I’ve reached my tipping point. The distortions and inaccuracies regarding the economic recession spewing from the mouths of many influential people — including our very own University professors — on a daily basis is egregious and must be addressed. Rather than examining the cause of the current economic debacle, teachers dwell on symptoms of the crisis, presenting an inaccurate view to students and indoctrinating them with nonsense in the process.

The explanation most commonly attributed to the recession espouses the notion that free market capitalism, deregulation and Wall Street greed resulted in the disaster. At best, this account is littered with half-truths, ignoring history that illustrates an alternative narrative.

By no means am I defending Wall Street. Beginning in the 1970s, Wall Street firms developed a series of financial instruments in the form of asset-backed securities like subprime mortgages. Believing these innovations to be foolproof, they had no idea their creations would implode, contributing to the housing bubble that allowed the current crisis to occur.

But ignoring policies that promoted this behavior represents a gross misunderstanding of the true cause of the crisis. As Harvard economist Jeffrey Miron pointed out in 2009, “private forces jumped willingly on a runaway train, but it was government that built the train and drove it off a cliff.”

The chief catalyst for the meltdown was the federal government, whose economic regulations and over-promotion of risk created the opportunity and incentives that manifested themselves in the shape of the financial crisis.

Loose lending practices involving the expansion of the subprime mortgage market at the hands of freewheeling financial institutions are often condemned as a failure of the free market. Yet, the banking sector is arguably the most regulated industry in the country. And the government incentivized these firms by pursuing policies of moral hazard.

Moral hazard is the promise of government bailouts to lenders in exchange for excessive risk-taking. Clear-cut examples can be observed in the subprime mortgage market, where banks abandoned reasonable lending practices and allowed individuals with poor credit histories to take out loans they were not equipped to handle.

These irrational loaning practices occurred partially a result of the government’s move to charter the nation’s largest mortgage lenders – Fannie Mae and Freddie Mac in 1938 and 1970, respectively. The willingness of creditors to issue subprime loans was further exacerbated by the Community Reinvestment Act of 1977, which pressured the industry to loan to risky borrowers. This phenomenon exemplified yet another failed remnant of the Great Society programs that Lyndon Johnson proposed during the 1960s.

With the implicit guarantee of a bailout by the federal government, Fannie and Freddie gladly obliged, taking on tremendous risk in the process. The issuance of subprime loans burgeoned and the housing bubble was created. These lending practices continued well into the mid-2000s with a financial industry hell-bent on maintaining the housing boom.

Faulty estimates of default risk by rating agencies also contributed to the crisis, as these entities responsible for providing judgment concerning the safety of securities badly misjudged risks. The rating agencies – Standard & Poor’s, Moody’s Corporation and Fitch Ratings – which the government contracted, were motivated to provide positive ratings, as it was most conducive to stimulating housing construction as well as establishing favorable connections with federal regulators.

Perhaps the most dominant force behind the economic downturn is the Federal Reserve and its monopolistic powers over the nation’s monetary policy. A highly politicized quasi-independent entity, the Fed shoulders much of the blame for creating the housing bubble by setting artificially low interest rates. This was evident in 2001 when former chairman of the Fed Alan Greenspan lowered a key interest rate to a historic low of less than 1 percent. By setting low interest rates, the Fed pumps billions of dollars into the economy, encouraging creditors to engage in risky behavior like subprime lending.

The expansion of currency coordinated by the Fed, known as inflation, drives up costs by reducing the purchasing power of the dollar. The rise in housing prices, sustained until 2007, was not merely a product of supply and demand. It was a result of a Fed monetary policy that artificially created demand by making it simple to obtain cheap credit and consequently spend recklessly.

There’s no doubt that self-interested Wall Street firms played an integral role in fostering subprime lending and the aggressive marketing of housing-backed securities. But a simple look into the roots of the crisis reveals that subprime lending and other actions of creditors were a symptom of the housing bubble – not its cause.

Some may find it difficult to stop using a free market that never existed as a scapegoat for the recession, but the fact is the government played a fundamental role in the crisis through economic intervention that provided incentives for reckless loaning practices in the first place – not the anti-capitalist rhetoric students are currently being spoon-fed inside University lecture halls.

Alex Biles can be reached at jabiles@umich.edu.

Leave a comment

Your email address will not be published.