Everybody, Tom Woods here. It's episode 25158 of The Tom Wood Show, and we have the distinct pleasure of being joined once again by the great Keith Knight. Keith Knight, long after all Woods is dead and buried. Keith Knight is going to be holding this 'cause that the the the flame of this cause aloft for all of you. He is managing editor at the Libertarian Institute. He's the author of Domestic Imperialism, Is It 9 Reasons I Left Progressivism. Yes, Sir.
All right. And I'm that was unnecessarily morbid, my introduction of you, but welcome all the same. Keith Knight. Tom, thank you so much for having me. Well, you're kind of, I don't know if I would say you're doing me a favor, but you're doing something kind of interesting today. We've done this before. This year, it turns out, is is the anniversary year for two of my books. So we did a 20 year retrospective on the Politically Incorrect Guide to American History.
Keith and I did. And Keith reminded me at the Mises Institute Supporters Summit over the weekend in Hilton Head that it's the 15th anniversary of Meltdown, my book on the financial crisis. And I'm just sick and tired of all these, all, all these, these anniversaries because it makes me feel old. But you know what? I'm going to, I'm going to get a visual aid to reward those of you watching on video. So hang on. All right, Here we are. This is the paperback edition.
Oh, since you've got your hardcore. The hardback. You got the hardback. Yeah, that's good. This is the paperback that includes a new introduction by the author. And you will note also that it used to say New York Times bestseller on a little strip here in the corner. There's a thing only I would notice. Now it says national bestseller, which is very lame sounding.
But that's because my publisher got into a dispute with the New York Times. They believe that the Times, in its weird undisclosed algorithm for determining bestsellers was unfairly excluding very, very big selling conservative books. And so they said, well, to punish the New York Times, we don't ever want to be considered for New York Times bestseller status ever again. And I thought, well, that's a weird way of sticking it to them. You're screwing all your authors.
Anyway, enough of that, Keith. Let's talk here. So what? How do you want to do this? You want more gossip about my publisher or what? What? What else should we talk? About, yes, but that's got to be just for the supporting listeners. Let's get they get the inside scoop. What I wanted to do was give people a general overview of the mainstream idea as to why there was a financial crisis in 2008, and then I want to discuss your
book. Here is Paul Krugman's book Arguing with Zombies, where Krugman says by 2005 or so, I and many but not enough others, had grown concerned about what looked like an immense housing bubble. It seemed obvious that bad things would happen when that bubble burst. As it turns out, it was far worse than almost anyone realized.
Years of financial deregulation and financial innovation, which often amounted to finding ways to evade regulation, had created a banking system that was, in a modern high tech way, just as vulnerable to panics as the banking system on the eve of the Great Depression. That is Krugman summarizing how he saw it coming. And he knew what the cause was. Deregulation and financial speculation. So I want to go through your book Meltdown.
You list 6 culprits as to what caused the financial crisis of 2008 where you say the median home price across all U.S. cities increased by 150% from August 98 to August of 2006. Your first culprit they are the GS ES government sponsored enterprises, Fannie Mae and Freddie Mac. What do we need to know about culprit #1? Oh, I, I, I instead, I want to attack Krugman and, and what he
said. Let me just say a couple quick sentences about Krugman. I I'm sure we'll probably get into that at some point, but I have to now that just said it there, there. Everything that the various institutions did leading up to this crisis they could have done at any time. There was no special deregulation that allowed them, that allowed banks to to hold securitized mortgages, securitization itself. None of these things were allowed because of quote UN
quote deregulation. There is no relevant deregulation that had anything to do with this crisis. Even the Washington Post admitted that there is no relevant deregulation that is involved here. But when you're Krugman it, it has to be that because your faith is in the idea that if wise people would only be given the scope they need to manage the economy properly, we wouldn't have these catastrophes. So therefore there must have been something somewhere that
would have prevented this. But the stupid rubes repealed it that, well, that would be nice to believe, but there is no such thing. And not to mention Greenspan himself was cheering on lowering interest rates to make housing more appealing. He cheered that on at the time it was being done. And so Oh my goodness, he congratulates himself on realizing that wait a minute, housing prices might be going up a bit much and this, this could be a problem. Well, what a surprise.
The guy who calls for the very policy that causes the problem is now a forecaster of the problem. I mean, yay, this guy is just hopeless. All right, so you asked me about the GSE. So we're talking, in this case, we're talking about Fannie Mae and Freddie Mac. So these are institutions that they're like, you know, like the worst of a, they're technically private, but private, wink, wink.
You know, everybody knows that. Well, first of all, their purpose was to make home ownership more attainable for Americans and they were private institution. But they're private, you know, kind of like the way the Fed is private. Like, you know, the no really private institution, you know, has its chairman selected by the US government. You know, like, can they vote on them? I mean, there's no company in
the economy that's like that. Well, likewise Fannie and Freddie, everybody knew and they themselves, I have quotations in one or two of my books about this. They themselves knew that if Fannie and Freddie ever got into any trouble as they supposedly helped Americans become homeowners, that they had a more or less infinite line of credit to the Treasury. And that is exactly what
happened. That is exactly what happened on on Christmas Eve as this was all happening it, it's the the, the infinite line of credit with the Treasury was officially established at at a moment when nobody's paying attention, it's Christmas Eve. But Fannie and Freddie would buy
mortgages from banks. That is to say, once, let's say an institution like Countrywide makes a mortgage loan to some family, Fannie, you could get a, you would get a letter in the mail saying from now on, this mortgage will be serviced by Fannie Mae. And so therefore you're going to make the payments accordingly. And so that means that Fannie Mae by buying this mortgage from the originating bank is buying the right to get the flow of mortgage payments over time.
