Reflections on the financial crisis.

• Author: Meltzer, Allan H.

I am going to make several unrelated points, and then I am going to discuss how we got into this financial crisis and some needed changes to reduce the risk of future crises.

Some Observations

First, we should close down as promptly as possible Fannie Mae and Freddie Mac. There never was a reason for those two institutions, other than to avoid the congressional budget process. The benefit that people got from Fannie and Freddie came from the subsidy to the mortgage interest rate. Congress could have passed that subsidy over and over again. They avoided passing it by taking the program off budget. That led to a benefit to members of Congress who participated in the profits of Fannie Mae and Freddie Mac. It is an example of bad government policy.

Second, looking ahead, the debt of the United States as a share of GDP is going to go from 40 percent to at least 60 percent. If you look at Japan, Italy, or Belgium, that doesn't seem like a startling number. The difference is that much of that debt is owed to foreigners. Looking ahead, get used to the idea that we're going to have to export more and probably see consumption grow at a slower rate. After years of rising expenditure on consumption in the United States, we are going to have to learn to tighten our belts a bit. That's not going to be an easy thing to do politically; woe to the president who presides over that period.

Third, I get a lot of questions from the press every day, and one of the questions these days is deflation. The last time somebody asked me that question--it must have been the 15th time I'd heard it--I said that was one of the most stupid question I'd heard in 40 years of dealing with the press. It's time that the people who talk about deflation went back to school and learned about the difference between maintained rates of change and one-time changes in level. The so-called deflation that we're going to have is the decline in oil and food prices that are the reverse of the increase in oil and food prices. Those are changes in the level of prices, but not in the sustained rate of change of prices. Deflation properly understood refers only to a sustained decline in the rate of change of prices. Incidentally, in Federal Reserve history, there are six or seven periods in which we had deflation. Only one of them was a disaster: the Great Depression. It was a disaster because while the deflation was going on, money growth was falling, so that the expectation was that deflation would continue. In the others cases of deflation, if you look at the footprints of those recoveries you wouldn't be able to distinguish them from any other recovery.

Fourth, is the bankruptcy law. There's a lot of pressure to change the bankruptcy law to adjust to the current circumstance. If we do that, the simple fact is, we won't have a bankruptcy law...