What Happened to Market Discipline?
Government-Driven Perverse Incentives Induce Irresponsibility
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Filed Under: Give Me a Break!
Tags: bailout • Barack Obama • big business • market discipline • moral hazard • perverse incentives • political opportunism • regulation • Too Big To Fail
During the late presidential campaign Barack Obama said, “[Today’s economic problems are] a stark reminder of the failures of . . . an economic philosophy that sees any regulation at all as unwise and unnecessary.”
What? Does that mean that until last fall the Bush administration embraced the free market? Nonsense. Governments at all levels have regulated and subsidized the housing and financial industries for years. Nothing changed under President Bush.
The government-backed Fannie Mae and Freddie Mac were created precisely to interfere with the housing and mortgage markets. In effect, Freddie and Fannie diverted money to people who wouldn’t have qualified for mortgages in a real private market.
Had actual private companies performed these activities, they would have been subject to market checks. But they were not. The results were predictable.
Now that it’s all tumbling down, the politicians and pundits blame the free market.
It’s not simply misunderstanding. It’s demagoguery by people who will never admit that their “progressive” social policies have spawned a taxpayer bill that boggles the mind.
This is a story not of private enterprise but of cynical political opportunism. Moral hazard—the poisonous mix of private profits and taxpayer-covered losses—is what you get when politicians indulge their hubris to redesign society. The bailout of those companies holding bad mortgages—big-business socialism—sets us up for the next crisis.
Could we count on the Republican presidential candidate to dissent? Not a chance.
John McCain said, “We are going to fight the greed and irresponsibility on Wall Street. These actions [leading to crisis] stem from failed regulation, reckless management and a casino culture on Wall Street. . . . We need strong and effective regulation. . . .”
He proposed a new bureaucracy, the Mortgage and Financial Institutions Trust (MFI), which he said would “provide troubled institutions with an orderly process to identify bad loans, provide funding and eventually sell them at a profit. . . . The MFI will supervise the sale of loan assets at market prices and purchase them as necessary” (emphasis added).
A government agency is going to buy bad loans and make a profit selling them. Give me a break!
Perverse Incentives
Irresponsibility induced by government-created perverse incentives is the culprit. For decades politicians of both parties have relieved big companies of the responsibility that market discipline would have imposed. The promise—explicit or implicit—to bail out companies “too big to fail” weakens market discipline. That invites recklessness.
What if the government cut Freddie, Fannie, Bear, AIG, and the others loose and let them do what other businesses do in hard times: renegotiate with creditors and revalue assets? Would there have been another Great Depression? Not likely. What turned a recession into the Great Depression was the Federal Reserve’s contraction of the money supply. I doubt they’d make that mistake twice.
Public officials say the big companies must be saved to prevent a devastating credit “lock.” Really? Without a federal bailout, lending wouldn’t have resumed? The market wouldn’t have sorted it out? Prices wouldn’t have found a more solid floor? We’ll never know.
We do know that the taxpayer will buy—probably for too much money, because the private sellers will fool the government managers—at least $700 billion in “illiquid” assets. Where will this money come from: taxation, borrowing or the printing press? What will that do to our economic well-being?
Crisis is the friend of the State. The politicians are desperate to be seen as “showing leadership,” so we’re surely in for a new round of government interventions. Watch for the equivalent of the Sarbanes-Oxley Act. There’ll be much posturing about how the new regulations “will keep this from ever happening again,” but that’s more nonsense because the root problem is not lack of regulation. It’s government social engineering of the housing market, which will be unchanged.
This is the path to stagnation and poverty. As Nobel Laureate F. A. Hayek taught, markets are too complicated for planners to know enough to plan them. The relevant information, scattered unspoken among billions of market participants, is beyond the bureaucrats’ reach.
We do need protection from reckless businessmen. But there is only one way to provide that: market discipline. That means no privileges and no bailouts.
Comment by Clair Schwan of Libertarian Logic on 26 January 2009:
Hayek was right. I always laugh at politicians and even the Federal Reserve when they pretend to know how the marketplace works, and therefore know how to manage it. No one knows exactly how it works, but it does. It is self-regulating, given some time and no meddling from do-gooders in public office.
But time isn’t what Americans like to invest. We like drive-up convenience. We like huge problems solved in 30 minutes and 3 commercial breaks. We like instant everything.
The biggest problem we have is thinking that government solves problems. With rare exception, government is the source of just about every problem there is. People don’t need management, they need to be left alone.
It’s an over-simplification, but the problem is two-fold. First, we have a public that expects the nanny state to solve the problem. Second, we have politicians that don’t have the guts to say “leave it alone” and let the marketplace work out private enterprise issues.
Sadly, it’s the “I owe, I owe, so off to work I go” crowd that ends up paying for it. And, they’ll continue to pay for it as long as they are afraid of standing in the soup line because of an economic collapse.
Clair
Comment by Stephane Budge on 27 January 2009:
To expand on this thought, the socialists in the “state” play on the emotions to get what they want. For example; the American auto industry. Foreign automakers came in and made a better car that appealed more to the consumer, which hurt the big three as less and less of their cars were purchased. The socialists appealed to the heart of the American consumer by saying basically, “How could you capitalists let all of those people employed by the big three be out of work? You heartless piece of human flesh.” And we, the one’s who can see through the lie of it, not wanting to seem heartless, let the socialists take our money and give it to an industry that is sucking the life out of us.
Time to stand up for ourselves and fight back. The more we are the “bigger person”, the more rights we will lose. React for the future and not for the moment.
Comment by James Brook on 2 February 2009:
Actually, Clair, many people know exactly how free markets work. F.A. Hayek and John Stossel know. The point that they were making is that there are too many decision points for central planners to handle. “Basic Economics” by Thomas Sowell explains this very well. These decisions are concerning priority, and are reflected in the price someone is willing to pay for any given good. Supply and demand interact to determine price for a myriad of goods. Individuals decide what price they are willing to pay, and that influences how much of a given resource is devoted to making one product over another. There are too many possible decisions to make for central planners to make all of them. You are right – the market is self-regulating. This is the mechanism of that self-regulation. This applies also to mortgages. The price of a mortgage is the interest rate. The individual lender’s confidence in the reliability of the individual borrower determines that price. The Community Reinvestment Act pressured lenders to lend to riskier borrowers, taking much of their decision making ability from them, skewing that mechanism.