This is a response to Marko's post on the Amendment 50 thread. I'm trying to avoid entirely sidetracking that discussion:
Originally Posted by marko
There is no such thing as the "free market" ... so therefore you can't blame the financial collapse on it.
Well, that opens the floodgates, but I suppose I asked for it. Thanks for the link, although I could have done without the implication that I’m perpetuating ignorant fallacies. I found your George Reisman article interesting enough to read in its entirety. However, I think his argument, and yours by extension is a bit of a straw man argument.
I don’t think we’re trying to write an article for an economic journal here. I generally try to avoid the political discussions on these forums because it’s hard to have organized discussions on complex topics in this format, but here am, so let’s give it a go. The term free market has a common meaning for most people that may differ from its strict definition in the context of macroeconomics. But also realize, I never even said that we have a “free market” economy. Do you honestly believe that I or anyone believes that we currently live in a “free market” economy as Resiman defines a laissez faire system? We talk about our system of capitalism on a scale, where on one end we have a total free market economy and on the other end we have pure socialism. It’s a small sliver of the U.S. population that would advocate for either extreme. However, there is much debate regarding where on that scale we should reside. I think one reason the term is often applied to the U.S. economy is because we tend to fall much closer to the laissez faire side than other 1st world countries.
Now, I say there are very few advocates for a true free market economy, and I believe that, but there has been an attitude, that seems to have been largely popularized by Reagan, that anything run by or regulated by the government is automatically bad. On education, such an argument would say that the reason there are problems with our educational system is because it’s run by the government and students have minimal choices about how much they pay, where they can enroll, and there are strict limits on their school’s autonomy. The solution is to disband the department of education, reduce taxes to reflect the billions of dollars in government spending, and allow the school system to be completely privatized, where anyone can go to any school, much like we are free to shop at grocery store we please (expect for effect of government subsides on corn and all that).
As surely you must know, that is an example of the common usage of the term “free market” and I’m open to suggestions on a better term that can be used to get the point across without offending economists.
The reason many people are now repudiating the idea that deregulating our financial system is always a good idea, is because we have seen a direct correlation between the current lending crisis and deregulation, lack of regulation, and lack of enforcement. I don’t pretend to understand all factors at work in our economy, and I believe our current economic woes are a result of the intersection of a multitude of complex factors, many of which I don’t understand. However, a few major culprits have emerged:
Reisman himself points out that mortgage loans packaged as securities sold on the stock market were major contributors. This was made possible largely by the Gramm-Leach-Bliley Act that further deregulated the Glass-Steagall Act, which had emerged after the Great Depression.
There was lack of regulation and enforcement in overseeing the credit rating strategies. A conflict of interest was created between the rating agencies and the banks issuing the loans. The rating agencies are paid by the banks, so when they issued a rating that was not acceptable; the bank often took their business to an agency that would offer a friendlier rating.
Credit Default Swaps were virtually unregulated and poorly understood.
Predatory lending was allowed to continue largely unchecked.
These are the types of things I was referring to in my statement. Many of these factors were preventable through SEC oversight and financial regulations, but the prevailing judgment was that the financial markets would control themselves and the government’s job was to step aside.
Anyway, back your Reisman article. One reason I found the premise interesting was because I do believe the one sensible argument people have put forth against the one I’ve made above goes something like: “The problem is not that we deregulated markets, but that we did not deregulate them enough. Our economy is already subjected to so much government regulation and interference that all we do is vainly try to balance governmental impact from multiple sides. If we were to release governmental control and create a true free market economy, then all these ills would take care of themselves based on the economic pressures of the market.” I think it’s a reasonable argument, but oh how do you prove it true or prove it false? Were we to really move to such a government, it would surely be one of the greatest economic changes and experiments in history. I’d be down with moving everyone who wants to partake to Wyoming or something and see how it works, but I don’t want to be part of the experiment.
Anyway, this seems to be largely Reisman’s argument. He outlines a number of ways that government artificially controls the market and how these interferences have lead to our current crisis. He spends a lot of time talking about policies of the Federal Reserve, over leveraged lending practices, CDOs, derivatives, and more. I found myself agreeing with most of his points. However, I think I diverge at the point where says this is proof that government intervention in our markets is the root of our problems. What he demonstrates is that many government policies have mismanaged our economy. For instance, he spends some time discussing how the Fed’s policy to drive down the federal funds rate kept interest rates artificially low and the damaging impacts of this “negative real rate of interest”. Well, even Greenspan himself admitted some, albeit qualified, culpability in the current situation due to Fed policy. I don’t think that all this proves one way or the other that government intervention in our markets is a problem or solution to a healthier, more prosperous economy. Alas, I’m not going to attempt to delve into my opinions on that.
I’d certainly be curious to hear your reflections on these thoughts.