Walter Williams's Lessons From the Bailout

by Don Boudreaux on October 8, 2008

in Current Affairs, Financial Markets, Government Intervention, Politics

My and Russ’s colleague Walter Williams draws important lessons from the bailout.

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MnM October 8, 2008 at 1:08 pm

Clear, concise, and eloquent. I enjoy reading Dr. Williams' writing. Please convey the compliment to him.

Speedmaster October 8, 2008 at 1:12 pm

We are very lucky to have Dr. Williams – one of the great minds of our time.

Charlie October 8, 2008 at 1:58 pm

"the GSEs have exceeded their housing goals."

Doesn't this mean that the CRA wasn't a binding constraint? This is evidence against Williams not for. Also, what is he talking about with the FASB and GAAP stuff. Here is what Bloomberg said, "Morgan Stanley, hired by the Treasury to probe the companies' finances, concluded the accounting, while legal, enabled Freddie, and to a lesser extent Fannie, to overstate the value of their reserves, according to the people who declined to be identified because the findings are confidential."

It's also funny to hear Walter Williams extolling calls for increased regulation. The same arguments could be used for increased regulation of the rest of the bailed out firms that were highly leveraged.

The point is not that Fannie and Freddie were a good idea. I was interning at the National Taxpayer's Union and wrote a paper, "The Harms of Quasi-Privatization" making exactly the point that the GSEs will have to be bailed out and thus we are privatizing the profit and subsidizing the loss. But just because the GSEs and the CRA were bad, doesn't mean that they explain the financial crisis. Why is this so hard to understand?

The fact is that the private market lead the way in subprime lending, not because they had to, but because they thought it was profitable. This is my favorite sentence, "The financial collapse of Fannie Mae and Freddie Mac is not a failure of the free market because lending institutions in a free market would not have taken on the high-risk loans." This is false. I guess Walter Williams doesn't listen to econtalk (or read the newspaper), because Arnold Kling explained that private companies did in fact issue (and buy) lots of high risk loans.

Fannie and Freddie doesn't explain why so many firms collapsed. Why did Lehman and AIG hold so much subprime risk? Why were people holding these stocks? They weren't forced to. Yes, the government shouldn't be encouraging home ownership, but does that explain why people bought houses for so much more than they turned out to be worth? Does it explain why wall street apparently forgot that housing prices go down?

Where is the coherent explanation?


RVTurnage October 8, 2008 at 2:32 pm

here's one from Arnold Kling that's lays it out really well.

Basically, they started holding these stocks because government policy made them appear profitable when otherwise they wouldn't. Government started the housing boom with the CRA, requiring Fannie & Freddie to increase low-income mortgages they held, easy money from the Fed and local development laws, guaranteeing a market for those mortgages with Fannie and Freddie.

Oh, and here's Russ's explanation too and another from Steve Horwitz.

Plac Ebo October 8, 2008 at 2:36 pm

If he's placing blame for the entire "financial mess" it sounds like scapegoating. There is quite a bit more to the financial crisis.

William Garland October 8, 2008 at 3:38 pm

What Dr. Williams discusses is not the entire cause of the financial mess but it is a significant contributing factor and one which has not been emphasized in many discussions. How many members of the public who don't actively follow the matter would be aware of its influence?

Charlie October 8, 2008 at 3:42 pm


"In fact, the capital regulations even told banks that holding private mortgage securities under Method B was less risky and therefore required less capital than Method A lending. The result was that Method B came to dominate the American mortgage market. Had the playing field been level, Method A would have remained in place, and Method B likely would never have gotten started."

This is from the Kling piece. But in what sense do regulations "tell" banks what is risky and what is not risky. If method B was ex-ante exceptionally risky, why did people lend capital to organizations engaged in method B practices? Why did people buy ownership in firms that engaged in such risky practices? Fannie's stock was over 60 a year ago, now it is at $1. If the market is good at evaluating what is risky and what is not, why were this equity holders so fooled by regulation? It seems much more likely that Kling ex post thinks something is very obvious, that wasn't obvious ex ante.

