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Overview

In the seventeenth century, a single tulip from Holland was worth more than ten times the annual salary of an unskilled laborer. The value of that particular flower rose so high that it caused a speculative frenzy among people who bought and sold them for large sums of money. This resulted in a crash when the prices fell back down to earth.

This sounds familiar, doesn’t it? Markets have been unstable since the tulip mania of the 17th century. In 2008, millions lost their jobs and homes during a global financial crisis that shook everyone’s confidence in markets.

The world is still recovering from the Great Recession. Economists warn that another crisis may occur in the future, and they don’t know when it will happen. There has to be a better way! This article discusses how we got into this mess and how we can fix it.

The US government is to blame for the 2008 economic crisis. An Austrian economic theory can explain past and present busts, and suffering a bankruptcy isn’t that bad because you can learn from it.

Big Idea #1: Deregulation and free markets didn’t cause the last financial crisis – government regulation did.

It’s common to hear people say that the government should be more involved in fixing the economy after a crisis. They think that this will solve all of our problems. But is it possible that government, which is supposed to fix things, actually caused the economic collapse? Let’s take a closer look at what happened. In 1999, Fannie Mae and Freddie Mac started a program called “The Affordable Housing Program,” which gave mortgages to low-income families who wouldn’t otherwise have been able to afford them.

The government created a plan to help people buy homes even if they had no money. They made new rules that allowed brokers to give loans with zero down payments and called them safe. The government also gave these risky mortgages their stamp of approval by calling them creditworthy when they were not.

Agencies that were supposed to be regulating the mortgage market didn’t want to call these mortgages risky. So, they tried their best not to do so and reassured the public as much as possible.

But the Federal Reserve is not to blame for the crisis. In fact, Fannie Mae and Freddie Mac are responsible as well. Here’s how:

In the early 2000s, interest rates were slashed to nearly zero by printing tons of money. This caused a housing boom and people bought homes at inflated prices. Investors hoped that they could get rich overnight so they piled into the market.

Home prices were rising, so a lot of people decided to buy homes. However, this was unsustainable because home values kept going up and speculators were buying houses without making any down payments. When the housing market collapsed in 2006, there were many foreclosures on homes that had been bought by speculators who walked away from their mortgages when they realized how much money they owed on their properties. The mortgage-backed securities market also fell apart because investors lost confidence in those products after seeing what happened with subprime mortgages.

The housing bubble burst because of reckless government policies that enabled people to spend money they didn’t have.

Big Idea #2: To understand the roots of the current crisis, we need to look at Hayek’s business cycle theory.

Friedrich Hayek, a Nobel Prize winner for economics, developed an economic theory that applies to both the most recent economic crisis and other major catastrophes in history. It’s called the business cycle theory.

The business cycle theory is based on the effects of government-suppressed interest rates. Since artificially decreased interest rates make people believe that more can be made for less, they start investing in projects not supported by their real savings.