Weisberg: Blame the Libertarians

A source of mild entertainment amid the financial carnage has been watching libertarians scurry to explain how the financial crisis is the result of too much government intervention, not too little. One line of argument casts as villain the Community Reinvestment Act, which prevents banks from "redlining" minority neighborhoods as not creditworthy. Another theory blames Fannie Mae and Freddie Mac for subsidizing and securitizing mortgages with an implicit government guarantee. An alternate thesis is that past bailouts encouraged investors to behave recklessly in anticipation of a taxpayer rescue. But libertarian apologists fall wildly short of providing any convincing explanation for what went wrong. Like all true ideologues, they interpret mounting evidence of error as proof that they were right all along.

To which the rest of us can only respond: haven't you people done enough harm already? We have narrowly avoided a global depression and are mercifully pointed toward merely the worst recession in a long while. This is thanks to an economic meltdown made possible by libertarian ideas. I don't have much patience with the notion that trying to figure out how we got into this mess is somehow pointless—Sarah Palin's view of global warming. As with any failure, inquest is central to improvement. And any competent forensic work has to put the libertarian theory of self-regulating financial markets at the scene of the crime.

More specific: In 1997–98, the global economy was rocked by a series of cascading financial crises in Asia, Latin America and Russia. Perhaps the most alarming moment was the failure of a giant, super-leveraged hedge fund called Long-Term Capital Management, which threatened the solvency of financial institutions that served as counterparties to its derivative contracts (much like Bear Stearns and Lehman Brothers this year). After LTCM's collapse, it became clear to anyone paying attention to this unfortunately esoteric issue that unregulated credit-market derivatives posed risks to the global financial system and that supervision was advisable. This was a very scary problem and a very boring one—a hazardous combination.

Neglecting to prevent the Crash of '08 was a sin of omission—less the result of deregulation, per se, than of disbelief in financial regulation as a legitimate mechanism. At any point from 1998 on, Bill Clinton, George W. Bush, their administrations or congressional leaders with oversight authority might have stood up and said, "Hey, I think we're in danger and need some additional rules here." Had the advocates of prudent regulation been more effective, there's an excellent chance that the subprime debacle would not have turned into a raging financial inferno.

This wasn't just a collective failure. Three officials, more than any others, have been responsible for preventing effective regulatory action for a period of years: Alan Greenspan, the oracular former Fed chairman; Phil Gramm, the heartless former chairman of the Senate Banking Committee; and Christopher Cox, the unapologetic chairman of the Securities and Exchange Commission. Blame Greenspan for making the case that the exploding trade in derivatives was a benign way of hedging against risk. Blame Gramm for making sure derivatives weren't covered by the Commodity Futures Modernization Act. Blame Cox for championing Bush's policy of "voluntary" regulation of investment banks at the SEC.

Cox and Gramm are often accused of being in the pocket of the securities industry. That's not entirely fair; these men took the hands-off positions they did because of their political philosophy, which holds that markets are always right and governments always wrong to interfere. They share with Greenspan, the only member of the trio who openly calls himself a libertarian, an aversion to any infringement of the right to buy and sell. That belief, which George Soros calls "market fundamentalism," best explains how permissive lending standards during a boom led to a global calamity that spread so far and so fast.

The best thing you can say about libertarians is that, because their views derive from abstract theory, they tend to be principled and rigorous in their logic. Those outside of government at places like the CATO Institute and Reason magazine are just as consistent in their opposition to government bailouts as to the kind of regulation that might have prevented one from being necessary. "Let failed banks fail" is the purist line. This approach would deliver a wonderful lesson in personal responsibility, creating thousands of new jobs in the soup kitchen and food-pantry industry.

The worst thing you can say about libertarians is that they are intellectually immature, frozen in the worldview many of them absorbed from Ayn Rand. Like other ideologues, libertarians react to the world failing to conform to their model by asking where the world went wrong. Their heroic view of capitalism makes it difficult for them to accept that markets can be irrational, misunderstand risk and misallocate resources—or that financial systems without vigorous government oversight constitute a recipe for disaster. They are bankrupt, and this time, there will be no bailout.