Suppose you believe the argument that CRA forced smart banks to give loans that banks knew were bad loans. In a well functioning market, how would banks respond? Banks would take the regulation as a constraint- "We have to make these bad loans, which will cost Y dollars, now we can no longer issue some of the marginal loans that are barely profitable. We will issue less loans and be less profitable…bummer." But, no you might argue, fannie and freddie were buying the loans from the banks. Ok, but then they were selling them. The buyers knew what the loans were and that they could default and lose value. They knew that the loans were issued from "method B," they should have said, "these loans are subject to default, we shouldn't pay very much for this security" then Fannie and Freddie would say, we can't sell these for very much, we shouldn't buy these loans for very much. And banks would say, we can't sell these for very much; we'd better not issue very many or only safe ones that will sell for more.

I need an analysis to go through this, not "regulation told banks." Government can induce people to act inefficiently, but how can it induce people to do what is bad for them even after government influence. In a neoclassical world, markets take government action as given and optimize. Why didn't that happen?


Charlie October 8, 2008 at 4:01 pm

"Market exchanges are mutually beneficial. When the law messes up by either poorly defining the rules of the game or trying to override them through regulation, self-interested behavior is no longer economically mutually beneficial. The private sector then profits by serving narrow political ends rather than serving the public. In such cases, greed leads to bad consequences."

This is from the Horwitz piece. And this is exactly the understanding behind all the "government caused this" arguments that I don't understand. Government doesn't change trade from being "mutually beneficial." How can it? If the government sets a minimum wage of $6 and the worker is only worth $5 to the company, the company just doesn't employ the worker. The government can't force it to take a loss, to do something that doesn't benefit from it. It can hinder it from doing something beneficial, but not force it to hurt itself.

Here is another bit:

"Many of you have rightly criticized the ethanol mandate, which made it profitable for corn growers to switch from growing corn for food to corn for fuel, leading to higher food prices worldwide. What's interesting is that you rightly blamed the policy and did not blame greed and the profit motive! The current financial mess is precisely analogous."

Yes, ethanol mandates are bad. We have more corn than we want and at higher prices, but do we predict that people will start building tons of corn farms, and that current corn farms will start trading well above the amount corn farms are worth. Should corn itself have a bubble as we all conclude that the price of corn can never fall? Will we start taking out loans to buy corn with no downpayments? Corn that we can't afford?

I'm not arguing that "greed, greed, greed" is some how explaining it. I am arguing from an economic prospective. I expect firms to maximize profits subject to constraints. What I don't understand is, how the implicit model of the "government caused this" crowd explains the crisis. And if your model can't explain what is happening, why would you use it to explain how to deal with what is happening?


Martin Brock October 8, 2008 at 5:23 pm

Where is the coherent explanation?

I agree, Charlie. The obsessive focus on government only contributes to the popular impression that politicians tell every story. Authoritarian politicians author the state, but they don't author everything that economists study; otherwise economics is only a branch of political science. Too often, it is.

We've reached a risk tolerance threshold, and demography plays a role. We should be discussing it.

Sam Grove October 8, 2008 at 5:27 pm

We can't assume that investors have an Austrian view of economics.

They look for and respond to signals.

What signals arose from the FED's expansion of credit.

muirgeo October 9, 2008 at 1:52 am

"The financial collapse of Fannie Mae and Freddie Mac is not a failure of the free market because lending institutions in a free market would not have taken on the high-risk loans. They were forced to by the heavy hand of government."
Walt Williams

Forced??? That's PATHETIC. Actually it's just a straight out lie. It's an act of desperation and it's demeaning to the person making the claim and anyone with half a brain. It's like cropping up a broken ideology with a 700 billion dollar bailout… it won't work.

Here's a much more honest and rational explanation of what happened and why; From Barry Ritholtz ; The Big Picture–1.html

"the proximate cause of the Housing crisis were 1) Ultra-low rates; and 2) Abdication of traditional lending standards, thanks to 3) originators ability to resell mortgages for securitization purposes, and hence, 4) not have to worry about loan defaults.

