Below is a copy-and-paste e-mail discussion I was having with a friend. I apologize for the rough, unedited blog post. For your enjoyment -
Anyways, I think it's obvious that what caused the meltdown was aggressive investment. Most point the blame to mortgage based CDOs, over-leveraged banks, the culture on Wall Street, and deregulation. However, everything I just mentioned could have also been used to support our benchmark economy prior to the GFC. As we discussed, all economic theories have positive and negative aspects. In our lifetime, with the exception of right now, I think free market, Hayek-influenced policy is what most Americans preferred. For years the financial sector was able to operate with minimal regulatory laws, and it worked. It was as close to a truly free market we will probably ever see. As Americans, we did not want limitations. And, as free-market thinkers, we ask: "Why should one be limited to what they can and cannot sell? Why should one be limited to how much debt they carry on their balance sheet? Why should someone tell someone else how to model their long-term business plan? It shouldn't matter... If they do not practice good business they will fail."
Banks were able to create complex investment packages that the most mathematically gifted couldn't understand. However, all of the consumers had to opportunity to, if they wished, research and choose what to and what not to "spend" their money on - capitalism at its finest. Well, bad business failed. However, we did not want to embrace the negative aspects of the Hayek and Friedman-based economic policies we wanted. As you know, the interconnection of all industries created a disastrous domino affect. When Lehman Bros. went bankrupt the negative aspects of a free market system was felt globally. So, instead of letting the theory run its course, which would have led to global depression and poverty, but could have also created the foundation for new and improved suppliers, we wanted to salvage our lifestyle. We created the whole "too big to fail" idea. But, according to the theories we practiced, nothing should be too big to fail but rather too stupid to survive.
Was it wrong to swap from a Hayek to Keynes approach in essentially one day? No, of course not. Why would anyone want to see a repeat of the depression? Most "experts" believe that if we allowed the markets to freely take their course in '08 that the world would still be feeling the affects, and perhaps still falling. Our lifestyles would have made a drastic change. Domestically, our national security would have suffered. We would have had to essentially start from scratch. In America, we're still pumping artificial, debt based money into the system to support our current needs and wants. (Which brings up the question of "Do too many Americans expect a fantasy lifestyle?" But that's a completely different social science question it's its own). And this new form of debt-based currency (which some argue is a military protected petrocurrency) brings up a whole new area of thought for modern economics.
Anyways, Another thing to consider is how much the times have changed since the classic Keynes and Hayek theories were developed. Keynes produced most his research before Bretton Woods and the World Bank Group became fully operational, and passed away shortly after the new global monetary laws took affect. Hayek was able to practice during the infancy of these new regulations, but retired three years before Nixon dropped the gold standard in 1971. There are many new aspects we need to consider in modern economic policy. And sure, classical economics refers to more of the big picture rather than these specific policies but, regardless, we still need more time to analyze the long-term affect of many of the decisions made since WWII. Heck, it took nearly twenty years for the markets to recover from the crash in '29, and even the Keynesian type initiatives then (Hoover Dam, Reconstruction Finance Corporation, etc.) cannot be accurately analyzed considering we became involved in a war during the process.
So, what caused the GFC? Capitalism. What promoted economic virtue in America? Capitalism.
