Introduction

Having reprinted an article last month from a webpage that I created for a short time some years back, I want continue in that vein this month. Given the political rhetoric surrounding affordability, the continued rise of inflation, and the ever-soaring $38-trillion dollar debt that future generations face in this country, I can’t think of a better book to revisit than Tomas E. Woods’ Meltdown, which I reviewed in August of 2009. I published that review on a now defunct webpage titled Analysis of Power. I still like that title, and I continue to engage now and then in AOP through this webpage, Contemplations. Although Meltdown dealt with the stock market collapse and bailout debacle of 2009, I strongly believe that what Woods presents in his work still needs to be heard today, loud and clear. In this country, we are still not heeding the lessons that should come with our folly of looking to the State to cure our economic ills, and in turn, to supposedly provided a life for us. What follows is a reprint of my book review from 2009.

Woods, T. E. (2009). Meltdown: A Free Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Washington DC: Henry Regnery.

Introduction

If there was ever a timely book to hit the market, it is Thomas E. Woods’ Meltdown. Like a bullet piercing its target, this book epitomizes the reality behind Frank Chodorov’s claim, economics is not politics. Indeed, as Woods so aptly demonstrates in this work, the political realm has so fouled up the economy, whether or not we will ever get it back on track is no mere academic question. If policy makers want to embrace legitimate economic knowledge, then they should study Meltdown. The major problem, however, with their reading it (besides not understanding it), is their having to take the blame for the economy in the first place. Additionally they would have to accept the cure – getting their butt out of people’s lives. Unfortunately, there are no actions more contrary to a politician’s mindset. One only has to listen to the pseudo praises about the present uptick in the market being due to the omniscient wisdom of the present administration. One wonders why people are intent on believing that the present market bubble at 9200+ represents a more sound economy than the bubble the previous administrations created when the market soared past 10,000. Woods explains why the present economy is no more stable than it was before the Meltdown. I will focus my review mainly on the first three chapters, not because the other chapters are less important, but because they speak directly to the present moment. Chapter 4 of Meltdown expands on Woods’ thesis that the Fed is the major culprit in the present as well as other economic crises. Chapter 5 presents an excellent historical overview of the Great Depression, explicating the major myths surrounding that event, particularly the idea that the free market caused the Depression and that the New Deal ushered in more sound economic times. Chapter 6 deserves special attention of its own with Woods’ sound scholarly discussion of money, where it comes from, the role it serves, and how the actions of central banking debase money. This chapter clarifies the misconception people have about inflation and deflation. In the final chapter, Woods asks the question, given where we are at with this present economic climate, What Now? Meltdown is a superb application of the Austrian theory of the business cycle to the present economic crisis. After reading it, I fail to see how anyone could blame those working in the free market for the present economic crises. For the mess we are in now, we have only the State to thank.

The Culprits: Chapters 1 & 2

Woods’ scholarly work takes you step-by-step through the faultless application of the Austrian theory of the business cycle, put forth by Ludwig von Mises and expounded by others (1). The first two chapters of this work explicate what Woods designates as the culprits behind the present meltdown. Rather than being the free market (which is anything but a monolithic entity), Woods delineates several political actions and institutions that created the downfall of the market. The culprits are: 1) Fannie Mae and Freddie Mac; 2) Community Reinvestment Act (CRA); 3) the government’s artificial stimulus to speculation; 4) the Federal Reserve and artificially cheap credit; and 5) the to big to fail mentality.

