John Taylor on the financial crisis

John B. Taylor, professor of economics at Stanford and a senior fellow at the Hoover Institution, has a piece in the Wall Street Journal on How Government Created the Financial Crisis. He opens by noting that

Many are calling for a 9/11-type commission to investigate the financial crisis. Any such investigation should not rule out government itself as a major culprit. My research shows that government actions and interventions -- not any inherent failure or instability of the private economy -- caused, prolonged and dramatically worsened the crisis.

The problems in the housing market, i.e. the housing boom and crash, were the result of monetary policy and a government induced relaxation in borrowing standards. A lack of liquidity was, wrongly, seen by many policymakers as the major problem and they attempted to fix things by trying to increase loan volume as far back as 2007. In 2008 there was additional "stimulus" and even lower federal-funds rates which were in turn followed by a set of arbitrary interventions, you know, selective bank bailouts, the inexplicable TARP etc.

Bernanke and Paulson come in for special blame, from Taylor, for creating regime uncertainty. Taylor writes:

On Friday, Sept. 19, the Treasury announced a rescue package, though not its size or the details. Over the weekend the package was put together, and on Tuesday, Sept. 23, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson testified before the Senate Banking Committee. They introduced the Troubled Asset Relief Program (TARP), saying that it would be $700 billion in size. A short draft of legislation was provided, with no mention of oversight and few restrictions on the use of the funds.

[...]

The realization by the public that the government’s intervention plan had not been fully thought through, and the official story that the economy was tanking, likely led to the panic seen in the next few weeks. And this was likely amplified by the ad hoc decisions to support some financial institutions and not others and unclear, seemingly fear-based explanations of programs to address the crisis. What was the rationale for intervening with Bear Stearns, then not with Lehman, and then again with AIG? What would guide the operations of the TARP?

Taylor's basic point is that the government has created the crisis and is now deepening and prolonging it by trying to "fix" the problem by intervening in the economy, despite the fact that it was, to a large degree, their previous interventions created the problem in the first place. Read the whole article, its well worth the time spent.