And the existence of Fannie and Freddie that we're willing to buy mortgages and we're willing to buy risky mortgages. And we know this again, from in from internal documents and we know what the what directors of the company were telling people that you got to be you if you get out of this company, if you're not ready to take risks. So it meant that even though it's true the private sector made a lot of bad mortgage loans, they knew they could sell them to Fannie and Freddie.
That's the point. That's the point that somebody like a Krugman is going to ignore. So I didn't choose Countrywide at random. Countrywide sold about 90% of its loans to Fannie and Freddie. They were Fannie and Freddie or Fannie Mae executives were caught in counting scandals in 2004. They were cooking their books to justify bigger bonuses for themselves. If a private firm had done that, there would have been consequences.
But everybody loved Fannie and Freddie because politicians could say, look at these institutions. They're helping you, Joe Taxpayer and Joe Voter, get the the home that you want. And so, yes, it's true, there was no explicit bailout guarantee. There was a chance that Fannie and Freddie would be allowed to go bankrupt. But the point is the markets didn't think so. So even in September 2008, Fannie and Freddie are on death's door.
They've got all these. They've got all these assets of their books that are not worth nearly what they were supposed to be worth. They were still able to borrow at rates only one percentage point higher than the federal government itself could could borrow at. And investors obviously believe the federal government would would come to the rescue. We have plenty of evidence for that. So, yeah, So Fannie and Freddie were creating moral hazard. And there's a lot of moral
hazard in this crisis. Moral hazard refers to the phenomenon whereby you don't where, where, whereby somebody else is going to absorb the risk or is going to absorb the cost of your behavior. So there's a kind of moral hazard. Let's say when you rent a car, you're not going to, you're not going to get an oil change for that rented car. You're not going to wash it. Maybe you might go 5 miles an hour faster over a, a speed bump because you don't own the long term value of that car.
You know, the, the, the rental agency does well. Likewise, moral hazard is present when, for example, there is an implicit or explicit bailout guarantee from the federal government. Because, you know, well, if I take a lot of risk, I could wind up with very high profits. I also could wind up with losses. But I I have it on pretty good authority that the losses will be absorbed by the suckers who make up the tax paying population of the US. And so that what does that
encourage? Obviously more risk taking than than would have been taken in the past, you know, in the in the absence of the moral hazard. Culprit #2 The CRA or Community Reinvestment Act? What do we need to know about the Community Reinvestment Act? Well, here's the problem.
I mean, the Community Reinvestment Act had to do with making sure it was a kind of affirmative action lending, making sure that banks were issuing mortgages in what the government considered to be sufficient numbers in the neighborhood where the bank itself was located. And a lot of people on the political right pointed to the Community Reinvestment Act as an example of the kind of thing
that led to the crisis. Because obviously these banks, if you, if you have to force a bank to make loans, that means that those loans were unattractive for some reason, or they would have made them already. So people would say that legislation like our law, a law like that, a requirement like that requires banks to make loans they wouldn't make otherwise. Why wouldn't they make them otherwise?
Because they're not good loans. And of course, what, what the, you know, getting past all the stuff about deregulation or this or that, the fact is this, the crisis occurred because the banks just made a lot of bad loans. You know, that's not a sexy explanation. You know, that's, but that's the reality. Banks made a lot of bad loans. The, the reason I, I'm not particularly taken by this explanation is that it is true. The Community Reinvestment Act goes all the way back to the
1970s. So given that the crisis occurs 2007 into 2008, that's an awfully long incubation period, You know, for, to, for that to be an explanatory factor. It didn't help, but it was carrying more of a burden than it should have by right wingers who didn't know what else to to say. They they don't want to blame capitalism because they feel invested in that, but they haven't learned anything about the Federal Reserve because National Review wasn't talking about the Federal Reserve.
Neoconservatism wasn't talking about the Federal Reserve. They had no explanation at hand. Whereas we as Austrian economists, you know of, of the Austrian school, we can say that the central bank plays a role here. And the central bank is not a creation of the free market. It is just the opposite. But they didn't have that read readily at hand. So they were forced to to search around for not very convincing explanations like this one.
And you explain, look, instead of taking a very volatile example that people know about, could you walk us through why we might see a disparity between whites and Asians getting approved for banking loans? Oh, yeah. So there was a there was some amid. For all I know, there's still some talk about discrimination in lending that there were, there are racial disparities in the, you know, the being awarded mortgage loans.
And because of these disparities, the, the allegation was the banks are discriminating. So the banks, on the one hand, we're told that the banks are selfish and evil and whatever. And look, that this banking system, you know, a lot of them are, but but this is the, you know, these kind of woke accusations are never that they never make the right accusations. You know, I think that their criticism of the Pentagon is that it's not bringing on enough trans people.
