Opinion: Free Market Minute

Instability, Regulatory Style

Capitalism in the Dock

“Black September, the biggest financial shock since the Great Depression, prompted a Republican Treasury secretary and Federal Reserve chairman to devise the most muscular government intervention in the economy since the Great Depression in an effort to prevent the economic devastation of the Great Depression.” That’s the official and revered version. Recent months, however, have seen extended debates emerge over the wisdom of regulatory prescriptions for every economic dip and potential ill, and the adherents of such ideas are studiously avoiding a thorough root cause analysis. That would lead them straightforwardly back (yes) to the revival and inevitable crack-up of Keynesian ideas once again in widespread policy practice. The consequences have already been costly, and all signs indicate that they will be increasingly so.

The Federal government, the Federal Reserve and the U.S. Treasury had long been debating just how broad the new powers to regulate markets and the financial sector of the U.S. economy should be. The aim was to ‘fix’ markets in the short run as best as can be done, and to build in safeguards for the long run. An ideal solution would somehow work so as never to allow such deep, sudden financial crises to occur again. Regulatory arguments today are a replay in many ways of those that accompanied the chartering and creation of the Federal Reserve in 1913, a ‘never again’ determination.

As is often the case when trying to dissect an economic problem, we need to decide where to fix our attention. We are making decisions right now and operating in the short run. The long run, while it isn’t infinitely far off, is our planning horizon—far enough off that we recognize that pretty much anything may change by then. And we bridge that gap between the ‘now’ and ‘eventual’ by trying to make short run plans that are consistent with reaching our long run objectives. The better the match between our short-run actions and their consequences for our long run goals, the better off we are. Ideally, this is what businesses, investors and markets, and we as individuals operating within them, succeed in doing. It’s precisely the function of markets to coordinate all these plans across individuals, across space, and across time. In the extremely complex process of producing even the simplest good, when those plans mesh it’s quite amazing, and very, very cool.

Enter the big problem. No, not capitalism or ‘excessive’ greed (whatever that means).

The big problem is the future. Specifically, the big problem is that the future is uncertain. And in the current short run, we always face the immediate opportunities and risks. Is Wall Street to blame? In part, yes, certainly. Congress, the Treasury, and the Federal Reserve have been more than ready to affix the full blame there, and have moved in (and continue to do so) with regulatory big guns. A hard look at some indefensible Wall Street behavior has been warranted by regulators, but as Congress and company appear to want to turn this into a full-blown referendum on capitalism, they also need to 1) take a look in a mirror of government behavior, ethics, transparency, and 2) make sure that they have tightly defined the problem that they propose to address. Vagueness besets the current tide of ideas gushing forth from Congress, and that could mean far greater worries about any recovery on the horizon. The existing regulations that contributed to this short term crisis, including the incentives that continue to create a moral hazard in lending, are significant extra-market sources of market instability. Increasingly, official sources are beginning to feel compelled to realize this, do the math, and take note. Let’s hope they continue this necessary examination of the government’s own culpability in this end of the market and financial mess.

The debate today, from clearer heads, suggests that we may just now be catching up with some of Keynes’ radical prescriptions. Congress intends to set new parameters for the decisions of private resource owners. The real fundamentals of our economy are at stake.