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THE SUBPRIME CRISIS

THE SUBPRIME CRISIS

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Published by Adrián Ravier
This article offers an analysis of the causes of the subprime crisis, explaining that it is not an isolated incident and that we should concentrate our attention on the Fed’s monetary policy and pressures on the banking system received from the U.S. government for flexible lending. It also critically examines the Fed’s exit strategy and fiscal policies that the government is taking to create jobs and stimulate the economy. We conclude that it should be no surprise if the U.S. economy should fall into a new cycle in the coming years, even though economics does not provides the tools to predict the precise timing of it.
This article offers an analysis of the causes of the subprime crisis, explaining that it is not an isolated incident and that we should concentrate our attention on the Fed’s monetary policy and pressures on the banking system received from the U.S. government for flexible lending. It also critically examines the Fed’s exit strategy and fiscal policies that the government is taking to create jobs and stimulate the economy. We conclude that it should be no surprise if the U.S. economy should fall into a new cycle in the coming years, even though economics does not provides the tools to predict the precise timing of it.

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Published by: Adrián Ravier on Sep 30, 2012
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11/30/2012

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45
T
he
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ubprime
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riSiS
A
driAn
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Avier
 
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ewin
ABSTRACT 
: This article ers an analysis f the causes f the subprimecrisis, explainin that it is nt an islated incident and that we shuldcncentrate ur attentin n the Fed’s mnetary plicy and pressuresn the bankin system received frm the U.S. vernment fr exiblelendin. It als critically examines the Fed’s exit stratey and scalplicies that the vernment is takin t create jbs and stimulate theecnmy. We cnclude that it shuld be n surprise if the U.S. ecnmyshuld fall int a new cycle in the cmin years, even thuh ecnmicsdes nt prvides the tls t predict the precise
timing
f it.
KEYWORDS
: housing bubble, Federal Reserve, savings, deregu
-
lation, Austrian, business cycle, Keynes, Leijonhufvud
 JEL CLASSIFICATION 
: B25, E32, E58, N12
Adrian Ravier (aravier@ufm.edu) btained his PhD in Ecnmics at the Universityf Rey Juan Carls in Madrid and is Prfessr f Ecnmics in the Schl f Business at the Francisc Marrquín University (UFM). Peter Lewin (plewin@utdallas.edu) btained his PhD in Ecnmics at the University f Chica and isClinical Prfessr f Ecnmics at the University f Texas at Dallas.
VoL. 15 | N
o.
1 | 45–74
 
SPRINg 2012
The
Q
uArterLy
  J
ournAL
 
f 
 
A
ustriAn
 
e
conomics
 
46
The Quarterly Jurnal f Austrian Ecnmics 15, N. 1 (2012)
IntroductIon
A
xel Leijnhufvud, an ecnmist knwn internatinally fr hiswrk n the literature f Jhn Maynard Keynes and Keynes
-
ianism (Leijnhufvud, 1968), has suested that the subprime crisisf 2008 mre clsely ts the Austrian business cycle thery f Ludwivn Mises and Friedrich Hayek, than the Keynesian framewrk.
1
In this paper, we prvide evidence fr that claim. Mre specif 
-
ically, we assert the fllwin:1) that the subprime crisis, r the “husin-bubble” is nt anislated incident. Rather, it is ne f a number f related eventswhse riins can be fund in the mnetary plicy that the Fed hasadpted at least since 1980;2) that when we cncentrate n the mst recent cycle, (Kruman,2002), we nd that the Fed intentinally replaced the dt-cm bubble with a husin bubble, expandin the mney supply at arate f 10 percent (measured by M2), and reducin real interestrates t lw fr t ln;3) that greenspan-Bernanke, n behalf f the Fed, asserted,withut fundatin and cntrary t the evidence, that the crisiswas nt rted in the plitics f the institutin they lead, but wasrather a lbal phenmenn, a “savins lut,” which reduced theln-term interest rate naturally;4) that the ppular explanatin that blames the dereulatinf markets as a cause f the crisis, is als unfunded. In fact, the bankin system is ne f the mst reulated sectrs in the U.S.ecnmy. It was, in fact, the excessive reulatin f the system,which channeled the easy mney plicy f the Fed int real estate,thus distrtin the physical capital structure f the ecnmy;5) that the bm we have seen in the husin sectr started between 2001 and 2004, and culd nly have persisted as ln asthe Fed was able and willin t keep interest rates lw, a plicywhich risks the precipitatin f eneral price inatin. In theface f this threat, the Fed nally raised interest rates, bwin tmarket pressure as the demand fr lanable funds increased. This
1
After prvidin a summary f his understandin f the current crisis Leijnhufvud(2008) arues: “This, f curse, des nt make a Keynesian stry. It is rather avariatin n the Austrian verinvestment theme.”
 
47
Adrian Ravier and Peter Lewin: The Subprime Crisis
prduced the inevitable deatin f the bubble and the nset f crisis and recessin, nt nly in the real-estate sectr, but als in the bankin-sectr which supprted it durin the bm;6) that the ln-term adjustment prcess invlvin as it desadjustin fundamental macrecnmic variables t underlyinecnmic realities has real and endurin cnsequences. Theseeects are nt “neutral.” Real capital value has been destryed inthe prcess;7) that while there is a cnsensus amn ecnmists abutexpandin the mnetary-base as the best “emerency stratey”when facin a pssible secndary cntractin, Bernanke culd haveavided micr-enineerin and the favritism and mral hazardthat it implies, and pted fr pen market peratins, rather thanthe selective rescue f sme lare cmpanies (thse that were “t bi t fail”);8) that accmpanyin the Fed’s mnetary plicy, the U.S.Treasury fllwed an expansinary scal plicy in an ert t bstemplyment and thus mitiate recessinary expectatins. But thescal decits that the federal vernment and state-vernmentshas and are accumulatin have nt delivered the prmisedemplyment increases. The scal crisis they have prducedprtend painful, but inevitable, adjustments—expansinary scalplicies cannt cntinue and will have t be reversed. We cncludethat it shuld be n surprise if the U.S. ecnmy shuld fall inta new cycle in the cmin years, even thuh ecnmics des ntprvides the tls t predict the precise
timing
f it.
1. tHE FEdErAL rESErVE durInG tHE 1980S And 1990S
In lkin fr the riin f the crisis f 2008, we shuld ntcnne ur attentin t the excesses f the Federal Reserve durinthe perid 2001–2006. This has been enerally the psitin takenin the recent writins f sme ecnmists f the Chica Schl(Anna Schwartz, 2009; Allan Meltzer, 2009). We suspect that thecnclusin these authrs reach is nly partially crrect. A cmpletecmprehensive study f the crisis must necessarily delve int themnetary plicy f the Federal Reserve in the late 1980s and the1990s (see Rer garrisn [2009a] and gerald o’Driscll [2009]).

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