That's not the correct criticism of the Pentagon. And likewise, these are not the correct criticisms of our current banking system. Well, one way you can definitively determine that these banks are not engaged in discrimination is simply to look at default rates. So if it were true that for some reason, even though they're dying, they're selfish and they want all the profits in the world, they would rather be racist against blacks than make
profits. OK, well, that seems kind of unconvincing given that you've all you do all day long is tell us how selfish they are. Why wouldn't they want to make money off black borrowers? You know? So the answer is you look at default rates. The default is rate is the rate at which people default on the loan. They don't make the payments. So if black applicants were being held to an artificially high racist standard, they should have lower default rates.
But they don't. So it turns out that the default rates are about the same, and that's because the loans were being made correctly in terms of of risk assessment. And so, yeah, it's true that Asians were getting mortgage loans at an even higher rate than whites were. Why? Because apparently they were more credit worthy or whatever factors you want to talk about. But the default rates are the same, and that's what the bank
cares about. Culprit #3 government artificial stimulus to speculation walk us through why this is a culprit in the financial. Crisis OK, so there's there's actually a lot to say on this. So I'll just pick a little, a little bit of the story, which is the, and we need to talk about the Federal Reserve, which is coming up, I think might be the next one after this one. And that will actually help us understand this a little bit better.
But we started to see lending standards go way down during this period because there's there's a, a very, very heavy push at the Department of Housing and Urban Development, the FHA, the Fed itself is also pushing this. Fannie and Freddie are also pushing it to get people into houses. And that meant all kinds of novel ways of getting people into mortgages who wouldn't
otherwise be qualified. So that would be, that would mean things like no doc mortgages, like you don't even have to show your employment so you don't have to convince us that you're creditworthy. It was wild the way they were giving away mortgages, but there was no way to keep these kind of creative instruments confined just to lower income kind of mortgages. Everybody wound up getting these
sorts of things. And what's more, the one thing, the one interesting Alan Greenspan move that is relevant to this discussion is that when the.com boom fizzled out, he pushed interest rates down further to try to stimulate things. And this was the first time in recorded history in the US that housing prices did not fall in a recession. They actually went up.
And this LED people to this false idea that was spread by all kinds of financial gurus that housing prices never fall, that you can't go wrong in real estate. Housing prices just go up and up. And this mentality in turn, coupled with all the various creative financing schemes, LED people to to get far, far further into flipping houses than they would otherwise have done. I'm going to buy this one, this
one, this one. And I just know that I can just turn this thing around and get a higher price. And everybody had been a customer or acclimated to that idea by all these voices they're hearing, and also by Greenspan continuing trying to continue the party from the.com boom by not letting the economy just kind of sort itself out
afterthe.com bubble burst. And in fact, Ron Paul on the floor of the US House in 2001 described exactly what was going on. Hesaidthis.com bubble has burst and now Greenspan is pumping up housing bubble. But get now we'll we'll say more about that when we get to the Federal Reserve thing. In fact, why don't we do that now? Fair enough. Culprit 4 is the pro ownership tax code. Anything we need to know about that before going?
Into I mean, I mean, you can read that in the book that I'll, I'll leave one of the six for people to be required to go buy the book. So we'll have a link to the book in the description and on the show notes page, by the way. So culprit #5 specifically is the Federal Reserve and
artificially cheap credit. Yeah. So during this time, we have the Federal Reserve increasing credit substantially and then we have all these incentives again coming from all these federal departments and from the GS, ES tending to steer that new money into into housing. And so, you know, there are, we've had the Great Depression, we've had financial panics, we've had recessions during various years. And they all have their own
individual characteristics. This particular one happened to have a major emphasis on housing. And we can understand why, given all the pressure on the part of these institutions to just to make these loans to to to build up the home ownership numbers. Democrats wanted that, Republicans wanted that, the Fed wanted it, the federal departments, all of these things. And so the existence of this Federal Reserve credit makes it
possible. For house prices to just continually rise away, where would people be getting the money to keep buying these houses? Eventually they'd be tapped out, but there's this enormous, vast amount of credit that's available. And so it just keeps going and going and going.
And this is something that also, I mean, yeah, we have laws saying you got to make this proportion of, of, of, of let's say subprime mortgage loans or you, you've got to make mortgage loans in the community or whatever. But we also have the incentive created by Fed credit. And that incentive kind of runs like this. And there's a, an analogy in the in the book to a basketball team. Let's suppose you, you have to pick five people from your gym class to be on your basketball
team. You're going to pick the five best you can. But then suppose I changed my mind and I said, well, you know what, you probably should have a bench of at least a couple of people. Pick two more. Well, those two more are going to be not as good as the first 5, right? Because you chose the best ones already. Well, likewise, when the Fed comes along, it increases credit, pushes interest rates down.
Now the banks are going to be making loans to, I mean, the banks are going to be loaned up to the extent possible at all times because they want to maximize their profits. So that means they've surveyed the market and they've found the most creditworthy people. But now suddenly there's increased credit in the marketplace and they have more
to play with. So now when they go back into the market to try to entice more people into getting mortgages, we know those people are going to be less creditworthy than the ones they already attracted. The same reason you already picked the best 5 basketball players for your team. So this is another factor contributing to this. In you walk me through the difference between what you call artificially low interest rates and interest rates that rise and
fall based on market demand. What makes the Fed interest rates intervention artificial, and why is that a problem? Interest rates fall when, when, when we as a society decide to save more of our resources that that pushes interest rates down. And when we decide to save more of our resources, we are basically saying we're not going to go into the economy and claim a lot of these, these kinds of things that that entrepreneurs
might need for their projects. So if I, let's say, say, you know, I'm going to save, I don't know, some wild amount. I mean, this would be considered a wild amount these days, 10% of my income. That means that I'm not going to go buying a whole lot. I'm not going to go buying consumer goods with that 10% for a while. And so during that time, that's exactly the time when we've all decided we're going to put a, a little bit of a halt on our
purchase of consumer goods. That's when entrepreneurs think, OK, well then now's the time for us to do long term projects like expand our physical plant or do research and development for future products people might want. In other words, longer term things because they've got the time we're saving right now and they've got the time and, and they have the resources, you know, the, the trucks that might have been driving retail products to the stores.
