Blaming Finance, Ignoring Real Causes

The fall 2014 Cato Journal has an article, ‘The Financial Crisis: Why the Conventional Wisdom Has It All Wrong,” [pdf] by Richard Kovacevich, Chairman Emeritus of Wells Fargo. The author is correct in saying that the conventional wisdom is wrong in blaming the slow recovery on the “uniqueness of a financially led economic recession.” The US economy recovered from the severe 1980 recession within two years, while now the economy is creeping like a turtle.

The economic cause of recovery and growth is simple. Economic investment – the production of capital goods – drives the business cycle. Recessions are caused by a sharp fall in investment. Then, as the prices of raw materials fall, and as land rent drops, a depression reduces these costs of production, therefore increasing profits, so investment recovers. Government can boost the recovery by further reducing the costs of production, by decreasing the taxes and regulations it imposed previously. This is the “supply side” policy of increasing investment and production by reducing the costs of regulations and taxes.

But this time around, the federal government did the opposite. Costly regulations have magnified, with an anti-supply-side effect. Every year, there are thousands more regulations that hamper enterprise, and finally, regulations plus taxes have achieved the tipping point of making it too costly for enterprise to invest and hire labor.

After the Crash of 2008, the federal government had two basic policy options: it could help the economy recover with market-enhancing supply-side policies, or else the government could enact the welfare-state agenda of greatly increased governmental medical services. The government chose the latter option, which imposed even greater costs on enterprise and labor.

When the recession hit the economy in 2008, one of the responses was TARP, the Troubled Asset Relief Program. As the article states, one of the problems with TARP was that it did not focus on the troubled banks, but imposed the policy on all banks. The banks that were not troubled had to obtain the funds and then pay interest on them. TARP imposed the impression that all banks were in trouble, which destroyed confidence, and then Congress responded to the turmoil by imposing 25,000 pages of Dodd-Frank regulations.

None of the financial regulations, going back to the Great Depression, confront the causes of the boom and bust. The fundamental cause is massive subsidies to land values. The Cato article focused on the financial industry, but the more fundamental issue is government policy regarding real estate. The problems of the financial industry originate in their financing of real estate.

The history of the Americas has been that of grabbing land and enslaving labor. In the American colonies, the British government promoted European settlement to control land and to profit from trade. After the defeat of the French in 1763, the United Kingdom changed policy to avoid conflict with the people of Quebec and with the Indians, by restricting western speculation and migration. That annoyed the landed interests enough to declare independence, and to establish a constitution that would better extend and protect land speculation. Huge grants of land were given to railroads, veterans, colleges, and speculators.

After the public domain was disposed of, the government continued the subsidy of the large landed interests with implicit policies that are invisible to the public and to most economists. The provision of public works, welfare to the poor and elderly, and artificially cheap credit, all generate greater land rent and land value. This amounts to a vast redistribution of wealth from workers, tenants, and enterprise owners, to landowners, especially the concentrated owners of commercial and farm land.

With a fixed supply of land, much of the gains from an economic expansion is captured by higher land rent and land value, which then attracts speculation that carries real estate prices to unsustainable heights. When land values crash, they bring down with them the financial system that provided the loans. None of the financial regulations touch this basic cause, and land-value seeking is so deeply ingrained in American culture that people favor it even at the price of high taxes, high unemployment, and the destruction of liberty.

Ask a typical American, “Would you favor a tax reform that eliminates taxes on your wages, on interest from your financial assets, and on buildings, replaced by a tax only on land values?” The answer is, “No! I would rather suffer unemployment, insecurity, crime, poverty, and loss of liberty, than have my precious land taxed!”

“OK, then, would you favor the complete replacement of government’s public goods with private, contractual, provision that eliminates the subsidy to land values?” “No! We need government to provide these things!”

Then you ask, “So why do you want the word ‘liberty’ put on our coins?” The answer is, “I want liberty so long as it is not put into practice!”

And that is why government deals with the superficial financial appearances, and not the implicit reality that causes the booms and busts.