Reflections on the causes of crises from one of America’s top bankers

Last night, some of us from Bogpaper Towers went along to a superb event run by the Adam Smith Institute. There, John Allison, Chairman of BB&T bank, spoke to us about the financial crisis and why regulation and government were the main culprits. Earlier in the week he wrote a piece for London’s CityAM, which we bring to you below.

The destruction of personal responsibility is the ultimate death of democracies

PUBLIC policy decisions are being made based on a myth. The misunderstanding driving this myth is that deregulation of the financial industry in the US, combined with greed in financial markets, caused the financial crisis and the continuing recession. And the root of this economic misconception is philosophical.

In fact, the crisis and recession are the result of destructive US government policies. The prime culprit is the Federal Reserve. In the early 2000s, the US faced a minor economic correction. Alan Greenspan, head of the Fed, was near retirement and didn’t want to leave on a bad note. So he loosened monetary policy, creating a massive bubble. Since the US dollar is the world’s reserve currency, this bubble was transmitted across the globe.

In the US, the bubble focused on the housing market, due to affordable housing (sub-prime) policies imposed by Congress on government-sponsored enterprises (Freddie Mac and Fannie Mae), which would never have existed in a free market. When Freddie and Fannie failed, they owed $5.5 trillion (£3.5 trillion) and had $2 trillion in sub-prime loans. As they had such a dominant share of mortgage lending, they drove down lending standards for the whole industry. And the problem became global. International banks had invested heavily in the US market and rising housing prices spread to countries like Spain and Ireland.

While an individual may think of a house as an investment, in economic terms a house is mainly consumption. We consume houses like we consume cars. Since we can only spend money once, over-investment in consumption leads to under-investment in production – we spent too much and saved too little. Using an agricultural example, we ate our seed corn. To plant next year’s crop, the US borrowed seeds from China and has to pay it back.

As the housing bubble developed, we taught millions of people the wrong skills – how to be construction workers, mortgage bankers, and property lawyers. They must now learn new skills. This takes time and contributes to lingering high unemployment.

But, as interesting as the economic issues are, the real cause of the financial crisis is philosophical. In Atlas Shrugged, the twentieth-century writer Ayn Rand identified the roots of all financial crises. The first fallacy asserts that you have an unlimited obligation to society and do not own your life. Everyone has a “right” to buy a nice house. But provided by whom?

Since such altruism doesn’t work, the back-up philosophy is pragmatism. The rule in pragmatism is simply “do what works”. But many programmes that work in the short term are destructive in the long term. Sub-prime mortgages worked for years.

When altruism is combined with pragmatism, it results in a “free lunch” mentality. In the US, all politicians know social security and Medicare are economic disasters, but no one has offered a serious solution and, if they did, they wouldn’t be elected. This mentality destroys personal responsibility, which is the ultimate death of democracies. Personal responsibility is our society’s central issue.

Rand also outlined the philosophical cure, as outlined in the US Declaration of Independence: life, liberty, and the pursuit of happiness. Each individual has a moral right to his or her own life. Each individual has a moral right to the products of his or her labour. If you produce a lot, you get a lot, including the right to give as much away to whoever you want to, for whatever reasons.

Rand emphasised that individuals need a clear sense of purpose, and a commitment to rational, independent thinking in order to earn self-esteem, which is the foundation for true happiness. She demonstrated that only in a free society, based on individual rights (including property rights), can we fully achieve personal happiness. A free market system is the only system that works because it is consistent with man’s nature. It is also the most moral system as it allows individuals to act as thinking beings, free to choose their own course, based on their values and beliefs.

If we can tackle the failure of personal responsibility, and rebuild free societies outside government interference, we can prevent the economic causes of the financial crisis from returning.

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