Well, if we're saving, they don't need as many trucks for that. So those trucks are now available for entrepreneurs to use. Like we're not stuck in a tug of war with each other. Like we want the trucks for, for bringing retail products to the stores, but you want the trucks for your long term investments that are going to result in consumer products only way, way down the line. We're not in a tug of war. It's a natural flow of the allocation of resources.
But if interest rates are pushed down artificially by the Fed, well, it looks like the general public has saved. But now when you go to start these long term projects, you're going to find that you're actually in a, in a, in a tug of
war with consumers. You're going to find that those complementary products you need to complete your big long term projects, they're going to turn out to be more expensive than you thought because they're actually being bid away from you by people lower in the production process, people closer to the consumer markets who want them for immediate consumption. And so now some of these products are not going to pan out. Some of these investments are not going to pan out.
And the result is a bust. The result is a waste of resources, half finished things, unprofitable investments that should never been begun. And then the recession period is when we sort this all out, reallocate resources into channels that are sustainable in the long run, and then we get a healthy economy again. Walk me through what you mean in the section Cluster of errors. Why is this significant when it comes to the Austrian explanation?
OK, so most people listening will know that there's something called an Austrian School of Economics, which is of course not a literal building but rather a school of thought, and that it's main proponents are people. I mean, from the beginning, Karl Menger, Wigan von Baumbauer, Ludwig von Mises, FA Hayek, and then many others after that, Israel Kerzner, Murray Rothbard, many others.
And they have a distinct way of looking at how to do economics, which is kind of a more old fashioned way, which does not make it wrong. That makes it much more likely to be right, actually. And among many other things, they have a distinct explanation for why the economy moves in a
cyclical pattern. Now, we know that in a market economy, if you are very bad at pleasing consumers, if you produce all the wrong things or you produce the right things but at prices nobody can afford, you are going to suffer. You're going to suffer losses and potential bankruptcy.
But if you are very good at anticipating consumer demand and you come up with products people want at prices they can afford, you're going to be rewarded with profits, which means you'll have now more resources at your command. And therefore the people who are the best at anticipating consumer desires will now be able to command more resources
to continue their good work. So if that's true, that the best anticipators of consumer preferences are rewarded and they get more and more resources, and people who are the poorest at it get punished and wind up being stewards of fewer and fewer resources, then the question becomes why doesn't the economy then move essentially in an upward trajectory? Because the best, the best entrepreneurs get rewarded and they're controlling more and more resources, and they're really good at this.
And so the economy should get better and better as this process continues. But you notice the economy instead moves in like a sine wave. It goes up and then it goes down. It goes that way. You know, we're doing well, then we're doing badly, then we're doing well, then we're doing badly. That doesn't seem to be the story that we're telling here about the the most skilled entrepreneurs getting more and more resources under their
control. Shouldn't that lead to better and better and better outcomes rather than up and down and up and down? So what is the source of this up and down? What is the explanation for this up and down? And we're sometimes inclined to think that maybe there's some localized problem, you know, like, or or maybe there's some some localized, for example, not necessarily just to a physical location, but to a particular
industry. Like let's say oil prices go up very suddenly or there are very suddenly shortages of oil and that has economy wide consequences. Well, OK, something like that happens. Or let's say Martians came and they like to drink oil and they drank like 9/10 of the supply in one day. Well, that would of course be a shock to the economy, but that's not what we're really looking for. That would be 1 localized, one time shock. We're looking for the explanation of a consistent
cyclical pattern. And so where Austrians look for that is in money and banking, because money is half of every transaction. You know, it's money for a winter hat or money for some bottled water or, you know, or money for a new car. Money is always half of every
one of those transactions. So if we're talking about a systemic problem that seems to affect all markets in the economy all at once, and it's it turns out that so many entrepreneurs will have been found to have made errors all at once in their entrepreneurial calculations, we need an explanation for this. And the explanation would seem to be something that affects the entire economy.
If it's a phenomenon that we see in the entire economy, we should look for the explanation in some phenomenon that affects the entire economy, and that's money. And so the the Austrians say now strictly speaking, the the, their theory of the business cycle can in fact exist even without the presence of a central bank. But in our case, we have the Federal Reserve System that pushes interest rates lower than they would be normally.
And the idea here is that is that entrepreneurs will be misled into making investments in the light of an interest rate that's telling them a lie, that's not giving them the full picture of the availability of resources. And so this will get entrepreneurs on the wrong track. And therefore we'll see this cluster of error that has this institutional explanation the the Federal Reserve. So that's, and, and not to mention, it's not just that entrepreneurs become foolish.
