolytes. You could put Milton Friedman in front of the current spokesmen in economics and it still would do no good. I know a lot of bank examiners (field examiners and mid-level supervisors, but not the heads of agencies) who saw the problems all along, who identified them, but who could not get their superiors to listen or act. The latter failed to understand or act because they perceived it in their interests not to understand or act (negative short-term political consequences and negative middle-term and long-term future career consequences). --
Dwight ,
I wrote this text in English for City Journal : no French version available , except if you translate it.
Guy Sorman.
Does this article exist in French? I would like to be sure my french friends read it. Maybe Mr.Sorman, who is french, might have written this originally in french.
Regards from St. Christophe-en-Brionnais, France
Persuading and educating the public about economic realities is a tall order, and it may be too late. The left's ethos of envy has taken hold in America, and its advocates have been put in office -- like toddlers left to play in a running automobile. If Americans become a howling mob seeking the blood of the 'rich,' whom are we to persuade?
The left has had much help in their agenda from the administrations of both G. H. Bush and G. W. Bush, and from Republicans in Congress all along the way, and this history harms the free-market narrative. These days those who do not believe America's difficulties arise out of free-market hubris believe they come from greed and sloth. These are the two horns of the leftist narrative, and none of the fiscal conservatives who have gained the nation's attention is willing to contradict it. Even as he fails, fear of the populist president stifles those who claim to know he and his followers are wrong. Perhaps the people who must first be convinced are conservatives themselves?
Common sense indicates that Krugmanian gov't spending multiplier is necessarily false.

If gov't spending could disproportionately stimulate the economy, there would never be such a thing as a recession!

A corollary would be that the nations that that the largest factions of the GDP spent in the public sector would be the strongest economies on the planet. Again, just emprically not true.
"Enough talented economists are on hand, however, to build the platform that we need for a free-market revival."

May I nominate Thomas Sowell? How about Walter Williams? Both are able to effectively communicate rather abstract economic principles using examples people see every day in their lives.
As someone involved in Baltimore investment management, I get more questions about the present and future health of the economy than ever. Whether you agree with Sorman's analysis or not, he raises a few excellent points that shouldn't be discarded. First, the only real way to make educated guesses about the direction of the economy and tactic that could potentially help guide that direction is to pay attention to and study previous economic patterns. Second, the narrative of these current economic times is not being communicated correctly or accurately to the average person. Mostly, people are introduced to our economic struggles via panicked news stories and sensationalized reports from talking heads. It certainly isn't helping.
Yeah, well, we all know what stringent criteria they use to award Nobel prizes these days. I've lost all respect for the award after it was given to President Obama after less than 2 months into his term when he had accomplished none of his policy objectives. Same thing goes for Krugman, I guess.
Outstanding article, the best one I have seen on the current economic situation. The road map for recovery lies within this article.
Know nothing blowhard August 16, 2010 at 8:30 PM
The real problem is the bailouts. Too Big To Fail does not exist in the real world and the bailout of the Sacred Cows - Bank of America, Citigroup, JPMorgan Chase and Goldman Sachs, only guarantees MORE BAILOUTS into the future. The current system is not the free market, it is fascism. America will continue to decay into poverty untill the FREE MARKET and the rule of law is returned to the currently poisoned financial markets. Nothing else will work. The UNITED STATES OF MEXICO/ARGENTINA fascism at it's finest.
Michael Dickerson:

If I were you, I would not be championing Krugman while villifying some largely nonexistent deregulatory climate of the last decade as a facilitator of massive malfeasance by Enron and others. Were you to be a well read individual, you would know two crucial facts that would prevent you from writing what you just wrote:

1. Enron was the prime backer of early Cap-and-Trade regulatory schemes, and
2. Paul Krugman was a PAID Enron advisor.
What about the Austrian School POV? No mention in this article, even though the school of thought saw this thing coming.

