What caused the crisis?

• Author: Moynihan, Michael C.
• Position: Soundbite - John B. Taylor interview - Interview

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Most pundits and politicians will tell you that the ongoing financial crisis is the result of too little regulation and that we need a heavy dose of government intervention to restore prosperity. But according to the Stanford University economist John B. Taylor, a member of the president's Council of Economic Advisers under both Gerald Ford and George H.W. Bush, the exact opposite is true. In his new book Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis (Hoover Institution Press), Taylor argues that the government bears the most responsibility for creating and sustaining the current crisis. And if we're to come out of it, he adds, we need a lot less federal interference, not more.

Senior Editor Michael C. Moynihan spoke with Taylor in February.

Q: What is the basic premise of Getting Off Track?

A: The conventional wisdom is that markets screwed up and we need more regulation. Rarely is the government mentioned as maybe having caused this mess. What l did was look at the data, and what kept popping up in each case was government intervening too much and making things worse.

Q: What did you identify as the cause of the current financial crisis?

A: Monetary excesses. The Federal Reserve took the interest rate down to very low levels, which generated a housing boom, which inevitably brings a bust.

Q: What prolonged the crisis?

A: Misdiagnosis. They thought it was just a liquidity problem--not enough money. But it was a problem in the banks. The banks had problems on their balance sheets and wouldn't lend to each other. I looked at the data at the time and saw that it was a risk problem, not a liquidity problem. So it was treated incorrectly: We had a stimulus package, a sharp cut in interest rates, and special facilities to provide more money.

Q: Give an example of how the government made the situation worse.

A: The easiest example is last fall, when you had this panic and the markets crashed. The government comes forth with a $700 billion package. The secretary of the treasury and the chairman of the...