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Obama's reform: Systemic danger once again

Obama is rushing to blame a mythical "free-wheeling" market for the economic crisis. But the truth is that the blame rests with the state, and with government intervention into the economy.

Pierre Lemieux - June 24, 2009

Transactions in securities “are affected with a national public interest which makes it necessary to provide for regulation and control... and to impose requirements necessary to make such regulation and control reasonably complete and effective... in order to... insure the maintenance of fair and honest markets”. The text explains how such intervention is required to face “[n]ational emergencies, which produce widespread unemployment and dislocation of trade... and adversely affect the general welfare”.

Last week, U.S. president Barak Obama presented his plan for financial regulatory reform, but the quotes above are not taken from there. Instead, they come from section 2 of the Securities Exchange Act of 1934, under Franklin D. Roosevelt’s administration. Seventy-five years later, Obama appears to have a similar approach in proposing (and here I quote Obama) “a set of reforms that require regulators to look not only at the safety and soundness of individual institutions, but also -- for the first time -- at the stability of the financial system as a whole”.

This is not the first time a systemic regulatory reform is introduced, we have
gone through this before.

The Great Depression started in 1929 and bottomed out in 1933, but economic activity did not return to its pre-depression levels until the Second World War. Government intervention deepened the recession in many ways, whether under President Herbert Hoover or his successor Franklin D. Roosevelt, who arrived in the White House in early 1933. The protectionist Smoot-Hawley Act of 1930 is widely blamed for worsening what could have been an ordinary recession. The U.S. federal government increased taxes in 1932, with similar effects. The same year, it created the Reconstruction Finance Corporation -- the Troubled Assets Relief Program (TARP) of the times. It bullied large companies into not reducing wages, thereby worsening and hiding unemployment. A host of controls -– in agriculture, finance, etc. -– as well as pro-union legislation slowed the rapid economic adjustments that would have been required to escape the recession. And the Federal Reserve System made everything worse by reducing the money supply, as the path-breaking work of Milton Friedman and Anna Schwartz has showed. You have there all the ingredients for transforming a recession into a deep depression.

In fact, Hoover had started the New Deal even before Roosevelt coined the term. Just as today, Hoover believed in “ample supply of credit at low interest rates” (although the Fed apparently did not follow), and in stimulus through public works. He boasted that he had “met the situation with the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic.”

The late Murray Rothbard argued that the recession itself was a product of the reckless increase of the money supply in the 1920s. Whether this is true or not, it is difficult to deny that government intervention had much advanced since the beginning of the 20th century. The creation of the Federal Reserve System in 1913 is symbolic of a phenomenon that was everywhere apparent. Between 1901 and 1928, federal expenditures were multiplied more than fivefold.

Herbert Hoover's and Franklin D. Roosevelt’s policies more than doubled federal expenditures between 1928 and 1938. Many of the laws and institutions involved in the housing and mortgage market that started the current mess were created as part of the New Deal, including the Federal Home Loan Bank Act of 1932, Fannie Mae in 1934, and the 1938 amendments to the National Housing Act. Americans (and subjects of other states who have followed American regulatory fashions) are labouring under the Securities Act of 1933 and the Securities Exchange Act of 1934 and their constant expansion over time. For example, the Securities Exchange Act has gone from its original 30 pages to 259 pages in 2004.

Note that all this growth in government power did not prevent the current crash.

More articles by Pierre Lemieux