The financial and economic crisis that came to a head in the late summer of 2008 has brought forth a huge government response, many elements of which are without precedent. The crisis, however, did not come from nowhere. In important regards, its roots lie, first, in government policies to promote more widespread homeownership than would occur in a free market and, second, in the Federal Reserve System's mismanagement of interest rates and the money stock. The crisis is far from over, yet it already appears that the surge of extraordinary government actions and the new policies that the crisis has provoked will give rise to important, permanent increases in the government's size, scope, and power. In this way, it mimics the national emergencies of the past century.
I. DIMENSIONS OF THE CRISIS AND THE GOVERNMENT'S RESPONSES
Although the National Bureau of Economic Research places the recent peak of economic activity in the fourth quarter of 2007, (1) real gross domestic product (GDP) did not reach its peak until the second quarter of 2008. (2) By the second quarter of 2009, real GDP had fallen by four percent. (3) Likewise, financial stringencies in certain credit markets began to appear in 2007, though they did not become widely noticed until late September 2008, when a full-fledged financial panic developed, and commentary in the news media and the statements of public officials took on a frightened tone. The civilian unemployment rate began to rise after March 2007, when it stood at 4.4%, and by October 2009, it had reached 10.2%. (4)
In response to the growing economic troubles, especially the perceived "credit crunch" of September 2008, policymakers in the Bush Administration (most notably, Treasury Secretary Henry Paulson), in Congress, and at the Federal Reserve System (the Fed) responded by initiating a series of unprecedented actions to rescue tottering banks and other financial institutions and to inject credit into the financial system. (5) In September, the Fed took control of the insurance giant American International Group (AIG), (6) and the Federal Housing Finance Authority took over the huge government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, secondary lending institutions that held or insured more than half of the total value of U.S. residential mortgages. (7) On October 3, Congress passed and the President signed the Emergency Economic Stabilization Act of 2008. (8) Title 1 of this statute authorizes the Secretary of the Treasury to create the Troubled Assets Relief Program (TARP) and authorizes as much as $700 billion for the purchase of so-called troubled assets, primarily mortgage-related securities, held by banks and other financial institutions. (9) Unable to implement the planned acquisition of troubled assets, the Treasury instead used TARP mainly to inject funds into the banks by purchasing preferred shares and warrants to purchase common stock from them.
By the end of 2008, the Fed had made large, unprecedented types of loans and had given other forms of assistance, including loan guarantees, asset swaps, and lines of credit, to securities dealers, commercial-paper sellers, money-market mutual funds, Fannie Mae, Freddie Mac, the Federal Home Loan Banks, buyers of certain asset-backed securities based on consumer and small-business loans, Citigroup (related to losses resulting from a federal government guarantee of a specified pool of assets), and fourteen foreign central banks. (10) The Treasury and the Federal Deposit Insurance Corporation also took a variety of other large-scale actions to prop up credit and housing markets during the final quarter of 2008. (11)
After Barack Obama became President, his administration and Democratic leaders in Congress concentrated on gaining passage of a new "economic stimulus" bill. These efforts ultimately resulted in the American Recovery and Reinvestment Act of 2009, which the President signed into law on February 17. …