What Most People Don't Know About Our 250-Year History, Part I

Forbes

2 days ago

The Fed allowed one-third of U.S. banks to fail during the Depression. FPG/Hulton Archive.
As we approach our country's 250th birthday, there is no better time to reflect on where we have been and how we got here. Yet Americans are surprisingly ignorant about our past. One reason: So much bad history has entered the popular culturecourtesy of bad historians, a few bad economists, and some talented writers like Charles Dickens and Upton Sinclair, who didn't understand history or economics at all.
To remedy this problem, I highly recommend The Triumph of Economic Freedom: Debunking the Seven Myths of American Capitalism by Phil Gramm and Donald J. Boudreaux. Gramm is a former U.S. senator and Boudreaux is a professor of economics at George Mason University. Together they have combed through the scholarly literature and savagely dismantled myths about our economic history – myths that are routinely taught in high schools and colleges across the country.
In this essay, I will address two severe economic downturns: the Great Depression and the more recent Great Recession.
The Great Depression
There are five myths here, beginning with the assertion that the depression was caused by capitalism and greed. Put differently, it's the idea that the worst economic downturn in our country's history occurred because of too much individual freedom and too little government.
In contrast, the authors write,
The worst failure was that of the Federal Reserve System, created to be a lender of last resort, providing liquidity to banks in times of a credit crisis. In fact, the Fed stood by, allowing one-third of the nation's banks to go out of business.
A second myth is the idea that in the early stages of the depression, Herbert Hoover stood by and did nothing. In fact, Hoover was a very activist president. In response to the economic downturn, he raised taxes, increased spending, signed the Davis-Bacon Act (ensuring higher wages on federal construction projects) and the Smoot-Hawley Tariff Act. Like many of Franklin Roosevelt's policies, most of what Hoover did made things worse, not better.
A third myth is that Roosevelt's policies saved us from the depression. In fact, they almost certainly caused the depression to extend for 12 years— longer than it did in any other industrialized country except for France. The authors write:
A fourth myth is that Roosevelt united the public in times of crisis. In fact, Roosevelt was a divider, not a uniter. He vilified successful industrialists who opposed his policies as 'economic royalists' who made up an 'economic autocracy.' In fact, it is probably no exaggeration to say that Roosevelt vilified the rich in the United States the way Hitler, at the same time, was vilifying the Jews in Germany.
University of Texas historian Henry W. Brands says that 'Roosevelt came disturbingly close to the demagoguery not only of Father Coughlin and the late Huey Long, but also of the fascists of Europe.'
The final myth is the idea that it took the enormous increase in government spending during World War II to pull us out of the depression. Were that really true, when the war ended and government spending precipitously retracted, we should have been right back into the depression again.
In the four years following the end of World War II, government spending fell by 75 percent. The federal deficit fell by more than 50 percent and then eased into a small surplus.
Yet income, output and economic wellbeing continued to rise.
The Great Recession
Following the Great Depression, the Great Recession—from 2007 to 2009—was our nation's most severe economic downturn. It encompassed a sharp fall in housing prices, accompanied by a spike in mortgage defaults, especially on subprime loans. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac)—two government-sponsored enterprises established to support home ownership—went into receivership.
There are four myths here, beginning with the assertion that the recession was caused by too much private sector greed and risk-taking and too little government supervision. If anything, the reverse is true. Subprime lending actually became a goal of the federal government—beginning under the Clinton administration, primarily through the expansion of the Community Reinvestment Act (CRA). The authors explain:
Using newly expanded CRA requirements, bank regulators began to pressure banks to make subprime loans. Guidelines turned into mandates as each bank was assigned a letter grade on its making of CRA loans. Banks could not even open ATMs or branches, much less acquire another bank without a passing grade—and getting a passing grade was no longer about meeting local credit needs. Increasingly, passing grades were gotten by making subprime home loans.
By 2008, roughly half of all outstanding mortgage loans in America—28 million in all—were high-risk loans.
The second myth is that the crisis was caused by lack of regulatory authority. In fact, there were a slew of federal and state banking laws, which gave rise to an army of regulators with the power to investigate, mandate corrective action, and fine and even imprison violators.
The problem was that the traditional interest in meeting community credit needs with sound banking practices was overridden by a new federal policy designed to make 'affordable housing' available to more and more people.
A third myth is that the recession was caused by banking deregulation—in particular by the Gramm-Leach-Bliley Act (GLB). In fact, GLB removed barriers to competition in banking—making the financial sector more efficient. But regulatory authority did not decrease. It increased. The Congressional Budget Office actually scored GLB as increasing regulatory costs.
Regarding GLB, President Clinton said, 'There's not a single solitary example that it had anything to do with the financial crash.'
The final myth is the idea that the length of the recession was somehow caused by banking practices. In fact, an unusually weak recovery was more likely caused by increased penalties for working and increased subsidies for not working.
During the Obama years, the authors say, the 'American economy was hit with a tidal wave of new rules and regulations across health care, financial services, energy and manufacturing.' At the same time there was an explosion in the enrollment numbers for disability benefits, food stamps and cash welfare.
So why are these facts so important to know?
George Santayana is reputed to have said, "Those who do not learn from history are doomed to repeat it." The experiences of the Great Depression and the Great Recession are events that no sane person should want to experience again.