How the Housing Crisis Vindicated the Austrian School of Economics

When the housing bubble finally burst and financial experts were scrambling to provide an explanation to the public, the Austrians were already armed with answers.

Looking back ten years later, it is clear that the 2008 financial crisis took many people by surprise. The economy seemed to be doing so well, and then suddenly, the rug was ripped out from under Americans as small businesses were closing, people were losing their jobs, and families were having their homes foreclosed in droves. The situation went from bad to worse when even large financial institutions began to crumble.

The entire economy had gone to hell, and people wanted answers. Specifically, they wanted to know how this problem had crept up without warning. And only one group of economists seemed to have any real grasp on the situation.

Mainstream economists scratched their heads attempting to make sense of the devastation. Not only were most unable to identify what had actually gone wrong, but when it came to providing answers, more spending and more government regulations seemed to be the only proposals on the table. Then, adding insult to injury, Congress approved the TARP bailout, and $700 billion of taxpayer-extorted funds were directed towards bailing out the same big banks that had helped precipitate the crisis in the first place.

The whole system appeared to be corrupt, and central planning did not seem to be doing the taxpayer or the economy any favors. But as people began to distrust and question the path our country was headed down, the Austrian school of economics, which had long since been abandoned and ignored by mainstream economists, began its resurgence.

The Road to Serfdom Revisited

In the wake of the tumultuous financial crisis, book sales of Nobel laureate and Austrian economist F.A. Hayek’s The Road to Serfdom quadrupled. The book had been published to great acclaim in the post-WWII era as the entire world was trying to make sense of the evil that had been unleashed upon humanity. In its pages, it warns of the dangers inherent to central planning and connects this to the rise of authoritarianism. Hayek also calls out those in power who are arrogant enough to believe they have enough information on hand to plan for an entire economy.

As the recession continued, and the government’s role in the crash grew more apparent to the American people, sales of The Road to Serfdom steadily climbed.

As the recession continued, and the government’s role in the crash grew more apparent to the American people, sales of The Road to Serfdom steadily climbed. This was quite extraordinary considering the book had originally been published six decades prior. After years of relatively stagnant sales, the book was flying off of shelves.

Attempting to explain this phenomenon, Bruce Caldwell writes:

“In the end, however, I think that the underlying reason for the sustained interest in Hayek's book is that it taps into a profound dissatisfaction in the public mind with the machinations of its government. Both Presidents Bush and Obama have presided over huge growth in the size of the federal government and in the size of the federal deficit, with little obvious effect on unemployment. Things seem out of control.”

He continues:

“Furthermore, a recurrent theme in the news is that, in contrast to the millions who are suffering, the politically connected are doing just fine. The examples are everywhere, from bailed out financiers getting huge bonuses to public union employees getting hefty pensions, from auto companies that are nationalized instead of going belly up to politically savvy firms that get government subsidies to produce products that would be otherwise unprofitable.”

The TARP bailouts had done just that. Individuals across the country were suffering, but the well-connected bankers were doing just fine. And there wasn’t just one political party to blame. For the first time in years, the public was starting to doubt the two-party system, which made Hayek’s book sales make even more sense since The Road to Serfdom is dedicated to “The Socialists of All Parties.” This was a message that rang particularly true in the post-housing crisis climate.

But in addition to Hayek’s words shedding some light on the current financial situation, his other contributions to free market economics help to explain how the crisis began.

The Austrians Knew

In 1974, economist Friedrich A. Hayek won the Nobel prize in economics for his work on the Austrian business cycle theory. The theory, which was first formulated by Ludwig von Mises, told of the cycles of economic booms and busts that occur when a central authority interferes in the economy, specifically with the manipulation of the money and credit supply.

When the government injects new money into the economy, this artificially lowers interest rates, causing an economic boom. But the boom is unsustainable since it is based on nothing but a mirage of additional savings conjured by the manipulated interest rates.

When the government injects new money into the economy, this artificially lowers interest rates, causing an economic boom. But the boom is unsustainable since it is based on nothing but a mirage of additional savings conjured by the manipulated interest rates. After the interest rates are allowed to rise to their market levels, boom turns to bust. If left alone, the market will adjust, malinvestments will be liquidated, and capital will be reallocated along sustainable lines. The bust is the painful, but healthy, process of recovery. But typically, governments try to avoid the pain with still more credit expansion, as well as stimulus packages and bailouts. These further interventions only create more problems down the road.

Since the Austrians were familiar with this theory, they understood that the housing market crash was a matter of when and not if.  And when the housing bubble did finally burst and financial experts were scrambling to provide an explanation to the public, the Austrians were already armed with answers.

At the height of the crisis, in the summer of 2008, FEE’s The Freeman published an article by Richard Ebeling called “The Current Economic Crisis and the Austrian Theory of the Business Cycle.” In the piece, Ebeling explains how the Austrian business cycle had been used to help predict the current crisis.

Speaking in regards to the two most recent financial crises, Ebeling writes:

“For many Austrian economists the past two business cycles have been, in the words of Yogi Berra, ‘like déjà vu, all over again.’’

