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Government intervention caused the economic crisis

Montreal, March 6, 2009 – It was not lack of regulation that led to the economic crisis but rather the harmful effects of government intervention. In an Economic Note titled The Origins of the Economic Crisis, published by the Montreal Economic Institute (MEI), economist Pierre Lemieux explains that “the current turmoil points more to government failure than to market failure.”

MEI president Michel Kelly-Gagnon adds that “the educational approach of this publication debunks a number of misconceptions and often misleading explanations on the origins of the current slump.”

We need to ask why some crashes, instead of remaining shallow recessions like the dotcom bust of 2000, become deeper recessions or depressions. We know that the crisis began in the U.S. residential mortgage market in 2007. The author explains that this market was encumbered by a large number of government interventions and distortions. A series of laws and regulations forced U.S. financial institutions, most notably Fannie Mae and Freddie Mac, to relax mortgage underwriting standards with the idea of promoting access to real estate ownership by targeted groups. Subprime mortgages were thus offered to individuals with insufficient incomes, poor credit, and very low if not zero down payments. Mortgage lenders considered them safe because the underlying mortgages benefited from explicit or implicit guarantees from the U.S. federal government.

Meanwhile, according to the author, growth in the money supply from 2000 to 2003 pushed interest rates as low as 1% in 2003, helping inflate the real estate bubble. By creating currency to stimulate the economy, the U.S. federal authorities precipitated the crash.

The limited deregulation experienced by American banks is not at issue, either. It enabled them to do what was already being done in Europe, such as operating securities firms or opening branches freely. At the same time, numerous laws increased the regulatory burden, so much so that U.S. federal government spending to control the finance and banking industry has risen by a factor of 12, in constant dollars, since 1960.

The author

The Economic Note titled The Origins of the Economic Crisis was prepared by Pierre Lemieux, an economist and professeur associé, Département des sciences administratives, Université du Québec en Outaouais.

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The Montreal Economic Institute (MEI) is an independent, non-partisan, non-profit research and educational organization. Through studies and conferences, the MEI informs public debates in Quebec and Canada by suggesting wealth-generating reforms based on market mechanisms.

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Information and interview requests: André Valiquette, director of communications, Montreal Economic Institute, Tel.: (514) 273-0969 ext. 2225 / Cell: (514) 574-0969 / E-mail: avaliquette (@iedm.org)

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