Government Action: The Great Oymoron

First, it is important to realize that these culprits cross political lines. There are little, if any, differences in the ways that either the Republican or the Democratic Parties have handled the economy through inflationary measures utilizing the Federal Reserve along with strangling much market activity in certain private sectors through regulation. As Woods explains, only politicians can foul things up with regulation, and then view the problem as too little regulation. In his opening chapter, “The Elephant in the Living Room,” Woods describes the belief systems held by politicians that only they can fix things. And if things go awry, that means they need to do more fixing. However, it’s the fixing that gets things broke. As he explicates throughout his work, of all the culprits listed above, the elephant in the living room is the Federal Reserve System (Fed for short). The Fed is anything but a free market institution. As Woods explains, the Fed is an arm of the federal government planning . . . created by an act of Congress . . . and dedicated to central economic planning (p. 8). The boom-bust cycle, or the bursting of the bubble as economists and investment planners describe it, is the result of the Fed’s manipulation of interest rates that floods the market with cheap money, producing a systemic problem throughout the market that leads to malinvestments that inevitably lead to a crash. As Woods explains, and further delineates in his book, the main action that has to be taken to end devastating boom-bust cycles involves, not a reforming or overhauling of the Fed, but its outright abolishment.

Fannie Mae and Freddie Mac

If there was ever an insult to the notion of free market institutions, it is designating the two government-sponsored entities (GSE’s), Fannie Mae and Freddy Mac, as free market institutions. Their proper names respectively are the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. They are nothing more than behemoth corporations created by Congress. The accounting that takes place as loans are shifted to the GSE’s is interesting indeed. Many people simply do not understand what Fannie Mae and Freddie Mac do and how they accomplish a bubble in the housing market. People mistakenly believe that these GSE’s perform mortgage loans for home buyers. On the contrary, using tax-payer money, Fannie and Freddie purchase loans from the banks after a bank has loaned to a consumer, and from that point on, the loans are no longer on the ledgers of the lending banks. Fannie and Freddie then proceed to bundle the loans and sale them to investors. But since the loans are no longer a part of the lending banks’ ledger, they can make more loans and begin the cycle all over again. Woods explains that this process inflates housing prices because of its artificial diversion of resources into mortgage lending. In other words, if the GSE’s were not purchasing these loans from banks, the banks would have to let the market dictate how many loans they could make, and the housing prices would be based on simple supply and demand and subjective evaluation.

Contributing to people’s misunderstanding of their workings is the fact that Fannie and Freddie are somewhat of a mystery. No one clearly understands their status: are they public or private? Woods explains:

As GSE’s, their exact status as public or private entities has always been ambiguous – they enjoy special tax and regulatory privileges that potential competitors do not, but their stock is traded on the New York Stock Exchange. Their securities are designated as “government securities” and can be held by banks as low-risk bonds. And for years, Fannie has had a special $2.25 billion line of credit with the U.S. Treasury. (p. 14)

What small business wouldn’t love a line of credit like that? These GSE’s are anything but private firms. Woods details how politics rule the day over the GSE’s activities. More recently, during the Clinton administration and throughout the Bush administration, Fannie Mae became involved in the manipulation of interest rates for helping disadvantaged groups become proud owners of homes they never really owned. The Clinton administration turned up the pressure on Fannie to expand credit to people ranging from low to moderate income. The unfortunate mixture of economics and politics raised its ugly head as it came to light that Fannie contributes a healthy source of campaign contributions to the Democratic Party, and that the GSE’s had been operated by prominent Democrats for years. Amidst all the talk about golden parachutes for CEO’s in the market, there was some screaming silence about the $100 million dollars that Franklin Raines, Clinton’s budget director, walked away with after a short period of operating Fannie Mae.

Woods’ description of the GSE’s raises one simple point among others. In looking to the bursting of the housing bubble, one cannot ignore the role of the government via Fannie Mae and Freddie Mac. More importantly one cannot ignore the gross inefficiency whenever government intrudes itself into a private sector.

The Community Reinvestment Act (CRA) and Affirmative Action in Lending

It is important to realize that although Woods delineates several culprits that contributed to the meltdown that recently occurred in the economy, from his perspective and economic reasoning, which is Misean and Austrian, the major problem is the Fed. Many people wanted to solely blame either the GSE’s or the CRA for the economic downfall. Although they contributed their share, nothing in the economy that transpired could have occurred without the easy money flooding the market via manipulation by the Fed.

