Author:
Thomas E. Woods
Length:
194 pages
Price:
$27.95
Reading
time: 3 hours
Reading
rating: 7 (1=very hard, 10=very easy)
Overall
rating: 4 (1=average, 4=outstanding)
Thomas
Woods has produced what is probably the most timely book published since the
beginning of the financial crisis. Meltdown chronicles the onset of the
recession from the beginning of 2008, but focuses on the collapse of the
housing and financial sectors. Though he
helpfully avoids oversensationalizing our current financial
predicament, he does not hesitate to draw relevant, and troubling, parallels
with the onset of the Great Depression.
Woods
gives an outstanding description of how the macroeconomy
works, and why it sometimes fails to work properly. He explains how the Federal Reserve System
regulates banking and credit, controlling the money supply to expand credit,
bank lending, and mortgage issuance over the last thirty years. As long as these activities are monopolized
by the government, periodic recessions and financial crises are inevitable.
During
the high-inflation 1970s, banks became unprofitable because the low interest
rates they were earning on mortgages and other long-term loans was greatly
exceeded by the higher interest rates they had to pay to attract deposits. In the wake of the S&L collapse of the
1980s, thrift institutions ceased to hold the mortgages they had issued. Instead they either packaged the mortgages and
sold them as mortgage-backed securities, or sold them to Fannie Mae and Freddie
Mac.
Without
competitors and backed by the implicit guarantee of government support, which
turned out to be real now that they've been bailed out, Fannie Mae and Freddie
Mac encouraged and in some cases forced banks and mortgage brokers to originate
more and more, increasingly risky loans.
Whether a mortgage was sold to another bank, one of the
government-sponsored corporations, or bundled into a mortgage-backed security,
once the mortgage was sold, the original issuer had shed any risk of loss in
the event of default. More and more
mortgages were given to borrowers who should never have qualified financially,
because everyone was making money as long as housing prices continued to
skyrocket.
Adjustable
rate mortgages, an innovation which enabled banks to continue offering loans during
the high-inflation days of the 1970, became instruments of financial seduction,
luring consumers into poorly-designed and unsustainable financial traps. Requirements for down payments were relaxed,
and often, eliminated. Not only could
people with poor credit histories get zero-down-payment mortgages, so could
their pets. Default risk was always
there to act as a brake on mortgage lending, but adjustable rate mortgages
greatly increased the possibility for default once the low introductory rate
was reset upwards after a few years. As
default risks ballooned, banks started to ignore them, because it didn't seem
to matter as long as the house values continued to increase year after year.
The
Federal Reserve kept credit artificially low, with artificially low interest
rates, for an unprecedented two decades.
Woods explains how this led to two recessions so far, in 2001 and
2008-09 (and counting), and how it prevented full recovery after the last
recession. People respond to low
interest rates by saving less and consuming more. At the same time, businesses take advantage
of low interest rates to borrow more for investment spending. The economy can always shift the composition
of its output by substituting consumption goods for investment goods or vice
versa, but when credit expansion enables both producers and consumers to spend
more, boom times start. Everyone is happy initially as the stock
market soars, wages and employment rise, and clueless politicians
take credit for it all. But living
beyond our means is not a strategy for sustainable growth, and eventually the
hysteria cannot go on—it must end in collapse.
Meltdown offers a great lesson
in basic macroeconomics, but it serves an even more important role in exploding
the many myths being invoked to justify bailing out troubled banks, industries,
and otherwise stimulating the economy. Stimulating
the economy for the last twenty years led to the housing and stock market
bubbles. The economic illiterates who
created the current crisis were until recently in charge of unprecedented
stimulus, bailout, and recovery programs.
With the change of administration, they've only been replaced with new
officials carrying out the same discredited policies.
Robert
F. Mulligan is professor of economics in the Department of Accountancy,
Finance, Information Systems, & Economics of the College of Business at
Western Carolina University. His
research interests are monetary economics, business cycle theory, and
constitutional political economy. For
previously reviewed books, visit our web site at www.wcu.edu/cob/bookreviews.