The policies and legislation in question encouraged or required financial institutions to give loans and mortgages to customers who were manifestly unable and unfit to repay. This money was lent primarily for the purpose of buying houses. The inevitable and foreseeable result was a wave of defaults and foreclosures: individuals and families unable to pay their monthly amounts.
As the number of defaults and foreclosures increased, the banks and other institutions who’d lent the money and who now were unable to get it back, were left with little or nothing, and went bankrupt. The number of lenders going bankrupt grew, and the size of the institutions going bankrupt grew. The pattern culminated in the bankruptcy of Lehman Brothers.
Lehman Brothers was a major company. It had more than 26,000 employees and over $600 billion in assets.
Naturally, some observers were surprised, shocked, or worried. They assumed that the bankruptcy of a major company would cause trouble for the economy. They were wrong. They had forgotten the economic principle of “creative destruction.”
It is easy to assume that, if a large corporation goes bankrupt, that this will create problems like unemployment, inventory shortages, etc.
This assumption ignores the fact that when a business fails and collapses, it creates opportunities for new businesses which are better, more effective, more efficient, bigger, more profitable, and more adapted to the marketplace. The end of an old business creates space for a new business.
Metaphors may be useful in understanding this concept: One demolishes an old building in order to construct a new, better, larger building; one cuts down some old trees in a forest in order to plant younger and healthier trees.
A bankruptcy can create short term dislocation, like temporary unemployment and a dip in the stock market. In the long run, however, it can create more jobs than it destroyed, and better-paying jobs with better chances for advancement, resulting in a net increase in prosperity. In many scenarios, workers who are laid off eventually find employment at higher wages than the job they lost. The stock market, likewise, will not only recover from a downtick, but eventually go even higher in the wake of bankruptcy.
This principle is associated with a broad variety of economists: Joseph Schumpeter, Karl Marx, Werner Sombart, etc.
Adherence to this principle would have directed that the government, in the wake of the Lehman Brothers collapse, should have refrained from any intervention, and allowed the next two companies in line to go bankrupt as well: Goldman Sachs and Morgan Stanley. Had they gone bankrupt, their workers would have found new jobs at higher wages, the stock market would have recovered from a drop and gone on to new highs, and general prosperity would have increased.
Sadly, various elected and appointed leaders in government forgot this basic principle — or never knew it to begin with.
Congress passed several pieces of legislation, primarily the Troubled Asset Relief Program (TARP) and the Emergency Economic Stabilization Act of 2008. These legislations gave billions of dollars to companies which were in danger of going bankrupt. In addition to Goldman Sachs and Morgan Stanley, other companies soon asked for help, including Citigroup, Chrysler, American Express, and many others. The money given to these businesses came from two sources: either it was confiscated from ordinary American citizens by means of taxes, or it was borrowed, and ordinary American citizens will be required to repay this money by means of taxes.
Instead of allowing these corporations to go bankrupt — and only a few of them would have done so; the others simply asked for the money and got it — the TARP legislation kept them alive, but allowed them to remain inefficient and irresponsible. Had they gone out of business, new and more productive companies would have arisen in their places.
The end result was higher taxes for ordinary people, and debts which will have to be repaid with even more higher taxes.
This colossal misjudgment was made possible by government officials who were ignorant of basic economic principles, or who ignored them, or who forgot them.
David Stockman was a U.S. Congressman and later Director of the Office of Management and Budget. Concerning TARP, he points out that many government officials understood why it was wrong:
Certainly President Eisenhower’s treasury secretary and doughty opponent of Big Government, George Humphrey, would never have conflated the future of capitalism with the stock price of two or even two dozen Wall Street firms. Nor would President Kennedy’s treasury secretary, Douglas Dillon, have done so, even had his own family’s firm been imperiled. President Ford’s treasury secretary and fiery apostle of free market capitalism, Bill Simon, would have crushed any bailout proposal in a thunder of denunciation. Even President Reagan’s man at the Treasury Department, Don Regan, a Wall Street lifer who had built the modern Merrill Lynch, resisted the 1984 bailout of Continental Illinois until the very end.
As David Stockman shows, this was not a “Democrat” issue or a “Republican” issue. It was an issue about the basic principles of economics. A free market must be allowed to find its own way to an equilibrium.
The women and men who promoted TARP were in many cases people of good will: they legitimately wanted to help. But even well-intentioned governmental interventions in a free market economy are harmful.
The economy organically works toward an equilibrium, and at that equilibrium point lies maximal prosperity for all. The blind forces of demand and supply distribute better wages and higher standards of living to everyone in the marketplace, from the smallest to the largest.
Statist intervention in markets can only prevent the economy from achieving the best results for everyone.