The credit crisis was caused by 1) the above securitized mortgage paper, that was 2) rated triple AAA by Moody's and Standard & Poors, which then 3) Which was then "insured" by credit default swaps (CDS) — the unreserved for, shadow insurance products 4) whose exemption was made possible by the Commodities Futures Modernization Act. That legislation exempted these derivatives from any supervision or regulation. The lack of reserve requirements is why there is now $62 trillion in CDS, many of which will never pay their counter parties the promised insurance."

Babinich October 9, 2008 at 5:28 am

Why can't Walter Williams run for President of the Unites States? :')

Walter Williams asks:
"Shouldn't the accounting standards businesses have to meet be applied to Washington?"

Of course they should. A bandit is a bandit and whether corrupt business person or a government bureaucrat.

Sam Grove October 9, 2008 at 11:14 am

the proximate cause of the Housing crisis were

Proximate is an important word here. There were a chain of causes. Proximate causes only determine the particular manifestation of systemic pressures.

It's like saying the proximate cause of toe joint swelling is inflammation of the tissues surrounding the joint, but the near proximate cause is the depositing of uric acid crystals on the joint cartilage, which is due to increased uric acid content in the bloodstream.

But the underlying cause must be determined to prescribe a remedy to relieve and prevent symptoms.

Our economy has been (still is) on a diet of easy credit. Our country suffers the effects of a credit monopoly exacerbated by government spending and loose fiscal policy.

Keith October 9, 2008 at 12:59 pm

Quote from Charlie: "This is false."

Well, I'm glad that's settled. Plus, muirgeo agrees with you. What other evidence is needed?

Charlie October 9, 2008 at 2:15 pm


"Quote from Charlie: "This is false."

Well, I'm glad that's settled. Plus, muirgeo agrees with you. What other evidence is needed?"

Keith, read the paper. Quite a few private firms were major players in the subprime market. There were private firms issuing loans, securitizing, and buying securities. So in every way private firms were involved in these high-risk loans. Also, Walter Williams' claim is stupid from a theoretical perspective. Why wouldn't private firms participate in high-risk lending? The market isn't afraid of risk, it just expects a higher return. Credit cards are high-risk loans and they are issued all the time.

Sorry Keith, your hero says dumb things.


maximus October 9, 2008 at 2:22 pm

"Forced??? That's PATHETIC. Actually it's just a straight out lie."

I doubt that Dr. Williams is using the term forced as though someone put a gun to people's head and forced them to do it. I'm pretty sure he is talking about the Hayekian/Misesian concept of "forced saving". Here's a link to an explanation from Roger Garrison, (it's too long to put directly in the comments section).

maximus October 9, 2008 at 2:26 pm

The title of the article in case that doesn't get you there is "Overconsumption and Forced Saving
in the Mises-Hayek Theory of the Business Cycle"
Roger W. Garrison

It should be on his website along with others he's written.

Rudy October 9, 2008 at 2:28 pm

Muir – I agree and think the word "forced" to make loans may be dramatic. To imply, however, no strong arming took place at all isn't true either.

The CRA certainly was given more teeth in the late 90's for loaning to people in redlined areas. With Congress pushing mortgage lenders and Fan/Fred to expand sub-prime lending – all were more than happy to oblige, especially with a back whisper promise of federal backing – loans shot up dramatically.

No moral hazard in this formula.

Keith October 9, 2008 at 4:00 pm

Quote from Charlie: "Sorry Keith, your hero says dumb things."

Wow, now he's my hero (although, I'm not quite sure which person you're referring to).

Maybe if you got your information from someplace other than the "paper", you would have a better understanding of the point. The market has been perverted and coerced by government. Simply because some companies have been perverted and coerced more than others, doesn't change that fact. And the perversion continues with the bailout.

I wonder why I have a different opinion as to who is saying dumb things.

Charlie October 9, 2008 at 4:12 pm

"The market has been perverted and coerced by government. Simply because some companies have been perverted and coerced more than others, doesn't change that fact. And the perversion continues with the bailout."

Thank you for another brilliant illustration of my point. Another assertion without a coherent story. The argument seems to be "the government does stuff, that stuff is bad, the economy is bad, therefore the government must be causing the economy to be bad."

Can anyone get from "perverted government activity" to credit crisis without market failure?


