A source of mild entertainment amid the financial carnage has been watching libertarians scurrying to explain how the global financial crisis is the result of too much government intervention rather than too little. One line of argument casts as villain the Community Reinvestment Act, which prevents banks from "redlining" minority neighborhoods as not creditworthy. Another theory blames Fannie Mae and Freddie Mac for causing the trouble by subsidizing and securitizing mortgages with an implicit government guarantee. An alternative thesis is that past bailouts encouraged investors to behave recklessly in anticipation of a taxpayer rescue.
There are rebuttals to these claims and rejoinders to the rebuttals. But to summarize, the libertarian apologetics fall wildly short of providing any convincing explanation for what went wrong. The argument as a whole is reminiscent of wearying dorm-room debates that took place circa 1989 about whether the fall of the Soviet bloc demonstrated the failure of communism. Academic Marxists were never going to be convinced that anything that happened in the real world could invalidate their belief system. Utopians of the right, libertarians are just as convinced that their ideas have yet to be tried, and that they would work beautifully if we could only just have a do-over of human history. Like all true ideologues, they find a way to interpret mounting evidence of error as proof that they were right all along.
To which the rest of us can only respond, Haven't you people done enough harm already? We have narrowly avoided a global depression and are mercifully pointed toward merely the worst recession in a long while. This is thanks to a global economic meltdown made possible by libertarian ideas. I don't have much patience with the notion that trying to figure out how we got into this mess is somehow unacceptably vicious and pointless—Sarah Palin's view of global warming. As with any failure, inquest is central to improvement. And any competent forensic work has to put the libertarian theory of self-regulating financial markets at the scene of the crime.
To be more specific: In 1997 and 1998, the global economy was rocked by a series of cascading financial crises in Asia, Latin America, and Russia. Perhaps the most alarming moment was the failure of a giant, superleveraged hedge fund called Long-Term Capital Management, which threatened the solvency of financial institutions that served as counter-parties to its derivative contracts, much in the manner of Bear Stearns and Lehman Bros. this year. After LTCM's collapse, it became abundantly clear to anyone paying attention to this unfortunately esoteric issue that unregulated credit market derivatives posed risks to the global financial system, and that supervision and limits of some kind were advisable. This was a very scary problem and a very boring one, a hazardous combination.
As with the government failures that made 9/11 possible, neglecting to prevent the crash of '08 was a sin of omission—less the result of deregulation per se than of disbelief in financial regulation as a legitimate mechanism. At any point from 1998 on, Bill Clinton, George W. Bush, various members of their administrations, or a number of congressional leaders with oversight authority might have stood up and said, "Hey, I think we're in danger and need some additional rules here." The Washington Post ran an excellent piece this week on how one such attempt to regulate credit derivatives got derailed. Had the advocates of prudent regulation been more effective, there's an excellent chance that the subprime debacle would not have turned into a runaway financial inferno.
There's enough blame to go around, but this wasn't just a collective failure. Three officials, more than any others, have been responsible for preventing effective regulatory action over a period of years: Alan Greenspan, the oracular former Fed chairman; Phil Gramm, the heartless former chairman of the Senate banking committee; and Christopher Cox, the unapologetic chairman of the Securities and Exchange Commission. Blame Greenspan for making the case that the exploding trade in derivatives was a benign way of hedging against risk. Blame Gramm for making sure derivatives weren't covered by the Commodity Futures Modernization Act, a bill he shepherded through Congress in 2000. Blame Cox for championing Bush's policy of "voluntary" regulation of investment banks at the SEC.
Cox and Gramm, in particular, are often accused of being in the pocket of the securities industry. That's not entirely fair; these men took the hands-off positions they did because of their political philosophy, which holds that markets are always right and governments always wrong to interfere. They share with Greenspan, the only member of the trio who openly calls himself a libertarian, a deep aversion to any infringement of the right to buy and sell. That belief, which George Soros calls market fundamentalism, is the best explanation of how the natural tendency of lending standards to turn permissive during a boom became a global calamity that spread so far and so quickly.
The best thing you can say about libertarians is that because their views derive from abstract theory, they tend to be highly principled and rigorous in their logic. Those outside of government at places like the Cato Institute and Reason magazine are just as consistent in their opposition to government bailouts as to the kind of regulation that might have prevented one from being necessary. "Let failed banks fail" is the purist line. This approach would deliver a wonderful lesson in personal responsibility, creating thousands of new jobs in the soup-kitchen and food-pantry industries.
The worst thing you can say about libertarians is that they are intellectually immature, frozen in the worldview many of them absorbed from reading Ayn Rand novels in high school. Like other ideologues, libertarians react to the world's failing to conform to their model by asking where the world went wrong. Their heroic view of capitalism makes it difficult for them to accept that markets can be irrational, misunderstand risk, and misallocate resources or that financial systems without vigorous government oversight and the capacity for pragmatic intervention constitute a recipe for disaster. They are bankrupt, and this time, there will be no bailout.
A version of this article also appears in this week's issue of Newsweek.