That said, the CRA played its role in loosening lending standards that led to the housing bubble that in turn led to the financial institutional meltdowns. According to Woods, although the CRA originated during the Jimmy Carter administration, it received a boost under the Clinton administration, and opened banks up to harsh lawsuits amid accusations of racism. Chodorov’s maxim speaks clearly here as no longer could banks look at individuals’ ability to repay loans, but instead they had to take into consideration their race. If a certain percentage of minorities did not receive loans, the Boston Fed deemed the credit standards used by banks as arbitrary and unreasonable measures of creditworthiness (Boston Fed Manual quoted by Woods, p. 18).

Woods further explains that although the CRA had a limited impact on the meltdown, the lending standards comprised by the CRA pervaded the entire mortgage-lending sector. Combined with the CRA, Fannie, Freddie, and HUD pressured banks to loosen their lending standards. Add to this the Fed’s credit expansion powers, and what you have is a housing bubble. Politics once again intruded upon economics with thugs from ACORN blocking businesses’ driveways, making business impossible for banks until they catered to demands to make billions of dollars of loans they would not have made otherwise in a free market. One wonders about the benevolence of such an action as borrowers of these loans began to default and lose their homes. Instead of expressing outrage at the government’s role in the housing debacle, the very culprits that gave rise to the problem blamed banks and predatory lending practices. When banks were strong-armed by threats of being labeled racist and intimidated by ACORN hoods, one also must wonder who the real predators are. They were nowhere to be seen or heard when people began to default on their homes. Why would they be? They could pass the blame off onto the market.

Government Artificial Stimilus

According to Woods’ analysis, although the CRA and subprime lending contributed to the housing bubble, these factors may have indeed been overemphasized by some people. When the Fed flooded banks with reserves to lend, practices such as 100% loans became common, especially among minority groups. Of course, such relaxed standards also expanded to those in higher-income brackets. Why not? The Fed had made the money available. But home prices increased, and so did foreclosures, with large increases in both the subprime and prime loans. So the notion of predatory lending to minorities and low socio-economic class borrowers did not fit the facts. Everyone jumped into the game, regardless of race and income, and signed the dotted line for homes they really could not afford. In the final analysis, Woods explains that foreclosures occurred mostly due, not to subprime loans, but to adjustable rates, a practice that Alan Greenspan encouraged people to take on.

Many people blamed the private rating agencies whose job is to rate the creditworthiness of the mortgages, hence the call for more regulation after the collapse of the housing sector. However, all these loans took place, first in institutions that are already highly regulated, the banks. And second, these problems occurred right under the SEC’s nose. Woods explains that the SEC actually controls these private rating agencies, and undue oversight would occur if they balked at politically popular lending. But through it all, the easy money that the Fed created for the banks sounded the death knell for the housing sector,

The “Too Big to Fail” Mentality

Personally, I know having heard this early on from Bush, other politicians, and talkshow hosts, I lost count many times I heard the words, too big to fail and systemic risks. Woods’ analysis is spot on about how this mentality creates moral hazard. The belief basically sends messages to business entities that you are too important to fail. Major firms are given the assurance that they will be protected from bankruptcy. Consequently, these firms make decisions that they would not otherwise make in a pure free market where the taxpayers are not brought on board to save their butt from bad business decisions. Such guarantees lead to a belief in an eternal boom. As Woods explains, when markets collapse, the Fed rushes to the rescue. The excessive expansion, however, would not have happened in the first place if the Fed had not made credit so easily obtainable.

The Federal Reserve

Although Woods discusses the Fed fifth before finishing the too big to fail mentality, I summarize his discussion of it last here because his take on the Fed is the thrust of his argument and follows from the Austrian theory of the business cycle (1). The Austrian theory of the business cycle most definitely sees the central banking system, the fractional reserve system, and the Fed as the major culprits in creating a. bubble that will sooner or later pop. Although Woods discusses the Fed as one of the six culprits in creating the housing bubble (his title of Chapter 2 is “How Government Created the Housing Bubble”), he expounds on central banking and the Fed as major forces of economic woes throughout our country’s economic history. Woods states that although the other five culprits are important in understanding the housing bubble (and by extraction, the meltdown in the financial sector as well), they by themselves cannot account for the sheer scope of the housing bubble and depth of the crash (p. 25). As a full explanation of these phenomena, Woods challenges us to understand why business cycles occur.

