The Evil That Good Men Do

Dolors & Sense

by Sanford Rose

KISSIMMEE FL—(Weekly Hubris)—3/21/11—People don’t cause recessions. Businesses don’t cause recessions.

Sure, we are all greedy and self-interested. But we, singly or in groups, are not powerful enough to do the wrecking job.

That work is done two levels above the common man by his alleged surrogates.

We elect presidents. They are mostly good men.

They appoint officials of the central bank. They are mostly good men.

The central bank causes recessions.

It’s as if, while we may strain to accomplish our own destruction, we can do so with the requisite thoroughness only remotely and by proxy, via the intercession of people who believe they are serving us.

That the job is done by this particular proxy is indubitable though, of course, the proposition is endlessly rebutted, both verbally and econometrically, by its representatives and apologists.

I hold no brief for conservatives, many of whom are not very good men. But they are right when they allege that the Federal Reserve caused the Great Recession of the last four years, much as it caused the Great Depression some 75 years earlier.

You cause a recession by selling a lot of government securities, driving up interest rates and paralyzing economic activity. You usually do so because you have bought too many securities when responding to the last recession. That lowers interest rates too much, overstimulating economic activity.

The Fed bought too much from 2002 to the beginning of 2004. It sold too much in the next two years.

Except for its “Golden Mean” years from the mid-1980s to the start of the millennium, the Fed has historically known only two speeds—too fast or too slow.

Leaning to counter the brief recession of the early 2000s (and mindful that the Japanese had entered a recession in the 1990s from which they seemed never to emerge), the Fed was far too easy.

The consequence was a vertiginous surge in home building and housing prices.

True, the Fed did not compel mortgage brokers and lenders to ignore sound underwriting standards. But in an environment of incredibly easy money and apparently endlessly rising prices, why worry about underwriting standards?

When prices are rising, there are few defaults since, normally, one can sell the house for more than the amount of the loan.

In this economic cycle, as in most others, micro-mistakes follow, and exacerbate, macro-mistakes.

They do not precede them.

First on the scene were those men of impeccable morality and commanding intelligence at the Fed.

What was their mistake? Perhaps to repose too much confidence in that morality and intelligence by deviating from a rules-based monetary policy, which had served the country well since the mid-1980s, to one based on judgment and discretion.

They wanted to do more good than was possible in the early part of the last decade. They were not only afraid of falling into the Japanese predicament. They were also alarmed by the trend toward fewer jobs per dollar of incremental US GDP.

And they were sure they had the brains and the knowledge to know when to stop exercising their discretion and return to a rules-based policy.

They didn’t.