Economic Troubles and the Growth of Government

The current recession and, especially, the related financial panic in the fall of 2008 have given rise to an extraordinary surge in the U.S. government’s size, scope, and power. As I write, the financial panic has subsided, but the recession, already the longest since the 1930s, seems likely to continue for a long time. Even when it has passed, however, the government will certainly retain much of the augmentation it has gained recently. Hence, this crisis will prove to be the occasion for another episode of the ratchet effect in the growth of government.

According to the National Bureau of Economic Research, the recession began early in 2008, but the decline became severe only in the latter part of the year. The financial panic that came to a head in late September 2008 proved to be the catalyst for an accelerated decline in real GDP and rise in the rate of unemployment. The so-called credit crunch in the fall of 2008 prompted the Fed, the Treasury, and the Congress to take a series of extraordinary actions in quick succession.

In September 2008, the Federal Reserve System (“the Fed”) took control of the insurance giant American International Group (AIG), and the Federal Housing Finance Authority took over the huge government-sponsored enterprises Fannie Mae and Freddie Mac, secondary lending institutions that held or insured more than half of the total value of U.S. residential mortgages. On October 3, the president signed the Emergency Economic Stabilization Act, which, among other things, created the Troubled Assets Relief Program (TARP), authorizing as much as $700 billion for the purchase of so-called troubled assets, primarily mortgage-related securities, held by banks and other financial institutions. Instead of making the authorized purchases, however, the Treasury used the TARP to inject funds into the banks by purchasing their preferred shares. In this way, the government acquired an ownership interest in nearly 600 commercial banks.

Meanwhile, the Fed made a series of unprecedented types of asset purchases and loans, loan guarantees, and asset swaps, and provided other forms of assistance to securities dealers, money-market mutual funds, Fannie Mae, Freddie Mac, the Federal Home Loan Banks, Citigroup, fourteen foreign central banks, and buyers of certain asset-backed securities based on consumer and small-business loans. As a result, the monetary base of the United States increased by more than 100 percent between August 2008 and January 2009.

After Barack Obama became president, Congress passed the American Recovery and Reinvestment Act, authorizing a variety of federal spending increases and some tax reductions over the period from 2009 to 2019. According to estimates by the Congressional Budget Office, the combined amount of these spending increases and tax cuts comes to $787 billion over the ten-year period.

These actions, among others, caused federal outlays to jump by 24 percent in fiscal year 2009, raising the U.S. government’s spending from 21 percent of GDP to 26 percent. They also increased the budget deficit by 246 percent, to approximately $1.6 trillion. Public debt held by the public rose from $5.8 trillion to $7.6 trillion during the course of fiscal year 2009, a 31 percent increase. These spending and borrowing surges will certainly have very long-lasting consequences.

Although these consequences are now in large part unavoidable, amelioration of their harm, as well as the prevention of similar government actions in a later crisis, requires a renewed commitment to liberty and a heightened understanding of its attainment and preservation. Toward these ends, the Independent Institute continues to work relentlessly.