Friday, 7 November 2008

Capitalism and the financial crisis

Walter E. Williams writes on Capitalism and the Financial Crisis. Williams makes an excellent point about the regulation of markets. Free markets are regulated, but not by the government, and interference with that regulation can create more problems than it can solve.
It is incorrect to say that laissez-faire or free markets are unregulated. There is ruthless regulation, but it's not by government. Take the mortgage industry. In the absence of government interference, it is unlikely that a lender would extend a mortgage to a person with a poor credit history, making no down payment, and providing no verifiable employment history. But under the pressure of the government's Community Reinvestment Act and Fannie Mae and Freddie Mac buying up or guaranteeing such mortgages, a lender will.

When businesses make unwise decisions that lead to bankruptcy, their assets are sold off to someone else who might be able to put them to wiser use. Government bailouts give businesses a reprieve that the market wouldn't give them. Bailouts have at least two effects. They permit continued unwise use of resources and it creates what economists call moral hazard, the expectation of future bailouts and others hopping on the bailout wagon.

The blame for our current financial mess rests with government, with the major player being the Federal Reserve Board keeping interest rates artificially low and the congressional and White House market interference in the name of more home ownership. In the clamor for more regulation over our financial institutions, has anybody bothered to ask whether people in government know what they're doing?
Free markets are regulated most powerfully by competition and ultimately by takeover and bankruptcy. These are much tougher regulators any any government agency. Within free markets a firm can pay the ultimate price for bad decisions but when the government interferes, that discipline is removed, and as Williams notes the result is the continued unwise use of resources and moral hazard.

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