It's also, as our friend Lucas Engelhart points out, that fools become entrepreneurs When it looks like, hey, everybody's succeeding and there's all this money that's so easy to get on easy terms and low interest rates, then you fools become entrepreneurs and they wind up making a lot of mistakes. And so that is the thing. What is the explanation for that cluster of error? And the answer is the artificial interference with interest rates on the part of the Fed.
And on top of sending a poor signal, I guess the chairman of the Fed could just come out and say there's not as much savings, so just ignore the interest rate. They create the incentive on top of it for people to actually take these loans out. You mean there's also the concern that if, if my firm doesn't take advantage of the cheap credit, all my competitors will and they'll use this moment
to expand their capacity. And it's not that every single person who starts a project during a boom is going to fail. Some of them will succeed. Some of them will roll the dice and they'll they'll get their project finished and everything will be fine. And So what you'll sometimes see is that there'll be this thought that if we don't also get while the gettin's good, we're going to come out worse. So we have to go out and be speculative.
And so in the, it's, it's analogous to what happens with the money supply and the ordinary person in an inflationary world, the ordinary person sees his money losing its value. And so he feels like, OK, I guess I have to go out and speculate too. I guess I better get in the stock market or, or something. It encourages speculative behavior so that people can just break even. In the book, you differentiate higher order stages of production and what you call
lower stages of production. So this is differentiating me going to the store and buying retail versus a construction company who is looking for places to mine lithium or whatever. Can you walk me through what differentiates higher order stages of production from lower and why that's significant? Now I can, I can give you as I just did, a, a, a very, very elementary overview of the Austrian theory of the business cycle without talking about
stages of production. But for people who want a, a bigger picture here, the idea of stages of production is runs as follows, that the highest order stages are the ones that are the farthest from consumers. And so that is to say research and development or mining, that's very, very far from let's say a wristwatch in a jewelry store, because that's going to take a long time. Like research and development, we don't even know what the product is going to be.
So that these are stages that are that are going to be that the fruits of those stages will not be consumer goods for a long time. So we have a stage like that. We, we might have, you know, we'll have like manufacturing, we'll have distribution. We're OK now we've so, so manufacturing itself is going to be a series of stages.
Maybe, maybe the first stage is the production of, you know, widget A, but widget A isn't useful to people without being combined with widget B, which is then another stage. But then once the product is created over the course of stages, then we have to distribute it. So we've got to physically transport it. We have to market it so that people know that it exists. We have to get it into that retail store.
And so if you think about a bagel in a in a deli, you have to think about, OK, we're going to, we're going to plant grain now that's very, very far away from your bagel. You know, then we have various stages that that grain goes through to become a bagel that is heated up and handed to you
in a retail store. And the idea of this, this idea of, of stage of production helps us to conceptualize what's happening in the business cycle in, in, in a, you know, an artificially induced boom is that you've got entrepreneurs now with the lower interest rates, these long term projects become very, very attractive, very much more attractive.
In the same way that if, if the 30 year mortgage rate for your house was cut in half, you would go out and buy, you might very well go out and buy a nicer house, you know, because, because that that slash in half, let's say, or even buy, you know, a percentage point or two makes a big, big difference in the, the payments you're going to be making over time, your mortgage payment will be way lower because of that. And so likewise, these long term projects become much, much more
attractive. So you've got entrepreneurs working up here on the higher order stages, But at the same time, consumers are just demanding their same pattern of consumption and saving that they had before. And so they want resources down here more of existing products. And meanwhile, because of the mismatch of the, because that we have artificially low interest rates and not the interest rates that emerge from the natural patterns of saving and consumption on the part of consumers.
We have a kind of a competition between entrepreneurs up here and consumers down here instead of the cooperation that would ordinarily occur if the interest rates were allowed to set themselves. And so that's that's the explanation of what what, what those terms mean. A lot of the financial terms can make things very confusing. Ludwig von Mises uses the analogy of a master builder to close out this section and then I want to go on to the next one. What is Mises master construction?
I forget what he calls it master. Can you either use a different analogy to explain this or walk us through Mises? Well, I'll walk us through the miserable even though we don't want to. It is an analogy involving a home builder. And unfortunately, the 2008 crisis involved housing. So when we use this analogy, we have to understand he's not literally talking about houses. He's thinking of the house as
representing an entire economy. So his analogy is this that he's, he's imagining an economy or he's imagining a master builder trying to build a house, but he's building a house in the same way that we're trying to run an economy with misleading interest rates and mismatches and what everybody's trying to do. So as a home builder, I'm trying to build a house. So I'm going to gather resources together and start building that house.
So in, in the case of, I mean, basically what's happened, the way I like to do the analogy is that what we have in the case of artificially low interest rates is a, is a home builder, a master builder who's become drunk and his drunkenness is making him sort of like see double. And he thinks he has more resources than he has. So when he draws up a blueprint for his house, he draws up a blueprint for a house that's much too ambitious given his
resource constraints. There's no way you can build this house with the bricks and all the other supplies that he has. But he's looking at the supply and it looks bigger. It looks big enough to build this house. And so in effect, this is what we're saying is it's like the economy itself becomes too ambitious. It's trying to do more than it actually can do. So the master builder goes about me, he can build some of it. And he starts building.
