How Did We Get into
This Financial Mess?
by Lawrence H. White
No. 110
November 18, 2008
Executive Summary
wise rein in their hyperexpansion, instead pushing
As policymakers confront the ongoing U.S.
them to promote "affordable housing" through
financial crisis, it is important to take a step back
expanded purchases of nonprime loans to low-
and understand its origins. Those who fault
income applicants.
"deregulation," "unfettered capitalism," or "greed"
The credit that fueled these risky mortgages
would do well to look instead at flawed institu-
was provided by the cheap money policy of the
tions and misguided policies.
Federal Reserve. Following the 2001 recession,
The expansion in risky mortgages to under-
Fed chairman Alan Greenspan slashed the fed-
qualified borrowers was encouraged by the federal
eral funds rate from 6.25 to 1.75 percent. It was
government. The growth of "creative" nonprime
reduced further in 2002 and 2003, reaching a
lending followed Congress's strengthening of the
record low of 1 percent in mid-2003--where it
Community Reinvestment Act, the Federal Hous-
stayed for a year. This set off what economist
ing Administration's loosening of down-payment
Steve Hanke called "the mother of all liquidity
standards, and the Department of Housing and
cycles and yet another massive demand bubble."
Urban Development's pressuring lenders to extend
The actual causes of our financial troubles
mortgages to borrowers who previously would not
were unusual monetary policy moves and novel
have qualified.
federal regulatory interventions. These poorly
Meanwhile, Freddie Mac and Fannie Mae grew
chosen policies distorted interest rates and asset
to own or guarantee about half of the United
prices, diverted loanable funds into the wrong
States' $12 trillion mortgage market. Congression-
al leaders pointedly refused to moderate the moral
investments, and twisted normally robust finan-
hazard problem of implicit guarantees or other-
cial institutions into unsustainable positions.
Lawrence H. White is the F. A. Hayek Professor of Economic History at the University of MissouriSt. Louis and an adjunct
scholar at the Cato Institute. He is the author of Competition and Currency, Free Banking in Britain, and The Theory of
Monetary Institutions.
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