September 21, 2008
The Free Market Challenge - UPDATED
Blogging at Paterico's Pontifications Justin Levine writes of the challenges the current market crisis creates for advocates of a free market economy.
The first fact that needs to be put on the table is that this crisis in no way represents a failure of the free market. In a free market, no lender would go out of their way to invent ways to give loans to people who could not afford to pay them back. They would not be writing zero down payment, no-document (proof of income) mortgages and refinancing loans to 100% or more of a home's value. These loans were solutions to expanded credit requirements mandated by regulation under the Community Reinvestment Act.
Institutions sought to minimize this risk they were forced to accept by creating complex and largely unregulated securities backed by these sub-prime loans. As the value of these loans and securities began to fall, the market did what it had to do. Institutions with weakened balance sheets found it difficult or impossible to get the credit they needed to operate. Had this market based judgment been allowed to occur in the first place, we wouldn't be in the mess we are in now.
The question is, now that we are in the middle of this crisis, what do we do about it? Levine is right about it being a challenging question.
I see the question as, "The government created this crisis. Can and should the government have a role in fixing it?"
Despite my adherence to the idea of a free market, even to the point of it being a "reflexive talking point," I do see a role and a responsibility for government in cleaning up its mess. But as a reflexive adherent to the free market, I would like to see that solution bring with it an acknowledgment of the failure of using banking regulation as a vehicle for welfare and social engineering. And with that acknowledgment a strong move toward deregulation and a free market. I see little value in the argument put forth by Washington and both presidential candidates that since too little regulation failed the solution is more regulation.
I believe that the number one priority of the government vis-a-vis the institutions it has nationalized should be to sell the assets of those institutions and completely disentangle them from federal ownership. This should be particularly so in the case of Fannie Mae and Freddie Mac whose existence as Government Sponsored Enterprises should be ended and what is left of them should be fully privatized.
The next most important step is to repeal the Community Reinvestment Act and allow banks to make loan and business decisions based on an assessment of the relative risk and return, not government's social engineering goals.
The proposed government bail-out gets one thing right. It starts from the understanding that the source of the problem lies with financial institutions' portfolios of bad debt. I don't know if what they are proposing is going to be a workable solution but I do know that the government walking away from this crisis it created and letting the whole economy collapse is not the answer.
I also know that if we ride out this storm and do nothing to correct the source of the problem we will have accomplished and learned nothing.
UPDATE: I wrote above that "I don't know if what they are proposing is going to be a workable solution." Since that time I and others have had further time to look at and evaluate the current proposal. Based on that review I think the current bail-out proposal is foolish, misguided and dangerous. One need look no further than this clause to get a sense of how bad this legislation is:
If they players on Wall Street don't get a warm fuzzy secure feeling from this and don't like the rules, then let them take their ball and go home. The rest of us will have to start a new game.
Giving the Treasury Department a check for $700 billion and free rein for what to do with it is a stupidly bad idea.
Which brings us back to the current economic situation with Freddy Mae, Fanny Mac, and a host of other institutions. I would argue the same dynamic is at work here. Freddy and Fanny were born out of government tinkering with market principles in a half-assed manner. So now the government was faced with a stark choice: More thorough regulations of the institutions, or a complete economic meltdown that would adversely affect everyone – including those who steered clear of the housing industry and are effectively “innocent” players here.
That is what I see as the real challenge for free market advocates today. There are very few genuinely laissez-faire institutions left when it comes to the large pillars of our economy. We could face this same situation again if we are lulled into thinking that 20% government regulations will always be better than 60% government regulation in all situations in every industry. Regretfully, many use the term “free market” as just a reflexive talking point these days rather than as a substantive idea that reflects the realities of today’s commerce.
Unfortunately he closed the comments to that post so that even an imperfect advocate such as myself could not make an attempt to answer that challenge. I emailed this concern to Patterico who offered that if I blogged my response it would be linked in an update. So I will give it shot.That is what I see as the real challenge for free market advocates today. There are very few genuinely laissez-faire institutions left when it comes to the large pillars of our economy. We could face this same situation again if we are lulled into thinking that 20% government regulations will always be better than 60% government regulation in all situations in every industry. Regretfully, many use the term “free market” as just a reflexive talking point these days rather than as a substantive idea that reflects the realities of today’s commerce.
The first fact that needs to be put on the table is that this crisis in no way represents a failure of the free market. In a free market, no lender would go out of their way to invent ways to give loans to people who could not afford to pay them back. They would not be writing zero down payment, no-document (proof of income) mortgages and refinancing loans to 100% or more of a home's value. These loans were solutions to expanded credit requirements mandated by regulation under the Community Reinvestment Act.
Institutions sought to minimize this risk they were forced to accept by creating complex and largely unregulated securities backed by these sub-prime loans. As the value of these loans and securities began to fall, the market did what it had to do. Institutions with weakened balance sheets found it difficult or impossible to get the credit they needed to operate. Had this market based judgment been allowed to occur in the first place, we wouldn't be in the mess we are in now.
The question is, now that we are in the middle of this crisis, what do we do about it? Levine is right about it being a challenging question.
I see the question as, "The government created this crisis. Can and should the government have a role in fixing it?"
Despite my adherence to the idea of a free market, even to the point of it being a "reflexive talking point," I do see a role and a responsibility for government in cleaning up its mess. But as a reflexive adherent to the free market, I would like to see that solution bring with it an acknowledgment of the failure of using banking regulation as a vehicle for welfare and social engineering. And with that acknowledgment a strong move toward deregulation and a free market. I see little value in the argument put forth by Washington and both presidential candidates that since too little regulation failed the solution is more regulation.
I believe that the number one priority of the government vis-a-vis the institutions it has nationalized should be to sell the assets of those institutions and completely disentangle them from federal ownership. This should be particularly so in the case of Fannie Mae and Freddie Mac whose existence as Government Sponsored Enterprises should be ended and what is left of them should be fully privatized.
The next most important step is to repeal the Community Reinvestment Act and allow banks to make loan and business decisions based on an assessment of the relative risk and return, not government's social engineering goals.
The proposed government bail-out gets one thing right. It starts from the understanding that the source of the problem lies with financial institutions' portfolios of bad debt. I don't know if what they are proposing is going to be a workable solution but I do know that the government walking away from this crisis it created and letting the whole economy collapse is not the answer.
I also know that if we ride out this storm and do nothing to correct the source of the problem we will have accomplished and learned nothing.
UPDATE: I wrote above that "I don't know if what they are proposing is going to be a workable solution." Since that time I and others have had further time to look at and evaluate the current proposal. Based on that review I think the current bail-out proposal is foolish, misguided and dangerous. One need look no further than this clause to get a sense of how bad this legislation is:
“Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”
Any action of the government involving this much money requires not only review and oversight from as many sources as possible, but a that review and oversight should have a layer of review and oversight. This is not the free market we're talking about here, this is the government. The best approach is to regulate it. Regulate it. And regulate it some more.If they players on Wall Street don't get a warm fuzzy secure feeling from this and don't like the rules, then let them take their ball and go home. The rest of us will have to start a new game.
Giving the Treasury Department a check for $700 billion and free rein for what to do with it is a stupidly bad idea.
Posted by: Stephen Macklin at 05:57 PM | No Comments | Add Comment
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