Rush Limbaugh: Who Lost Capitalism?

Every once in a while America loses something—China, Vietnam, Wall Street—and we try to figure out who lost it. Rush Limbaugh thinks he knows:

The issue is not a runaway, unregulated free market. The issue is not the failure to regulate. The issue is not stupid and crooked executives throughout the banking industry doing stupid and crooked things, although there was some of that. There's some of that in every area of life. But that's not the cause. What you need to understand, my good friends, is that this situation has occurred and is occurring as a direct result of government policies: liberal government policies that were used to force the issuance of trillions of dollars in risky loans that people could not pay back. And when they couldn't pay them back, people couldn't get the asset value that they had sold and packaged the mortgages for, and everything crashed, everything crumbled.

But conservative jurist Richard Posner, over at his blog with free-market economist and Nobel Prize-winner Gary Becker, has a different take:

I do not think that the government does bear much responsibility for the crisis. I fear that the responsibility falls almost entirely on the private sector. The people running financial institutions, along with financial analysts, academics, and other knowledgeable insiders, believed incorrectly (or accepted the beliefs of others) that by means of highly complex financial instruments they could greatly reduce the risk of borrowing and by doing so increase leverage (the ratio of debt to equity). Leverage enables greatly increased profits in a rising market, especially when interest rates are low, as they were in the early 2000s as a result of a global surplus of capital.

The mistake was to think that if the market for housing and other assets weakened (not that that was expected to happen), the lenders would be adequately protected against the downside of the risk that their heavy borrowing had created. The crisis erupted when, because of the complexity of the financial instruments that were supposed to limit risk, the financial industry could not determine how much risk it was facing and creditors panicked. Compensation schemes that tie executive compensation to the stock prices of the executives' companies but cushion them against a decline in those prices (as when executives are offered generous severance pay or stock options are repriced following the fall of the stock price) further encouraged risk taking.

Moreover, even when businesses sense that they are riding a bubble, they are reluctant to get off while the bubble is still expanding, since by doing so they may be leaving a lot of money on the table.

Finally, if a firm's competitors are taking big risks and as a result making huge profits in a rising market, a firm is reluctant to adopt a safe strategy. For that would require convincing skeptical shareholders and analysts that the firm's below-average profits, resulting from its conservative strategy, were really above-average in a long-run perspective.

But I think economist Donald Straszheim is closest to the truth:

Too many people without a sufficient credit or work history, other assets or even evidence of the ability to live a stable life were given mortgages, pushed along by Washington's politically correct desire to have the homeownership rate ever rising and by Wall Street and the mortgage brokers maximizing their income, and institutional investors buying securities that were highly questionable. There is plenty of blame to go around. The "bailout," misleading term, is as much of Main Street as it is of Wall Street.