Sam Grove October 9, 2008 at 6:59 pm

Credit expansion by the FED is at the root.

Keith October 10, 2008 at 10:57 am

Quote from Charlie: "Can anyone get from "perverted government activity" to credit crisis without market failure?"

Yes, read the original article.

What exactly is a "market failure"? That's the most idiotic term I've ever heard. You might as well say a hurricane is a weather failure.

The market is. Just because it doesn't give you the results you want, doesn't mean it failed. It means you were doing the wrong things to get the results you wanted.

Charlie October 10, 2008 at 11:25 am


In economics, a market failure is when resources aren't allocated efficiently.

Which article am I supposed to read?


Keith October 10, 2008 at 12:26 pm

Quote from Charlie: "In economics, a market failure is when resources aren't allocated efficiently.

Which article am I supposed to read?"

What does 'allocated efficiently' mean? Who decides what is efficient?

Please don't give us some utilitarian drivel or talk about the common good.

The original article by Walter Williams that started this thread.

Sam Grove October 10, 2008 at 1:04 pm

In 'manipulative economics', "market failure" is a disguised call for government intervention by people who think the market should be doing something else.

By manipulative economics, I mean the attempt to achieve certain macro economic results by altering macro factors such as the money supply.

When these manipulative economic experts use the term "market failure", it is usually an admission that their manipulations didn't deliver the results they had been trying to achieve.

There are those who suggest that the current mess is an example of market failure, when actually, this is how the market works.

This is a confluence of signals delivering the message that the manipulations have only succeeded in postponing necessary corrections until they can no longer be ignored.

The signals are shouting now, and the manipulators are trying to muffle the message with massive currency and credit expansion. This after their failure to stamp out the message with bailouts.

Not gonna work.

Charlie October 10, 2008 at 3:51 pm


Efficiency is usually understood as Pareto Optimal, meaning there is no other allocation that makes some one better off without hurting someone else.

Also, please point to where in the article WW explains how the government policies created the credit crunch. My whole point is that he doesn't make that link.


Charlie October 10, 2008 at 4:16 pm


Market failure doesn't have to be macro related at all, and it doesn't necessitate government action, in many ways that is something GMU is known for arguing. Alex Tabarrok (a gmu professor) once put it "chicago says,'markets work, use markets' MIT says, 'markets fail, use government' and GMU says, 'markets fail, use markets'"

But market failure can be as simple as a positive or negative effect on a third party (pollution is a pretty canonical example), limitations on contracts (you can't write a contract before you are born for instance), asymetric information (cab drivers in an unknown city), or moral hazard (there is no market for insurance
from legal fees).


Sam Grove October 10, 2008 at 7:14 pm

The market does not exist to ensure that all cab drivers are familiar with a city they are in, but it does assure that they will become familiar or lose out to drivers who know their way around.

Common law addresses third party effects, and I do believe there has long been a market for adjudication.

The market is there arena where people buy and sell, it is not a means for negating facts of nature.

The market is a dynamic process which accommodates or delivers both failure and success. When there are problems, there are opportunities.

Of course, economists speak in a technical sense when they say "market failure", but I don't think that means the market is a like a mechanism that occasionally breaks and fails to behave as expected.

Too often market failure is cited as a reason for government intervention, but where is all the talk of political failure or the failure of democracy?

Sam Grove October 10, 2008 at 7:15 pm

If you look at my post, I did supply a particular context for taking issue with "market failure".

Charlie October 13, 2008 at 2:01 am

"where is all the talk of political failure or the failure of democracy?"

In just about every political discussion?

Keith October 13, 2008 at 7:29 am

Quote from Charlie: "Efficiency is usually understood as Pareto Optimal, meaning there is no other allocation that makes some one better off without hurting someone else."


Again, who decides who is hurt and who is better off?

You keep using "market failure" to justify your oligarchic interventions, but you can't even adequately define it.

Sam Grove October 13, 2008 at 1:23 pm

In the American dialog, there is little mention of "political failure".

It may be implicit, but not intentionally I think. And when political failures do become explicit, the failure is usually ascribed to things like:
not enough money
lack of political will
'bad' regulations
the other side

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