Thursday, June 10, 2010

The House That Uncle Sam Built

(found this on Value Investing World).

In this essay, we trace the path of the recession from its origins in the housing market bubble to the policies offered to cure the aftermath.

The theme of "The House that Uncle Sam Built: The Untold Story of the Great Recession of 2008" is that government policy, not a failure of free markets, caused the economic trauma we have been experiencing. We do not live in a free market. We live in a mixed economy. The mixture varies by industry. Technology is primarily free. Financial Services is primarily government. It is not surprising that the most government regulated and controlled segment of the economy, financial services, experienced the biggest problems. These problems were created by actions by the Federal Reserve combined with government housing policy (especially the government sponsored enterprises - Freddie Mac and Fannie Mae). Misguided government interference in the market is the real culprit in laying the foundation for the Great Recession.

This paper provides a "common sense" and understandable outline of fundamental causes and cures. The analysis is based on long proven economic laws. Despite the wishes and hopes of politicians, economic laws are just as immutable as the laws of physics. If you jump off a ten story building, hitting the ground will not be pleasant. If the Federal Reserve holds interest rates below the natural market rate by rapidly expanding the money supply ("printing" money) as Alan Greenspan did, individuals and businesses will make bad investment decisions and there will be negative consequences to our long term economic well-being. There are no free lunches.

When a doctor misdiagnoses a disease, his treatment will likely make the patient sicker. If we misdiagnose the causes of the Great Recession, our treatment will reduce our long term standard of living. While the U.S. economic system is highly resilient, and we will likely have some form of economic recovery, almost every significant government policy action taken in response to the Great Recession will reduce the quality of life in the long term. Understanding that failed government policies, not market failure, caused our economic challenges is critical to defining the appropriate cures. Since government created the problem, i.e. caused the disaster, it is irrational to believe that more government is the cure. We owe it to ourselves and to our children and grandchildren to take these issues very seriously.

Continue Reading the PDF.