The Austrian theory analysis claims that the government’s manipulation of the money supply produces an unsustainable boom that ineluctably leads to a bust. To have a clear understanding of the business cycle, one must also understand the distinction between consumption and production goods (the latter also called higher order goods by some economic theorists). When the Fed manipulates the money supply and floods the market with money, a false signal is sent to business entrepreneurs to invest in longer-term projects such as raw materials, construction, and capital goods. These higher order goods are used to produce consumption goods. If people have legitimately produced a pool of savings, then business entrepreneurs can more safely assume that money and demand are available for long-term projects. However, there is a difference between money that is actually saved by people and money that the Fed generates and floods into the economy. At a time when people are consuming or do not have savings, the Fed’s manipulation of the money supply diverts resources into projects that are not driven by true consumer demand and are, thereby, not sustainable. The Austrian theory of the business cycle claims that this false signal generated by the Fed produces a systemic error throughout the economy,

Woods explains that in this recent economic meltdown, the money generated by the Fed found its way into the housing market, and combined with lax lending standards, and the role of the GSE’s, the result was excessive home purchases and speculation regarding the housing industry. As previously stated, the government, after fouling things up, is wont to blame others for the mess it created. Predictably, the government blamed predatory lending, when the government itself provided the money to be lent, and greedy speculators, when a bubble created by the government drew speculators into the market. With what appeared to be a solid economic reality that would go on and on, why wouldn’t speculators enter the sector? That is what they do. Woods says it clearly: Cheap money draws people into speculation who do not belong there, who know little about the market involved, and who see in it as an irresistible get-rich-quick-scheme.

As far as predatory lending is concerned, Woods further eplains that with the new money created by the Fed, the banks lent it to individuals who previously would not have been cleared for a loan. Although good entrepreneurship comprises understanding the market and where it’s headed, fiat money makes it extremely difficult to distinguish between a sound project and a.bubble project (p. 27).

Expanding on the Problems that Government Creates: Focus Chapter 3

In Chapter 3 of Meltdown, “The Great Wall Street Bailouts,” Woods discusses the recent and present bailouts that the government provided for firms like AIG, Fannie and Freddie, and other industries, what was eventually called the Emergency Economic Stabilization Act of 2008. He takes on Paulson and Bernanke’s explanation of the economic crisis and the ways they sought to save things. Woods works with the facts, taking us through each bailout and the nationalization of businesses. He once again expounds on the notion of too big to fail and argues that the fate of Lehman Brothers should have been the fate of those firms and industries that received a bailout. When companies are fed the notion that whatever they do will not lead to bankruptcy, moral hazard is created, and these companies make business decisions that they would not otherwise make, believing that the taxpayers have their back.

Utilizing the Austrian theory of the business cycle, Woods argues that firms need to suffer the market consequences of their decisions. While the government is telling people all will be well if they keep borrowing and spending, logical economic thinking signals that a bust is a time to step back from spending and increase savings and contract rather than expand credit. Woods explains: Excessive, imprudent lending and credit creation led to the economy’s depressed condition in the first place by misallocating so much capital into unprofitable and even absurd lines of production. The economy needs time to restructure itself, for market participants to sort out which investments are sound and which are squandering capital, and for asset prices to be brought back into line with reality, in order for rational economic calculation to proceed once again. Banks should do exactly what they appear to be doing: restoring sane and sensible lending standards and scrutinizing loan applications more carefully (p. 42). Such a process is exactly what the Austrian theory of the business cycle calls for. Businesses that make bad investment decisions need to liquidate, declare bankruptcy, and let other healthier businesses take over any usable assets they possess.

