Is capitalism in peril?
Is capitalism, as Keynes and his few but loyal followers suggest, subject to an inherent instability? Did the “deregulation” of the Bush years cause the bubble that was toxic enough to jeopardize the global economy? Jeffrey Friedman, who recently wrote The Causes of the Financial Crisis, seeks to answer these questions in an article appearing in the journal of the American Enterprise Institute, a neoconservative think tank. In the article, Friedman makes a compelling case that deregulation did not cause the banking crisis that began in the U.S. with the Lehman Brothers fallout. To the contrary, he says, it was too much regulation, specifically The Recourse Rule which
“Required [banks] to hold 80 percent more capital against commercial loans, 80 percent more capital against corporate bonds, and 60 percent more capital against individual mortgages than they had to hold against asset-backed securities, including mortgage-backed securities rated AA or AAA. The Rule thus created a 60-80 percent incentive to buy highly rated MBS [Mortgage Backed Securities] for any bank that wanted to reduce its capital reserves.”
Given that capital reserves exist in order to insure banks against uncertainty in the marketplace, this rule encourage banks to be overleveraged. This, he argues, is what caused the systemic risk to the American banking system and was piled on an already disastrous subprime crisis. He continues
“And without the Recourse Rule, there is no reason that American banks that were trying to leverage up would have converged on mortgage-backed bonds. No other group of investors—not hedge funds, not pension funds, not mutual funds—were, as a whole, so overinvested in mortgage-backed bonds. But then, only banks were subject to the Recourse Rule”
Thus, Friedman showed it was a combination loose monetary policy (artificially low interest rates) and overregulation (The Recourse Rule) that helped to cause the current depression. He goes on to criticize both the left and the right for their treatment of this topic and asserts that competition is the distinguishing characteristic of capitalism. “Since regulators’ and citizens’ ideas are imposed on the whole system at once, they can’t be put to the competitive test,” he says.
Overall, it was refreshing to read an article from a neoconservative think tank where Austrian theory was implicit in the entire article. Furthermore, Friedman identified the ultimate culprit, Washington.