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Wednesday, September 23, 2009

Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse

Thomas Woods’s Meltdown is a marvel of writing and publishing. Having arrived on shelves in February, it offers a complete analysis of the causes of the current recession as well as a critical assessment of the mistakes policymakers have already made, and will likely continue to make, in response to the economic decline.

The marvel is the speed with which Woods put together a book of almost 200 pages and Regnery got it on the market. Under the circumstances, one might expect the book to come up short in coverage or depth of analysis, but it doesn’t. In fact Meltdown, despite a couple of minor flaws, is the best one-stop analysis of the recession available, which makes it the book to give anyone who wants to understand how government intervention caused this mess and how Austrian economics can explain those causes and the problems with the proposed cures.

The opening chapter provides an overview of events as well as a taste of the mainstream media analysis of the meltdown. Mostly that consisted in blaming it on “free market,” or “unregulated” and/or “laissez-faire” capitalism, with almost no one asking whether such an assessment of blame makes any sense. That chapter also acknowledges the “elephant in the room”–namely, the Federal Reserve System. Woods rightly notes that almost all the commentary on the recession has ignored any substantive discussion of the role that the central bank played in creating the boom that in turn led to the bust.

The broad case for government as the cause of the meltdown is offered in chapter two. Woods names six “culprits.” First are Fannie Mae and Freddie Mac, the government-sponsored enterprises that dominate the mortgage market. Largely immune from profit and loss, and able to “make markets” in ways that truly private firms are not, Fannie and Freddie created implicitly government-backed markets for trading mortgages and mortgage-backed securities. This encouraged mortgage originators to keep creating new mortgages, however risky, knowing that Fannie and Freddie could use their special line of credit at the U.S. Treasury to buy those up and resell them on the secondary market. This was hardly a “free market.” Rather it was one in which these creatures of government operated without being subject to the market’s own normal regulatory processes–namely, profit and loss and risk management.

Minor culprits include the Community Reinvestment Act and other forms of affirmative action in lending, as well as the ways that government policy stimulated speculation. Among the factors Woods mentions here is the role played by the credit ratings agencies, which are themselves a cartel protected by the Securities and Exchange Commission. This is a point that many observers, even free-market ones, have overlooked in their analyses. Woods is to be commended for bringing it in.

But the bulk of his blame lies with the Fed. Woods offers a complete analysis of the Fed’s role in the context of an accessible account of the Austrian theory of the business cycle. He clearly explains the interaction of savings, time preferences, and interest rates under stable monetary conditions in order to show what happens when the Fed intervenes with an expansionary monetary policy. Chapter five follows up with a good discussion of the myths of the Great Depression.

The final two chapters are on money and “what now?” The key argument of both is that the Federal Reserve System and the other elements of central banking are the real source of trouble and that we should reconsider this institution. Woods includes a nice refutation of a number of arguments against gold and other commodity standards. These two chapters are valuable, although I wish Woods had acknowledged that his implicit monetary theory, including his definitions of inflation and deflation, is not the only one in the Austrian tradition. (It relies on a Rothbardian 100-percent-reserve perspective on money and banking.)

Although in a few places Woods comes across as unnecessarily angry, which might turn off readers not predisposed to his message, Meltdown is in many ways an extraordinary achievement. He has digested complex theory and a whole range of recent history and presented the single best analysis of the current recession out there. It is a terrific example of using Austrian economics and free-market thinking to analyze the real world–and doing it in a way that is highly accessible to the general reader.