There are other books on the financial crisis. Why, then, bother with this one? The answer is its author: few people have greater understanding of the financial crisis than John Allison. Mr. Allison has almost 40 years’ worth of experience in banking, including 19 years as the CEO for BB&T. During his time as CEO, BB&T’s assets grew from $4.5 billion to $152 billion. This made it into one of the largest banks in the US. It’s no mystery that he made it onto Harvard Business Review‘s list of the top 100 most successful CEOs in the world. His widely recognized achievements and understanding of the free market were both reasons he recently became the new president of the CATO Institute.
Mr. Allison’s experience in banking, particularly during the financial crisis, lends him credibility when he identifies government interference in the economy as the basic cause of the financial crisis. Indeed, BB&T didn’t engage in subprime lending precisely because Mr. Allison early on recognized subprime loans as a hazardous product of a banking system thoroughly distorted by regulations. As a matter of fact, Allison deems banking to be one of the most regulated industries in America—the primary regulator being the Federal Reserve.
The Federal Reserve is the central bank of the United States, a government entity whose authority to regulate interest rates, by increasing or decreasing the money supply, is enforced by the Federal Reserve Act of 1913. The Federal Reserve laid the foundation for the housing bubble in the early 2000s by keeping interest rates artificially low and thereby making borrowing unusually affordable. For a while interest rates were actually lower than the general rise in prices; in effect, people got paid to borrow money. No wonder, then, that people were eagerly taking on unprecedented levels of mortgage debt.
On the premise that homeownership was a “right,” government-sponsored entities Fannie Mae and Freddie Mac guaranteed loans for as many Americans as possible, including low-income families with little or no credit. Freddie and Fannie thereby created a new and growing market for these so-called subprime loans—precisely the sort of loans BB&T refused to give. Freddie and Fannie ended up guaranteeing loans worth trillions of dollars. Consequently, millions of Americans, including many low-income families, jumped on the homeownership bandwagon and began bidding up prices for houses. The housing bubble was born.
Other forms of government interference contributed to inflating the housing bubble. Allison cites, among others, the Federal Deposit Insurance Corporation. The FDIC encouraged banks to act irresponsibly by helping them realize that the government wouldn’t allow them to fail. For the same reason, most people wouldn’t and didn’t consider the reputation, track record or financial status of their banks. And while the FDIC encouraged some banks to act irresponsibly, the Community Reinvestment Act forced other banks to lend to low-income families who wouldn’t normally be able to afford it.
Fearing that they had already expanded the monetary supply too much, the Federal Reserve then raised the interest rates in 2004-2006. As expected, those who had been thinking about buying a house gave up that idea, because they now couldn’t afford a mortgage loan. For the same reason, many who for a time had been able to afford their mortgage loan were now instead forced to sell their house. Housing demand fell and so did housing prices: the housing bubble burst. The economy as a whole lost trillions of dollars. Soon, defaults on loans led to failed banks. This was the beginning of a long chain of events, leading up to the Great Recession.
So much for the assertion that the financial crisis was caused by the lack of regulations and government oversight. The free market isn’t to blame, since there is no free market to blame. The “fingerprints” of the real culprit—the government—are all over the place.
What, then, is the cure to our current predicament? A major part of the solution is to get the government out of banking. The Fed should not have the power to distort the interest rates by artificially increasing or decreasing the money supply. Interest rates should instead be determined by the market. The government shouldn’t guarantee loans or force banks to give loans to people with bad credit. Instead, the rational judgment and self-interest of the bankers—not anyone’s need or desire for a house—should determine who will get a loan for a house and under what conditions. Furthermore, the government should not insure anyone’s deposits. Each person should protect his deposit with his own rational judgment. If banks aren’t trustworthy, no one will deal with them and competing banks will win their business instead. This means that banks will have to earn the trust of their customers by spending years of building up a spotless reputation. Banks should not be bailed out by the government. If they make mistakes or act irrationally, they suffer the consequence, not the taxpayers. This will encourage banks to act more rationally with regard to their long-range profit. The solution is, in other words: free banking. As expected, the very market forces which deliver the goods in every other industry, will also deliver the goods in the banking industry.
Allison’s analysis doesn’t stop at politics and economics. He goes deeper, arguing that the fundamental cause of the financial crisis is our society’s moral code. Most people think of homeownership as a desirable thing. Indeed, it’s regarded as a part of the American dream; it’s sometimes even regarded as a “right.” It is thought that we have a moral duty to sacrifice ourselves for the needy because they are needy. Therefore, the government should help the poor and needy, to get a loan for a house. That’s how we ended up with Freddie and Fannie. It’s also worth noting that the various government interventions intended to help the poor buying a house probably hurt the intended beneficiaries the most, by creating the very financial crisis which left them and millions of Americans buried in debt as well as facing the risk of losing their jobs and home.
John Allison’s book is, to conclude, both enlightening and entertaining. Being packed with examples tied to the wider principles of politics, economics and philosophy, the book delivers a uniquely inductive, and for that very reason, unusually compelling case for the free market. While you may not end up agreeing with the author, you will appreciate the book for encouraging you to question your own beliefs.