Friday, May 09, 2008

Blame the Fed

Gerald O'Driscoll blames Greenspan for the current economic mess:

The U.S. economy is in the midst of an old-style credit crunch brought on by a combination of bad policies and incredibly lax underwriting standards at financial institutions. The biggest policy failure was the decision by Alan Greenspan's Federal Reserve to hold interest rates too low for too long. That led to a tsunami of credit that inundated the economy with cheap money. Mortgage lenders in particular were flush with funds and searched for deals wherever they could be found. Heretofore unqualified borrowers suddenly "qualified" as underwriting standards relaxed and then disappeared.

No one person, or even small group such as the FOMC, knows the correct price for credit. As O'Driscoll points out, we've seen this before in command and control economies with other products. Why would fixing the price of credit be anymore successful than fixing the price of, say, toilet paper?

There is a wonderful parallel here to the collapse of the Soviet Union. As the great Austrian economist Ludwig von Mises argued almost 100 years ago, central planning inevitably fails because there are no market prices to allocate resources. Market prices can only be the outcome of actual market transactions among buyers and sellers. Planners used mathematical formulas to value resources, especially capital. Now Wall Street wizards have imported Soviet thinking to allocate financial capital. Is it any wonder that it failed?

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