Does the Financial Crisis Discredit Libertarianism?

Writing in Slate, Jacob Weisberg claims that the financial crisis discredits libertarianism:

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....

[T]o 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...

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.

There are several problems with Weisberg's thesis. First, the US had hardly been following free market financial policies in the years prior to the crisis. Many commentators have pointed out the central role of government sponsored enterprises (GSEs) such as Fannie and Freddie Mac in promoting subprime and other risky mortgages that investors were willing to acquire in part because they believed that the GSEs would be backed by a government bailout if anything went badly wrong. As the term "government-sponsored" implies, Fannie and Freddie were hardly free market institutions. Some libertarian-leaning scholars, such as Peter Wallison in this 2005 article, have long predicted that their policies could lead to catastrophe unless reined in. The crisis was also fueled by the Federal Reserve Board's promotion of artificially easy credit over the first half of this decade. To put it mildly, libertarians have never liked the Fed. They have have often emphasized, as I did in this April post, that it is dangerous to give a small group of government technocrats vast power over the economy.

Recent American economic policy has not been especially pro-market in areas outside finance regulation either. During his first five years in office, George W. Bush presided over the biggest expansion of government spending in decades, including a major increase in regulatory spending.

Second, even if one can say that the US was following market-based policies in recent years, the same can't be said of European nations such as Germany, Iceland, and Spain, all of which have had mortgage/financial crises at least as severe as ours. If the financial crisis discredits "libertarianism" in the US, does it also discredit German social democracy? In my view, neither is true. But Weisberg's logic points in that direction.

Finally, no ideology can be judged solely by its performance in one particular crisis. Any set of policies is imperfect and therefore may provide flawed answers in a particular situation. Here is where Weisberg's analogy with communism circa 1989 breaks down. The problem with communism was not that communists had handled some one isolated crisis poorly. It is that communism's overall record over many decades was one of repression, mass murder, and economic decline - all with few or no offsetting benefits. Economic liberalization over the last several decades, by contrast, has lifted millions out of poverty around the world and greatly increased both personal freedom and standards of living. As Gary Becker points out, the period of economic liberalization in the twenty years or so prior to Bush's "big government conservatism" saw enormous economic gains. He suggests that if today's crisis were indeed an inevitable result of that liberalization, the overall balance sheet (25 years of massive progress vs. 2-3 years of painful recession) might be worth it.

It would be foolish to completely dismiss the possibility that libertarians were overly optimistic about the virtues of unregulated financial markets. It may turn out that some new forms of finance regulation will be justified. I do not believe that libertarian thought is perfect; far from it in fact. I merely think it is better than the available alternatives.

Be that as it may, libertarianism, like other ideologies, must be judged by its overall record. And that record must be compared to the overall record of the alternatives. For example, even if new regulation is indeed needed, we must be sensitive to the danger that crises such as this one present tempting opportunities for governments to expand their power in harmful ways that go far beyond what is necessary to address the crisis itself.

Weisberg is right to predict that libertarian ideas will face an uphill political struggle over the next few years. After Obama wins, government will almost certainly expand considerably, helped by a combination of united Democratic government and a crisis atmosphere. Even if McCain somehow manages to pull out the election, things won't look too good for free market ideas. Economic crises often provide a strong impetus for government intervention and the ideologies that advocate it. I'm not convinced, however, that free market advocates will be permanently defeated. Still less do I believe that they deserve to be.

UPDATE: Matt Welch has a good response to Weisberg's piece here.