In the early 2000s, Austrian economist Mark Thornton went on the record several times warning of a housing bubble, but he wasn’t the only one. Financial commentator and CEO of Euro Pacific Capital Inc., Peter Schiff, also made numerous television appearances where he used the Austrian business cycle to explain the coming crisis years before the bubble actually burst.

In 2003, when the housing market was booming, another Austrian, Texas Congressman Ron Paul, warned:

“The special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions...Like all artificially created bubbles, the boom in housing prices cannot last forever. When housing prices fall homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.”

This is exactly what happened five years later, and after Ron Paul ran as a Republican presidential candidate during the 2008 primary season, both Austrian economics and F.A. Hayek became household names.

End the Fed

College students are no strangers to political activism. While many are drawn to issues like stopping the war on drugs or ending the surveillance state, monetary policy is not always seen as the sexiest of issues. And yet, all across the country from 2007-2012, young people were joining together in the thousands to hear about monetary policy from an 80-year-old doctor.

In 2008, the Republican presidential debate stage was filled with the usual defenders of the status quo, and while each candidate spoke in soundbites without any real substance behind their words, one man was refusing to play by the rules.

We didn’t want soundbites, we wanted the truth. We wanted to understand how this happened so we could fix it and prevent it from happening in the future.

When asked about the financial crisis, Congressman Ron Paul spoke of the Austrian business cycle and the role the Federal Reserve was playing in manipulating the money and credit supplies. But these were the answers that frustrated Americans had been searching for. We didn’t want soundbites, we wanted the truth. We wanted to understand how this happened so we could fix it and prevent it from happening in the future.

Speaking economic truth on a stage filled with economic illiterates, Congressman Paul said:

“But if you want to understand why we have a problem, you have to understand the Fed, because the cause comes from the business cycle.  We shouldn't be asking what to do exactly with the recession—obviously, we have to deal with that—but you can't solve, you can't cure the disease if you don't know the cause of it.  And the cause is the booms. When there are booms, and they're artificial, whether it's the CRA or whether it's the Fed, easy credit, when you have bubbles, whether it's the NASDAQ or whether it's the housing bubbles—they burst.  And when they do, you have to have corrections. And that's what we're dealing with.”

The other candidates and the moderator rolled their eyes and laughed at Paul as he called out the Federal Reserve, but the audience members were taking every word to heart. Someone was finally giving them the answers they were looking for.

Suddenly, rallies were taking place across the country, and thousands of people were gathering to hear Ron Paul speak about Austrian economics while the crowds chanted “End the Fed” at the top of their lungs. This was not only an outlet for the frustration felt with the powers that be—it was also a lesson in economics.

In September 2009, Ron Paul published a book called End the Fed. In the book’s acknowledgments, he thanked “his great teachers” who, among others, included Ludwig von Mises and F.A. Hayek. For the curious individuals who picked up this book looking for answers, myself included, the acknowledgment section sent us down a rabbit hole of economic thought, exposing us to new ideas we had never heard before: to websites like FEE.org and Mises.org.

Each time Paul went back on the debate stage, he implored the audience to research Austrian economics, and each time more people listened. Not only was Paul gaining in the polls, but this “fringe” economics group was also gaining real traction.

Ordinary people were going out and buying economic texts by Mises and Hayek. In fact, people were so curious about Hayek and Austrian economics, a music video depicting a rap battle in which Hayek explains the business cycle to John Maynard Keynes went viral. And this new interest in sound economics did not stop after the election ended and Obama got into office.

An Idea Whose Time Has Come

As the years progressed, the influence of the Austrians continued to grow. While not a pure Austrian but most certainly an ally to the movement, Ayn Rand’s popularity also began an upswing at this time, and Atlas Shrugged experienced a surge in sales. While not entirely the same, the Tea Party movement was also very much inspired by this rebirth of sound economics. In fact, the very first modern day Tea Party event is said to have begun with Ron Paul in December 2007.

By the time the 2012 presidential elections were upon us, the other candidates were attempting to capitalize on Ron Paul’s popularization of the Austrian school. In fact, fellow Republican candidate hopeful Michele Bachmann even name-dropped Ludwig von Mises on the debate stage in an attempt to win the audience and appear cool.

When asked to explain her ideal vacation, a question that really had no place on the presidential debate stage in the first place, Bachman replied, "When I go on vacation and I lay on the beach, I bring von Mises." It is unknown if the former congresswoman has actually ever read Mises, but her comments represent so much more than that. Bachman using Mises to gain popularity in the election showed how dramatically the tide had shifted.

Individuals were no longer content to let the government take the economic reins while they sat back and dealt with the disastrous consequences.

Individuals were no longer content to let the government take the economic reins while they sat back and dealt with the disastrous consequences. The housing crisis had left irreversible scars that gave many Americans a desire to understand the economy in ways they hadn’t before. What they discovered was that the economy was too complex to be controlled by a select few people, especially when those people worked for the government. And after decades of waiting in the shadows while the mainstream mocked them, the Austrians were finally vindicated.

More by Brittany Hunter

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