In his small
and incisive book Getting off Track:
How Government Actions and Interventions Caused, Prolonged, and Worsened
the Financial Crisis, John B. Taylor argues that, contrary to the period
called “the Great Moderation,” which began in the early 1980s, monetary policy
in the early 2000s became too loose, too easy.
This easiness led to the housing boom and, eventually, to the housing
bust. That policy, Taylor explains, was
“essentially discretionary government interventions” (p. 3) and those interventions
“deviated from the regular way of conducting policy” (p. 4). “[B]y slashing interest rates . . . the Fed
encouraged a housing price boom,” he says (p. 5).
According to
Taylor, other nations mimicked the Fed’s eccentric interest policies, which encouraged
the problems we later faced to surface elsewhere also, in places like Spain and
Greece. Among the problems we eventually
faced were falling house prices, delinquencies, and foreclosures, which had
their expected deleterious effect on financial markets. The bottom line, Taylor argues, is that a
strong connection exists between monetary excesses and risk-taking
excesses: “the rapidly rising housing
prices and the [initially] low delinquency rates likely threw the underwriting
programs off track and misled many people” (p. 13). But, as housing prices fell, folks began to
wonder of it was worthwhile to continue making payments on houses not worth
what was still owed on them. Too many
borrowers decided they were not, and simply stopped paying. Government backed agencies like Freddie Mac
and Fannie Mae instituted policies that made balance sheets even worse. Securitization, meant to be a source of
financial strength and stability, served more to undermine the whole
system. As is often the case with
government programs, they were more a part of the problem than of the solution.
Taylor argues
that three types of government intervention served only to prolong the crisis
rather than to cure it: (1.) the term auction facility, introduced in December
2007, designed to increase the flow of credit; (2.) temporary cash infusion of
100 billion dollars to the American public in February 2008 intended to jump
start consumption and spending, but which was hoarded instead; and (3.) cutting
interest rates, which led to a decline in the value of the dollar (pp. 19-24).
But, as Taylor
tells it, the crisis not only got prolonged, by October 2008 it got worse. To Taylor, it worsened “by a factor of four”
and became “a serious credit crunch with large spillovers” (p. 25). TARP’s $700 billion, Taylor says, were by no
means adequately overseen, the entire bill reaching only to 2 ½ pages, thus
lacking sufficient oversight, restrictions, and structure. The result of this lack of foresight and
structure was widespread public uncertainty and the reluctant and timid
investment that normally follows it.
After
delineating what went wrong, and why, in the 2008 financial crisis, Taylor
examines what went right in the two decades preceding it. “Getting economic policy on track,” he says,
“is never easy” (p. 31). Accomplishing
it included “changes in monetary policy,” (p. 35), crisis prevention, primarily
by means of a flexible exchange rate and predictability of policy (p. 39), and
preventing the forces of globalization from reversing previous local
accomplishments (p. 43).
To Taylor,
because banks and government misdiagnosed the problem as one of liquidity
rather than uncertainty, their policies not only proved ineffective but
actually prolonged and deepened the crisis.
The Fed provided liquidity to ease the problem, yet the financial cancer
grew. Not all economists fell into the
diagnostic trap. Some saw the real
problem early on; Taylor was one. His
colleague John Williams was another.
They focused on three things, Taylor says: (1) credit default swaps -- the probability of banks defaulting on
their debts; (2) Libor-Tibor spreads
-- roughly a counterparty risk measurement between yen and dollar based banks;
and (3) Libor-Repo spreads -- a
comparison of risk between secured and unsecured lending in the interbank
market (p. 53-55).
Taylor affirms
strongly that we “should base our policy evaluations and conclusions on
empirical analyses, not ideological personal, political, or partisan grounds”
(p. 63), seeming not to recognize the ideological basis of believing that such
data and analysis can ever constitute (or arise from) an ideology-free zone.
Taylor rightly
warns us against thinking that frequent and large government actions and
interventions are the only answer to our current economic problems” (p.
62). They are not. By thus declaring himself, Taylor stands
against both George W. Bush and Barack Obama, Bush’s successor. The former said that he abandoned free market
principles in favor of government intervention in order to save the free
market. The latter said that only
government can break the vicious cycles that cripple our economy.
In opposition
to them both, Taylor declares (and this quotation serves as a suitable summary
of his book’s argument: “Government actions
and interventions caused, prolonged, and worsened the financial crisis. They caused it by deviating from historical
precedents and principles for setting interest rates that had worked well for
twenty years. They prolonged it by
misdiagnosing the problems in the bank credit markets and thereby responding
inappropriately, focusing on liquidity rather than risk. They made it worse by supporting certain
financial institutions and their creditors but not others in an ad hoc way,
without a clear and understandable framework” (p. 61).
Taylor’s
quotation above obviously shows that he is not against all government
involvement in such matters. Perhaps he
ought to be more so. But at least he is
not dazzled by the expertise of the reputed experts, whose track record says that
they are better at getting things wrong than at getting them right.
One last point: the question and answer session at the end of the book is so good that it alone is worth the price of entry.
One last point: the question and answer session at the end of the book is so good that it alone is worth the price of entry.
