DISTRIBUTED TO THE TRADE BY NATIONAL BOOK NETWORK WWW .NBNBOOKS.COM CATO INSTITUTE 1000 MASSACHUSETTS AVE., N.W. WASHINGTON, D.C. 20001 WWW.CATO.ORG CATO INSTITUTE 1000 MASSACHUSETTS AVE., N.W. W ASHINGTON, D.C. 20001 WWW.CATO.ORG “T he story of this storm in the global markets is the story of how government intervention to solve previous crises laid the foundation for a new one,” writes Johan Norberg in this important new book. Tracing the causes of our current financial crisis with liveliness and clarity, Financial Fiasco shows the mistakes made in Washington, on Wall Street, and in communities across America that led to the eco- nomic meltdown. While many analyses of the crisis have placed the blame solely on Wall Street, Norberg exposes the crucial role government regulation played in creating the opportunities and incentives that led to the econom- ic meltdown. In six concise chapters, Financial Fiasco tells the com- plex story of the crisis, showing how monetary policy, housing policy, and financial innovations combined to create financial catastrophe. The final two chapters describe the government’s mismanagement of the crisis and how we are now dangerously repeating many of the very same mistakes that caused it. An understanding of the roots of the financial crisis is crucial for every American who has felt its effects—and would like to prevent the same disaster from happening again. Financial Fiasco provides that understanding, with great insight, clarity, and wit. Just as important, Financial Fiasco serves as a pro- found warning against pursuing the wrong solutions. “After government authorities had helped create the worst financial crisis in generations, the climate of ideas has now shifted dramatically in the direction of bigger and more active government,” Norberg writes. Finan- cial Fiasco is the perfect antidote to those ideas, a cau- tionary tale on how to stop confusing the disease with the cure. U.S. $21.95 OTHER BOOKS AVAILABLE FROM THE CATO INSTITUTE In Defense of Global Capitalism BY JOHAN NORBERG Global Tax Revolution: The Rise of Tax Competition and the Battle to Defend It BY CHRIS EDWARDS AND DANIEL J. MITCHELL Cowboy Capitalism: European Myths, American Reality BY OLAF GERSEMANN JOHAN NORBERG is a senior fellow at the Cato Institute. His book In Defense of Global Capitalism has been published in more than 20 countries. He wrote and hosted “Globalisation Is Good,” a documentary for Channel Four in Britain. He lives in Stockholm. Johan Norberg exposes the abiding hypocrisies of policy that generated this crisis far better than an American insider could. A masterwork in miniature. —AMITY SHLAES SENIOR FELLOW IN ECONOMIC HISTORY, COUNCIL ON FOREIGN RELATIONS, A UTHOR, THE FORGOTTEN MAN: A NEW HISTORY OF THE GREAT DEPRESSION You don’t have to be an economist to gain a clear understanding of the diverse forces that produced the financial fiasco that Johan Norberg describes: lax monetary policy by the Federal Reserve System, overpromotion of homeownership by the government and government agencies, and transformation of the mortgage loan industry into an issuer of securities backed by a pool of mortgages of varying quality. The result is the collapse of the asset price boom in house prices, loss of wealth, and a dysfunctional financial credit market. —ANNA J. SCHWARTZ COAUTHOR, A MONETARY HISTORY OF THE UNITED STATES This highly readable book, by a historian, gives an unbiased explanation of the various factors leading to the financial meltdown, and says that if we’re looking for scapegoats, we need only to take a look in the mirror. Norberg has done a yeoman’s job in economic diagnostics. Whether the American people want to take the necessary treatment is another question. —WALTER E. WILLIAMS JOHN M. OLIN DISTINGUISHED PROFESSOR OF ECONOMICS, GEORGE MASON UNIVERSITY Financial Fiasco is a penetrating and frightening analysis of the causes and consequences of the 2008 financial panic. Norberg lays out with precision and detail how a perfect storm of misguided government policies and private-sector exuberance combined to create the worst economic downturn since World War II. This is essential reading for everyone who cares about our economic future, but especially for those who are still not sure what caused the crisis. As Norberg makes clear, private forces jumped willingly on a runaway train, but it was government that built the train and drove it off a cliff. —JEFFREY MIRON SENIOR LECTURER IN ECONOMICS, HARVARD UNIVERSITY “ “ “ “ “ “ “ “ 18634_DustJacket-R2.qxd:18634_DustJacket-R2 7/28/09 9:56 AM Page 1 DISTRIBUTED TO THE TRADE BY NATIONAL BOOK NETWORK WWW .NBNBOOKS.COM CATO INSTITUTE 1000 MASSACHUSETTS AVE., N.W. WASHINGTON, D.C. 20001 WWW.CATO.ORG CATO INSTITUTE 1000 MASSACHUSETTS AVE., N.W. W ASHINGTON, D.C. 20001 WWW.CATO.ORG “T he story of this storm in the global markets is the story of how government intervention to solve previous crises laid the foundation for a new one,” writes Johan Norberg in this important new book. Tracing the causes of our current financial crisis with liveliness and clarity, Financial Fiasco shows the mistakes