This slim yet insight-packed volume makes fair progress toward explaining the 2008 financial crisis. The first of the book’s three chapters outlines the “housing industrial policy” that led to the crisis. The second discusses the conflict between concentrated political power and effective use of socially dispersed knowledge, and the third suggests reforms.
Tracing the government’s ever-greater role in financing and encouraging housing debt, especially since the 1960s, Kling observes that regulation-fostered securitization of mortgages necessarily obscures risk. A bank exercises the best oversight over loans that it awards directly; in an unhampered market, loan officers have little incentive to prefer an indirect or “securitized” method of lending. But by rigging the housing market for decades to promote the holy grail of home-ownership, politicians fostered and even mandated many dubious mortgages that wouldn’t otherwise have passed muster. Kling draws on his background as a former Freddie Mac economist to highlight the specific problems of the rickety financial structures that were only made possible by governmental assumption of risk. “Without the [government] guarantees [of mortgage-based securities]—or apparent guarantees—indirect lending would not have been possible,” he concludes.
In Kling’s view, bad mortgage regulations, a spate of mortgage loans requiring unrealistically low down payments, and what he calls a “suits vs. geeks” divide were the main causes of the housing bubble. But the last two “fundamental” causes stem from the first. So the author’s explanation of the housing crisis boils down almost entirely to the welter of incentive-skewing mortgage regulations.
The book surveys and critiques several alternative explanations for the crisis, including the oft-heard but historically unintelligible claim that it resulted from “deregulation.” Unfortunately, this tour does not investigate the role of the Federal Reserve. Economist Robert Murphy is among those of Misesian-Hayekian persuasion who point to the malinvestment-encouraging effects of the credit splurge of 2001–2003, the period during which the Fed lowered the federal funds target interest rate from 6.5 to 1 percent. The omission is odd since Kling elsewhere acknowledges the importance of the Austrian analysis.
A more fundamental discrepancy between knowledge and power than that exemplified by the suits/geeks divide is that exemplified by the hubristic power-grabbing of government officials, both before and after the economic blowout. Instead of arguing that in 2008 officials should have abstained altogether from such interventions as using tax dollars to buy “toxic” assets, the author suggests that the government might have instead tried the stopgap measure of “impos[ing] penalties on firms that make extravagant demands for collateral to back repurchase agreements” and other financial instruments. Limiting a fresh bout of intervention in that way would have been better than the blundering and direct central planning the federal government undertook, but it would still have amounted to giving economic actors orders, discouraging reliance on local knowledge and conditions. “Extravagant” terms of contract may be the only ones on which a trade can be conducted that satisfies both parties.
The second chapter considers the syndrome of force-wielding politicians and bureaucrats pretending to know better than individuals their own unique circumstances, values, goals, and options. The conflict between the individual’s knowledge and freedom, on the one hand, and coercive rules which preempt that knowledge and curtail that freedom, on the other, lies at the heart of the 2008 debacle (and many other economy-wide slumps). Markets are characterized by price signals and other coordinating mechanisms that enable human beings to make effective use of widely dispersed knowledge, very little of which we can ever grasp firsthand. Kling observes that modern economies are becoming ever more specialized and complex even as political power becomes more centralized and resistant to calls for reform. He tries to come up with empirical gauges of both trends, although that isn’t strictly necessary to refute the fallacies and expose the hazards of central planning.
The problem of how to prevent or ameliorate the blunders of the commissars is tackled in the final chapter. The author suggests various half-measures that proponents of fully free markets will be less than satisfied with: proposals, for example, to merely decentralize government functions that would be better delegated altogether to the private sector. Still, most of Kling’s proposed reforms—including a scheme that would enlist “competitive governments” to jockey for the chance to collect your garbage, and another to dispense vouchers rather than Medicare-style reimbursements to pay medical costs—might make it easier to achieve thoroughgoing restoration of markets than leaving things as they are.