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The Case For Big Government?   November 16th, 2008


More observations...

On a recent visit to the local book store, a book called "The Case For Big Government" by Jeff Madrick caught my eye. It wasn't really what I was looking for but I've always been curious to understand liberals' rationale for big government. Explanations I've been offered by liberals usually come down to emotional or ideological beliefs that I've never seen really backed up by hard data. So with a title like that I figured this might be a very interesting book that would truly make the case for big government: And by "make the case" I mean offer some concrete, real-world information of why big government is good policy. I thought the book would either make the case for big government and convince me or, at the very least, show me the information they think vindicates their position.

Alas, I was disappointed--not surprised, but disappointed. The book could've been better titled "A History of the American Econonmy" with a subtitle of "And How The Government Has Participated In It." The book wasn't a waste of time--indeed, there was a lot of economic history packed into the book which I found interesting. However, I didn't find that the book "made the case" for big government. It simply documented the government's participation in the economy over the last two centuries. The closest it came to making the case was something along the lines of "Since the government was growing during the 1900's and so was the economy, obviously a growing government doesn't harm the economy." I'll leave it to the intelligence of the reader to guess why that isn't a very compelling argument.

Then I happened upon a Time Magazine article that, like many others recently, interpreted the election of Obama as some kind of fundamental shift of the American electorate and a rebirth of liberalism--toward the "big government" that the book I read championed (though for which it did not make the case). The Time article said, in part:

If liberalism collapsed in the 1960s because its bid for cultural freedom became associated with cultural disorder, conservatism has collapsed today because its bid for economic freedom has become associated with economic disorder... In the newly deregulated American economy, fewer people had job security or fixed-benefit pensions or reliable health care. Some got rich, but a lot went bankrupt, mostly because of health-care costs. As Yale University political scientist Jacob Hacker has noted, Americans today experience far-more-violent swings in household income than did their parents a generation ago.

Starting in the 1990s, average Americans began deciding that the conservative economic agenda was a bit like the liberal cultural agenda of the 1960s: less liberating than frightening.

In short, as I wrote earlier, a single presidential election and a shift of one American out of twenty-five towards the Democratic party is apparently all that's needed for some people to interpret this as the demise of conservative ideology and a broad acceptance of liberal big government.

What's frustrating is that it seems clear that the Democrats won for exactly two reasons: Five years of anti-Bush hatred and their successful campaign against the War in Iraq. It didn't work for them in 2004, worked better in 2006, and when combined with a well-timed financial crisis, it pushed them to victory in 2008. It's not like they've been campaigning on "big government" or "more government spending" to any significant degree. Yet they're using their victory as a mandate not against Bush or the War in Iraq, but as a mandate towards their economic and social policies.

Conservative Economic Policy Didn't Cause the Crisis

The subtitle pretty much says it all: It was not conservative ideology or economic policies that caused the current crisis. It was due to the wrong regulations and bad regulations.

As I wrote about a week after the financial crisis erupted, the primary causes of the crisis were an unusually large spike in the number of foreclosures and the fact that so many trillions of dollars of credit default swaps (CDS's) were structured around the success of those mortgages. Neither of these were caused by conservative principles of low taxes, low government spending, the deficit, the debt, free trade, or deregulation.
    The Housing Bubble and Bust

    The spike in foreclosures was due primarily to homes being sold to people that couldn't afford them a la the Carter and Clinton-era Community Reinvestment Act . As I mentioned mentioned before, the CRA didn't require all of the bad loans that were made--but it inspired them to be made since, in a growing housing bubble, it seemed there was no risk in doing so.

    The housing bubble itself was caused by the influx of unqualified home buyers increasing the size of the market, and due to unusually low interest rates. But it wasn't the typical 30-year mortgage rates that were insanely low (they bottomed out at around 5.25% ), it was the fact that even at 5.25% many of the unqualified buyers couldn't afford the mortgage. So they were offered ARM loans which, at their lowest, offered initial rates of about 3.45%. At such low rates it seemed that even the unqualified buyers could afford a house; and the demand created by all of these people flooding into the market caused home prices to constantly increase. So even if these unqualified buyers ultimately couldn't afford the house, they could just sell it at a profit.

    It most definitely wasn't conservative ideology and principles that led to the housing bubble. Conservatives believe in personal responsibility, and there is nothing responsible about an individual buying a house he can't afford; nor is there anything responsible about a bank loaning the money to that individual. Of course, like everyone, we would like to see more people be able to own their own homes--but that must be accomplished by creating an economy that generates more wealth so that more people can afford a home. It's not accomplished by government regulations that encourage banks to give mortgages to people that can't afford them.