made in Washington, on Wall Street, and in communities across America that led to the eco- nomic meltdown. While many analyses of the crisis have placed the blame solely on Wall Street, Norberg exposes the crucial role government regulation played in creating the opportunities and incentives that led to the econom- ic meltdown. In six concise chapters, Financial Fiasco tells the com- plex story of the crisis, showing how monetary policy, housing policy, and financial innovations combined to create financial catastrophe. The final two chapters describe the government’s mismanagement of the crisis and how we are now dangerously repeating many of the very same mistakes that caused it. An understanding of the roots of the financial crisis is crucial for every American who has felt its effects—and would like to prevent the same disaster from happening again. Financial Fiasco provides that understanding, with great insight, clarity, and wit. Just as important, Financial Fiasco serves as a pro- found warning against pursuing the wrong solutions. “After government authorities had helped create the worst financial crisis in generations, the climate of ideas has now shifted dramatically in the direction of bigger and more active government,” Norberg writes. Finan- cial Fiasco is the perfect antidote to those ideas, a cau- tionary tale on how to stop confusing the disease with the cure. U.S. $21.95 OTHER BOOKS AVAILABLE FROM THE CATO INSTITUTE In Defense of Global Capitalism BY JOHAN NORBERG Global Tax Revolution: The Rise of Tax Competition and the Battle to Defend It BY CHRIS EDWARDS AND DANIEL J. MITCHELL Cowboy Capitalism: European Myths, American Reality BY OLAF GERSEMANN JOHAN NORBERG is a senior fellow at the Cato Institute. His book In Defense of Global Capitalism has been published in more than 20 countries. He wrote and hosted “Globalisation Is Good,” a documentary for Channel Four in Britain. He lives in Stockholm. Johan Norberg exposes the abiding hypocrisies of policy that generated this crisis far better than an American insider could. A masterwork in miniature. —AMITY SHLAES SENIOR FELLOW IN ECONOMIC HISTORY, COUNCIL ON FOREIGN RELATIONS, A UTHOR, THE FORGOTTEN MAN: A NEW HISTORY OF THE GREAT DEPRESSION You don’t have to be an economist to gain a clear understanding of the diverse forces that produced the financial fiasco that Johan Norberg describes: lax monetary policy by the Federal Reserve System, overpromotion of homeownership by the government and government agencies, and transformation of the mortgage loan industry into an issuer of securities backed by a pool of mortgages of varying quality. The result is the collapse of the asset price boom in house prices, loss of wealth, and a dysfunctional financial credit market. —ANNA J. SCHWARTZ COAUTHOR, A MONETARY HISTORY OF THE UNITED STATES This highly readable book, by a historian, gives an unbiased explanation of the various factors leading to the financial meltdown, and says that if we’re looking for scapegoats, we need only to take a look in the mirror. Norberg has done a yeoman’s job in economic diagnostics. Whether the American people want to take the necessary treatment is another question. —WALTER E. WILLIAMS JOHN M. OLIN DISTINGUISHED PROFESSOR OF ECONOMICS, GEORGE MASON UNIVERSITY Financial Fiasco is a penetrating and frightening analysis of the causes and consequences of the 2008 financial panic. Norberg lays out with precision and detail how a perfect storm of misguided government policies and private-sector exuberance combined to create the worst economic downturn since World War II. This is essential reading for everyone who cares about our economic future, but especially for those who are still not sure what caused the crisis. As Norberg makes clear, private forces jumped willingly on a runaway train, but it was government that built the train and drove it off a cliff. —JEFFREY MIRON SENIOR LECTURER IN ECONOMICS, HARVARD UNIVERSITY “ “ “ “ “ “ “ “ 18634_DustJacket-R2.qxd:18634_DustJacket-R2 7/28/09 9:56 AM Page 1 FinancialFiasco_BG_IntroPages 6/4/09 4:00 PM Page 1 FinancialFiasco_BG_IntroPages 6/4/09 4:00 PM Page 1 WASHINGTON, D.C. FinancialFiasco_BG_IntroPages 6/4/09 4:00 PM Page 2 Copyright © 2009 by Cato Institute. All rights reserved. Library of Congress Cataloging-in-Publication Data Norberg, Johan, 1973– Financial fiasco : how America’s infatuation with homeownership and easy money created the economic crisis / Johan Norberg. p. cm. Includes bibliographical references and index. ISBN 978-1-935308-13-3 (alk. paper) 1. Home ownership—Government policy—United States. 2. Financial crisis— United States—History—21st century. 3. Keynesian economics. I. Title. HD7287.82.U6UN67 2009 330.973—dc22 2009026629 Cover design by Jon Meyers. Printed in the United States of America. C ATO INSTITUTE 1000 Massachusetts Ave., N.W. Washington, D.C. 20001 www.cato.org A : 18115$CHFM 07-23-09 11:56:46 Page iv (4) – no folio Layout: 16567 : 804 For Alexander —who will look back on these as the good old days. A : 18115$CHFM 07-06-09 14:40:32 Page v (5) Layout: 18115 : 905 A : 18115$CHFM 07-06-09 14:40:32 Page vi (6) – no folio Layout: 18115 : 904 We will not have any more crashes in our time. I find the markets very interesting, and the prices low. So where should a crisis come from? —John Maynard Keynes, 1927 The most common beginning of disaster was a sense of security. —Marcus Velleius Paterculus, Compendium of Roman History A : 18115$CHFM 07-06-09 14:40:33 Page vii (7) Layout: 18115 : 905 A : 18115$CHFM 07-06-09 14:40:33 Page viii (8) Layout: 18115 : 908 [...]