There’s a reason why economies have based their currencies on something tangible since at least the Roman Empire. As John Allison explains, if we don’t do the same, high government debt and the threat of stagflation will never go away.
Question: What measures should we take to help prevent crises in the future?
John Allison: Well, if I were in charge, I would go to a private banking system in a monetary standard based on market criteria, which would probably be a gold standard. Not because there’s anything magical about gold, but because gold is limited, it’s hard to find, it’s expensive, and it provides discipline. As long as we have a Federal Reserve, we’re going to have a high level of government debt until we get into serious financial trouble—it’s almost inevitable. If you look, governments have been basing the currency since at least the Roman Empire, and even before that, and we have been debasing our currency and we will get in trouble. If we don’t go to a gold standard and a private banking system, then I think the Federal Reserve ought to have less power, not more. We ought to go with what Milton Freedman said and grow the money supply at a fixed rate, like 3 percent. Because every time they over correct, you don’t know that the over correction has happened until two, three years down the road and we’re looking at that same kind of risk right now with stagflation in the future.
And then the other option would be the one I described before with more capital and less regulation, which is a very practical option and almost the opposite of the direction we’re going now with just plain more regulation, we’re going to make the system more vulnerable, not less vulnerable.
Question: Can you elaborate on your criticisms of government policies and explain what you see as the most promising alternatives to these policies?
John Allison: Yes. I think that the primary cause of the financial crises was government policy. We don’t live in a free market in the U.S. we live in a mixed economy. The mixture depends a lot on the industry. Technology is probably 80 percent free, 20 percent government, financial services is 70 percent government, 30 percent free. Not surprising, the most regulated industry is the one that had the biggest problems. What happened is government policy created a bubble in the residential real estate markets, that bubble burst, which bubbles always do, and that got transmitted into the capital markets and into the economy in general. It is true that individual financial institutions made some really big mistakes, but it was in context of government policy errors. And the three big causes were first, the Federal Reserve. In a certain sense, people don’t, they know this, but they don’t get it. The government owns the monetary system in the US. In 1913, the monetary system was nationalized. If you’re having trouble in the monetary system, by definition, it’s a problem of government policy. If interstate highway bridges were falling down, people would say, “Well, what’s wrong with the government? They own the highways, they own the monetary system.” The Fed was created to take out volatility in the economy, what they’ve done is take out the short-term volatility and push problems into the future. Because in a free market, as human beings, we’re not…we’re always, it’s always in a correction process, good businesses are growing, bad businesses are going out of businesses. If you take out the bottom side, you push the problems into the future.
And then specifically, Alan Greenspan had negative real interest rates for several years, Bernanke created inverted yield curve. Those are huge incentives for people to invest and take high levels of risk. We couldn’t have had a financial crises if the federal reserve hadn’t printed the money. The FDIC creates a lack of market discipline, where people like **** West and Indie MAC, that all, and Countrywide, all that fail that can grow their assets, high risk assets, very easily by buying deposits and because of the FDIC insurance, the typical depositor doesn’t think about the risk in the institution they’re invested in. And then it ended up in the housing market because of a goal really set in 1999 by Bill Clinton, for Freddie Mac and Fannie Mae to have over half their loan portfolio in affordable housing. And so a lot of the bubble ended up in the housing market and Freddie Mac and Fannie Mae never would have existed in a free market. They were guaranteed by the federal government, when they went broke, they were leveraged a 1,000 to 1 and they had $5 trillion in liabilities. And politics played a huge role. I personally was involved in the committee trying to do something about Freddie Mac and Fannie Mae, because you could run the numbers and you knew they were going broke, but Congress wouldn’t do anything about it, because affordable housing was kind of a religious belief of Congress and secondly, Freddie and Fannie were huge contributors to both democratic parties. So yes, individual financial institutions made mistakes, but in the context of some really serious government policy errors.