Moral hazard

For nearly three years now, I have been criticizing the Fed and two American administrations for their shortsighted attempts to deal with the latest recession. It started with the silly idea to stimulate consumer demand by sending "free" money to every American in early 2008. The plan escalated over the next year with a series of expensive bailouts of companies deemed "too big to fail." It marched on under zero interest rates with unprecedented deficit spending labeled "stimulus package." And the most insane of all "counter cyclical" measures was the federal tax credit to first-time homeowners in 2009. All these measures created incentives for misbehavior.

The question is: What would Friedrich Hayek say if he were alive during these trying times? He would most likely begin by drawing out the attention of the last two presidents, their Treasury secretaries, and the board of the Federal Open Market Committee to the fact that the financial crisis was a product of malinvestment. He would point out that too low interest rates over too long a period of time (blame the Fed) have combined with too easy access to credit (caused by federal government regulation) to produce an unsustainable boom in the housing sector. And he would warn that doing more of same would create a moral hazard.

Just as in any previous speculative fiascoes in the history of capitalism (think of the infamous Dutch "tulip mania" of the early 17th century, the spectacular French Mississippi bubble of the early 18th century, the American radio euphoria of the early 20th century, and the speculative dot-com balloon in the 1990s), the collapse of hundreds of thousands of real estate projects in the last few years is not the problem we should be concerned with. Our troubles were caused by artificial manipulation of the money supply. It established non-market credit conditions, which were exacerbated by distorted incentives of bad regulation. The interventionist combo gave misleading signals to investment banks, prospective homeowners, and construction companies alike.

Stimulus packages and bailouts do not cure the disease. They only mask the symptoms and perpetuate our problems by rewarding malinvestment.