Woods goes on to discuss the moralist hit that short-selling took, explaining that it is a normal market phenomenon and that banning it has more perverse effects than good. One of the more enlightening sections of this chapter for me is Woods discussion of deregulation. He claims that while attacks on deregulation were unfounded, those who argue that deregulation is not the problem with the present crisis are likewise in error. The issue here is the banking system. As long as the banks are insured by taxpayer money, says Woods, then they should not be allowed to take greater risks than what their insurance of deposits allow. But these risks were exactly the problem exacerbated by the CRA, Fannie, and Freddy. So the risks that these banks took through relaxed lending standards were the failure of regulation, not deregulation. True deregulation would cut taxpayer ties to the banks altogether.

Woods discusses the inevitable consequences of the bailouts – more bailouts in the future. With the string of bailouts that occurred, the precedent has been set, and the private sector will be poorer than it otherwise has to be. Finally, Woods raises the question: What happens when the bill comes due? Fiat money generated by the Fed does not exist in an endless supply. Somewhere the house of cards will get shaky. Whatever else the government did wrong, the major malevolent consequence is that its actions have siphoned off resources from true wealth producers – true entrepreneurs. Resources are diverted into firms and industries that should otherwise fail. Woods states: . . . there is no shortcut to wealth. We cannot become prosperous by pushing interest rates lower than the market would have set them. There is no monetary magic wand that can make everyone rich. The interest rate was at the level the market established for a reason, and when governments and their central banks artificially interfere with it, they mislead investors into destructive courses of action they would not otherwise have taken. They encourage investments in lines that make no long-run sense. They encourage consumption at a time when investors are starved for capital (p. 60).

Conclusion

There is so much more that one could expound on in this timely work. And although Meltdown clarifies for people the business cycle and the role of the Fed in producing our economic woes, it does much more than that, bringing economic sense to areas about which most people are simply unaware. The free market versus the government, money and its role in business, consumption, production, inflation, deflation, and the common but distorted rhetoric around what we have all been taught about the Great Depression. The seven chapters of Meltdown weave a tapestry of insight into the economic world of free enterprise and its doomed fate at the hands of the State.

So what do we do with this knowledge? Woods, in his final chapter titled “What Now?” delineates several important courses of action if we want to see the economy get back on track and this country once again become a haven for liberty. First, Woods explains that we need to reverse our notion that spending and consuming is what is good for the economy. Rather than merely consuming, we need to produce. In order to produce, businesses need to save so as to invest in production. Second, businesses need to fail rather than receiving a bailout at hands of the taxpayer. Bankruptcy, Woods explains, is a legitimate path for dealing with malinvestment and business failure. The world, really and truly, will not come to an end if bankruptcy proceedings are carried out for a number of businesses. Third, Fannie Mae and Freddie Mac should go away; they should be abolished. Woods suggests that both GSE’s should go through bankruptcy proceedings themselves and their assets auctioned off to private mortgage guarantors (p. 148). Fourth, Woods calls for an end to bailouts and government spending. The incessant government spending depends on fiat money generated by the Fed and the central banking system, and ultimately much higher taxes, regardless of what politicians say. Government spending is nothing more than constant indebtedness. Along those lines, fifth, Woods declares that government needs to cease its manipulation of money through the Fed. The manipulation of money is inflationary, and through legal-tender laws, alternative sources of money are not available when the dollar is being abased. Sixth, (the one I like the best), abolish the Fed. This final action would also lead to seventh, shutting down the Fed’s ability to lend money, and eighth, ending its monopoly over money. Woods points to von Mises and Hayek, and their call to separate money from the State. As Chodorov succinctly put it: economics is not politics.

References:

(1) Ebeling, R. M. (ed.) (1996). The Austrian Theory of the Trade Cycle and Other Essays. Auburn, AL: Mises Institute.

John V. Jones, Jr. Ph.D/March 14th, 2026

ANALYSIS OF POWER/Economics