This is a major shortfall in Mr. Sorman's work here.
Is this a joke? What you call a "counter-narrative" is just a "counter-definition" of "free-market" ideology to somehow advocate for more, however much "smarter", regulation.
No-one has a handle on the current state of the American economy. Most of it is bureaucratized and it looks like the rest will soon be. Such bureaus do away with the price system.
Babes in the economics woods can find their way home in two easy steps; read Henry Hazlitt and Thos.Sowell. Simple-minded Octogenarian
Karl from Chicago August 16, 2010 at 4:25 PM
"Since the financial crisis began in September 2008..."

The German government rescued IKB Deutsche Industriebank in July 2007.

The American Home Mortgage Investment Corporation filed for bankruptcy in August 2007.

Bear Stearns was rescued in March 2008.

In other words the financial crisis began well before September 2008. If you can't make it past the first sentence without such a major mistake, you have no credibility.
Babes in the economics woods can find their home in two easy steps; read Henry Hazlitt and Thos.Sowell. Simple-minded Octogenarian
Michael Dickerson August 16, 2010 at 3:26 PM
Holy Mother of God! So the fact that housing prices outran the underlying disposable income of the buyers in the market by a HUGE amount, a ration easilt picked up by some astute individuals, is too arcane to note as a growing bubble to these free-market economists? And the fraudulent activities of Wall Street and the mortgage brokers were NT part of the frre market in actions. That is total BS.

The houding market brought this recession all on its own. Krugman et al are right and the Univ. of Chicago profs have been proven to be fools, so they invent an alternative to explain their failings.

After the S&L debacle, Enron, World Co, the and now this only mules would fai; to recognize that de-regulation also know as freeing the free market is THE cuprit.
Everything in this article makes perfect sense except it is missing one very important point. The degree of certainty concerning the economic/financial rules to be faced in the future have a very strong impact on business/financial decision-making. It is the role of government to maintain a certain level of stability with regard to the rules so that planning for the future can be effectively done. When the government sets out to make dramatic changes on several fronts in the rules, this creates instablity and uncertainty as decision-makers must guess at the likely impact or pull back and wait for the dust to settle. This is what started the recession in 2007 as the Progressive Democrats took control of the legislature loudly touting all that they had on their agenda from letting the Bush tax cuts expire to comprehensive healthcare to cap and trade, etc. As a result, decision-makers decided to put future plans on hold, purchasing decreased, inventories grew, orders decreased, folks were laid off leading to mortgage defaults and foreclosures and the rest is history. Simple. THE CURE - REVERSE TO PROGRESSIVE AGENDA AND INSTILL PRO-BUSINESS STABILITY BACK INTO THE MARKET PLACE.
Bravo! Excellent analysis!
Booms and busts will always occur except in a moribund socialist economy. Human nature inflates value because people hope that their wildest dreams have come true and go crazy with greed and vanity. Human nature also collapses value as people fear their worst nightmares are about to come true and panic in fear self doubt. No one wants to be the last one in or the last one out. No amount of regulation will prevent this. The only thing regulation can mitigate is manipulating these emotions to profit a few sharks. The advantages of a free market are 'settled science' but it is in the short-term interests of the public sector and some oversubsidized businesses to ignore that fact.
Great article - I will recommend it to all my e-mail contacts/and facebook friends!
I am at a loss as to how Mr. Sorman can write a piece about the free market explanation about the autumn 2008 meltdown and the ensuing recession while omitting any mention about the Austrian perspective on the crisis. As a group, the Classicals were just as stunned by the onset and severity of the financial crisis and the recession as the Keynesians were.

Mr. Sorman apparently believes that adherents to the Austrian school are market 'extremists'; in fact, the Austrians, bellowing unheeded warnings about central bank price fixing, malinvestment, and monetary debasement were veritable Cassandras earlier this decade, being as they were among the ONLY people to see this debacle coming.

