It’s never been more important for advocates of individual liberty to emphasize that what is failing today is not the free market but the state. To claim otherwise is to ignore generations of pervasive and deep-seated privilege through government interference with the marketplace.

Intentions are irrelevant. The laws of economics proceed whether those who interfere have good motives or bad. But we should not be oblivious to the fact that most interference is not purely “public-spirited.” Rather, it’s self-serving, as power-wielding politicians hunt for votes and reward corporate and other allies.

Many of the privileges have been in the form of guarantees to institutions that lend money to homebuyers. The subprime-mortgage mess, overblown by the news media as it is, has been portrayed as the result of recklessness and predation by lenders in an unregulated marketplace. But would they have lent money to people with bad credit and no assets if they knew that they and their stockholders would have to bear the losses in full?

Such lending can only be explained by the presence of an explicit or implicit guarantee against loss. And only the government—the Federal Reserve (the government’s legal counterfeiter) in particular—is in a position to offer such a guarantee by overtly or covertly promising to come to the rescue with low interest rates or injections of liquidity. (Incidentally, about half of foreclosures involve prime, fixed-rated mortgages.)

The result this intervention is called moral hazard, a well-known phenomenon in which a guarantee against risk increases the likelihood of risky activity. Put another way, people respond to incentives. When someone else bears the losses, people act differently from how they would act if they expected to bear the losses themselves. When the market is disciplined by free competition, all incentives point in the direction of prudent risk-taking. Government intervention changes that. See the history of the S&L collapse for details.

This is key to the mortgage difficulty that has spread through the credit markets and helped bring the economy to a crawl.

Another part of the story is the government’s efforts to drastically lower the cost of buying a home. A combination of government agencies and government-sponsored enterprises (FHA, VA, Fannie Mae, Freddie Mac) made it possible for people to buy houses with little or no down payment and insured mortgages. On top of that, the federal government threatened sanctions against lenders that were reluctant to take on low-income borrowers with poor credit (“redlining”).

The result was a volume of mortgages that would be viable only as long as home values continued to increase. But despite government-fueled expectations and ill-advised policies, there was no guarantee of that. When values went south, a slew of homeowners were left with loans that were larger than the market price of their homes. The absence of equity made default an attractive option.

The government-boosted secondary market for mortgages and the emergence of mortgage-backed securities, pioneered by government-sponsored enterprises like Freddie Mac, put the volume of shaky mortgages in a position to rattle hedge funds and “too large to fail” investment banks. Now lenders are reluctant to part with their money, and the economy is in the doldrums. The Fed stands ready to help the troubled investment bankers, reinforcing moral hazard.

The consequences of government’s interference are finally clear for all to see.

This mess is largely the product of a tangled web of government policies, including land-use controls that made housing artificially expensive. The free market cannot justly be blamed because for ages there has been no free, undistorted market in housing or money. The privileges granted under political capitalism, or the corporate state, have seen to that. Yet the only “solutions” most people can imagine consist of more of the same and worse, including ex-post changes in mortgage contracts, interest-rate freezes, expanded authority for Freddie and Fannie, and wider scope for Fed bailouts of investors through loans based on bad collateral.

The table is set for the next “crisis”—which will of course be attributed to laissez faire. The fix is in.

* * *

California homeschoolers got a scare recently when an appeals court said their form of education is illegal. But almost before they could react, the court agreed to rehear the case. What’s next? Steven Greenhut reports.

If a politician wants to sound reasonable, he calls for compromise. As Gary Galles points out, some things can’t be compromised.

Land-use controls not only interfere with property rights; they also set off a never-ending competition to influence policymakers. The economic consequences, says Bruce Benson, are serious.

Freedom in particular areas of life can wax and wane. So how are we doing today? David Boaz takes an inventory.

Concern about the growth of government in America didn’t begin in the Progressive Era or during the New Deal. It was present from the start, when the Constitution’s ink was still wet on its parchment. One of the most eloquent of voices warning of imminent danger belonged to John Taylor of Caroline. Joseph Stromberg explores his constitutional philosophy.

This issue’s columnists examine some intriguing topics. Richard Ebeling looks at secession in connection with Tibet. Lawrence Reed wonders what’s wrong with private ownership of historical artifacts. Thomas Szasz debunks anti-psychiatry. Burton Folsom discusses John D. Rockefeller and his enemies. John Stossel says lobbying abuses could be stopped by shrinking the government. Walter Williams insists on distinguishing rights from wishes. And Steven Horwitz, reading a conservative argument for government intervention in the mortgage mess, replies, “It Just Ain’t So!”

Books subjected to review deal with the Constitution, Pearl Harbor, the Duke lacrosse case, and Prohibition.

—Sheldon Richman