Those who believe that Herbert Hoover took a hands off approach to the banking crisis in the early 30s believe the government has to act to end the credit crisis. Of course, Hoover was actually very active by signing the Smoot Hawley tariff act and the Reconstruction Finance Corp. so the charges of doing nothing are wrong. Are the people who make this claim unable to read history or do they just not want to know the truth? That is something only they can answer, but one wonders what they will say if the current myriad interventions of the Fed and Treasury don’t work.
So if Hoover was interventionist (just not as much as FDR) and that didn’t work, is there a school of economic thought that understands this? Yes (via the Financial Post):
To the extent that this assessment has been made, it represents an important victory for a school of thought that has long hung on the margins of the economics discipline: the Austrian school of economics, whose most illustrious figures include the Nobel prize winning Friedrich von Hayek and Ludwig von Mises. Austrian economists hold that downturns are the inevitable aftermath of loose monetary policy, thus opposing explanations typically heard prior to the current crisis that attributed recessions to price shocks, underconsumption or central bank tightening of monetary policy.
But if, to rephrase a well-known Nixon quote, we are all Austrians now, it illogically only extends to the diagnosis of the crisis and not to the school’s market-based cure. For it is just not consistent to simultaneously assign blame to Greenspan’s easy money and then support government intervention to fix the damage, as so many of the business op-ed writers and talking heads on CNBC have.
As the Austrian tradition points out, the dilemma with easy money is that the central bank sets rates below that which the market would naturally set. The natural rate reflects people’s willingness to trade present for future satisfactions. When the actual rate is established under this, entrepreneurs and firms are issued a false signal that people are willing to defer more consumption into the future than they really are. As a result, excess investments in capital goods industries, such as housing, are made on the expectation that these will pay off in the long-run. The boom ends when monetary conditions are tightened back to natural levels or the passage of time makes clear that the demand was never really there to sustain the investments made. At this point, a crisis takes place in which capital investments get liquidated and resources are shifted such that the economy’s productive capacity more appropriately reflects people’s time preferences.
As I pointed out in a recent article, there are not a lack of buyers for the bad mortgage paper. There is a lack of sellers at the clearing price:
But, as hinted by CIBC’s recent deal with Cerberus to reduce its exposure on US$1.05-billion in problem mortgages, there is a sea of cash sitting in private equity, hedge and vulture funds waiting to buy distressed securities if the price is right. That they haven’t bought much yet suggests the banks are resisting lowering their price. There being pressure to expedite the transfer of securities and assist the banks, the government is very likely to acquiesce to this resistance, pay above market and effectively institute a price support mechanism for mortgage assets.
The actions of the government have prevented prices from reaching their natural clearing price. If the government would just get out of the way, prices could fall, buyers would buy and we would get through this faster. Unfortunately, that isn’t going to happen. As George Bragues puts it:
“We might have done nothing”,Hoover said, “[but] we determined that we would not follow the advice of the bitter-end liquidationists.” Thus has the Bush administration decided as well, having successfully cajoled a recalcitrant Congress to follow Hoover’s example.
Hopefull, we won’t follow through with all the mistakes that FDR added to the Hoover legacy. If the next administration continues to fight the market, we will be a long time getting out of this.