Who's responsible for our financial crisis? The government says Stanford economist.

I've been listening to "The Forgotten Man" by Amity Shlaes, a history of the Great Depression 1930s era. What's happening today sadly sounds like a rerun of what happened in the 1930s.

I'm up to the 1934s and FDR's New Deal which was really just an amalgam of unrelated and uncoordinated government activities instituted in response to the economic crisis and based on the "progressive" ideology which guided FDR and his advisers. They really didn't know what they were doing. FDR's policies were really just an extension and massive expansion of Hoover's after the crash of 1929.

At a point, when things weren't turning around, the Roosevelt Administration went looking for scapegoats, particularly business leaders.

Here's a link to an interesting analysis of our financial crisis by a Stanford professor John B. Taylor who outlines missteps made by the Bush Administration and the Fed over the past several years.

My research shows that government actions and interventions -- not any inherent failure or instability of the private economy -- caused, prolonged and dramatically worsened the crisis.

The classic explanation of financial crises is that they are caused by excesses -- frequently monetary excesses -- which lead to a boom and an inevitable bust. This crisis was no different: A housing boom followed by a bust led to defaults, the implosion of mortgages and mortgage-related securities at financial institutions, and resulting financial turmoil.

Monetary excesses were the main cause of the boom. The Fed held its target interest rate, especially in 2003-2005, well below known monetary guidelines that say what good policy should be based on historical experience. Keeping interest rates on the track that worked well in the past two decades, rather than keeping rates so low, would have prevented the boom and the bust. Researchers at the Organization for Economic Cooperation and Development have provided corroborating evidence from other countries: The greater the degree of monetary excess in a country, the larger was the housing boom.

The effects of the boom and bust were amplified by several complicating factors including the use of subprime and adjustable-rate mortgages, which led to excessive risk taking. There is also evidence the excessive risk taking was encouraged by the excessively low interest rates. Delinquency rates and foreclosure rates are inversely related to housing price inflation. These rates declined rapidly during the years housing prices rose rapidly, likely throwing mortgage underwriting programs off track and misleading many people.

Adjustable-rate, subprime and other mortgages were packed into mortgage-backed securities of great complexity. Rating agencies underestimated the risk of these securities, either because of a lack of competition, poor accountability, or most likely the inherent difficulty in assessing risk due to the complexity.

Other government actions were at play: The government-sponsored enterprises Fannie Mae and Freddie Mac were encouraged to expand and buy mortgage-backed securities, including those formed with the risky subprime mortgages.

Government action also helped prolong the crisis. Consider that the financial crisis became acute on Aug. 9 and 10, 2007, when money-market interest rates rose dramatically. Interest rate spreads, such as the difference between three-month and overnight interbank loans, jumped to unprecedented levels.

Diagnosing the reason for this sudden increase was essential for determining what type of policy response was appropriate. If liquidity was the problem, then providing more liquidity by making borrowing easier at the Federal Reserve discount window, or opening new windows or facilities, would be appropriate. But if counterparty risk was behind the sudden rise in money-market interest rates, then a direct focus on the quality and transparency of the bank's balance sheets would be appropriate.

Early on, policy makers misdiagnosed the crisis as one of liquidity, and prescribed the wrong treatment.

The government distorted sound money practices in an effort to keep the economy chugging along. Those actions and then ones in response to the financial crisis have only deepened the crisis we're facing.

Seeing what's happening with the Obama mega-billion economic stimulus bill looks like something the "progressives" would have done during the Roosevelt Administration. Lots of pork, social spending and efforts to further regulate and control society and the economy.

Then as today, the Keynesian economists were in the driving seat in terms of influencing government policy. The whole rationale behind the stimulus bill is that government spending is necessary to jump start the economy. Lot's of observers say that won't happen and will only add to the debt burden facing our government and society.

Getting it right doesn't like look like it's in the cards for the foreseeable future.

Will Obama simply push a rewarmed version of the "New Deal?"

President-elect Obama did an excellent job of selling "change" to the American people during the last election. What wasn't always so clear was what that "change" would look like. He did talk about raising taxes on the wealthy, redistributing wealth as a good thing, giving lower income Americans a refundable tax credit, and moving towards universal health care.

In reality, he was only advocating further advances along the lines of the "New Deal" programs of FDR which means more government, more taxes and more regulation of various areas of human life.

Will the current financial crisis be used as a pretext for advancing this agenda just as FDR did the New Deal in the 1930s? Is this another case of history repeating itself? Amity Shlaes, author of a recent book on the Great Depression, suggests that's just might be what happens in this New York Post op/ed piece.

She writes:

THE trouble with new financial crises is that they provide pretexts for implementing old social agendas. As the president-elect's new chief of staff, Rahm Emanuel, said recently, "never allow a crisis to go to waste."

Consider President Franklin Roosevelt's New Deal, which President-elect Barack Obama invokes when he talks of "a defining moment." Like Obama today, FDR was inaugurated into trouble. He wisely addressed the financial crisis through the steps that we learned about in school. He signed deposit insurance into law, reassuring savers. He created the Securities and Exchange Commission, making the stock market more transparent and consistent. He soothed our grandparents via his radio Fireside Chats. This was the FDR we love.

But FDR also used the crisis mood to push through an unprecedented program of reforms that progressives had been hoping to put in place for years. Sen. George Norris of Nebraska, for example, had for decades argued that utilities should be in the public, not the private, sector. As far back as the early '20s, Norris wanted to build a big power project on Tennessee River. He wanted the government - and not the Ford Motor Company, which was drawing up such plans - to be in charge. FDR made Norris' progressive dream a reality by creating the publicly owned Tennessee Valley Authority. Washington won out, but it wasn't clear its power served the South down the decades.

Will Obama attempt to do the same thing?

The Obama administration isn't likely to advocate a new NRA. But President-elect Obama may go along with Democrats in Congress as they push other old social agendas. They, like the early-'30s Democrats, now have the ugly snapshot of capitalism for which they longed.

Foremost on their reform agenda, as in 1993, will be health insurance. Indeed, we are practically guaranteed a "healthcarization" of our financial crisis, even though health care and mortgage-backed securities have little to do with one another. "Nationalization" used to be a scare word. But the easy nationalization of the giant AIG makes the nationalization of private health care suddenly seem possible.

A Democratic Washington also will likely legislate the fondest wish of private-sector unions - the famous "card-check" legislation that will deprive workers of the chance to cast an anonymous vote on shop unionization. This, in turn, will put upward pressure on wages that workplaces can't afford.

The greater danger is that the public-sector unions, with support of Democrats, will push up their own pay aggressively. Behind the GM crisis is the crisis of state and city budgets - which the demands of AFSCME, the public-sector union, will only exacerbate.

President-elect Obama creates an opening for such demands when he says, as he did recently, that everything about the last four years was wrong. Everything? Sure, the financial crisis needs addressing. But government health care and card check don't have much to do with mortgage crises.

So remember what's really be going on: Voters want change - Obama's campaign message. But the Democratic Party is widening the definition of change by the hour. And the crisis? It's just a pretext.

If Obama does push New Deal approaches we can expect greater economic difficulties in the form of a much longer recession if not depression or maybe more likely, the return of inflation. The latter resulting from an unwillingess to confront our nation's unwillingness to live within our means.