Reflections on the 2008 Financial Crisis

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***excerpt from a paper on the causes and consequences of the 2008 financial crisis***

This paper has tried to demonstrate that government intervention and politics have had equally important roles in magnifying the devastating impact of the banking crisis in the United States and around the world, not just the alleged free market ideology and capitalist greed pervading private banking institutions at the time. Peter Schiff (2007) explains the outcomes quite succinctly when he observes:

“Economists today view the apparent overinvestment occurring during booms as mistakes made by businesses, but they don’t examine why those mistakes were made. As [Austrian School economist Ludwig von] Mises saw it, businesses were not recklessly overinvesting, but were simply responding to false economic signals being sent as a result of inflation.” (88)

Governments can send false signals to investors and commercial banks when they promise a safety net of capital relief in a crisis and take on the function of creditors to income brackets of the population that have already been labelled by the market as risky debtors. While it is important to help those less fortunate, at what point should social programs be considered more harmful than helpful in lifting people out of poverty and then teaching them to live beyond their means?

The problem with Keynesian thinking is its assumption that the U.S. government must be the “lender of last resort” to bail out investment banks with taxpayer dollars rather than to allow free market mechanisms to reward financial risk management and punish risky transactions. Bailouts lump taxpayers and shareholders into the same boat of punishment, paying for the consequences of massive private sector failures in order to save jobs. Unfortunately, bailouts can also reward executive officers and managers for terrible performance, damaging minority shareholder and consumer protections. Another Keynesian approach to solving the liquidity crisis might have considered re-distributing those billion-dollar bailouts to individual Americans or rewarding businesses who had prudently stayed away from risky financial behaviour. However, there is something to be said for the Austrian School’s acceptance of the inevitability of economic shocks and building resilience into existing systems.

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Schiff, Peter. (2007). Crash Proof: How to Profit from the Coming Economic Collapse. New Jersey: John Wiley & Sons.