Sunday, February 17, 2008

Neither does the Mixed Economy, Flibbert.

Today's post was inspired by Flibbertigibbet's "Socialism Doesn't Work" series. From the Randex blog today I spotted a mention of Ayn Rand by New York Governor Elliot Spitzer. In an interview given to CNBC before Spitzer testified before the House Capital Markets subcommittee on the bond insurer financial crisis, Spitzer blames the breakdown on the fact that we were "bowing down to the ideology of Ayn Rand" in decrying regulatory interference in the financial markets. His thesis is that if regulatory agencies had been allowed to act that they could have headed off the crisis that began in the sub-prime mortgage market and reflected the free market gone amok.

If someone was telling me his position in chat, this would be the place to respond with a "wtf?" Government central control or regulation of the economy does not work. It does not work in a socialist centrally planned economy as Flibbert points out and it also does not work in a Mixed Economy such as ours where there are both elements of the free market and centralized planning and regulation. What is especially pernicious in the Mixed Economy such as ours is that the free market gets the blame for economic failures when usually the culprit is government. Witness Mr. Spitzer's analysis of the financial crisis facing us today.

At a sequence of decision points, this [subprime mortgage] crisis could have been averted but the regulatory system broke down because we were bowing down to the ideology of Ayn Rand and, with all deference to Chairman Greenspan, when regulators say 'We believe in Ayn Rand; we don't want any regulatory impact,' you will have breakdowns and crises like this.

As I and others like Steve Forbes and most recently Ayn Rand Institute Director Yaron Brook in a Forbes Op-Ed have argued, the financial crisis was caused by Fed monetary policy. As Brook writes,

Now it is of course popular practice to blame economic problems, not on government intervention but on the free market. But observe that all of the most prominent problems today--problems with housing, financial markets, health care, oil--involve some of the least-free sectors of our economy, those with the most government intervention.

Consider the extent of government culpability in the current subprime meltdown. There is the Federal Reserve, which wrought havoc with the markets by manipulating interest rates, first setting them below the rate of inflation and then quintupling them.

The Fed's initial policy convinced subprime borrowers that if they took out mortgages tied to Fed rates, they could afford homes that they ordinarily couldn't. The Fed's artificially low rates fueled a borrowing spree and housing bubble that were instrumental in the subprime meltdown. Then there is the network of entities backed by the government, like Fannie Mae (nyse: FNM - news - people ) and Freddie Mac (nyse: FRE - news - people ), which were big champions of subprime lending and big propagandists for the idea that everyone needs to own a home to live the American Dream. Finally, there is the government's long-standing policy of assuring large financial institutions that they are "too big to fail," which encourages short-range, high-risk investments.

When central planning and regulation replace even portions of the free market, market forces break down, even if portions of the economy are still relatively free. In the case of the sub-prime mortgage crisis, it is the profit motive's reward of sound decision making that was subverted by the Fed's monetary policy. As Flibbert explains in the 2nd part of his Socialism Series

But the more fundamental problem is the fact that socialistic systems cannot meet even the most basic needs of its participants because failure is a critical aspect of progress.

By "failure," I mean that the old must give way to the new, the inefficient is driven to extinction by the more efficient.  When light bulbs were invented, candle makers were steadily driven out of business.

Failure, and it's brother Success are a key to a functioning free market. The market rewards Success and punishes Failure via the profit motive. Profits accrue to those who make better decisions and they flee those who make poorer decisions, and in that way the market regulates itself. Those who make poor decisions don't get to do so for long because their profits dry up. The Fed's recent weak dollar policy effectively removed the differentiation provided by the profit motive by essentially injecting liquidity into the markets, without regard for who was making better decisions than others. With all this extra liquidity, bankers went looking for ways to use it. They experimented by offering loans to riskier prospects. They experimented by monetizing those loans in the form of new bond instruments, which insurers had to then rate, but never having worked with these new instruments, the knowledge to appropriately quantify the risk they posed was absent. In a truly free market this all would have been done in successive stages by the few who proved successful at it (via the profit motive) and the risks of such new instruments would have become known over time. But in our mixed economy, the free money provided by the Fed was provided to everyone at once, and the result was an awful lot of poor decisions made.

Spitzer argues that there should have been more "cops" watching the candy store when all the "kids" were foolishly spending their money, but the reality is what does one expect when the "parent" gave everyone extra allowance without respect for who had earned it and who hadn't? When one decries the free market run amok, it must be a completely free laissez free market one is talking about, otherwise, you can bet that it's government involvement in the economy that is to blame.

1 comment:

Kendall J said...

I had some additional observations that weren't really germaine to the main thesis of the post so I'll include them in this comment.

First, you should check out the Spitzer video. His comment on Rand is in the first few minutes, and his tactics are those of the mixed economy crusader who believes that the free market is to blame for all these breakdowns. He points the finger at Washington's "cops" and unabashedly denies that his own New York state regulatory agencies did anything wrong. His playbook is borrowed however, from one Rudy Guiliani, who made his name just as Sptizer is doing now by crusading against the financial markets. In Guiliani's case it was the junk bond market and Micheal Milken who were to blame. In fact, Milken almost single handledly found a way to finance the free market consolidation that occured in the wake of Reagan deregulation. Without Milken, the 80's would not have been the boon times they were.

Second, note Spitzer's willingness to associate Greenspan with Rand. Keeping regulatory bodies at bay is all Randian ideology being implemented. Yet, Rand would never have approved of the existence of a FED managing monetary policy in the first place. No, this is Greenspan's ideology, not Rand's, but Rand is the one smeared. Had we actually been implementing Rand's ideology, none of this would have happened!