[StBernard] Flawed Logic

[Westley Annis]

Flawed Logic
Brian S. Wesbury and Robert Stein 05.12.09, 12:01 AM ET


Both Robert Kuttner, a long-time critic of free markets, and Richard Posner,
a long-time supporter of free markets, recently made the same argument. 

Kuttner said "markets are not self-correcting. If they were, [then] Wall
Street would not be lined up for trillions of dollars in government
handouts." Posner, in a recent Wall Street Journal editorial, said
capitalism is "not inherently stable." He argued that the seriousness of the
downturn--which he says it is the worst since the 1930s--is proved "by the
dizzying array of programs the government is deploying and the staggering
amounts of money it is spending."

This if-then argument--"if the government is spending lots of money, then
the economy must really be bad and markets don't work"--has been made by
many analysts in recent months. But just because it is being used in
prominent places does not mean it is right. In fact, these statements of
logic are deeply flawed and mistaken.

If fire trucks came roaring up to your house, and the firemen started
spraying water, breaking out windows and chopping holes in the roof, one
would think the house was on fire. But it doesn't have to be.

Activity alone is not proof. Just because the government has gone nuclear
does not mean that it was necessary.

With all due respect to Richard Posner, this is not the worst economic
crisis since the Great Depression. In fact, it is probably no worse that the
banking crisis of the 1980s and 1990s, when agricultural leverage, oil loans
and recycled petro-dollar lending to Latin America went bad all at once. The
losses were so bad that, on a mark-to-market basis, every money center bank
(those that lend to governments and large companies rather than just smaller
companies and consumers) was bankrupt in the early 1980s. At the same time,
because Paul Volcker pushed short-term interest rates well above long-term
rates, banks and S&L's were paying more for deposits than they were earning
on loans.

Eventually, between 1980 and 1995, 3,000 financial institutions went
bankrupt. But these bankrupt banks and savings and loans did not destroy the
economy. The government gave banks time to work out their problematic loans.
Meanwhile, the Reagan tax cuts sparked growth, and the economy eventually
grew its way out of the worst of it. The Resolution Trust Corporation was
finally put into place in the late 1980s to clean up the banks that just
could not dig their own selves out of the mess.

In other words, the Bush and Obama teams have done things that the Reagan
administration would have never done. Mark-to-market accounting rules have
significantly increased the size of financial market problems. Then, when
mark-to-market rules forced banks to the brink, the government used this
manufactured problem to justify its heavy hand of regulation and control.
The stress tests were just another chapter in this saga. Government
involvement begets more government involvement.

In response to all of this, we propose a different argument, using different
logic. If the government had not involved itself so deeply in this crisis,
then the U.S. economy would most likely have avoided a recession altogether.


Capitalism is not broken. Laissez-faire is still the best, self-correcting
system of economic organization. Allowing the market system to deal with the
problems of the last few years would have been much better than having the
government do it.

In fact, it's almost as if the government has committed arson, disabled the
internal sprinkler system and is now claiming that the building owners are
liable for the amount it costs to put out the fire.

Brian S. Wesbury is chief economist, and Robert Stein senior economist at
First Trust Advisors in Wheaton, Ill. They write a weekly column for Forbes.