    If anything, the housing bubble is a demonstration of what happens when we reject conservative ideals. A lack of responsibility on both the part of the borrowers and the lenders led to the bubble, the resulting bust, and the subsequent financial crisis.

    Credit Default Swaps

    As I mentioned in my previous article, the mortgage crisis probably wouldn't have been enough to cause the current economic crisis if it weren't for all the credit default swaps (CDS's) that had been built on top of the bad mortgages.

    As I also wrote, the issue of credit default swaps is a point where I agree some common sense regulation was lacking. But it should be made clear that, as far as I have been able to determine, this was not caused by Republican deregulation or Republican resistance to new regulation. It's simply an area of the financial industry that the government hadn't regulated because it wasn't sure what kind of regulations were needed, if any. Additionally, credit default swaps are effectively private contracts between two parties that willingly enter into those contracts. The government was obviously hesitant to limit or regulate private contracts when it wasn't even sure the regulation was needed or would be helpful.

    It seems obvious now that regulations are needed. I said that back in September when it became clear to me that credit default swaps were not just being used as a form of insurance (their original purpose), but essentially being used as a means of gambling. Regulations should be implemented to make sure that only those that hold an investment can buy a CDS to protect that investment; and there should be regulations that ensure that an entity that sells a CDS has the financial resources to back up the CDS's they sell.

    Having said that all that, it should be noted that the abuse of CDS's does not absolve the bad mortgage lending practices that led to the housing bubble. In fact, it's entirely possible that if good mortgage lending practices had been implemented that the entire CDS market built on top of it would have been fine. Had bad loans not been extended to unqualified home buyers, the CDS market probably would have been fine. Likewise, if the CDS market had had been subject to the two regulations I mentioned above, the housing market probably wouldn't have triggered all of this.

All this is to say that the current crisis is most definitely not the result of conservative economic policy. Rather it was the combination of two issues: Excessive government regulation encouraging bad lending in the mortgage market combined with practically non-existent regulation in the CDS market. These combined to create the perfect economic storm.

While liberals may claim that the lack of regulations of CDS was due to Republicans, I haven't found any evidence that that is true. I have yet to find any information that suggests that any deregulation legislation actually deregulated credit default swaps (derivatives) in a way that led to our current problem. Nor have I found any information that suggests that Democrats were making a concerted effort to regulate them but were stymied by Republicans.

For all the articles I've read that portray the 2008 election as a rejection of conservative ideals, I have yet to find one such article that explains which conservative ideals led to the housing bubble or the problem of credit default swaps.

The Solution Isn't Big Government

This leads us back to the original topic: Big government.

Many pundits, commentators, and politicians are writing articles that basically argue that the new administration should adopt a big government strategy. They claim that the current crisis proves that conservative economic ideology has failed and claim that the 2008 election proves that the country wants liberal economic policies. However, neither are true.

As I wrote last week, the 2008 election was not a massive rejection of conservative principles: It was a change of opinion in one out of twenty five Americans on the two issues Democrats have been campaigning on since 2004: Bush and the War in Iraq--even when they've campaigned on the issue of the economy, they haven't been arguing for big government policies, they've just been arguing for vague "change." And as I've explained in this article the current economic crisis is not the result of conservative economic policies. It's not the result of low taxes, low government spending, or deregulation.

Additionally, it should be kept in mind that federal government spending has increased from $1.789 trillion in FY2000 to $2.979 trillion in FY2008 --a 66% increase in less than a decade. That leaves me wondering: Is the argument that that isn't enough government spending and the only reason we're not doing better is because the government hasn't spent more? Or is it just that we aren't taxing the rich enough? If so, I'd be very interested in someone telling me how increasing taxes on the rich is going to improve our economy or how increasing taxes on the rich would've avoided the housing bubble or credit default swaps. Obviously it wouldn't have.

The fact is that conservative economic principles did not cause the current financial crisis and a move to big-government liberal economic policies is not going to fix it. Yes, we need to implement some common-sense regulations on credit default swaps (derivatives). Yes, we need to eliminate absurd legislation such as the Community Reinvestment Act to make sure we never give any bank an incentive to make bad loans. But both of those solutions can--and should--happen without an abandonment of solid conservative economic policy. In fact, many of us would argue that, when it comes to spending, President Bush has been more liberal than Clinton... and that approach hasn't exactly helped the economy.

We can argue the merits of conservative and liberal economic theory but it is absolutely disingenuous to suggest that conservative principles caused the current crisis. They simply had nothing to do with it.

But that won't stop proponents of liberal policies from attempting to convince the public otherwise.

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