Financial Crisis Caused by Government Regulation?

The best evidence is that the problem was triggered by previous government regulation combined with an unrealistic belief on the part of many people that housing prices could only go up. It is important to understand the cause because, if we do not, we are unlikely to choose good solutions. Indeed, the US federal government has, for the last few months, chosen one bad solution after another.

One cause we can rule out is greed. It is true that most people most of the time are greedy if, by “greedy,” we mean that they are pursuing their own self-interest.

That is, most people are out mainly to achieve their own goals and not the goals of strangers. So, if greed is such a constant, why is not it one of the causes? The answer is that it is because it is a constant. You cannot explain why something changed by pointing to something that is constant. To explain why something changed, we need to point to something else that changed.

As Donald Boudreaux, an economics professor at George Mason University, put it: “Saying that ‘greed’ caused today’s problems is like saying that gravity caused the death of someone pushed from the top floor of the Empire State building. Some things are sufficiently constant in human affairs–and self-interest, even greed, is among them – that they explain nothing.”

Indeed, one of the founders of economics, Adam Smith, in his famous book The Wealth of Nations argued not only that are people self-interested, but also that this self-interest causes them to do valuable things for their fellow humans. The most famous quote from The Wealth of Nations is Smith’s statement: “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own self-interest.”

We also can rule out deregulation. Although many people blame deregulation for the financial crisis, they do not make a clear, logical argument for their claim. The main deregulation that occurred during the run-up of house prices was the Gramm-Leach-Bliley Act of 1999, which repealed part of the 1933 Glass-Steagall Act and, thereby, allowed commercial banks and investment banks to merge. But there is no obvious connection between this 1999 deregulation and the problems that later happened in the housing sector.