Pundits and politicians are virtually unanimous in saying today’s economic turmoil is the result of a laissez-faire policy in Washington and an orgy of greed and irresponsibility on Wall Street. Some samples:
John McCain: “We are going to fight the greed and irresponsibility on Wall Street. These actions [leading to the crisis] stem from failed regulation, reckless management, and a casino culture on Wall Street….We need strong and effective regulation, a return to job-creating growth and a restoration of ethics and the social contract between businesses and America.”
Barack Obama: “[The economic problems are] a stark reminder of the failures of crony capitalism and an economic philosophy that sees any regulation at all as unwise and unnecessary.”
New York Times: “The regulatory failure is rooted in a markets-are-good-government-is-bad ideology….”
Laissez faire in Washington? On what planet? Governments at all levels have regulated the financial industry from the time of the founding. The Clinton-era repeal of the 1930s law — Glass-Steagall — prohibiting the same company from engaging in commercial and investment banking did not constitute root-level deregulation, since the new full-service banks are still subject to myriad rules set by politicians and bureaucrats. (The end of the New Deal’s arbitrary separation of investment and commercial banking was forced on the government because new global competition in financial services was harming American companies.)
At the Division of Labour blog, economist Lawrence H. White asks: “What deregulation have we had in the last decade? Please tell me. On the contrary, we’ve had a strengthening of the Community Reinvestment Act, which has encouraged banks to make mortgage loans to borrowers who previously would have been rejected as non-creditworthy. And we’ve had the imposition of Basel II capital requirements, which have encouraged banks to game the accounting system through quasi-off-balance-sheet vehicles, unhelpfully reducing balance sheet transparency.”
Most fundamental of all, the government — after promoting easy loans to borrowers with dubious creditworthiness — stood ready to save big companies — most especially the government-created and government-favored Fannie Mae and Freddie Mac — from their own dangerous policies. (The “F” in those acronyms stands for federal. For details see my “Bailing Out Statism.”)
What about greed? Here White also has something important to say: “If an unusually large number of airplanes crash during a given week, do you blame gravity? No. Greed, like gravity, is a constant. It can’t explain why the number of crashes is higher than usual.” Likewise, greed (however you define this essentially useless concept) can’t explain the current economic troubles. Why didn’t these troubles occur earlier? Were people less greedy then?
What about irresponsibility? Now we are getting to the crux of the matter. There was irresponsibility — but only because the government for decades has pursued a policy of relieving big companies of the responsibility that otherwise would have been imposed by market discipline and competition. That’s a good way of summing up the government’s approach regardless of which party was in power: the weakening of market discipline. Any promise — explicit or implicit — to bail out companies and any regulatory, tax, or trade policy that raising the barriers to entry for new competitors weakens market discipline and invites — yes, invites — recklessness.
The point isn’t greed and irresponsibility; it’s incentives. In a truly free market — when business people know they will suffer the consequences when they do stupid things — “greed” (whatever that may be) tends to create general benefits. (“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”) In a government-regulated and government-guaranteed environment, “greed” can inflict harm on innocents, such as the taxpayers or consumers via inflation. Institutions determine whether self-serving action benefits or damages others. Institutions that respect freedom, property, and self-responsibility promote the general welfare. Institutions that forcibly transfer wealth, punish responsibility, and reward irresponsibility promote social and economic catastrophe.
Good intentions count for nothing in this context. The laws of human action (praxeology) can’t be repealed or got around.
The danger is, once again, that the current problems created by the corporate state (state capitalism, if you will) will be “addressed” through major new government interventions devised by politicians desperate to do something. We will likely end up with the equivalent of the Sarbanes-Oxley Act for financial companies and new regulatory mechanisms. Thus the government will set the table for the next crisis.
This is already taking shape. Democrats and Republicans (including John McCain) complain that financial instruments have become so complex that even the people trading them don’t understand them. Perhaps. Would newly empowered regulators understand them? Apparently not. Well? Does that mean no market activity would be permitted until the regulators understood them? Think of the consequences that public policy would inflict! Just what we need: an FDA for the financial markets.
The matter of what regulators do and don’t understand raises the all-important “knowledge problem,” one of the objections that destroys the case for external regulation of markets. F.A. Hayek, drawing on the work of important philosophers, stressed that much knowledge relevant to economies is tacit and unarticulated; it is local knowledge; it is “knowing how” rather than “knowing that.” This information is totally inaccessible to the regulators, which is why they can be counted on to mess things up. Any new regulatory regime will have unintended consequences — and we won’t like them.
The complexity of financial markets is beyond the comprehension of mere mortals. Trying to make these markets safe through government management is as sensible as waving a magic wand while chanting “abracadabra.”
Admittedly, we do need protection from recklessness. But oddly, the same people who condemn Wall Street for its irresponsibility support government bailouts — even as they say bailouts are a necessary evil. When will these folks see that the promise of rescue encourages recklessness? The best way to discourage it is to make clear that no one is too big or important to fail. Market discipline is the best protector of the public. But that requires laissez faire– no privileges whatever.
A final thought — actually a thought experiment: Imagine that Al Gore or John Kerry had been elected president. When the mortgage problems and their rippling consequences set in, can you see the New York Times or Keith Olbermann blaming Gore’s or Kerry’s laissez-faire, “markets-are-good-government-is-bad ideology”? The question answers itself, leading one to ask if Republican administrations inevitably produce serious negative externalities for the free-market movement that Democrats couldn’t produce if they tried.