Libertarian Perspective: Why the Crash of 2008 Is Not a Market Failure

Government officials, media commentators, and even some economists are leaping to the mistaken conclusion that the financial waterfall of 2008 is a colossal market failure. We hear that the free market went wild because of too much deregulation. But by focusing too narrowly on regulations, critics ignore the wider issue of governmental intervention. Economic analysis shows that it was interventions that caused not only this recession but all past panics and depressions. The long-term cure for the boom-bust cycle is a truly free market, not ever more intervention.

The Crash of 2008 was easily predictable by anyone who understands the economics of business cycles. As an economist, I wrote a number of articles on the coming crash before 2008, including two columns for the Libertarian Perspective.

In my column of October 16, 2007, I wrote, “There is nothing the [Federal Reserve] can do to prevent the next recession” that I predicted would occur in 2008. The low interest rates accommodated by the Fed after 2001 sparked a real estate boom that burst in 2006, which was inevitably followed by falling land values and a crash of the financial derivatives based on mortgages.

I also explained that “The real estate boom gets escalated by another government intervention: the tax system.” Government works and services such as freeways, streets, parks, fire protection, security, and schooling make land more productive and attractive. This gain in land rent and land value is a subsidy to landowners, because these services are mostly paid for by taxes on goods, wages, and enterprise. Land speculation exploits the rise in land values during an economic boom, causing an even greater and unsustainable escalation of real estate prices.

The way to prevent the boom-bust is to prevent the financial and tax interventions of government. We should abolish the Federal Reserve and let the money supply and interest rates be set by a truly free market, not a governmental monetary authority. We must also replace punitive taxes on labor, goods, and enterprise either by privatizing schools, streets, and other governmental works, or by eliminating the land-value subsidy. Third, we should take back the rent generated by government services by having landowners pay an assessment on their land value.

After the transition to this tax shift, a payment based on land rent or site value would not hurt even landowners, as the purchase price of land would fall to that level where the payment is offset by not having to pay the same amount in mortgage interest. That’s because a levy on land value constitutes an elimination of a government subsidy, rather than an imposed cost on the owners.

Those who read my column of August 2, 2005 were warned of the coming crash well in advance. I wrote, “House prices will plunge, defaults will crash the banks, and many will be unemployed. California’s public finances will again be in crisis.”

In addition to interventions and the tax system, the federal government sponsored and guaranteed the secondary market in mortgages, in which Fannie Mae and Freddie Mac bought loans from banks, which could then make more mortgage loans. The federal and state governments promoted home ownership with loan guarantees, tax breaks, subsidies, and regulations that promoted home buying by risky low-income folks. Government is supposed to protect people from fraud, yet it allowed massive deception in derivatives based on mortgages. Fraud is not a market failure but rather the failure of government to prevent such acts of theft.

Even worse, government guarantees and bailouts (such as with the Savings and Loans in the 1980s) create the expectation, now fulfilled, that government will rescue banks, insurance companies, brokerage firms, and other institutions that are “too big to let fail.” This is called “moral hazard” in insurance and economics, and we now have it on a massive scale.

I warned in 2005, “We will just have to ride this real estate tsunami wave and then plunge down the financial waterfall that lies ahead.” Again I say, “The cause is the same all over: government financial and fiscal interventions. So please … don’t blame the market!”

Fred E. Foldvary
Fred E. Foldvary, Ph.D., is an author and economist who writes commentaries respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He is the author of The Soul of Liberty, Public Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary's areas of research include public finance, governance, ethical philosophy, and land economics. He has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at San Jose State University.