“Liquidate labor, liquidate stocks, liquidate real estate,” U.S. Treasury Secretary Andrew Mellon may or may not have told President Herbert Hoover in the early years of the Great Depression. “It will purge the rottenness out of the system.” This is what has since become known as the “Austrian” view (although most of its modern proselytizers are American): Economic actors must learn from their mistakes, “malinvestment” must be punished and busts are needed to wring out the excesses created during boom times.
Within the economic mainstream, there is some sympathy for the idea that crisis interventions can create “moral hazard” by bailing out the irresponsible. But the argument that financial crises should be allowed to wreak their havoc unchecked has few if any adherents.
When a financial crisis hit in 2008 that was probably worse than anything the world had seen since the early 1930s, it was the mainstream, non-Austrian view that won out. The bailout of the big banks in late 2008, while hugely unpopular with the general populace, has garnered near-unanimous support from economists. In a paper eventually published in the Journal of Financial Economics in 2010, the University of Chicago’s Pietro Veronesi and Luigi Zingales concluded that even without including the impossible-to-measure systemic benefits, the cash infusions and guarantees orchestrated by Treasury Secretary Hank Paulson created between $73 billion and $91 billion in economic value after costs.
The Federal Reserve’s subsequent (and continuing) support of asset markets has been somewhat more controversial, but still meets widespread approval among economists. More controversial yet have been fiscal stimulus efforts like the American Recovery and Reinvestment Act of 2009. But the tide of economic opinion and evidence seems to have turned in their favor too.
In sum, the economic mainstream got its way, the Austrians didn’t, and we all appear to be better off for it. It has been a tough five years, but not nearly as tough as the early 1930s. The biggest policy mistake we made was probably not the bailouts or the deficit spending, but the failure to stop Lehman Brothers from failing on Sept. 15, 2008.
Yet despite this record of relative success, most of the commentaries that were published in the lead-up to the fifth anniversary of that fateful day focused instead on the opportunities missed. Princeton economist Alan Blinder’s op-ed in The Wall Street Journal is a prime example of this. Blinder laments that the dangerous financial practices that precipitated the crisis have mostly been left in place. Contrasting the tepid regulatory measures taken since 2008 with the remaking of the financial system that took place during and after the Depression, he writes: “Far from being tamed, the financial beast has gotten its mojo back – and is winning. The people have forgotten – and are losing.”
What Blinder and his kindred spirits (including myself) generally fail to discuss, though, is that one of the main reasons the people have forgotten is because economic policymakers succeeded in averting anything quite as memorable as the widespread economic misery that swept the U.S. in the early 1930s. By giving us a Great Recession instead of a Great Depression, they made it much harder to assemble a political consensus for truly dramatic change.
This is where the Austrians surely have it right. If you’re spared the full consequences of your actions, you’re far less likely to learn what you did wrong. That still doesn’t seem like enough reason to justify a do-nothing economic policy in the face of a financial crisis. But it ought to be clear by now that there are also real costs to doing something.
(Justin Fox is executive editor, New York, of the Harvard Business Review Group and author of “The Myth of the Rational Market.”)
© 2013 Harvard Business School Publishing Corp.