And then he realizes, wait a minute, I, I can't finish this house, though the one in, in the blueprint. So he starts thinking, all right, well, I guess the, the only way to handle this is to build a more modest house. You know, I, I'll, I'll, I, I was too ambitious here. I'll try to build a more modest house. So let's see, we'll get rid of the gazebo. There's no way I have the resources for that. The second wing of the house, forget it. We're just not going to be able to build that.
So he tries to think of with the resources I have, what can I in fact do? And I'll explain how the, this how this is in fact an analogy in just a minute. But if somebody said to him, well, what if you continue to drink, you know, just drink some more, maybe that'll help you because then that'll make you think there are more resources. Now nobody could think that's the solution to his problem.
Fool him into thinking he has even more resources so that he continues to build the original house that we know he doesn't have the resources to build. If he did that, OK, he would continue building this. But then he'd realized, wait a minute, I just wasted even more resources and more labor time that I could have devoted to the building of the smaller house. Now this whole thing has to be demolished so that I can rebuild a house that is plausible given the existing resources that I
have. So the analogy is when we have a recession, this is, in effect the economy saying we've been too ambitious. We were trying to start way too many things all at once. We don't have the resources for them all. So we got to go back to our blueprint. We got to figure out what things we really can do, what things are really sustainable, what kind of economy we can have that can really work, and we'll go do those things. But that's the recession period.
So the recession period is actually the restoration to health. But during that period you have people saying, well, wait a minute, what if the government just spent a lot of money or the Fed printed up a lot more money? Well, OK, so again, we see that there's an analogy here that is like saying, let's get the the master builder even drunker than before, and we don't want to do that. What we want entrepreneurs to figure out. All right, look, we were misled into doing things we should have
done. Let's step back a minute and see what we can in fact do now. But if the Fed is going to is going to push interest rates even lower, that's going to make it even harder to figure out what we should do. And that's going to encourage us to persist in the wrong things, the same way we would have encouraged the Master builder to persist in building an unbuildable house. And that's what Alan Greenspan did in 2001.
People persisted in investment and spending decisions they shouldn't have persisted in. And so we don't want them. We want that master builder to see the world clearly, and when we hump the economy with all this artificial stuff, all it does is is make him fall back into his initial errors. And So what is true of him in the analogy is true of the
economy and the aggregate. In the face of hundreds, dozens, maybe hundreds of regulatory agencies, 10s of thousands of codes in the pages in the Federal Register, thousands of bureaucrats, the progressive and will have the confidence to say it was actually deregulation because it's not the number that matters, it's the quality. And what happened was they've repealed glass Steagall in the 90s, allowing commercial and
investment banks to merge. How can we falsify this thesis that repealing Glass Steagall was the cause of the O8 crash? Yeah, it's just, I didn't, I have friends who take this position and I think they're just not I, I don't know where they're coming from on this because so-called glass, there's the what what we had was the, the, the partial repeal of Glass Steagall around 1999. The so-called Glass Steagall had separated commercial and investment banking from each
other. And the repeal of that simply said that the same holding company can own both a commercial bank and an investment bank. That was it. And all that did was make the United States like every other country in the world. No other country in the world had that restriction. So the idea that repealing that caused a financial crisis that spanned the globe when only the US had that provision in the 1st
place is unconvincing. No other country has had any problem with that and and neither have we. And so when we look at like who are three of the major players that had major troubles during the financial crisis, Bear Stearns, Lehman Brothers and Merrill Lynch, well, those were pure investment banks. They never crossed over into commercial banking. Same with Goldman Sachs, Washington Mutual and Wachovia, which went under. They just, they lost money the old fashioned way.
As I said at the beginning, they made bad loans to homeowners. And AIG is an insurance. Firm is an insurance, right? Yeah, AIG and, and AIGAIG wound up getting, you know, the, the bailout thing is the other side of all this. AIG wound up getting a bailout and then just months later its former CEO said, you know, in retrospect, probably we shouldn't have gotten that bailout. We should have been allowed to go bankrupt. And then the, the, the, the rest of the US wouldn't have had to
deal with our, our problems. The whole, I mean, I'm, I'm, maybe I'm getting ahead of us here, but I, I don't, I don't want to get into all the technical details about credit default swaps. But the point is that with AIG, we were told, as with COVID, we don't have time to listen to you people. It's an emergency. We have to take action. And so we were told that AIG has all these toxic assets that, and so that their, their counterparties are going to go bankrupt if AIG goes bankrupt.
But, and so, and you're not going to get your paycheck because the Main Street banks are going to get hit by this. Almost none of AI GS bad assets were held by Main Street banks.
They were held by about a dozen major institutions, and those institutions alone would have taken a hit, and they could have absorbed that hit because those institutions had about $20 trillion in assets and they were facing maybe between 60 and $80 billion in losses, which is about the equivalent of one year's worth of executive bonuses. But sorry, no, we we have to bail them out.
And then that leads to even more moral hazard because now everybody knows that if push comes to shove, the Fed will come along, tell everybody to shut up and make things right with the federal government, too, will come along and make things right. And that means that you're encouraging people to engage in all kinds of risky behavior that they would have been punished for. So the Sallie Mae deregulation, alleged deregulation like
they're doing us so many favors. This did not apply to the most volatile banks who crashed during the recession. Therefore, to say there's a causal link is nonsensical. That's your general response. Yeah, It doesn't tell the story that we lived through. It has nothing to do with that
story. And, and I think I've, I've heard several people say, but the reason people cite this, they think is that as with somebody like Krugman and I, by the way, I don't know what Krugman's opinion on this particular question is, but it's the same mentality. There must have been some repealed thing that would, if we had kept it, have prevented this outcome. They have to believe that, that the smart people, the experts running things must have anticipated this.
