A few minutes ago, I came across yet another AP news item about the current financial crisis in the US. The article reports that Barack Obama “said the final product must protect U.S. taxpayers and include a commitment to new regulatory reforms.” My first thought was “hell, yeah!” there has to be some sort of regulation to prevent this nonsense from occurring again. My second thought was “surely the free market advocates are going to come out of the woodwork to criticize this.”
Now I’m going to explain the situation as I see it. I’m not an economist, mind you. So economists are likely to find this awkward.
According to the “free market” theory, markets are able to self-regulate. Business practice which produce no value cannot survive in a market because the market will not provide the means for those practices to perpetuate themselves. The current crisis can be taken as an example. The bankruptcies we are witnessing are precisely how the market is self-regulating itself. Financial institutions engaged in practices which did not produce value. It was not immediately apparent to the market that there was a problem but as soon as the problem became evident, the means of support for those practices evaporated and the market corrected itself. So far so good. The market does actually seem to regulate itself.
Yet, this does not mean that governmental regulation is not desirable. Here’s the problem. The swings of the market are affecting the lives of real people. The proponents of the free market view the processes which influence the market as if it were a pure cybernetic system. There are inputs, feedback loops and outputs and that’s all there is to it. The human factor is excluded entirely. Yes, the market will regulate itself but this regulating process is not without consequences. People lose their homes, their retirement funds, their jobs, etc. Financial rules could be established to help prevent business practices based on illusory value. They would dampen the swings so to speak.
Then there is the fact that the market as a whole is driven by decisions taken in micro-contexts. These decisions are rarely made to benefit the market as a whole. On the contrary, they are made to benefit whomever is the most powerful stakeholder in the micro-context in which the decision is made. A common example is the CEO who slashes a company’s R&D. This improves the balance sheet in the short run because a significant expense has been eliminated but it also cripples the company’s capability to compete in the future. I think the situation is similar in the case of the bad loans which were issued. Issuing those loans seemed like a good deal seen from the point of view of the micro-contexts in which those loans were issued. Nobody paid any attention to the fact that as a whole the lending practices were unsustainable.
To sum up, yes the market can regulate itself but the swings of the market are damaging to our society. It does not benefit society as a whole to let the market prop itself up by means of illusory value and then correct itself later.