Five years ago this coming Sunday, Lehman Brothers failed and with it the Great Recession accelerated. For me it had been the start of something wonderful! I have discovered my passion for ideas. In 2007/2008 I did not understand what was happening. I could not find any convincing arguments as to how the crisis happened. Blaming greed or capitalism in itself seemed too simplistic to me.
Thus, I started researching financial deregulation, Fannie Mae and Freddie Mac, fair-housing policies, mortgage-backed securities, and the role of central banks. Eventually, I stumbled across the business cycles theory of the economists Ludwig von Mises and Friedrich von Hayek. Their body of work made sense to me and gave me a whole new perspective. I have not stopped studying markets and governments since.
According to Mises and Hayek, when central banks artificially lower interest rates it leads to increased liquidity in the banking system, which is meant to increase the availability of loans. With lower interest rates more investments become realizable. Projects get started, workers get hired, consumption and taxes are rising. The economy is doing well, so what is the problem?
The problem is that all the investment projects depend on real savings; on goods and services available within the economy. A mere increase in paper money cannot replace a lack of savings. At some point investors realize that their projects cannot be finished since there are not enough savings in the economy, prices will go up, and investments become unprofitable. The bubble bursts. This is what happened in the last financial crisis and during many other periods of financial distress. Artificially low interest rates fueled a boom, millions of unneeded houses were built, and the phony wealth disappeared. Admittedly, there are many facets to a crisis and no theory can explain it all. However, the briefly outlined business cycle theory by economists associated with the Austrian School has a lot of merit and explanatory power.
Opponents of the “free market” are correct when arguing that deregulation and some inventions within the financial system contributed to the crisis. However, what they often fail to recognize is the interwoven nature of the system of modern day “capitalism.”
Deregulation of these financial assets was being tackled under the pretext of giving every American the chance of owning his or her own home. That these policies also benefitted powerful interests in finance made it the perfect policy storm.
In and amongst the crash, Lehman Brothers failed. It was supposed to fail. There should have been more bankruptcies. These were prevented by the interlinked nature of big finance and big government. The results were bailouts, regulation and an economy that after five years is still very slowly recuperating. What are the underlying problems that led up to this situation? Is it the greed of bankers or the political power? Most people nowadays want to see tighter controls on markets, capital controls, and more regulation. Bigger government is the proposed solution to big business. What no one has explained to me so far is how big business can be refrained from capturing this regulatory process once again. Many of the presented answers are piecemeal approaches that lead, if thought through, to a spiral of interventionism to make the fixes air-tight.
What a prosperous society needs is a system that rewards behavior which benefits the whole and punishes undesired actions. Of course, no feedback system is perfect, since human beings are imperfect. However, the profit and loss system is a beneficial feedback system which has enabled us to live in a world with laundry machines, with phones that are more powerful than older computers, and a world in which pencils are being created even though no single person has all the knowledge needed to build one.
Within politics we do not have such a feedback mechanism. The people crafting fair housing policies did not pay for their mistakes. Maybe some got replaced by other politicians but where do we see changes? Interest rates have been at 0.25% for four years. Banks are even bigger now than they used to be. Politically connected businesses make huge profits. Unemployment is only going down because more and more people are exiting the labor force and economic growth is lagging behind.
These are the results of a system that gives few people power to steer a complex society. The Pretense of Knowledge to believe that society can be molded via the swift hand of the regulatory pen into any shape desired is a mirage. Studying markets and ideas have made me more humble in terms what politicians can achieve and more excited about what peaceful cooperating individuals can accomplish under the stability of the rule of law and a non-invasive government. The collapse of Lehman Brothers opened up a whole new world to me. For this I am thankful and I hope that more people start questioning the status quo without having another major crisis.
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