But the stupid rubes got rid of their their wise regulation. They have to believe. They can't just believe that maybe the experts themselves might have driven us into into this dead end. Yeah, because I would have assumed that if you had a bank that was allowed to diversify its portfolio with commercial and investment payments or investments, I thought that they would be more stable.
So that actually makes sense. All right, so now we get on to we're in the recession now we got to come up with a solution. Fortunately, Nobel Prize winning economist has the answer for us. He summarizes the theory of John Maynard Keynes on page 96 of Arguing with Zombies. Here it is. Get a pen, because you're going to want to jot down a few things. The economy isn't like an individual family that earns a certain amount and spends some other amount with no relationship between the two.
My spending is your income and your spending is my income. If we both slash spending, both of our incomes fall. In a situation in which many people have cut spending, the result is depressed incomes and a depressed economy with millions of willing workers unable to find jobs. The government is not in competition with the private sector. Government purchases don't use resources that would otherwise be producing private goods. They put unemployed resources to work.
Budget deficits haven't led to soaring interest rates, and the Fed's money printing hasn't led to inflation. Austerity policies have greatly deepened economic slumps almost everywhere they have been tried. Spending cuts and or tax increases should wait until the economy is no longer depressed and the private sector is willing to spend enough to produce full employment. What, if anything, is wrong with
that response? We have come upon the old issue of idle resources and somebody like Krugman is, you know, I, I, I want to emphasize people. He's, you can't just go up to Paul Krugman and say, don't you know about the broken window fallacy? He does. And, and he will admit to you that in an economy with full employment of resources, the broken window fallacy would be a
problem. And for the broken window fallacy is the boy throws a baseball through the window and it breaks it. And the home owner is very unhappy because now I have to replace the, the window. But the, the, the midwit economist comes along and says, oh, but actually the breaking of the window will be a stimulus to the window repair industry because he can only see one thing at a time. But the problem is like that, the resources that go into that can't go into something else.
And so if there hadn't been a broken window, I could have had a nice window and a new sweater. But since I have to spend the sweater money on repairing the window, now I have only a window. So it's a, it's a, it's a loss as a normal person would think. Destruction is a loss. Krugman agrees with that. So we don't want to think he's just a dummy. What his, his argument is that when you're in a recession, the, the, the resources in question
aren't being used by anybody. So it's not like, you know, we, we have to pull resources away from one thing in order to do, let's say some government make work jobs. He's saying people are just sitting there, they're not doing any work, you know, So he's, he's in effect saying this is a case where the window repair man was unemployed, you know, so we're not pulling him away from some other employment. He was just sitting there anyway.
So we're putting him to work. And this is a net plus for the economy. So the, the problems with this are the at least two fold. Number one, when he says that resources are unemployed, he means like, you know, he means mostly labor, that people are unemployed, people are unemployed, but also resources, you know, there are buildings that aren't being used because the the factory closed or, you know, and all the machines in the factory are just sitting
idle. And wouldn't it be good if we could do something with those things? So let's stimulate them into activity. The problem with this is they're idle for a reason. If, if the prices of those things like that machinery of that building went low enough, somebody would buy it and start producing something in there. But right now the economy is trying to price those things and trying to figure out at what price level is it profitable to use this thing.
And just artificially saying we'll go in there and start making stuff is not helpful. We need to figure out is it economical to make stuff? Maybe, maybe this, this whole building's a total loss for all we know, but we need time to figure that out. And politicians can't figure that out. They're going to, they're just going to say, well, employ some of my local constituents in doing some random thing of that building that's not making us richer. So that's, that's one problem.
The other problem is so that other problem is why are the resources idle in the 1st place? Krugman never wants to answer this question. Why did the resources suddenly go idle? Well, because of what we learned, the Austrian business cycle theory, they started on, on projects that were unwise and unsustainable shouldn't have been started. And so we don't really want to restart them. Why would we want to restart them? Maybe they shouldn't have been
started again. Entrepreneurs need time to figure out how to fit these resources now into the new economy that we have, not the imaginary economy we thought we had when we were drunk, this real economy. So that's going to take a little bit of time. And then finally, when Krugman says we're not using resources, that the privates, we're not competing with the private sector, when the government directs the allocation of resources and employing individuals and jobs, we're just
taking idle things. But that's impossible. What project could Krugman come up with that absolutely, precisely uses only those human and physical resources that happened to be idle at the time? No matter what project it is, it is going to be competing with real projects that have real consumer demand behind them. Not just politicians saying, hey, create these jobs so that I look like a cool guy in front of my constituents. That only impoverishes us.
Those types of jobs, they don't create anything we want. If they did, we would voluntarily support those jobs with our purchases. So Krugman, no matter what he claims he can do, cannot create jobs and projects that precisely pull only the resources that are temporarily idle. He will be competing with the private sector that is actually currently in the process of trying to produce things we
really need. He equates the involuntary investment of the taxpayer with things that actually reveal choice preference of what people actually want. Exactly. Right. Just seconding two more questions with regard to historical narratives. What are some lessons we can learn from the depression of 1927? Years after the Federal Reserve was established, there was a depression. The panics did not end. What are some lessons from the depression of 1920?
