Government’s Role in the Financial Crisis

George Soros is planning to set up an economics institute at Oxford University—in order, apparently, “to steer the discipline away from the champions of the free market and deregulation who, the billionaire financier believes, share the blame for the global economic crisis.” He is frustrated by “the way global financial markets work on the premise that markets can be left to their own devices.”

Ian Goldin, director of the James Martin 21st Century School, applauded the move on the grounds that it would “broaden the debate.”

We need to broaden the debate, all right. In particular, we need to broaden it beyond two sides—neoliberals and “Progressives” — who agree that the global finance capitalism we’ve had in recent decades was a “free market.”

Just for starters, the market in mortgage-based securities is almost entirely a creation of the federal government. Before the feds created Freddie Mac to guarantee MBS’s, they were shunned as too risky by the vast majority of investors. Until then, derivatives were mainly stodgy investments in commodities futures used by farmers as a form of insurance against a catastrophic fall in prices.

Under the terms of the Basel II Accord, which went into effect in 2004, a direct mortgage loan by a local bank to a customer with a satisfactory credit rating carries a risk weighting of 35%. A mortgage-based security, on the other hand, carries a risk weighting of only 20%. So the reserve requirements were set higher for mortgages held by the original issuing bank (which “entailed local knowledge,” as Sheldon Richman points out) than for MBS’s purchased from other banks. The lower reserve requirement for MBS’s meant a larger amount of money was available to be lent against a given reserve, which created a strong incentive for banks to sell their own mortgages as quickly as possible and load up on MBS’s. In the words of Les Antman, “Basel II virtually mandated that banks sell their loans if they wanted to be competitive.”

But government’s role goes back a lot further than that. It includes government intervention to enforce artificial property right that made land and capital artificially scarce and expensive relative to labor, and thereby weakening the bargaining power of labor. It includes government policies to encourage centralized, capital-intensive mass production using expensive product-specific machinery rather than decentralized production integrating general-purpose electrical machinery into craft methods. It includes policies promoting over-accumulation of capital and the cartelization of markets, to the point that mass production industry could not dispose of its full product in a free market.

It was because of these prior interventions that we have a plutocratic class with enormous piles of investment money, and a shortage of profitable investment opportunities. In an economy with wider distribution of wealth and decentralized production capability, where production capacity was driven by local demand and a higher level of purchasing power for labor, most of the preconditions for our bloated FIRE economy wouldn’t even exist.