Mr. Sorman might broaden his horizons if he spent less time talking to Cochrane, Zingales, Taylor, et al. and secured an interview with Austrians such as Robert Higgs or Russ Roberts or monetary economists such as George Selgin.
The impetus bestowed by technology had been absorbed at precisely this point(the internet, e-mail and cell-phones were virtually non-existent circa 1990). What could provide another such a spike to productivity and available capital in the future? That is the real question confronting us. Tweaking the system will certainly not bring it about, nor prevent the excesses which will follow in its wake.
Wonderful article. I'll do my part to bring light to it by sharing this link as much as possible.
...and what, precisely, was it that prompted these fits of laughter, J Dickenson?

Oh, and I will require supporting documentation...
Gary Heminger of Marathon explains what happened:

As I said in my previous post, it's one thing to pay through the nose due to supply and demand, and something different to be paying through the nose because futures contracts are in short supply.
The problem with gasoline prices going to $4.50 a gallone, wasn't the free market. The trusty old Law of Supply and Demand would have done just fine working itself out. Trouble was, there was never a supply and demand problem in petroleum, the problem was in an overheated futures securities market. It's one thing to be paying through the nose because oil is scarce, and something completely different to be paying through the nose because futures contracts are in demand. That is what the problem was.

Nothing is so well calculated to produce a death-like torpor in the country as an extended system of taxation and a great national debt. - William Cobbett (1762–1835), English journalist, reformer. Letter, 10 Feb. 1804.

Wanna come out of this? Reverse what got us into this.

Take those trillions dumped in to the American worker's rucksack and pull it out. Every dollar of debt represents a period of future labor hours that must be performed but not welded to individual self-interest. That formula never worked.

Wall Street is now recognizing what the American people realized two years ago - that it is mathematically impossible to pay the National Debt including unfunded liabilities back. And even if you don't agree with that, the perception in the private sector believes it hence, no one (including institutions) are willing to take a risk. We have psychologically and materially beached our ship.

We are now in the process of forcing an intractable federal government to recognize what the rest of us have been screaming across the vacuum of space for several years.

And it's coming, for what we are left with is a MASSIVE taxation and regulatory machine that has nothing to tax or regulate.

Are we Hobbes or Locke? The Hobbsians must come out of governance.
It's unclear how Krugman, supposedly a Nobel Laureate, advocates "we'll make it up on volume" when it's clear, this stimulus didn't work, but he'll argue it wasn't big enough. When would it be big enough then to prove Keynesian economics is a failed policy?

It's like the "saved or created" number. No way to disprove it, so it must be true.

We have a group in Washington who cling to this failed policy because it most closely resembles their politics. Big government can do it all. . . .the monetary policies of Freidman, etc, do not conform to their religeon of big government, ergo, they're unwilling to consider alternative ideas.

And let us not forget Obama's reasons for dismissing other economic plans. . . "I won." was the only justification used for dismissing other responses.

How do you reason with "I won" hmmmm?

You can't. That's not someone who is interested in "reasoned" arguments about the economy.

And therein lies the problem. "I won" is not an economic policy. "I won" is not an economic theory.

"I won" is an immature, infantile and selfish belief in one's overblown sense of self importance.

We will not have a coherant economic policy until Obama is gone in 2012, but first, we will remove the other "enablers" in the house and the senate.
Oh my goodness, never in my life have I seen any article so absurd as this! I nearly fell out my chair laughing at the stupidity of this author! Unbelievable!
After so many decades economists are finally coming around to the notion that perpetual motion machines do not exist and friction is an inherent part of market behavior. The only way for energy to be transmuted into economic utility is through human efforts, usually with technological aids, that create or add value to products. Efficiency in production never removes the fundamental requirement for energy utilization in creation— intellectual or physical— and there is always a non-recoverable price exacted for all transformations.

The neglect of our energy infrastructure is not a quick fix and will haunt economic recovery efforts in the next decades.