Yeah, so. The that I, I wrote an article for the Intercollegiate Review on that. I don't remember the title of it, but that it, it gave my most thorough overview on it. I do talk about it in meltdown to about the degree that you know, an ordinary person would need. But for the nerd, you're going to want to look for my article in the Intercollegiate Review.
But the long and the short of it is this Joseph Schumpeter, while great, not not in in the Austrian school, but a great, very interesting economist, said at the time that that downturn 1920 to 21 was itself evidence that the economy reverses itself when after there's a downturn that you don't need outside help, you don't need artificial stimulus, you don't need anything like that, that entrepreneurs eventually sort
things out. And so you did have a very severe downturn that year, like production following by the following, by a double digit percentage, double digit unemployment, a very, very substantial downturn. And by the middle of 2000, I'm sorry, not 2000 and 1921, Warren Harding had as his secretary of commerce Herbert Hoover, who was not the laissez faire ideologue. We've been told he was something of a progressive and he was urging Harding to do something.
Oh, by the time it occurred to him to quote, UN quote, do something, the and the economy had already reversed itself. The recession was already over. So there is something to that. And yet we know all about the Great Depression and the phony story whereby the New Deal solved it. It obviously did not. But nobody knows about that depression of 1920 to 21, and it's obvious why. Final question, Herbert Hoover. The narrative is we had a
depression. Unfortunately, we had this laissez faire obsessed Herbert Hoover who basically sat on his hands until we got the New Deal by Franklin Roosevelt. Fortunately enough, we've already gone over how the New Deal led to the double dip recession of 1937. If we just focus on this concept. Hoover was an economic isolationist or a free market thinker. What is wrong with that theory,
if anything? Well, the New Dealers themselves admitted that they're the entire New Deal was just an extrapolation from what Hoover was already doing. And in fact, FDR ran against Hoover on the grounds that he was a big spender and FD Rs vice presidential nominee said that Hoover was taking us down the road to socialism. Now what? So how how come they didn't know that Hoover was a laissez faire ideologue at this point?
The the the good sound revisionism on this has pretty much come through, just hasn't trickled down to the general public. But I even saw Apbs special saying that, yeah, we all know now that Hoover was an economic interventionist. Well, who's we? I mean, a few people do, but the general public typically doesn't. But you look at Bob Murphy's
done great work on this. He has the politically incorrect Guide to the Great Depression of the New Deal, and he's gone through the numbers of comparing Hoover's spending and FDR spending. And, and because Hoover did spend an enormous amount on public works and not to mention he had agriculture policies and wage policies, which wasn't a policy, but it was a strong urging to major companies to keep, keep wages up at a time when when prices were were
falling pretty dramatically. But to keep nominal wages up at a time that we know that would just encourage people to hire fewer people at at that particular moment. But when we when we go down the line, he raised taxes and he raised taxes on all kinds of different things, not just income, but all kinds of particular excise taxes on particular products. He was lending money to the states for their for them to do various public works types of
programs themselves. So he intervened over and over. In fact, he says in his memoir that we might have done nothing, but that would have been catastrophic. So yeah, it it, it, it is not so it is. It is indeed not so. Hoover was a kind of proto progressive who thought that. In fact, he says repeatedly that laissez faire is dead, It's over. It's an old idea. We've now moved on to this new modern way of of planning with cooperation between government and business. It's all in there.
One of the great lessons I learned from Diary of a Psychosis, your book published by the Libertarian Institute, is ask yourself, what should we expect to see? So when they tell us, well, we need a mask mandate, well, we'd expect to see cases going up, mask mandate enforced, and then
cases going down. So when someone says Hoover was a hands off free market guy, we would expect to see Hoover come into office and then spending and government regulation slowly decreasing on top of the Smoot Hawley tariff taxes from econlib.org. Federal spending in 1929's budget that Hoover inherited was $3.1 billion. He increased spending to 3.3 billion in 1933, point, 6 billion in 1931, and 4.7 billion and 4.6 billion in 1932 and 1933 respectively, a 48% increase over his four years.
So that is just another verifiable lie that the progressives and neocons are constantly shoving down our throat, ushering in a totalitarian bureaucracy within our shores for our own good. Meltdown is an absolutely excellent book, one of the early books I read in libertarianism after Ron Paul's The Revolution and Frederick Bastiat's The Law. Thank you so much Tom Woods for talking to me about this.
Well, thank you, Keith Knight, for asking me questions about it. It is the 15th anniversary. There is a new introduction bringing things a little bit up to date. This is one of those things, like COVID, that if we get it wrong, then the conventional wisdom becomes the stupid heads wouldn't let the experts take care of business, you know? And it's like, yeah, how many
these people have no shame. So if any of this interests you, check out Meltdown. We'll have the link in the description and on the show notes page tomwas.com slash 2558. Also, I have a big booster and indeed a member of the board of the Libertarian Institute, and that is Libertarian institute.org, which I very much want to encourage you to check out. So thank you, Keith Knight, and thank you ladies and gentlemen. Make yourself and those you love less vulnerable to the regime,
both mentally and physically. Get more forbidden information at tomsfreebooks.com and be sure to subscribe to the show wherever you listen. See you next time. Like the sound of the Tom Wood show? My audio production is provided by Podsworth Media. Check them out at podsworth.com.