... three chapters deal with the prelude to the crisis the various factors that then meet in chapter 4 and reinforce one another into an historic financial chaos whose consequences I describe in chapters 5 and 6 Chapter 1: Monetary policy How the U.S central bank (the Fed) and the surpluses of fast-growing emerging economies made money cheaper than ever in the past decade, and why that money ended up in... quickly, and the ink of the magazines warning of a repeat of the Great Depression had hardly dried before the economy had shaken off the stock market crash and was back on track A hero had been born With Greenspan at the helm, the Fed used the same modus operandi whenever crisis loomed: quickly cut the benchmark rate and pump liquidity into the economy That is what it did at the time of the Gulf War, the. .. Mexican peso crisis, the Asian crisis, the collapse of the Long-Term Capital Management hedge fund, the worries about the millennium bug, and the dot-com crash and on each occasion, commentators were surprised by the mildness of the subsequent downturn In someone with Greenspan’s clear-cut opinions about the importance of free markets, this readiness to throw money at all problems was surprising However,... interest on the money they borrowed; at the end of the year, they could get away with 1.75 percent and they would not have to pay more until almost three years later But this was not enough for the Fed, and the market players were clamoring for more to cope with the downturn Basically, this desire to help the economy squares well with the task that the Fed has been given by Congress Unlike most other central... back out of the country at the first whiff of a crisis The straw that finally broke the camel’s back was the deep Asian crisis in 1997, when the Western world and the International Monetary Fund forced the countries hit by the crisis to meet humiliating requirements if they were to get any help Many Asian countries decided then and there never again to be dependent on the generosity of the outside... more money into the economy, which also held the long-term rate down The belief that only external factors control the long-term rate is incorrect Research in recent years shows that the Fed’s adjustments to short-term rates strongly influence rates on 1 0- and 30-year loans as well.31 In other words, the choices made both by the Fed and by developing countries played a large part in causing 10-year... depending on how hard it was to build new homes there The economist Paul Krugman, who is usually no enemy of economic regulation, wrote in August 2005 that from the perspective of housing policy, the United States consists of two different countries: one in the middle 7 FINANCIAL FIASCO and the other along either side In the inland region, or ‘‘Flatland,’’ building is fairly simple and cheap, and no housing... politicians and businesspeople who use the ‘‘perfect storm’’ metaphor for this crisis do so to explain its catastrophic consequences They believe they took all the necessary precautions and sailed their ships the way they should, but that they happened to find themselves in a storm beyond their control As a result, they cannot take responsibility for the losses and problems that have arisen However, my... loans and then lend the money long term, but doing so always involves large risks because the people you have borrowed from 4 Preemptive Keynesianism short-term may suddenly decide that they want their money back (or that they will not renew your short-term loan) while you have passed on that money to others and promised them they will not have to repay you for a long time As Greenspan admitted, the. .. their economies going But in the first years of the 21st century, that changed quickly, and China and the oil exporters in particular began to save their surpluses In 2004, they amassed $400 billion of financial capital, and two years later they topped $600 billion Most of those savings they exported to the United States by buying Treasuries, causing the price of money there the interest rate—to stay . Congress Cataloging-in-Publication Data Norberg, Johan, 1973– Financial fiasco : how America’s infatuation with homeownership and easy money created the economic crisis / Johan Norberg. p. cm. Includes. over the world are losing their jobs, their busi- nesses, and their homes and yet what we have seen so far is just the beginning of the recession. We are experiencing the first global financial crisis. ope- randi whenever crisis loomed: quickly cut the benchmark rate and pump liquidity into the economy. That is what it did at the time of the Gulf War, the Mexican peso crisis, the Asian crisis,